Ask Colin

Will technical analysis be less effective for share trading as more people begin using it?

The markets are a place where thousands of people transact business with each other. They all have different wants, needs, expectations, time frames and so on. Time frames are one of the easiest to understand. If one person was buying for a long-term income stream and capital gain, he or she might easily do a deal with another person if they were a short-term trader who could not tolerate an unanticipated short-term dip in the price.

Another easy one to understand is that a small trader can hop in and out of the market, but a large portfolio fund manager might have to buy patiently, because she had to manage the large purchase over many months without unduly affecting the market price.

I once did an experiment in a technical analysis workshop. I taught students technical analysis. Then I gave them what was a fairly clear-cut chart. I asked them to work in seven groups and tell me for both a long term investment and a short term trade, did they want to buy or sell, at what price would they act and where would they put their stop-loss level. When I put all their decisions up on a grid, it was quite obvious that a competent broker could have made a lively market in the room. Yet they all had the same knowledge about the chart and technical analysis.

All of this also ignores psychology - it is only discussing the rational person. However, most of us are not totally rational. We are ruled by emotions like fear, greed, hope, ego and so on. We human beings also have an infinite capacity to rationalise what we believe. We have selective eyesight and hearing that filters out what we do not want to see or hear. Two ordinary and normal people, well trained in technical analysis, can see different things on a chart if they are already involved with the stock in some way.

Never fear, as people get better at it, the game will get tougher. But there will always be markets while humans trade them or program the computers to trade them automatically. If something gets so well known that everyone starts to use it, then people will find ways to profit from what the crowd is doing. For example, they will try to get in early and the profit will no longer be there when the signal is given. Professional traders already do it all the time - they trade against the amateurs who are following some system.