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Technical Analysis of Stocks: Understand the Pros and Cons

April 26, 2022 by Daniels Trading| Tips & Strategies

In today’s equities marketplace, the technical analysis of stocks is a popular discipline. Each day, millions of market participants use tools, indicators, and price action as primary decision-making mechanisms.

Read on to learn more about the advantages and disadvantages of stock market technical analysis.

The Technical Analysis of Stocks

Technical analysis is the study of past and present price fluctuations to predict future market behavior. It is a go-to method in the forex, futures, and shares markets. Within the realm of equities, technical analysis helps market participants address volatility in shares, indices, and exchange-traded funds (ETFs) from a practical standpoint.

Of course, you should remember a few important pros and cons when using technical analysis to trade and invest in stocks:

Pros

Every type of analysis has unique advantages. The following benefits of the technical analysis of stocks are worth consideration:

Objectivity

When applying technical analysis to stock prices, it’s relatively simple to stay objective. Remember, technical analysis is the study of price action in isolation—no external factors are considered. When a trader buys or sells a stock based on technical analysis, the decision is free of nuance. Past and present price behavior dictate an action. In this way, subconscious, personal, and obscure biases are avoided.

Consistency

Technical tools and indicators are mathematically based. They are derived from price data using formulae without ambiguity. Although the actual values vary, calculations are based on a structured analytical approach.

For example, assume Trader A is a big fan of the 200-day simple moving average (SMA). Trader A can rest assured that no matter which stock the 200-day SMA is placed on, the value is derived in a standardized fashion. So Trader A’s 200-day SMA technical analysis of stocks is consistent. Regardless of the stock or price, it provides an apples-to-apples comparison of the period’s price action.

System Building

A trading system is a structured, rules-based approach to buying and selling securities. It’s a set of parameters that governs every action a trader makes in the market. The objective consistency of technical analysis makes it an ideal foundation for stock investment and trading systems.

Cons

No analytical base is free of drawbacks. Here are three downsides of technical analysis:

False Signals

The technical analysis of stocks indeed promotes consistency and objectivity, but it is also a rigid approach to trading. Regardless of the state of the market, technical indicators continue to produce data and buy-sell signals. This is what they are designed to do, but the odds of creating false signals increase during less-than-ideal trading conditions.

Hindsight Bias

Another downside to relying on technical analysis for crafting trading decisions is hindsight bias. Technical tools are frequently deemed effective or ineffective per backtested results. Unfortunately, backtesting studies often fall victim to pitfalls like data back-fitting, flawed historic data sets, and user bias. With inaccurate backtesting, an indicator may be applied improperly in the live market.

Lack of Fundamentals

Technical analysis does not account for the fundamentals local to the stock market or individual shares. Important economic releases, corporate reports, and external events are all ignored. Key fundamentals can drive long- and short-term volatility in the markets. Although the technical analysis of stocks accounts for enhanced price action, it doesn’t factor in the increased risks posed by evolving market conditions.

Interested in Becoming a Market Technician?

To become an expert in technical analysis, you have to start somewhere. StoneX’s e-book, Technical Analysis for Beginners, is a great place to begin your journey. Before you trade another share of stock, download your complimentary copy here.

Download the Technical Analysis Ebook

Filed Under: Tips & Strategies

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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