Whipsaws
A whipsaw occurs when the market does the opposite of what is expected. An investor who makes a trading decision based on an expectation of the path of future prices, only to have the opposite occur is said to have been "whipsawed".
All formations, patterns, indicators and technical tools fail at various times and so should only be used to build a body of evidence in forming a trading decision rather than being solely relied upon. There are a number of valuable studies that lead to intuitive understandings about price and volume but a strong compliment to technical analysis is an understanding of the trends and changes in the fundamentals and economic activity that ultimately lead valuation levels in the markets.
The MACD indicator (solid red line) is the difference between two moving averages and is plotted with a trigger line which is another moving average displayed as a dotted line on the graph above. When MACD falls below the trigger line, a sell signal is given and when the MACD rises above the trigger line a buy signal is given. One weakness with this indicator is that during periods of many short term price reversals, the MACD can crossover its trigger line many times, giving inappropriate buy and sell signals. Here's a close up view of Alza Corporation to more clearly illustrate the concept of whipsaw.
Sometimes methods of filtering out whipsaw signals is to generate the indicator on a moving average of prices rather than on the closing prices. In this way, a smoothing of the closing prices has already taken place before the indicator is applied to the data. Generally, using a 2 or 3 day moving average on the closing prices and then generating the indicator using that data can help eliminate some of the whipsaws that are bound to occur.
There is always a tradeoff between timeliness of the signal and filtering to reduce whipsaws that will become part of the individuals decision making process in deciding whether to filter price data and in what way.
To the right technical studies are examined in more detail to provide a sense of conformational evidence for traders of the critical day. Click on any of the terms to take a closer look at a technical discussion on that topic. All formations, patterns, indicators and technical tools fail at various times and so should only be used to build a body of evidence in forming a trading decision rather than being solely relied upon. There are a number of valuable studies that lead to intuitive understandings about price and volume but a strong compliment to technical analysis is an understanding of the trends and changes in the fundamentals and economic activity that ultimately lead valuation levels in the markets.
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