What Technical Analysis Can and Cannot Do

What you will learn

• Why technical analysis works with probabilities, not certainties.
• How self-fulfilling effects can make some levels matter, and why they are unreliable.
• How to calculate expectancy, the average result per trade, in units of risk.
• Which questions technical analysis cannot answer.

Explanation

Technical analysis (TA) is the study of past price and volume data to make decisions about possible future price movement. It does not look at company earnings or the economy. That is fundamental analysis.

A chart shows what buyers and sellers did. It does not show what they will do next. So the honest output of TA is never "price will rise". It is "in situations like this, price has often behaved in a certain way, and here is where I am wrong".

Probabilities, not certainty

Every setup has some unknown chance of working. Even a good setup loses often. What matters is the combination of how often it wins and how much it wins compared with how much it loses. We measure this with R: 1R is the amount you plan to risk on one trade. A trade that makes twice the planned risk is +2R.

Expectancy is the average result per trade: (win rate × average win) − (loss rate × average loss), all in R.

Self-fulfilling effects

Many traders watch the same round numbers, the same moving averages and the same previous highs. When many people place orders near a level, that level can matter simply because people act on it. This is a self-fulfilling effect. It is real but weak: large participants know where crowded stop orders are, and levels often break.

Limits

• TA cannot foresee news, interest-rate decisions or company announcements.
• Price can gap (open far from the last close), so a loss can be bigger than your planned stop.
• Past patterns are historical observations, not guarantees about the future.
• Different traders can read the same chart differently. Clear written rules reduce this problem.

Worked example

Hypothetical example: a trader records a setup and assumes it wins 45% of the time. Average win is +2R. Average loss is −1R. Planned risk per trade is €100. Fees, spreads, slippage and taxes are excluded.

1. Win part: 0.45 × 2R = 0.90R
2. Loss part: 0.55 × 1R = 0.55R
3. Expectancy: 0.90R − 0.55R = 0.35R per trade
4. In euros: 0.35 × €100 = €35 average per trade, before costs

This average hides a lot of pain. The chance that any five specific trades in a row all lose is 0.55 × 0.55 × 0.55 × 0.55 × 0.55 ≈ 0.050, about 5%. Over hundreds of trades, losing streaks of five or more are therefore very likely to happen at some point. And the 45% is an assumption: the real future win rate is unknown.

Common mistake

Practice activity

On paper: a hypothetical setup wins 35% of the time. Average win is +3R, average loss is −1R. Calculate the expectancy in R and in euros with €50 risk per trade. Then write one sentence about what this number does not tell you.

Key takeaways

• Technical analysis describes probabilities and defines where you are wrong. It does not predict with certainty.
• Judge a setup by expectancy in R, not by win rate alone.
• Self-fulfilling effects exist, but popular levels also break often.
• Gaps and news can make a loss larger than the planned stop.

Next step

In the next lesson you will learn precise definitions of market structure, so your chart reading becomes rule-based instead of a feeling.