The title of this article may be somewhat active, but Forex traders need to know if their technical analysis is subjective or objective. David Aronson, the author of Evidence-Based Technical Analysis, says that there are two kinds of technical analysis, subjective and objective. Here is what he says about both:
“Objective TA methods are well-defined, repeatable procedures that issue unambiguous signals. This allows them to be implemented as computerized algorithms and backtested on historical data.
Subjective TA methods are not well-defined analysis procedures. Because of their vagueness, analysts’ private interpretations are required. This thwarts computerization, backtesting, and actual performance.”
In other words, anytime a trade signal is interpretative or leaves in question the direction of the trade, the exit, or the entry, the technical analysis is subjective, and in my words, worthless.
Many traders will argue that this is not true but take, for example, Elliot Wave Theory. This has been around for a long time and makes claims that, if true, would be the perfect way to trade. Elliot Wave Theorists, for example, don’t feel using indicators are valid methods of trading because they don’t determine the direction of a trend and how long it will last.
Assuming they are correct, the Elliot Wave Theory can be refuted by asking if it is formulated and computerized in a way that the results can be tested. So far, to my knowledge, it hasn’t. Indicators, on the other hand, can be so formulated, and therefore, the results do not have to be interpretative.
Elliot Wave Theory, along with other theories of trading, are subjective and require interpretation. Aronson goes on to say that, “… subjective TA cannot be called wrong, because to call it wrong implies it has been tested and contradicted by objective evidence. Subjective TA is immune to empirical challenge because it is untestable. Thus it is worse than wrong; it is meaningless.”
The point here is not to pummel EWT but for traders to analyze their trading systems as to whether they are objective or subjective.
The importance of an objective trading system are threefold:
1. Signals that come from an algorithmic formula are clear and concise.
2. An objective system can look at statistical data from the past and help in decision making for the future.
3. The results of an objective trading system can be recorded much like the batting averages of baseball players so that the trader knows exactly what to expect.
Regardless of what we think, technical analysis may or may not lead to reliable trading results. Price spikes created by noise from smallish price positions can move markets and create uncertainty, thereby rendering many day trading or scalping systems, including automated trading systems useless. Richard Olsen, Ltd has written about this as I have.
Bernard Mandelbrot, Professor Emeritus of Mathematical Sciences at Yale University, the inventor of fractal geometry, believes that technical analysis is financial astrology.
He may be right. If so, and if there is money to be made in the Forex market, how would we trade successfully?
There are several things the trader must do:
1. Understand price theory and how it affects the trading method that they employ. This is true of scalpers, day traders, short term traders, and long term traders. If you misunderstand price theory in conjunction with your trading method, you will not be as profitable as if you did.
2. Understand how and who trades in the currency market and how the size of currency positions can affect the currency pair you are trading in.
3. Understand when the market has the highest chance to be vulnerable. It is at these moments when you must be ready to pounce.
4. In so much as technical analysis may be a reliable source of trading, incorporate a system that is algorithmic and provides precise entry and exits. A system that can be analyzed statically to give you information about future trading and the ability to record your results.
Technical analysis may be financial astrology; however, some of the hocus pocus can be removed by making sure that the TA you are using is objective and not subjective. If it is, then use the data that can be pulled from it to help you make better trading decisions in the future. Just remember to use your mind and look for those moments where the market is vulnerable and then pounce.