Let’s say you had to buy or sell the MHI (mini-Hang Seng index futures), based on the following 1-minute chart. Which would you choose? Take a second or two to make your decision before reading on.
Ok, let’s conduct some analysis to find the right answer.
And because we all love indicators, we’ll place some on the chart to help guide our decision making.
The chart below clearly shows that while the session gapped up at the open it sold off strongly, developing into a downtrend. Recent price action has broken the previous swing low on increasing volume, with the MACD histogram crossing below the zero line to indicate bearish momentum.
Clearly, this is bearish, and this market is going lower. This is a SELL signal.
Or is it? What if we looked at it differently?
With a slight change of indicators (see below), the same chart shows a bullish scenario.
While there has been a downtrend in place since the open, momentum has clearly slowed. The strong break down to new lows at around 12:15 (mid chart) was not able to follow through to lower prices, indicating some buying support. The current price swing has brought us down to retest that area, with a lower tail again indicating some level of rejection of the lower prices (although we do acknowledge that the tail is small). We’re now positioned at the lower Bollinger band support with stochastics oversold and turning up. Volume increasing dramatically on increased candle range after an extended move down into support indicates a potential climactic reversal.
This is a great bullish setup, either for an immediate entry in anticipation of the level holding, or perhaps a stop entry on breakout of the candle high if you prefer confirmation. This is clearly a BUY signal!
So, which way did the market go?
While it’s not relevant to the point of the article, I know I’ll get email complaints if I just leave you hanging like this, so you’ll find the chart at the bottom of the article. Price did go up to retest the previous swing high.
So, what am I getting at here?
Your analysis, no matter how skilled, is still just your point of view. Your assessment of any directional bias, and ultimately your entry or exit decisions, are based on your mental model of the markets; your beliefs about how the markets work.
We don’t trade the markets. We trade our model of the markets. And a model, no matter how accurate, is still just an approximation of the market.
It’s just your opinion.
And you’re trading against other traders who have examined the same information as you and developed a completely opposite opinion.
It is possible to assess both a bullish and a bearish bias to any market at any time, in particular when allowing analysis over different timeframes or analysis methodologies.
Neither assessment is right. Neither is wrong. They’re just different ways of analysing the same price action. Both may profit depending on holding times, despite their completely opposite entry direction. Likewise, both may lose, once again depending on the trade exit.
It’s very important to understand this. We make our trading decisions based on our analysis; analysis which is based on an imperfect model of the markets, and carried out by an imperfect analyst, subject to numerous human performance limitations in the area of perception and memory, and subject to numerous decision making errors through the heuristics and biases that cloud our judgment.
We trade based on very flimsy evidence.
If you want to make it in this game, get rid of any thoughts that technical analysis is some form of magical predictor of future price direction. And the same goes for any other form of analysis, whether fundamental, quantitative, planetary or whatever else turns you on.
When you make your entry decision, someone else is likely making an opposite decision, based on exactly the same evidence.
This is not to say you shouldn’t use technical analysis. We have to use some means of assessing the higher probability opportunities in the market. And we should spend a significant amount of time improving our market model; understanding market context and price flow.
But when you hit that buy or sell button and enter your trade, it doesn’t matter how good your analysis was. It’s now a whole different game – trade management. Managing risk, because it’ll often be the other guy who’s right, and maximising opportunity, for those times when fortune has smiled on your analysis.
© Copyright 2009. Lance Beggs. All Rights Reserved.
Nice article! ???
But created doubt which setup to use and when.
Its breakout failure set up