Among traders, whether they dabble in Chinese assets or anything else that can be charted (with “charted” being the operative word), there are individuals who use technical analysis to varying degrees. From traders who let’s say include technical analysis in their arsenal as yet another tool to market participants who swear by technical analysis to such a degree that it ends up representing the only aspect they base their decisions on: no news, no fundamental analysis… just technical analysis exclusively.
As can be seen, approaches are all over the place, but what is technical analysis in the first place?
Broadly speaking, think of technical analysis as chart analysis, or in other words letting price action do the talking so as to:
- Identify trends in order to either trade with them or act as a contrarian
- Identify patterns that are bullish (ascending triangles, inverse head and shoulders, etc.) or bearish (descending triangle, head and shoulders, etc.)
- Eliminate bias and more or less hidden agendas from the equation compared to let’s say methods such as news-oriented trading
… the list could go on and on.
In and of itself, there is absolutely nothing wrong with technical analysis, nor is it a mistake to use technical analysis when trading Chinese assets, as long as… and this tends to be the elephant in the room… you understand what technical analysis can tell you and especially what it cannot.
We would like to make it crystal clear that the ChinaFund.com team does not believe the future can be predicted. Neither through technical analysis, nor through fundamental analysis, following the news or reading tea leaves. Therefore, any strategy that revolves around technical analysis essentially using the past (past price action) to predict the future is flawed right from the beginning.
Why, then do some traders swear by certain patterns?
It is indeed true that in some cases, a lot of back testing has been performed so as to draw conclusions related to one pattern or another. For example, perhaps a certain trader has noticed that whenever a so-called descending triangle forms (as the name suggests, a descending triangle has a base that acts as support for an extended period of time and a series of lower highs which act as descending resistance), prices have the tendency of going down more frequently than up. As such, the trader in question concludes that descending triangles have a greater than 50% probability of leading to downward price action.
“Probability” is the operative word.
There is nothing wrong with using technical analysis as long as you understand that, at best, it provides insights related to probabilities and most definitely not certainties (predicting the future). Viewed from that angle, technical analysis seems downright logical. Of course a descending triangle tends to be rather bearish in nature in light of the fact that bulls only manage to create lower and lower highs when pushing the price up, whereas bears keep managing to successfully bring prices to the horizontal support level.
Descriptive rather than predictive, to put it differently.
And, indeed, technical analysis is quite useful when viewed through that lens because it enables price action to do all of the talking and tell you the story of a (Chinese) asset at one point in time without bells and whistle… less noise, so to speak.
Less, but not “no” noise, mind you.
While charts do not let’s say lie like your friendly neighborhood financial media pundit does, they can be manipulated by deep-pocketed investors such as whales, who use the impressive capital they have at their disposal to paint the proverbial tape, making the chart seem bullish so as to incite FOMO buying or bearish so as to trigger panic selling.
Can this continue indefinitely? No.
Can this be an effective short-term strategy? Most definitely.
The nuance here is that for better or worse, one can expect charts to provide a better noise to information ratio than other sources, just avoid the mistake of assuming shenanigans are out of the question just because charts are not individuals. While that may be the case, they can be manipulated by individuals and at least from a short-term perspective, frequently are.
As a conclusion that leaves little to no room for interpretation:
- When used as something descriptive, technical analysis can be remarkably useful at providing accurate information pertaining to a certain market or asset, with less noise than most alternatives, even with potential manipulation looming as a threat (easier to accomplish with let’s say highly illiquid Chinese stocks than something like the EUR/USD forex pair, once again a nuance worth taking into consideration)
- When used as something predictive, let’s just say technical analysis ends up oftentimes venturing into “quack science” territory, a space we would strongly recommend staying far away from, with its various gurus and snake oil salesmen that should be avoided
The ChinaFund.com team cannot stress this enough: whether we are referring to technical analysis in the context of Chinese assets or anything else, run for the proverbial hills whenever so-called experts are pitching anything from trading methods to software that somehow enable you to predict the future. Think of it as a close-to-foolproof warning signal.
Instead, treat technical analysis as something that enables you to reasonably assess probabilities when trading Chinese assets… or anything else for that matter. Is it perfect? Most definitely not, especially when it comes to the predictability dimension (nothing is!), but there is absolutely nothing wrong with that in light of the fact that it can be useful enough if done properly. Is it a tool in the arsenal of the ChinaFund.com team? Most definitely, and should you or your organization be interested in more information about how we can put the various tools at our disposal to good use together, we are only a message away and can be reached through the Contact section of our website.