At iSigma, our systems are based entirely upon strict technical analysis. The good side to this is that our methods have worked handsomely for us. The downside is that technical analysis is still viewed as suspect by many. A quick examination of the technical analysis materials in common circulation is sufficient to explain why this skepticism is so common. This article will deal with some of the more popular technical methods by grouping them into three categories, data plotted on the price chart, data plotted below the price chart and visual methods. Be advised that none of the methods or indicators here are used in our systems.

This is the category containing the most popular indicators, including moving averages, volatility bands, trendlines, etc. The popularity of these indicators is most likely a product of their effectiveness. As we explain here, these indicators can serve as the building blocks of somewhat better than average trading systems. The reasons that these systems are only somewhat better than average stem from the fact that the indicators they are based on are used as proxy for the price even though the price may be quite different. Imagine a trader calling a broker to buy shares which are currently trading at $17 with the moving average at $15. The trader had better not plan on buying at $15. The broker will allow a trader to trade for the current market price. This is the number that matters. Since the market price is already available, why worry with the value of the moving average (or volatility band or trendline or any of countless other chart overlay indicators) at all?

In addition to drawing all kinds of lines and bands and averages on the price chart itself, many traders also try to enhance their trading by examining certain indicators which are commonly rendered below the price graph. Within this class of indicators are momentum, moving average convergence difference (MACD), average true range (ATR), stochastics, %R, on balance volume (OBV), relative strength index, etc. It's beyond the scope of this article to explain the calculation of each of these, however they all are used very similarly. Traders who use these types of indicators typically have rules such as "If the XYZ indicator moves above 0, then buy some shares." This leaves a trader in a difficult dilemma, to place a transaction without considering the current price, or to possibly override the indicator due to price action and sacrifice consistency. Additionally, a good portion of this class of indicators are intended to indicate when a trader should buy on weakness or sell on strength. This might initially seem like a tidy way of buying low and selling high. Carried out to its logical conclusion, this sort of thinking would dictate to keep adding to a position as it continues to lose money. Repeat this process enough times and the trader has thrown so much good money after bad that continued trading ceases to be an option.

In addition to the more formulaic methods listed above, there are a host of technical methods based on visual examination of price charts. Candlestick charts, point and figure charts, Gann angles, pattern such as head and shoulders and the like are all examples of visual methods. Certainly a benefit to such methods is that anyone can immediately use them with only some brief training on what patterns to look for. This is also the reason why such methods often have disappointing results. Traders eager for action will insist that they see their favorite pattern in the charts whether the pattern is truly there or not. People mistakenly think they see movement in shadows and children can see animals in clouds before they are able to read. Can these people somehow restrain their own creativity in order to visually examine charts of price activity?

If the last three sections left you thinking that all technical analysis is too troublesome to put to use, you're almost correct. Most technical analysis really isn't worth using because it relates to factors which don't directly affect the trader's bottom line. There are only three numbers that really make a material difference in the outcome of a trade, the price when the trader initiates a position, the price when a trader closes the position, and the size of the transaction. If you buy 100 units at $10 and sell then at $12, you have a $200 profit no matter what the moving average or RSI or OBV or point and figure chart looked like. This basic fact is at the core of the iSigma approach to technical analysis and it is the main reason for the results we've been able to achieve.

A document covering every type of technical analysis would require hundreds of pages and would be superfluous to the intent of this article. That doesn't mean we want to leave any questions unanswered. If you have questions concerning another form of technical analysis that we didn't address here, please follow one of the contact links on this site and let us know.