It took just one week to invalidate a typical reversal rounding top formed in SLV, the Silver ETF. This marks another major failure of technical analysis, one of the many witnessed in the last couple of years. Should traders stop using this type of analysis?
I referred to the classic rounding top pattern in my post “Rounding Top Pattern in Silver. Reversal or Continuation?” a week ago. As it may be seen from the updated chart below, the rounding top pattern has failed:
As a matter of fact, there have been a series of failures of classical chart patterns in SLV as I have pointed out in past blogs. This particular failure of the rounding top is another blow to those who believe in technical analysis. For example, in Technical Analysis of Stock Trends by R. D. Edwards and J. Magee (9th ed.), a book that is considered the Bible of technical analysis by some, the following statement can be found:
“Under what might be called normal market conditions, those chart patterns which reflect trend changes in most simple and logical fashion work just as well with commodities as with stocks. Among these we would list Head-and-Shoulders formations, Rounding Tops and Bottoms, and basic trendlines.” (p. 303)
So what happens when these patterns do not reflect trend changes but instead continuation, as in the current example in SLV? What does technical analysis has to say about it? Below are some typical arguments made dy technical analysts and my answers:
(1) The pattern was not confirmed.
Answer: The notion of confirmation when integrated in technical analysis removes any assumed predictive capacity due to the fact that it relies on hindsight.
(2) This pattern worked in some other market(s)
Answer: This is called selection bias. It is like trying to prove to someone who did not win the lottery that the negative expectation game of playing the lottery is a winning game because someone, somewhere won the lottery.
(3) Technical analysis is correct but you do not understand it
Answer: When cornered, some technical analysts will often become very aggressive and argue that the real problem is that people do not understand the method. This is a fallacy of course that reverses the burden of proof.
(4) Technical analysis works well if you place your stops correctly
Answer: This one makes me laugh. Everything works well if you place a stop. The problem is that after so many stops you won’t be able to place another one due to depleted capital.
So what is technical analysis? I have expressed my views already in a previous post. In short, classical technical chart analysis is not useless but it can be very dangerous.
Disclosure: no relevant positions.