Applying a technical analysis approach to trading and investing has many benefits but also some limitations.
New traders should be aware of both the advantages and disadvantages before attempting to read price charts through technical analysis and applying it to a trading or investing strategy.
Benefits Of Technical Analysis
There are many benefits for using technical analysis to help analyze price charts of various markets.
The main benefits of using technical analysis include:
- It helps provide entry and exit trading and investing signals
- It helps traders analyze the market conditions better
- It can be used to indicate potential price reversals
- It can easily be applied to any financial market on any timeframe
- It can signal large price moves
- It can be learned relatively quickly
- It can be used when building a trading algorithm or trading strategy
These benefits make using technical analysis a useful tool to guide traders and investors in finding trading and investing opportunities.
Technical Analysis Can Help Provide Buying And Shorting Trading And Investing Signals
Technical analysis measures historical price data and can assist in finding new buying opportunities that set up in the various markets.
Technical trading indicators and chart patterns regularly alert new buying and shorting signals.
Many successful traders utilize technical analysis to buy and sell.
For example, the winner of the investing championship every year is won by a trader or investor that uses technical analysis to make buying and selling decisions (1).
These traders achieve these performances by using technical analysis as a method for analyzing markets.
Technical Analysis Can Help Traders Analyze The Market Conditions Better
Another benefit of technical analysis is it can help traders and investors figure out the market sentiment and market conditions.
Knowing when a market is more risky and volatile is crucial for any aspiring trader or investor and technical analysis is a method traders use to figure this out.
In this context, technical analysis can help protect a trader against a potential increased price volatility and bigger capital drawdowns.
Technical Analysis Can Assist In Spotting Price Reversals
Technical analysis can help a trader find areas of interest on a price chart where prices tend to reverse from.
Trend lines, reversal chart patterns and technical indicators after methods used within technical analysis to spot these areas where prices may reverse from.
As a result of using technical analysis, traders will be able to know where they should set targets for taking profits, place stop losses or enter trades at these price inflection points.
Technical Analysis Can Be Applied To Any Financial Market On Any Timeframe
Another advantage of technical analysis is that it can be applied in any market or trading instrument from stocks, currencies, indices, futures, commodities and cryptocurrencies.
It can also be applied to any timeframe of trading or investing from extreme short term to much longer term.
One research study from the Expert Systems With Applications Journal found that using a specific chart pattern technical analysis trading strategy intraday resulted in consistently profitable trading results (2).
Another study from the Financial Innovation Journal found that applying a longer term moving average technical trading strategy was profitable in certain stock markets of BRICS member nations (3).
These studies show that technical analysis can easily be applied to both short term and longer term trading and investing and that technical analysis can also be applied to markets in any country from the Dow Jones to the Nikkei.
This means technical analysis is useful in helping traders read any market and it isn’t restricted to one market or one country.
Technical Analysis Can Help Traders Find Find Potential Large Price Moves
A benefit of technical analysis is it can signal potential large breakout price moves in any market.
Most top traders attempt to find these potential technical breakouts in a market and technical analysis helps them to spot these patterns.
Chart pattern recognition is the most common way of finding markets and price charts with potential breakouts.
Technical analysis can be a useful tool to find potential 50 – 100% + price movements as evidenced by results from top traders that utilize technical strategies.
Technical Analysis Is Not Difficult To Learn
Unlike fundamental analysis that has many components like economics, finance, accounting etc., technical analysis has three main components, mainly technical indicators, chart patterns and trendlines.
As a result, new traders tend to find learning technical analysis much easier than fundamental analysis.
Also, as technical analysis is a more visual method of analyzing markets, it makes it easier for people to learn it too.
Technical Analysis Can Be Used When Building A Trading Algorithm Or Trading Strategy
Another major benefit of technical analysis is that it can be used when developing a technical trading strategy or building a trading algorithm.
Technical analysis indicators, chart patterns and trendlines can all be included in a trading strategy or can be programmed into a trading algorithm.
This is a great reason as to why it is so beneficial to know technical analysis.
Limitations Of Technical Analysis
There are also a number of limitations and disadvantages when using technical analysis that new traders and investors should be aware of.
The limitations of technical analysis are:
- It is not always accurate
- It can sometimes cause traders to overtrade
- It can have a low win rate when applying it
These are the main limitations with technical analysis that traders and investors should be aware of.
Technical Analysis Is Not Always Accurate
A limitation that new traders are not usually aware of is that technical analysis is not always accurate when trying to predict future price movements.
This means the indicators can erroneously offer potential buying and selling signals which cause losing trades.
No technical indicator is 100% accurate but some specific technical analysis indicators can be extremely inaccurate and need to be avoided.
Technical Analysis Sometimes Causes Overtrading
Technical analysis can sometimes offer too many trading signals, especially on shorter timeframe price charts.
Trading indicators like the MACD or RSI, when used on shorter timeframes, regularly offer buying and shorting alerts.
Newer traders tend to follow all the signals these indicators alert which can result in overtrading.
Generally, the shorter timeframes charts are the most problematic for technical indicators and should not be used without fully understanding the limitations of each indicator.
Technical Analysis Can Result In Traders Having A Low Win Rate
Technical analysis can result in traders having a low win rate. This is not a problem if the risk versus reward for a trade is good.
However, if a trader has a low risk versus reward, then a higher win rate is needed.
Technical analysis indicators and chart patterns can routinely have as low as a 20% win rate in some scenarios.
This can be a limitation to traders that seek higher win rates.