I’ve always been a little skeptical about technical trading. One of the things that I find hard to buy is the notion that ‘risk’ can be measured purely by the standard deviation of the price of the stock. Surely this only measures how ‘volatile’ a stock is, but it is different from the notion of ‘risk’? Because a stock is risky if it goes in the opposite direction than the position you took and you lose capital, not that its price action may be a bit more neurotic.
And then there’s this other notion that I find hard to accept, which is that you are able to predict, or find patterns in, price movements purely based on price and volume action.
Price, to me, are the outcome variables. The economic world consists of infinite number of independent variables, the combined sum of which, gives the price. If you are saying that price itself can be used to predict price, then in your model of things, price becomes the independent variable. What kind of explanatory power does a model have when you’re using the outputs to predict outputs? I don’t really understand.
But to proponents of technical analysis, this is precisely what they’re suggesting. Their departure point seems to be that they don’t care about the million variables in the ‘real world’ - price itself is a good encapsulation of all the sum total of demand and supply. Moreover, they don’t try to make a claim on the relationship between those hidden variables and the price at all. Instead, they see that prices are a result of certain hidden behaviors. These behaviors are internal to price action itself, and they can be surprisingly persistent across different types of instruments. These behaviors create waves - and a good technical trader, will be able to identify these behaviors, and are able to ride these waves for profit.
Now, these behaviors are not always present in a certain instrument, and like waves, they’re always shifting. But if you identify a place where there’s good odds of a a behavior being present, then making bets in those places will be a profitable thing for you to do.
I want to believe this thesis - but so far, I really have not seen anything that tells me that there is a generalizable behavior present in the price action themselves.
But then again, all I’ve tested is the long-short SMA thesis against AAPL stock - perhaps I need to backtest a whole bunch of different behavior types to see whether opportunities exist before I jump to conclusions.
My mind is not made up yet.