Читать книгу The Handbook of Technical Analysis + Test Bank - Lim Mark Andrew - Страница 15

As with most forms of analysis, technical analysis has both objective and subjective aspects associated with its application. It is objective insofar as the charts represent a historical record of price and market action. But it is subjective when the technical analyst attempts to analyze the data.

Analyzing price and market action consists of three main activities, namely:

1. Identifying price and indicator patterns

2. Interpreting the data

3. Inferring potential future price behavior

Analyzing price and market action is ultimately subjective because all analysis is interpreted through various behavioral traits, filters, and biases unique to each analyst or observer. Behavioral traits include both the psychological and emotional elements. As a consequence, each analyst will possess a slightly different perception of the market and its possible future behavior.

Subjectivity in the Choice of Analysis and Technical Studies

The sheer number of ways to analyze an individual chart contributes to the overall level of subjectivity associated with each forecast. The problem is twofold:

• What is the most appropriate form of technical analysis that should be applied to a particular chart?

• What is the most appropriate choice of indicators to apply to a particular chart?

These are the usual questions that plague novices. The following charts depict the various popular forms of analysis that can be applied to a basic chart of price action. The following examples are by no means exhaustive. Figure 1.9 starts off with a plain chart devoid of any form of analysis.

Figure 1.9 A Simple Price Chart.

Source: MetaTrader 4

The next chart, Figure 1.10, shows the application of basic trendline analysis on the same chart, tracking the flow of price action in the market.

Figure 1.10 Trendline Analysis on the Same Chart.

Source: MetaTrader 4

In Figure 1.11, moving average analysis is now employed to track the same flow of price action and to provide potential points of entry as the market rises and falls.

Figure 1.11 Moving Average Analysis on the Same Chart.

Source: MetaTrader 4

Figure 1.12 depicts the application of chart pattern analysis to track and forecast the shorter-term bullish and bearish movements in price.

Figure 1.12 Chart Pattern Analysis on the Same Chart.

Source: MetaTrader 4

Figure 1.13 is an example of applying two forms of technical analysis, that is, linear regression analysis and divergence analysis to track and forecast potential market tops and bottoms. Notice that the market top coincided perfectly with the upper band of the linear regression line, with an early bearish signal seen in the form of standard bearish divergence on the commodity channel index (CCI) indicator.

Figure 1.13 Linear Regression and Divergence Analysis on the Same Chart.

Source: MetaTrader 4

Figure 1.14 is an example of applying a couple of additional forms of analysis to the basic linear regression band. In this chart, price action analysis is used in conjunction with volume analysis to forecast a potential top in the market, evidenced by the preceding parabolic move in price that is coupled by a blow-off.

Figure 1.14 Linear Regression and Volume Analysis on the Same Chart.

Source: MetaTrader 4

In Figure 1.15, volatility band, volume, and overextension analysis are all employed to seek out potential reversals in the market. We observe that price exceeds the upper volatility band, which may potentially be an early indication of price exhaustion, especially since it is accompanied by a significant volume spike. The moving average convergence-divergence (MACD) indicator is also seen to be residing at historically overbought levels, which is another potentially bearish indication.

Figure 1.15 Volatility Band, Volume, and Overextension Analysis on the Same Chart.

Source: MetaTrader 4

As we can see from just a few forms of analysis presented in the preceding charts, there are many ways to view the action of the markets, depending on the context of the analysis employed. For example, if the analyst is more interested in viewing and understanding the action of price within the context of over-reaction or price exhaustion in the markets, he or she may opt to apply technical studies that track levels or areas of potential over-reaction or price exhaustion. Technical studies that tract such behavior include linear regression bands, Bollinger bands, moving average percentage bands, Keltner and Starc bands, areas of prior support and resistance, and so on. Alternatively, if the analyst is more interested in viewing and understanding the action of price within the context of market momentum, he or she may instead opt to apply breakout analysis of chart patterns, trendlines, moving averages, and so on. As long as the reason for using a particular form of analysis is clear, there should be no confusion as to what the studies are indicating.

Contradictory, Confirmatory, and Complementary Signals

There are many instances when two oscillator signals are in clear and direct opposition with each other. This is inevitable, as each oscillator is constructed differently. The mathematics underlying each oscillator varies with the purpose it is designed for, and in most cases, it involves the manipulation of price, volume, and open interest data. A few reasons for conflicting oscillator and indicator signals are:

• The mathematical construction of each oscillator or indicator is different.

• Each oscillator or indicator tracks a different time horizon.

• Two identical oscillators may issue inconsistent readings due to missing data on one of the charting platforms.

• Two identical oscillators may also issue inconsistent readings due to variations in the accuracy, quality, and type of data available on different charting platforms.

For example, applying an oscillator that uses price, volume, and open interest as part of its calculation will yield inconsistent readings should one of the data be unavailable on the charting platform. The analysts may not be aware of the missing data and struggle to make sense of the inconsistency. The accuracy of the data is also of paramount importance for effective analysis of price and market action. Dropouts in the data as well as the inclusion or exclusion of non-trading days will cause inconsistent readings between charting platforms. There may also be variations in the oscillator readings should volume be replaced with tick volume, sometime also referred to as transaction volume. Tick volume tracks the number of transactions over a specified time interval, irrespective of the size of the transactions.

It is also important to note that conflicting signals may not always be in fact conflicting. As pointed out, the time horizons over which each signal is applied may be different. In Figure 1.16 we observe that the CCI readings over the range of prices are markedly different. The 20-period CCI indicates a slightly overbought market whereas the 100-period CCI suggests that prices are slightly oversold. There is in fact no real conflict between the two apparently opposing signals. The indicators are merely pointing out that prices are slightly overbought or overextended in the short term, but over the longer term, prices are in fact slightly oversold, that is, relatively cheap. Therefore, instead of viewing the signals as opposing or contradictory, the astute trader immediately realizes that the most advantageous point for initiating a long entry would be when prices are cheap both in the long and short term. This is easily identified on the charts by looking for oversold readings on both the 20- and 100-period CCI within the area of consolidation, as indicated at Point 1. Therefore, the trader may decide to go long once price penetrates the high of the candlestick indicated on the chart. In this example, we see conflicting signals actually complementing each other and affording the trader an advantageous entry at relatively low prices.

Figure 1.16 Conflicting Signals on the Daily Alcoa Inc Chart.

Courtesy of Stockcharts.com

The important point to remember is that any form of analysis may be employed, as long as the analyst is intimately familiar with the peculiarities associated with each form of analysis. It is better to be conversant with one form of analysis than to employ a slew of technical approaches without fully grasping the intricacies of each approach. This leads to confusion and ineffective analysis. It must be noted that combining technical studies will frequently result in both confirmatory and contradictory signals as we have seen, with many of the signals being also complementary as well. Only add studies once the first form of analysis is fully mastered. The practitioner must always remember that no form of analysis is always perfectly representative of the market, and it is inevitable that different forms of analysis will many times lead to conflicting signals.

Subjectivity in Pattern Identification

As mentioned, interpretation and inference of potential future price action based on historical price behavior is essentially an exercise in subjectivity. Each analyst will interpret and infer future price action according to his or her own experience, knowledge, objectives, beliefs, expectations, predilections, emotional makeup, psychological biases, and interests.

The identification of price patterns may also present some challenge to the novice practitioner. Occasionally, the markets will conveniently trace out various price patterns that may cause some confusion. Refer to Figure 1.17.

Figure 1.17 Conflicting Chart Pattern Signals.

In this example, we see two chart patterns indicating potentially contradictory signals. The ascending triangle is regarded as a bullish indication, while the complex head and shoulders formation is potentially bearish. Therefore, as price starts to contract, forming a symmetrical triangle, an analyst may be somewhat perplexed at the conflicting signals, being unable to provide or issue a clear forecast as to whether the market is indeed potentially bullish or bearish.

One way to resolve this apparent conflict is to first identify the size of each pattern. The sentiment associated with larger patterns or formations will take precedence over that of smaller formations. These larger formations are more representative of the longer-term sentiment whereas the smaller formations are more indicative of short-term sentiment. Hence in our example, the bullish sentiment associated with the ascending triangle takes precedence over the bearish sentiment associated with the complex head and shoulders formation. Therefore, until price breaches the complex head and shoulders neckline, the entire formation may be regarded as a potentially bullish pattern. Following this simple rule helps reduce some of the subjectivity involved in reading price and chart formations.

Figure 1.18 depicts an idealized scenario where all the chart formations are potentially bearish.

Figure 1.18 Chart Pattern with Complementary Signals.

There is no conflict in sentiment between these formations as they are all in perfect agreement. The smaller formations act as additional evidence and add to the overall bearish sentiment. There is also a lesser amount of subjectivity involved when reading the sentiment associated with formations that are in perfect agreement. Nevertheless, it should be noted that although such formations may appear somewhat more straightforward with respect to inferring potential future price direction, any upside breakout of the larger descending triangle may well precipitate a vigorous and rapid rally in prices due to the unexpected nature of such a move. Traders must exercise caution especially when shorting such a formation as prices can quickly explode to the upside, caused by an avalanche of short covering.

Interpretational and Inferential Subjectivity

This element of subjectivity with respect to interpretation and inference is not merely confined to applications in technical analysis. In fact, every form of analysis involves a certain amount of subjectivity and arbitrariness when it comes to its interpretation. For example, let us assume that the price of oil has risen significantly. This event in itself can be interpreted in two different ways. One fundamentalist may strongly believe that this rise in oil prices will impact the markets adversely as it will raise the underlying cost of commodities, whereas another fundamentalist may strongly believe that the rise in oil prices is a direct result of market demand, a bullish scenario indicating a healthy and growing economy. In another example, a technical analyst may strongly believe that an overbought oscillator reading is a clear indication that the trend is strong with further continuation expected in price, whereas another technical analyst may strongly believe that the overbought signal is a clear indication that the market may be already overextended and therefore expects a reversal in trend. The beginner quickly realizes, after some reflection, that for every bullish interpretation, there exists an equal and opposite bearish interpretation. This is one of the main reasons why forecasting is regarded as largely subjective.

Subjectivity and Selective Perception

Human bias is another factor that adds to the degree of subjectivity when attempting to interpret technical signals. Chartists will many times ignore signals that conflict with their preconceived ideas of where the markets ought to be at any one time. They only select oscillators and indicator signals that support their analysis of the market. For example, a chartist uses three oscillators, the MACD, relative strength index (RSI), and stochastics. The chartist has a bullish view of the markets and believes that it is about to break to the upside. All of the oscillators have bullish readings except for stochastics. The chartist ignores the stochastics signal because it does not agree with his or her view of the markets. On a subsequent occasion, it is MACD that is not in agreement with the chartist’s view, and only the signals from the other two oscillators are heeded. This is known as selective perception. See Figure 1.19.

Figure 1.19 Selective Perception and Conflicting Oscillator Signals.

Selective perception adds to the subjectivity of the forecast, as there is no fixed point of reference or basis for making decisions based on evidence. Choosing only signals that agree with one’s view will lead to biased and erroneous interpretations and unfounded forecasts. In fact, it is when there are discrepancies in the signals that the chartist gains the most information from the markets, as it may be an indication that there could well be some form of underlying weakness in the markets.

Subjectivity in Determining an Event: The Point of Entry

Identifying, interpreting, and inferring market action are not the only areas where subjectivity plays a significant role. The determination of the exact points of entry to and exit from the market is also subjective at the most fundamental level of observation. What appears to be essentially objective is also built on a foundation of subjectivity. An example will help illustrate the point. Refer to Figure 1.20.

Figure 1.20 Example of Subjective Objectivity.

Assume that a chartist is interested in identifying a market top via a trendline penetration. The chartist locates two significant troughs in an existing uptrend and draws a line connecting the two troughs, projecting that line into the future. Price eventually makes a top in the market and subsequently declines and penetrates the uptrend line, signifying the formation of a market top. This seems to be a totally objective exercise since the uptrend line and the point of penetration were clearly marked and recorded on the charts. Unfortunately, the objectivity ends here. Although each act of identifying the trend reversal was purely objective, the variables upon which the process of identification is based is determined subjectively by each chartist, according to their goals, biases, experience, and preferences. Another chartist could well have drawn a steeper trendline and declared that the penetration of this new trendline marks the true point of reversal in the market. As you can see, although each act of identifying the exact point of reversal is strictly objective in itself, the existence of alternative trendlines introduces an element of subjectivity as to which trendline penetration is the definitive indicator or signifier of the trend reversal. We can find another example of this subjective objectivity. Automated or program trading is usually regarded as a purely objective mode of trading where all the rules of engagement with the market are fully codified and mechanically executed. This removes all subjectivity with respect to the entries and exits. Just as in our previous example, the point of penetration of each trendline was also purely objective. However, should the automated trading software allow for some parameter adjustments, this instantly introduces an element of subjectivity as to which parameter adjustments are the definitive settings for a profitable trading campaign. Therefore, no matter how objective each individual act is, once the possibility of alternative acts exists, the issue of subjectivity arises. In a sense, each determination is individually objective, but collectively subjective.

The very act of determining the exact entry point to initiate a trade is somewhat subjective. Let us assume that a trader is interested in initiating an entry at the break of an uptrend line. Price initially fails to exceed a previous peak, which is a bearish indication. Price subsequently declines and breaches the uptrend line, and in the process triggers a trade. Some questions that a trader may now ask are:

• At which point after the breakout do I initiate an entry into the market?

• What is a reasonable amount of price penetration required before an entry is initiated?

• Do I wait for the penetration bar to close first or do I initiate an entry at some arbitrary point during an intraday violation of the trendline?

• What if the penetration bar closes too far away from the original trendline breach?

• How would I know if the violation is merely a false breakout?

• Should I allow for a larger penetration before initiating an entry in order to filter out potential false breakouts? If so, how much larger a penetration is required to filter out such breakouts?

The answers to all of these questions really depend on the objectives of the trader and what he or she is attempting to achieve. There are essentially two ways of initiating an entry at the breakout of some price barrier. The first is to initiate an entry at some arbitrary point just after a breakout. The other is to initiate a trade based on some fixed rules of entry and exits. See Figure 1.21.

Figure 1.21 Subjectivity in the Rules of Engagement.

Subjectivity arises not because the rules of engagement are unclear, but rather because of the number of choices available. Hence, each trader will select the rules of entry and exit that suit their personality, risk capacity, or familiarity with a certain mode of engagement. A trader could initiate a trade once price moves a certain distance away from the breakout, or once the penetration bar closes. Traders may even choose to enter the market after a certain amount of time has elapsed from a breakout. Figure 1.21 lists three main types of filters that traders frequently use to initiate an entry. Price, time, and algorithmic filters will be discussed in more detail in Chapter 5.

Summarizing, even if the rules for identification, interpretation, and inference are rigidly codified, the very fact that we have choice renders the entire analysis subjective from the ground up. Hence the argument that technical analysis is subjective in fact represents a general comment on all forms of analysis. It is not unique to technical analysis!

Here is a little exercise in subjectivity associated with pattern recognition. See Figure 1.22. Without looking at Figure 1.23, try to see if you can figure out the trend changes by drawing simple trendlines. After you have finished, refer to Figure 1.23 to see if you have drawn the same trendlines as indicated on the chart.

Figure 1.22 A Basic 4-Hourly Bar Chart of USDCAD.

Source: MetaTrader 4

Figure 1.23 Trendline Analysis on the 4-Hourly USDCAD Bar Chart.

Source: MetaTrader 4

There will most likely be a difference in the points chosen in drawing the trendlines. The very fact that you can draw alternate trendlines introduces an element of subjectivity in identification, interpretation, and forecasting.

Now go back to Figure 1.22 and try to identify some chart patterns (if you know some). After you have finished, turn to Figure 1.24 to see if you have drawn the same patterns.

Figure 1.24 Chart Pattern Analysis on the 4-Hourly USDCAD Bar Chart.

Source: MetaTrader 4

Were there differences in the chart patterns drawn? Do not worry if there are differences. It is merely a consequence of subjectivity.

Subjectivity in Pattern Recognition Diminishes with Practice

Here is another example based on the same USDCAD chart. Were you aware of the subtle angular symmetries in the USDCAD? See Figure 1.25. Analysts also pay attention to the angles of ascent and descent in the markets. A novice may not be able to clearly identify chart patterns, trendlines, or angular patterns at the very beginning. But with enough practice, the pattern-recognition abilities will gradually improve, becoming more obvious as the skill in reading charts improves. As a consequence, the amount of subjectivity associated with identifying patterns will gradually diminish.

Figure 1.25 Angular Symmetries on the 4-Hourly USDCAD Bar Chart.

Source: MetaTrader 4

Refer to Figure 1.26. Here is the same chart of the USDCAD again. But this time, we see the underlying beauty and symmetry of price, tempered and forged by the expectation, psychology, biases, and emotions of all market participants. To a trained eye, a simple chart of price action is as beautiful as any work of art. For technical analysis is, in itself, an art.

Figure 1.26 Underlying Market Symmetry on the 4-Hourly USDCAD Bar Chart.

Source: MetaTrader 4