Does technical analysis actually work?

Technical analysis has passionate believers and fierce critics. The honest answer is somewhere in between, and the evidence is clearer than either side usually admits.

The case against

• Efficient markets: the weak form of the efficient market hypothesis says past prices can't predict future ones (lesson 1.11). If a pattern reliably worked, it would be traded away.
• Data mining: test enough indicators on enough history and some will look great by chance. Most fail out of sample.
• Subjectivity: two analysts can draw different lines on the same chart. Patterns are easy to see in hindsight.
• Costs: many signals look profitable before spreads, commissions and slippage, and lose money after.

The case for

• Momentum is real: one of the most robust findings in finance. Stocks that have outperformed over the past 3-12 months tend to keep outperforming in the short term (Jegadeesh and Titman, 1993). Trend following across futures markets has a long documented record too, notably in crises.
• Early studies: research in the 1990s found that simple moving-average rules had predictive power in a century of Dow data, though the effect faded in later periods, consistent with alpha decay (lesson 4.3).
• Flows are real: levels like VWAP, prior highs and big option strikes matter because large participants act at them (lesson 5.5).
• Behaviour: fear, greed, anchoring and herding are persistent, and price patterns are partly a record of them.

What tends to hold up

Trend and momentum on medium timeframes, volume-backed breakouts, and levels tied to real positioning. What tends not to: single candlestick signals, precise pattern targets (lesson 5.4), indicator stacking, and short-term signals that ignore costs.

Using it honestly

• Use charts for timing and risk management, not as a replacement for knowing what you own.
• Define in advance what would prove you wrong, and act on it.
• Test ideas on data you didn't use to find them, including costs.
• Combine with fundamentals and macro: the why behind a move often decides whether a technical level holds.

Key takeaway

Technical analysis isn't magic and it isn't nonsense. Trend and momentum have real evidence behind them, much of the rest doesn't, and the most valuable thing a chart gives you is a clear place to manage risk.

Educational content only, not financial advice. Investing involves risk and you can lose money.

Sources (5)

1. Fama (1970): Efficient Capital Markets: A Review of Theory and Empirical Work
2. Jegadeesh and Titman (1993): Returns to Buying Winners and Selling Losers
3. Lo, Mamaysky and Wang (2000): Foundations of Technical Analysis
4. Marshall, Young and Rose (2006): Candlestick technical trading strategies
5. McLean and Pontiff (2016): Does Academic Research Destroy Stock Return Predictability?