Subjectivity in Determining an Event: The Point of Entry
Identifying, interpreting, and inferring market action are not the only areas where subjectivity plays a significant role. The determination of the exact points of entry to and exit from the market is also subjective at the most fundamental level of observation. What appears to be essentially objective is also built on a foundation of subjectivity. An example will help illustrate the point. Refer to Figure 1.20.
Figure 1.20 Example of Subjective Objectivity.
Assume that a chartist is interested in identifying a market top via a trendline penetration. The chartist locates two significant troughs in an existing uptrend and draws a line connecting the two troughs, projecting that line into the future. Price eventually makes a top in the market and subsequently declines and penetrates the uptrend line, signifying the formation of a market top. This seems to be a totally objective exercise since the uptrend line and the point of penetration were clearly marked and recorded on the charts. Unfortunately, the objectivity ends here. Although each act of identifying the trend reversal was purely objective, the variables upon which the process of identification is based is determined subjectively by each chartist, according to their goals, biases, experience, and preferences. Another chartist could well have drawn a steeper trendline and declared that the penetration of this new trendline marks the true point of reversal in the market. As you can see, although each act of identifying the exact point of reversal is strictly objective in itself, the existence of alternative trendlines introduces an element of subjectivity as to which trendline penetration is the definitive indicator or signifier of the trend reversal. We can find another example of this subjective objectivity. Automated or program trading is usually regarded as a purely objective mode of trading where all the rules of engagement with the market are fully codified and mechanically executed. This removes all subjectivity with respect to the entries and exits. Just as in our previous example, the point of penetration of each trendline was also purely objective. However, should the automated trading software allow for some parameter adjustments, this instantly introduces an element of subjectivity as to which parameter adjustments are the definitive settings for a profitable trading campaign. Therefore, no matter how objective each individual act is, once the possibility of alternative acts exists, the issue of subjectivity arises. In a sense, each determination is individually objective, but collectively subjective.
The very act of determining the exact entry point to initiate a trade is somewhat subjective. Let us assume that a trader is interested in initiating an entry at the break of an uptrend line. Price initially fails to exceed a previous peak, which is a bearish indication. Price subsequently declines and breaches the uptrend line, and in the process triggers a trade. Some questions that a trader may now ask are:
• At which point after the breakout do I initiate an entry into the market?
• What is a reasonable amount of price penetration required before an entry is initiated?
• Do I wait for the penetration bar to close first or do I initiate an entry at some arbitrary point during an intraday violation of the trendline?
• What if the penetration bar closes too far away from the original trendline breach?
• How would I know if the violation is merely a false breakout?
• Should I allow for a larger penetration before initiating an entry in order to filter out potential false breakouts? If so, how much larger a penetration is required to filter out such breakouts?
The answers to all of these questions really depend on the objectives of the trader and what he or she is attempting to achieve. There are essentially two ways of initiating an entry at the breakout of some price barrier. The first is to initiate an entry at some arbitrary point just after a breakout. The other is to initiate a trade based on some fixed rules of entry and exits. See Figure 1.21.
Figure 1.21 Subjectivity in the Rules of Engagement.
Subjectivity arises not because the rules of engagement are unclear, but rather because of the number of choices available. Hence, each trader will select the rules of entry and exit that suit their personality, risk capacity, or familiarity with a certain mode of engagement. A trader could initiate a trade once price moves a certain distance away from the breakout, or once the penetration bar closes. Traders may even choose to enter the market after a certain amount of time has elapsed from a breakout. Figure 1.21 lists three main types of filters that traders frequently use to initiate an entry. Price, time, and algorithmic filters will be discussed in more detail in Chapter 5.
Summarizing, even if the rules for identification, interpretation, and inference are rigidly codified, the very fact that we have choice renders the entire analysis subjective from the ground up. Hence the argument that technical analysis is subjective in fact represents a general comment on all forms of analysis. It is not unique to technical analysis!
Here is a little exercise in subjectivity associated with pattern recognition. See Figure 1.22. Without looking at Figure 1.23, try to see if you can figure out the trend changes by drawing simple trendlines. After you have finished, refer to Figure 1.23 to see if you have drawn the same trendlines as indicated on the chart.
Figure 1.22 A Basic 4-Hourly Bar Chart of USDCAD.
Source: MetaTrader 4
Figure 1.23 Trendline Analysis on the 4-Hourly USDCAD Bar Chart.
Source: MetaTrader 4
There will most likely be a difference in the points chosen in drawing the trendlines. The very fact that you can draw alternate trendlines introduces an element of subjectivity in identification, interpretation, and forecasting.
Now go back to Figure 1.22 and try to identify some chart patterns (if you know some). After you have finished, turn to Figure 1.24 to see if you have drawn the same patterns.
Figure 1.24 Chart Pattern Analysis on the 4-Hourly USDCAD Bar Chart.
Source: MetaTrader 4
Were there differences in the chart patterns drawn? Do not worry if there are differences. It is merely a consequence of subjectivity.
Subjectivity in Pattern Recognition Diminishes with Practice
Here is another example based on the same USDCAD chart. Were you aware of the subtle angular symmetries in the USDCAD? See Figure 1.25. Analysts also pay attention to the angles of ascent and descent in the markets. A novice may not be able to clearly identify chart patterns, trendlines, or angular patterns at the very beginning. But with enough practice, the pattern-recognition abilities will gradually improve, becoming more obvious as the skill in reading charts improves. As a consequence, the amount of subjectivity associated with identifying patterns will gradually diminish.
