A Few Notes on The Art and Science of Technical Analysis

November 2, 2012 • Posted in Technical Trading

Adam Grimes (Chief Investment Officer of Waverly Advisors) prefaces his 2012 book, The Art and Science of Technical Analysis: Market Structure, Price Action, and Trading Strategies, by stating: “This book…offers a comprehensive approach to the problems of technically motivated, directional trading. …Trading is hard. Markets are extremely competitive. They are usually very close to efficient and most observed price movements are random. It is therefore exceedingly difficult to derive a method that makes superior risk-adjusted returns, and it is even more difficult to successfully apply such a method in actual practice. Last, it is essential to have a verifiable edge in the markets–otherwise no consistent profits are possible. This approach sets this work apart from the majority of trading books published, which suggest that simple patterns and proper psychology can lead a trader to impressive profits. Perhaps this is possible, but I have never seen it work in actual practice. …The self-directed trader will find many sections specifically addressed to the struggles he or she faces, and to the errors he or she is likely to make along the way. …[Institutional] traders will also find new perspectives on risk management, position sizing, and pattern analysis that may be able to inform their work in different areas.” Using example charts for many assets from different times over different time frames and from different markets, he concludes that:

From Chapter 1, “The Trader’s Edge” (Page 7): “Every edge we have, as technical traders, comes from an imbalance of buying and selling pressure. …we do not trade patterns in the market–we trade the underlying imbalances that create those patterns.”

From Chapter 2, “The Market Cycle and the Four Trades” (Page 45): “When buying pressure seems to be strongest, the end of the uptrend is often near. When the sellers seem to be decisively winning the battle, the stage is set for a reversal into an uptrend. This is why it is so important for traders to learn to stand apart from the crowd, and the only way to do this is to understand the actions and emotions of that market crowd.”

From Chapter 3, “On Trends” (Page 95): “…many outstanding trades come in trending environments. Market structure in trends is often driven by a strong imbalance of buying and selling pressure, it is often easy to define risk points for trades, and some of the cleanest, easiest trades come from trends. However, markets do not always trend.”

From Chapter 4, “On Trading Ranges” (Page 120): “Compared to trends, trading ranges are more complicated, and present more challenges and dangers to traders who would trade within these structures. The highly random nature of price action in these ranges often creates illusions of patterns that do not exist. …However, market structure rests on an alternation of trending and trading range patterns…”

From Chapter 5, “Interfaces between Trends and Ranges” (Page 121): “At best, these interfaces between trends and trading ranges are periods of great uncertainty and potential volatility. At worst, many traders will find that these are the most difficult areas of market structure to read reliably, and that they are the source of consistent losses.”

From Chapter 6, “Practical Trading Templates” (Pages 187-188): “There are only three core concepts here, which express the tendency of the trend to continue and the tendency of support and resistance to both hold and break. …this simple set of trading patterns offers a comprehensive tool kit for approaching market structure and price action in any market and any time frame.”

From Chapter 7, “Tools for Confirmation” (Page 230): “The only reliable patterns are those that are truly driven by large-scale institutional buying and selling pressure, and technical traders have an edge only in the presence of a real buying and selling imbalance. …using a relative strength screen as the first step in a technical process that then focuses on individual patterns will usually have the trader focused on the markets that are, by definition, experiencing an imbalance of buying pressure.”

From Chapter 8, “Trade Management” (Page 253): “The work of monitoring and reviewing your positions must be done every day without fail. The less you want to do it, the more important it is.”

From Chapter 9, “Risk Management” (Page 290): “Traders must make clear distinctions between the normal risks associated with any trade and the more extraordinary risks that can potentially destroy a trading account or end a trading career.”

From Chapter 10, “Trade Examples” (Page 291): “…my trading style, which is a pure swing trader’s approach…can be summarized as follows: Understanding the bigger picture money flows between markets. …Waiting for precise patterns that indicate the presence of an imbalance. …Executing trades to position with the statistical tendency behind the pattern. Managing the risk in the trade appropriately, perhaps adjusting the positions as the trade develops. …playing for one clean swing in the market.”

From Chapter 11, “The Trader’s Mind” (Pages 372-373): “Consistency is important from at least two perspectives. First, it is not possible to evaluate the efficacy of any trading system or rule set if you are not applying it with perfect consistency and discipline. …Second,…consistency in your planned study times, review and even specific screen setups will foster the rapid assimilation of market patterns on a deep level, quickly leading to the growth of real market sense and flow.”

From Chapter 12, “Becoming a Trader” (Page 375): “…trading is hard–very hard. It will challenge you in ways that you cannot imagine, and it will take much longer than you expect to reach a level of competence. Your success will be incremental and ephemeral at first. Expect an emotional roller coaster where progress is followed by errors and failures that erase most of that progress in the next period.”

In summary, traders will find The Art and Science of Technical Trading a clear explication of technical trading and trade/risk management beliefs, but not a source of benchmarks for successful technical trading performance.

Cautions regarding findings include:

  • In general, the book does not offer empirical (statistical) evidence for stated beliefs about technical trading rules/patterns and practices.
  • Presented trading rules and practices are often quite complex, making empirical validation very difficult and suggesting the potential for data snooping bias in their selection.
  • As noted in the summary statement, the book does not quantify expected trade-level or portfolio-level outcomes associated with correctly applying stated beliefs.
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