TL;DR – It looks like technical analysis doesn’t stand up to scientific scrutiny in any study I could find which took steps to filter out the effects of self fulfilling prophecy. I, personally, am choosing not to engage in it any further.
I was starting to learn technical analysis. However, I wasn’t getting any good results when backtesting (after I caught myself and took steps to stop myself from exerting my own confirmation bias on my tests). So I decided to try to dig into the science behind it to see if spending any further time studying it would be worth it.
I’m being careful here not to cherry pick data. The reason I’m focusing on the articles I’ve linked is because they are the ones that bothered to take into account and take steps to eliminate results skewed by self fulfilling prophecies and confirmation bias. Aside from the last one which I included because it was the most comprehensive one I could find.
I wanted to know if technical analysis actually works. I didn’t want anecdotal evidence. I wanted scientific evidence.
This is what I found.
This first bit of research is by far the easiest to understand as it isn’t written in scientific jargon. It’s not quite as scientific as the others and was done by one person who had the same questions I did.
They tested MACD, RSI, Bollinger Bands and Stochastic Oscillator.
They found that for all asset classes, with the exception of one, technical analysis had zero alpha. (No gains)
They were tested standalone and in combination with other indicators.
The only exception they found was Bitcoin, but they also threw in the side note that Bitcoin is primarily a retail driven asset and as retail investors believe in technical analysis it’s more likely that the combined buys and sells due to the belief in the indicators were causing the indicators to work and not the other way around.
However they did point out that, seemingly ironically, reversing filtered indicators had some slight positive alpha for non Bitcoin asset types.
They did mention they would have to test a much larger sample set to see if the Bitcoin alpha or the indicator reversal alpha with other asset classes would hold up.
But the correlation for other asset classes was so slight they acknowledged it wouldn’t be profitable.
Let’s look at another study. Now we’re getting really scientific and busting out mathematical equations with symbols that most of us can’t even read.
They tested out some popular candlestick patterns on a market in Thailand over a 100 year period (they picked Thailand emerging markets to avoid the issue of data snooping). They tested the candlesticks along with Stochastics, RSI and MFI. They tested a number of different holding periods as well.
They found that the candlestick patterns were not statistically significant and would not result in positive returns even when combined with other indicators.
Let’s look at yet another study. This one contains a bit of a case study but they do their own work to draw their own conclusions.
This one is the only one that focused at all on resistance. They basically determine that the probability of bouncing correlates with the growth of the investors trust on following bounces. Essentially, it is a self fulfilling prophecy and the resistance lines only form because of the investors growing trust in the probability of a bounce.
The following is this real gem here.
It’s really long. It’s really comprehensive. Though the authors do note their own results are inconclusive and this is more of a discussion starter. They did find a few actual positive correlations between certain samples, however they also did note that they were only reproducible during certain time spans.
I will wager my own best guess that the historical time spans where they did work were most likely the time spans where those methods were most frequently being used in those markets and could potentially be explained away as self fulfilling prophecies since as far as I could tell this is the one study I listed where they didn’t necessarily use criteria that would exclude that bias from the results.
What will I gain from the hours of reading I just did on these topics? I will conclude that technical analysis is not something which I will personally put any more time into learning. I think any of the proven correlations which I could find were not significant enough to result in gains, especially after taking slippage and brokerage fees into account. Furthermore, the methods which did have a positive correlation only seemed to be effective during certain historical times or in domains ruled by retail traders due to the self fulfilling prophecy.
In addition, quite a bit of information in some of these studies showed that all of those indicators were outperformed by simple buy and hold strategies.
I’m sure that more than a few people will disagree with me here. But these are my own conclusions. Take from it what you will.