Technical Analysis and Market Sell Offs

Technical Analysis and the Credit Crisis of 2008

In the current market environment, many technicians are left wondering if technical analysis really works.  The reality of it is that a trader must first know what type of technical indicator or chart pattern works in a specific market.  This level of awareness of the current market conditions can only be developed from years of technical analysis education on a host of topics.  The learning curve is steep and is not conquered by simply memorizing definitions and stock trading strategies.

Technical Indicators

Oscillators

Technical indicators are a powerful tool but left in the wrong hands, can prove disastrous to a trading account.  Oscillators move back and forth between overbought and oversold levels on stock charts.  This form of monitoring the market works well in sideways markets but are less reliable in strongly trending markets. 

During the credit crisis of 2008 the stock market began a steep sell off that lasted for months.  Traders that utilized oscillators for trading stocks received a number of oversold signals as the market continued to trend lower.  Notice how in the below chart the Dow setup a number of false buy signals.  Everyone of these buy signals would have resulted in a loss.

Momentum Indicators

Momentum indicators can display oversold and overbought levels, but there are no limits on the values of the indicator.  Hence, if a market is trending hard in one direction, the indicator will go as far as the market is willing to take it.  Notice how in the above example, someone using technical analysis would have chalked it up to nonsense.  But look below how using a momentum technical indicator did not provide another buy signal until the market began to stabilize somewhat.

Summary

In summary technical analysis like any other form of judging the market requires skill.  Many investors have used the recent sell off as a reason to denounce technical analysis altogether, but with the right mix of trading strategies.  Just think about the trader who used the MACD in the above chart example, this person hit the jackpot on their shorts.