Technological advancement over the years has led more and more people to enter into trading in the stock market. With the idea of making a quick buck, individuals get into trades by using technical analysis. But individuals should understand that there can be limitations of technical analysis when used in trading.
In this article, we will be discussing the limitations of technical analysis.
What is technical analysis?
Before jumping into the limitations of technical analysis, let us first understand what technical analysis means
Technical Analysis is a method of forecasting future prices of securities based on information available to us in hand. It uses support and resistance, Demand & Supply of the security, candlestick patterns, chart patterns and different indicators in order to predict the future price of the securities.
Basic assumptions of Technical Analysis
Following are the basic assumptions of technical analysis:
- Market discounts for everything: Technical analysis makes the assumption that everything that has or affects the company will be reflected in the price of the share at any given time.
- Price moves in a trend: Another assumption of technical analysis is that the future price is likely to move in a trend that has been established rather than move against it.
- History tends to repeat itself: Technical analysis assumes that price patterns of shares tend to be repetitive which can be used to generate buy or sell signals.
Limitations of Technical Analysis
Following are the limitations of technical analysis:
- Possibility of giving false signal:
Though technical analysis is based on various mathematical and logical factors, they may give signals which are opposite to the market. While technical analysis may tell you market may move upwards, the markets can go downwards and vice versa.
- Analysts bias:
There is no hardcore method one has to follow while doing technical analysis. Due to this, the analysis will be based on the personal bias of the individual. If an individual is bullish in nature, then the bullish bias will overshadow the analysis and vice versa.
- Open to interpretation:
Since there are different methods of analyzing data in technical analysis, it is always open to interpretation. Two individuals can look at the same charts and see two different patterns, both of which can have logical support and resistance levels that justify the positions.
- Ignores Fundamentals
Technical analysis excludes important elements like corporate reports, economic releases, and outside events that have an impact on the share price of the company because it is based on mathematically based market data.
- Technical analysis can be too late:
A share can have a substantial move already taken place by the time the trend is identified using technical analysis. Since the share has already made a large move, the risk-to-reward ratio for the individuals will be less.
In this article, we covered what is technical analysis, the assumptions of technical analysis and the limitations of technical analysis.
Though technical analysis has its own set of limitations, it can be greatly beneficial to individuals if it is used correctly and they can earn good returns by using it. Rather than avoiding trading because of the limitations of technical analysis, individuals can inculcate stop loss and targets while trading. This can help them limit their losses in case incorrect analysis and also help them maintain discipline in the market.
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