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Subjective vs Objective Technical Analysis Focus On Rules

Based Testing Of Technical Indicators And Trading Systems
Posted By Bigtrends On October 12, 2012 @ 7:25 am In | C omments Disabled

STORYTELLING AND TEC HNIC AL ANALYSIS

Subjectiv e v s Objectiv e Technical Analy sis

F ocus On Rules Based Testing Of Technical Indicators And Trading Sy stems

Humans can't not tell stories: that's the result of decades of research in cognitive science,
psychology, neuroscience, and philosophy into our tendency to string together disparate events into
coherent narratives. If you're philosophically inclined, you know that David Hume got it right
centuries ago: when we identify causation, what we are really doing is composing fictions to help us
make sense of the buzzing world around us.

But it would be a mistake to confuse our convenient fictions with the underlying nature of reality. The
problem is that it's very hard to know when we've hit upon a law of nature and when we're just
making things up. C onsider this famous example of an experiment involving a split-brain patient who
was presented with two images, each beyond the view of the eye associated with the other lobe:

"The man's left hemisphere saw a chicken claw; his right saw a snow scene. Afterward, the man
chose the most appropriate matches from an array of pictures visible to both hemispheres. He chose
a chicken to go with the claw, and a shovel to go with the snow. So far, so good. But then Dr.
Gazzaniga asked him why he chose those items and struck gold. The man had a ready answer for
one choice: The chicken goes with the claw. His left hemisphere had seen the claw, after all. Yet it
had not seen the picture of the snow, only the shovel. Looking down at the picture of the shovel, the
man said, "And you need a shovel to clean out the chicken shed." The left hemisphere was just
concocting an explanation, Dr. Gazzaniga said. In studies in the 1980s and '90s, he and others
showed that the pattern was consistent: The left hemisphere takes what information it has and
delivers a coherent tale to conscious awareness. It happens continually in daily life, and most
everyone has caught himself or herself in the act overhearing a fragment of gossip, for instance,
and filling in the blanks with assumptions."

What goes for apples falling from trees also goes for Apple (AAPL) falling from recent highs: we can
either be vigilant about excising spurious causal claims from our investing, or be ready to lose money
for the sake of good feelings.

For instance, many traders rely heavily on subjective technical analysis to inform trading decisions, a
practice which might uncharitably be called the systematic and deliberate confusion of storytelling
with truth-telling. The fact that I can make a plausible case for a future stock price based on some
lines on a chart doesn't mean anything by itself. If there were quantifiable, repeatable, testable
methods for checking the validity of a given chart pattern or rule set, then we could use reliable
performance metrics to identify which circumstances were likely to be profitable.

Objective technical analysis can meet this test, potentially (e.g. rule sets relying on moving averages,
quantified breadth or volume indicators, autocorrelation with a paired asset, etc.), but, by definition,
subjective technical analysis is in the eye of the beholder.

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 Objective technical analysis tells stories in the form of buy and sell signals based on a concrete rule
set. Those stories are precise, and can be confirmed as true or denied based on the evidence.
Subjective technical analysis, in contrast, tells vague stories that cannot be proven or disproven: you
might see a head and shoulders where I do not, or an ascending triangle or a cup and handle or, or
begin your Fibonacci retracement at a different point, or surf a different set of Elliott waves

Academic researchers have made hundreds of attempts in published papers to test the validity of
technical analysis patterns and rule sets. The unfortunate conclusion is that, in most cases, we are
confusing fiction with reality and the exceptions that stand out, such as trend-following
methods, are again entirely objectiv e and rules-based rather than intuitiv e or
subjectiv e.

[BigTrends.com: We have long advocated and utilized a systemized, tested approach to charting and
trading. There should be a logical basis to your trading/investing ideas and pattern recognition is a
part of this, but one should then quantify that there is an 'edge'. We've long used a variety of
momentum, volatility and trend indicators as the best proven methods, which this article (and the
scientific research [1] he cites) backs up. Additional methods mentioned such as Fibonacci, Trendline
Support/Resistance, Narrowing/Widening Formations, etc, also have value however in our view, as
backing up an initial signal and showing important levels. What some traders neglect or overlook is
that the time frame selected and data points are very important and can change any results
significantly the author mentions different retracement or wave points yielding different results
which we agree with, but we tend to utilize those types of methods as secondary evidence at clear
levels of trend reversals based on our many years of experience (as opposed to making the data 'fit'
your theory). But we agree that breakout/momentum/trend identifying and following is the most
effective and proven method of technical analysis many tested indicators, methods and systems
fall within this category (such as Oscillators, Moving Averages, Acceleration Breakouts, Low-Risk
Entry Points Within Strong Trends, etc).]

Stories that can be passed perfectly from one hearer to the next (objective and quantifiable) seem to
have more predictive power than entertaining but elusive yarns like you might hear around a
campfire.

This presents a challenging resolution for the remainder of 2012 and beyond. Life is short, and
capital is limited. Why waste time and energy on unverifiable prognostications when we could be
pursuing methods with a rational, quantifiable chance of success? Since we can't not tell stories
about the events we see, I'd rather construct fictions that I can later test for accuracy.

C ourtesy of Jared Woodard, C ondorOptions [2 ]

[3 ]

Article printed from Bigtrends: https://www.bigtrends.com

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 URL to article: https://www.bigtrends.com/education/subjectiv e-v s-objectiv e-technical-
analy sis-focus-on-rules-based-testing-of-technical-indicators-and-trading-sy stems/

URLs in this post:

[1] scientific research: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1656460

[2] C ondorOptions: http://condoroptions.com/
[3] Image: https://www.bigtrends.com/wp-content/uploads/2012/10/DTW-BT-
Logo10.png

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