Evidence-Based Technical Analysis

This book’s central contention is that TA must evolve into a rigorous observational science if it is to deliver on its claims and remain relevant.

This book’s central contention is that TA must evolve into a rigorous observational science if it is to deliver on its claims and remain relevant. From Art to Science. Traditional technical analysis (TA) often relies on subjective interpretations and anecdotal evidence, resembling a faith-based folk art more than a rigorous science. To truly deliver on its claims of forecasting future price movements, TA must embrace the scientific method, grounded in objective observation and statistical inference. This evolution, termed evidence-based technical analysis (EBTA), charts a course between blind faith and relentless skepticism. The Scientific Method. The scientific method is the only rational way to extract useful knowledge from market data and determine which TA methods have predictive power. It involves formulating testable hypotheses, collecting objective data, and using statistical analysis to evaluate the evidence. While the scientific method doesn't guarantee success, it significantly increases the chances of extracting valuable insights from market behavior. EBTA's Goal. The goal of EBTA is to create a body of knowledge about market behavior that is as reliable as possible, given the limitations of evidence gathering and the powers of inference. This involves a continual process of testing, refining, and discarding ideas that fail to hold up under scrutiny, leading to a progressively more accurate understanding of market dynamics.

Much of popular or traditional TA stands where medicine stood before it evolved from a faith-based folk art into a practice based on science. Meaningless Claims. Subjective TA methods, characterized by their vagueness and reliance on private interpretations, fail to meet the criteria for legitimate knowledge. Because they cannot be objectively tested or refuted, claims of their effectiveness are essentially meaningless. Examples include classical chart pattern analysis, hand-drawn trend lines, and Elliott Wave Principle. The Programmability Criterion. The acid test for distinguishing an objective from a subjective method is the programmability criterion: A method is objective if and only if it can be implemented as a computer program that produces unambiguous market positions (long, short, or neutral). All methods that cannot be reduced to such a program are, by default, subjective. Faith-Based Approach. Subjective TA is akin to religion, based on faith rather than evidence. While proponents may offer cherry-picked examples of success, these anecdotes cannot compensate for the lack of objective, statistical validation. Subjective TA is not even wrong. It is worse than wrong. Statements that can be qualified as wrong (untrue) at least convey cognitive content that can be tested. The propositions of subjective TA offer no such thing.