The Limitations of Technical Analysis: A Personal Perspective

Technical analysis is a method where you try to predict stock prices by looking at past market data—there's a lot of back and forth about whether it works. Some investors are all for it, but honestly, plenty of folks will tell you that many of these fancy chart-reading techniques don't deliver.

Let’s go back to the basics. There are two options for technical analysis: either they work or they don't. Let’s look into them

The Two Outcomes of Technical Analysis

Let's explore the two potential outcomes of employing technical analysis:

1. The Method Fails: This is, unfortunately, the more common scenario. Technical analysis promises a certain level of predictability in an inherently unpredictable market, often leading to strategy failure.

   Highly paid traders often debate that technical analysis is a skill developed through hard work, and not everyone is cut out for it—many are not beating the market. Even they agree that most technical analysis strategies flat-out fail and that they have failed in the past. They also argue that this is partly the reason they are paid more.

   
   This notion raises a fundamental question: Can it be considered a reliable strategy for the average investor if it requires such a rare skill?

   Research suggests that about 70 to 90% of traders lose money. It is, of course, impossible to get an exact number, but as a rule of thumb, 70-90% is close to the “correct” ballpark figure. 

2. The Method Succeeds: Now, consider a scenario where technical analysis does work. Take a hypothetical stock valued at $40 that your technique identifies it and you purchase at $30. The issue here is the stock market's dynamic nature, driven by supply and demand.

The Dynamics of Supply and Demand

Purchasing the stock at $30 begins to drive the price up towards the actual value of $40. The more successful your method is, the quicker it pushes the price up*. But what happens as you approach that $40 mark? The margin for profit diminishes, especially if you're not trading with substantial capital. For individual investors with limited resources, the strategy's effectiveness decreases as the price reaches its true value of $40.

*Of course to drive up the price you have to have meaningful amounts of capital to push up the price

The Catch-22 of Successful Trading

This leads to a Catch-22 situation: the more successful the trading method, the less profitable it becomes for the individual investor. Without the kind of capital that institutions like hedge funds wield, maintaining meaningful profits becomes increasingly challenging.

Why I Favor Fundamental Analysis

Given these considerations, I am skeptical of the long-term efficacy of technical analysis. The stock market is not a static game of patterns but a dynamic arena of evolving financials. That's why I lean towards fundamental analysis—it's a method that considers a company's actual value, financial health, and market position, offering a more sound basis for investment decisions.

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