In Figure 1.16 we observe that the CCI readings over the range of prices are markedly different. The 20-period CCI indicates a slightly overbought market whereas the 100-period CCI suggests that prices are slightly oversold. There is in fact no real conflict between the two apparently opposing signals. The indicators are merely pointing out that prices are slightly overbought or overextended in the short term, but over the longer term, prices are in fact slightly oversold, that is, relatively cheap. Therefore, instead of viewing the signals as opposing or contradictory, the astute trader immediately realizes that the most advantageous point for initiating a long entry would be when prices are cheap both in the long and short term. This is easily identified on the charts by looking for oversold readings on both the 20- and 100-period CCI within the area of consolidation, as indicated at Point 1. Therefore, the trader may decide to go long once price penetrates the high of the candlestick indicated on the chart. In this example, we see conflicting signals actually complementing each other and affording the trader an advantageous entry at relatively low prices.
Figure 1.16 Conflicting Signals on the Daily Alcoa Inc Chart.
Courtesy of Stockcharts.com
The important point to remember is that any form of analysis may be employed, as long as the analyst is intimately familiar with the peculiarities associated with each form of analysis. It is better to be conversant with one form of analysis than to employ a slew of technical approaches without fully grasping the intricacies of each approach. This leads to confusion and ineffective analysis. It must be noted that combining technical studies will frequently result in both confirmatory and contradictory signals as we have seen, with many of the signals being also complementary as well. Only add studies once the first form of analysis is fully mastered. The practitioner must always remember that no form of analysis is always perfectly representative of the market, and it is inevitable that different forms of analysis will many times lead to conflicting signals.
Subjectivity in Pattern Identification
As mentioned, interpretation and inference of potential future price action based on historical price behavior is essentially an exercise in subjectivity. Each analyst will interpret and infer future price action according to his or her own experience, knowledge, objectives, beliefs, expectations, predilections, emotional makeup, psychological biases, and interests.
The identification of price patterns may also present some challenge to the novice practitioner. Occasionally, the markets will conveniently trace out various price patterns that may cause some confusion. Refer to Figure 1.17.
Figure 1.17 Conflicting Chart Pattern Signals.
In this example, we see two chart patterns indicating potentially contradictory signals. The ascending triangle is regarded as a bullish indication, while the complex head and shoulders formation is potentially bearish. Therefore, as price starts to contract, forming a symmetrical triangle, an analyst may be somewhat perplexed at the conflicting signals, being unable to provide or issue a clear forecast as to whether the market is indeed potentially bullish or bearish.
One way to resolve this apparent conflict is to first identify the size of each pattern. The sentiment associated with larger patterns or formations will take precedence over that of smaller formations. These larger formations are more representative of the longer-term sentiment whereas the smaller formations are more indicative of short-term sentiment. Hence in our example, the bullish sentiment associated with the ascending triangle takes precedence over the bearish sentiment associated with the complex head and shoulders formation. Therefore, until price breaches the complex head and shoulders neckline, the entire formation may be regarded as a potentially bullish pattern. Following this simple rule helps reduce some of the subjectivity involved in reading price and chart formations.
Figure 1.18 depicts an idealized scenario where all the chart formations are potentially bearish.
Figure 1.18 Chart Pattern with Complementary Signals.
There is no conflict in sentiment between these formations as they are all in perfect agreement. The smaller formations act as additional evidence and add to the overall bearish sentiment. There is also a lesser amount of subjectivity involved when reading the sentiment associated with formations that are in perfect agreement. Nevertheless, it should be noted that although such formations may appear somewhat more straightforward with respect to inferring potential future price direction, any upside breakout of the larger descending triangle may well precipitate a vigorous and rapid rally in prices due to the unexpected nature of such a move. Traders must exercise caution especially when shorting such a formation as prices can quickly explode to the upside, caused by an avalanche of short covering.
Interpretational and Inferential Subjectivity
This element of subjectivity with respect to interpretation and inference is not merely confined to applications in technical analysis. In fact, every form of analysis involves a certain amount of subjectivity and arbitrariness when it comes to its interpretation. For example, let us assume that the price of oil has risen significantly. This event in itself can be interpreted in two different ways. One fundamentalist may strongly believe that this rise in oil prices will impact the markets adversely as it will raise the underlying cost of commodities, whereas another fundamentalist may strongly believe that the rise in oil prices is a direct result of market demand, a bullish scenario indicating a healthy and growing economy. In another example, a technical analyst may strongly believe that an overbought oscillator reading is a clear indication that the trend is strong with further continuation expected in price, whereas another technical analyst may strongly believe that the overbought signal is a clear indication that the market may be already overextended and therefore expects a reversal in trend. The beginner quickly realizes, after some reflection, that for every bullish interpretation, there exists an equal and opposite bearish interpretation. This is one of the main reasons why forecasting is regarded as largely subjective.
Subjectivity and Selective Perception
Human bias is another factor that adds to the degree of subjectivity when attempting to interpret technical signals. Chartists will many times ignore signals that conflict with their preconceived ideas of where the markets ought to be at any one time. They only select oscillators and indicator signals that support their analysis of the market. For example, a chartist uses three oscillators, the MACD, relative strength index (RSI), and stochastics. The chartist has a bullish view of the markets and believes that it is about to break to the upside. All of the oscillators have bullish readings except for stochastics. The chartist ignores the stochastics signal because it does not agree with his or her view of the markets. On a subsequent occasion, it is MACD that is not in agreement with the chartist’s view, and only the signals from the other two oscillators are heeded. This is known as selective perception. See Figure 1.19.
Figure 1.19 Selective Perception and Conflicting Oscillator Signals.
Selective perception adds to the subjectivity of the forecast, as there is no fixed point of reference or basis for making decisions based on evidence. Choosing only signals that agree with one’s view will lead to biased and erroneous interpretations and unfounded forecasts. In fact, it is when there are discrepancies in the signals that the chartist gains the most information from the markets, as it may be an indication that there could well be some form of underlying weakness in the markets.
