Challenges of Technical Analysis

Those who doubt the value of technical analysis for

investment decisions question the usefulness of this
technique in two areas.
•Firstly, they challenge some of its basic assumptions.
•Secondly, they challenges some specific trading rules
and their long-run usefulness. In this connection, we
consider these challenges.
 Challenges to the assumptions
Technical Analysis
• The major challenge to technical analysis is based on the
empirical test of the efficient market hypothesis (EMH).
Technical trading rules to generate superior risk adjusted
returns after taking account of transaction cost, the
market would have to slow to adjust prices to the arrival
of new information. The two sets of test of the weak form
are, 1) the statistical analysis of price to determine if price
moved in trends or were a random walk, and 2)the
analysis of specific trading rules to determine if their use
could beat a buy and hold policy after considering
transaction costs and risk.
• Regarding the analysis of specific trading, the vast
majority of the results for the trading rules that have been
tasted support the EMH.
 Challenges to technical trading rules
• An obvious challenge to technical analysis is that the past price
patterns or relationships between specific market variables and
stock prices may be repeated. As a result, a technique that previous
worked might miss subsequent market turns. For example, assume
that many analyst expect a stock selling at $40 a share to go to $50
or more if it should rise above its current pattern and break through
its channel at $45.as soon as it reaches $45, enough techniques will
buy to case the price to rise to 50, exactly as predicted. In fact,
some techniques may place a limit order to buy the stock at such a
breakout point.
• Finally it implies that the use of various techniques is neither
completely mechanical nor obvious. We will discuss in connection
with several trading rules, the standard values that signal
investment decisions can change over time.