1.Why does technical analysis work ? What are the underlying philosophies?
TA is about predicting future pattern based on historical data. because in the past the price has stopped falling to a level and started raising, there’s a possibility it might work again in the future. the more number of times it behaved in a certain way the more chances it will repeat in future. the underlying philosophy is behaviour patterns. does it mean it will work every time. no. the chances are better. now you build a complete system (with good money management, risk protection (stoploss) ) so that even if it works x number of times out of 100 you can still make money. there are systems with profitability at 25% hit rate
2). Where can we apply technical analysis, where we can’t apply technical analysis?
we need to apply TA within the fundamental analysis. that means first identify what to buy. then apply TA to figure out when to buy. TA gives you better margin of safety. TA works well for large cap stocks. it doesnt work so much in indian equity as there are gap ups/downs and volumes are far far less compared to forex markets. it doesnt work well when the fundamentals are changing. like ajanta rose 50% in 3 days due to fantastic results. in such case no resistence or trends would work. use TA within FA. dont use TA by itself however great you are at it. when everything else is same, then TA would work. that means no news, no results, no govt policy decisions, no major econonic events domestic/global
3). What are the risks involved in technical analysis. What are the ways to reduce the risk?
the risk is we cant guarantee future based on past. so always have a stoploss. try to get more safety margin, get risk reward ratio in your favor, take only the strongest signals. major risk is most of the exotic indicators wont work in indian context, they are researched to work within a certain asset class with some behaviourial pattern. use simple indicators and use them wisely.
4). What are the success rate? May be few academic paper link should do, where these methods are put into test tubes to analyze them?
this is a tool. not a strategy by itself. it is as good as the person using it. you give a best tool to a fool, he can blow up the account in no time. can we asses the success rate of fundamental analysis ? there are lot of knowledgable investors in this forum who have invested in ashriya. can you blame their analysis ? there are so many factors in each analysis and some lay more importance to some factors and sometimes it works and some times it doesnt. how many of the ‘turn around’ stories have really turned around ? how many of ‘short term’ mismatches have actually closed ? giving a number to the success rate is meaningless. giving 100% doesnt make it poolfroop, giving 0% make it worthless. combined with other skills such as proper mental model, proper money management method you can make a losing strategy into a winning proposition.
5). There are countless folks who have made fortune by following fundamental analysis. Are there folks who have made similar fortune by doing tech analysis
yes there are. i have seen some brilliant guys in every field. the common factor among all these folks are they are very simple, they apply simple common sense, have tons of patience, have excellent control over the mind. you hear so many failed patterns because there are more greedy people around. i can say 90% of investors/traders i came across are greedy and want to become rich over night. IBM hires a topper in oceanalogy because a smart guy is smart regardless of what field he comes from.
6). What about mini-black-swan event like Arshiya/Ajanta. Can they be predicated in advance via tech analysis.
no. technical analysis doesnt predict such events. TA takes past data and extrapolates into future. its not a magic wand to see whats in future. can fundamental analysis predict labour strikes and pollution issues in hawkins ? we can only react after the event.
in short, its better to use TA in conjuction with FA and try to increase margin of safety, get more conviction, be ready to face ‘temporary’ road blocks successfully. confluence of several factors (both TA and FA) make it a winning proposition.