Technical Analysis? 5 Reasons To be Sceptical about Charting

Friday, Feb 03 2012 by
18
Technical Analysis 5 Reasons To be Sceptical about Charting

The cult of technical analysis and day trading seems to grow and grow. The Web is crawling with technical analysis (TA). Tax changes have created a boom in spread betting, and hundreds of courses have sprung up to teach traders to read short term 'technical' chart set ups. All of this - coupled with the ongoing use of the terminology by market commentators and practitioners - may make you wonder whether technical trading rules are profitable and whether an investor not using them is missing out. 

The short answer is no, not really, at least not in developed markets like the US or the UK.  This isn't to say that there couldn't be some technical indicator that might work consistently in some market. But if there is, it seems to have escaped the attention of any rigorous academic study on the topic that we've come across, especially for stocks. Furthermore, most of the popular TA indicators appear not to be predictive and should probably be disregarded.

So what is Technical Analysis? 

Technical analysis is the forecasting of market prices by means of analysis of data and charts generated by the process of trading.  Its origins can apparently be traced to the seminal articles published by Charles H. Dow in the Wall Street Journal between 1900 and 1902. Technicians believe that certain chart formations and patterns will indicate market psychology about either an individual stock or the market as a whole at key turning points. This is based on three key assumptions:

  1. Market action discounts everything - A fundamental principle is that a market's price already reflects all relevant information (including external drivers such as economic, fundamental and news events), so you just need to know the history of a security's trading pattern to predict its future pattern.
  2. Prices move in trends - Technical analysts believe that prices trend directionally, i.e., up, down, sideways or some combination. 
  3. History tends to repeat itself - Technical analysts believe that price action also tends to repeat itself because investors collectively tend toward patterned behaviour. Because investors collectively repeat the behaviour of the investors that preceded them, technicians believe that recognisable (and predictable) price patterns will develop on a chart. 

With those assumptions under their belt, technicians use charts search for archetypal price chart patterns (e.g. the well-known head and shoulders or double top/bottom reversal patterns) and look for forms such as lines…

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


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39 Comments on this Article show/hide all

PhilH 3rd Aug 20 of 39

In reply to Ramridge, post #19

Hi Ramridge,


Exactly!
For me, my use of TA means that I don't have cash invested in a high quality company that is either trending south or consolidating.


I currently have about 20% cash and a list of about 10 high quality stocks that have passed my filters and I'm just waiting for them to break out.


"Come into my web" said the spider to the fly

Cheers
Phil

Professional Services: Sunflower Counselling
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Ramridge 3rd Aug 21 of 39
1

In reply to PhilH, post #20

Hi Phil -
OK. Now here is my conundrum. How do I catch the shares that seem to defy gravity?

Examples, AO World, Asos in its early days, i.e. those which show a near 45 degrees constant rise over months/ years, and on fundamental grounds they are just laughed off.

TA and FA miss these completely.

I have been scratching my head over these for some time, but haven't come across any sensible approach, researched or otherwise.

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PhilH 3rd Aug 22 of 39

In reply to Ramridge, post #21


I'm not worried about missing them.
As I said in another thread I rather find 10 double baggers than trying to chase a ten bagger.

Cheers
Phil

Professional Services: Sunflower Counselling
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Frankyboy 3rd Aug 23 of 39

 Hi Phil,

But still people seem to be determined to know everything about a company they invest in, to know when a CEO/CFO breaks winds and what that might mean. Kidding themselves that they know enough about the business to be sensible investors, not these fly by night traders.

That's my viewpoint too Phil! :)  As I said, if Tesco could pull the wool over the eyes of the City 'experts' what chance has Joe Investor got to sensibly analyse fundamentals.  Also, as with the Brexit decision, for example, the complexity and interactions within and without the company are quite beyond prediction or human judgement.  No one can foresee the future, unless you're looking back from the Deep Future!

Another thought is to look back at the FTSE100 constituents of fifty, or more, years ago....you won't recognise half the names.....everything in life is transitory and unpredictable.... as they say, the only certainty is uncertainty!

I must admit to a modicum of envy with respect to your annual results Phil.... Excellent.  Perhaps I would benefit from some counselling!

Imran, I also bought the same book as Phil, sample here  https://www.harriman-house.com/samples/97808571926...   years ago but haven't followed up by applying it, although I like the ideas..... there's just so many TA strategies out there it's best to concentrate on a couple of strategies as Phil does.  Jeremy du Plessis, the author of that  book, ran a well respected investment software company called Indexia which was later taken up by Updata....bit of history there.....and many popular software companies include point and figure charting options.  Also, worth looking at YouTube for some background on these.

Finally, I also agree with Phil that it's a free world and there are both fundamental and TA strategies which can work BUT a combination of both is the best approach.... but it's all difficult!

Frank

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Frankyboy 3rd Aug 24 of 39

In reply to Ramridge, post #21

Hi Ramridge,

Try using a 50 MA, for example, or find a period that fits the bounce points of that particular trend. Try and buy when it pulls back to this MA. I often use lines of support but it's usually best to use log scales to make this work for longer periods. Look for RSI and MACD divergence.... but remember nothing is built in stone and what you need to try and do is get the 60-70% probability on your side.
Put trending shares into a dedicated watch portfolio and look at it every few days to spot the buying points.

Again I agree with PhilH and also Ed Croft's recent article on forum fun...IGNORE them.....rather spend that time honing your knowledge.

However, as with these comments/forums it does help to weather what can be a solitary pastime!

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Ramridge 3rd Aug 25 of 39

Hi Frankyboy -
Thanks for your helpful suggestions.
I may end up ignoring this type of shares, but only after I had a good search to see if there is any decent approach I can hang my hat on (I don't want to use the word method because it sounds too scientific and I sense there isn't a half-decent scientific approach to this).
Not ready to throw the towel in yet!

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Warranstar 3rd Aug 26 of 39

Currently I only use Fundamental Analysis, which includes all the Stockranks . But I am prepared to consider the idea that a little Technical Analysis might also be beneficial. Maybe this might work along the lines of:
FA helps me decide what to buy
TA helps me decide when to buy
What do you think? If I was to use TA like that, then which one indicator would be the best to use?

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Noodle Hat 3rd Aug 27 of 39

In reply to Warranstar, post #26

This is the general jist of Weinstein and Mark Minervini. Screen first for high quality, growing stocks. Then use TA to time the buy, breakout on volume.

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Noodle Hat 3rd Aug 28 of 39

they keep is simple. think its basically 2 moving averages, Relative strength and volume ( average over 3 month and daily)

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Warranstar 3rd Aug 29 of 39

In reply to Noodle Hat, post #28

Thank you Noodle Hat. I will take a closer look.

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Frankyboy 4th Aug 30 of 39
2

Needle Bat is right. Keep it simple. I flick, at speed, through charts looking for breakouts, trends, new lower highs, rsi/macd divergence and patterns. These are added to watch, timing, final buy etc portfolios.
Previously, I would then use PE ratios to narrow them down but now I check Stock Ranks, usually value and quality (realising that the data upon which these figures are based could be quite old) as I prefer to judge momentum by myself. So from the PE point of view, I've have had my toe in the fundamental waters for quite a few years.
To avoid being myopic I would recommend to everyone interested in charts to look at 5-10yr charts on log scale to get the BIG picture and to see where the stock is now relative to the past. This can be eye opening. Never buy on news without looking at this and realising where the share price is.
You will see the past trends VERY clearly. Depending on your software, swipe the chart for, say, two weeks or so of data around the start and end of trends. With this couple of weeks chart, LOOK at what happened to the indicators at that time... just use MACD, RSI, 20/50MA and maybe Stoch, OBV and momentum.... This is VERY educational and once you see what happens at the beginning of trends, try and spot similar activities occuring CURRENTLY.
SOMETIMES keep it REALLY simple just look at long term charts with NO indicators..... like the Stockopedia mini chart arrays on 10yrs...very illuminating and doesn't overload the brain.
Treat trading volume with great suspicion.....there'a all sort of funny goings on which are sometimes totally disconnected with price movement....again, you will see this irrationality in the long term charts. Avoid illiquid small caps whose Market Makers will make more money from their large Buy/Sell differences (Spreads) than you probably will!
Be patient but nervous enough to pull the sell trigger when you have to.
Just a few thoughts.

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Carey Blunt 4th Aug 31 of 39
1

I think that possibly there is a difference between the approaches you are all describing in your replies here and some of the TA stuff thats out there in the world which the article is saying doesn't really work.

I would say there is a difference between those who look at MACD and japanese thingimy clouds and moving averages and who look at the chart in some way during their stock selection or selling process and the people you can find on the bulliten boards who are making their decisions based on the fact that if you squint and look hard enough, part of the chart in the bottom corner looks a bit like a christmas tree and so its obviously a buy!

I wouldn't argue with any of your responses to this article, they are all sensible use of charts in my opinion.
I probably wouldn't listen very long to someone telling me that I should consider buying a stock because part of a chart looks like a magpie or is similar to part of a chart 3 years ago when the stock then did well afterwards.

I think thats what the article is bebunking isn't it?

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schober 4th Aug 32 of 39

"Reason 2: Empirical evidence for TA is negligible"
Hmmmm ................. so what does the author make of this papar?

http://cs229.stanford.edu/proj2013/TakeuchiLee-ApplyingDeepLearningToEnhanceMomentumTradingStrategiesInStocks.pdf

It has raised the curiosity of Anthony Garner (a very sceptical chap), and me too
https://anthonyfjgarner.net/articles/

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andrewdb 4th Aug 33 of 39

In reply to schober, post #32

Disclosure : II do not trust TA

Three thoughts

0
There are some real long-lasting patterns in the market that can be used by anyone and are widely known
(a) Seasonality
(b) Momentum
(c) Defensives
So, saying 'all TA is bunk' is a little unfair

1
Just as 55% of verbal communication is non-verbal (body language etc), I think there is more to TA than staring ata chart.
I have a feeling those who use TA successfully choose a list stocks to watch from a universe and then looking at the chart see a pattern in some of them - a sub-list and then select the 'highest probability trades' from that sub-list.
I think that they may have used a chart pattern to justify a decision they have already made.
This may come across as negative, but if it makes you money, you don't need to be concerned.

2
I read the paper and thought 'wow'
Then I noticed that the training period was 65-89 and test period was 90-09 and then thought
(a) it looks like the training period was a period before HFT and other AI algorithms really hit the market
(b) it looks like the testing period was a period before HFT and other AI algorithms really hit the market

Not to say this is anything other than v.v. impressive but just like the people who developed the original turtle rules made money until those rules were arbritaged away by the market, I suspect the same patterns found would not work so well 2010-15.




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Carey Blunt 5th Aug 34 of 39

In reply to PhilH, post #15

Hi PhilH,
Just been doing some research on Ichimoku clouds. Interesting stuff and I put some stocks on my watchlist through the ichimoku trader website to see what they came up with.
Are you saying that if you had a share on your watchlist (lets say with a high stockrank) but which didn't have 5 "Bull" signals would you hold off buying until it had all 5 signals?
or does it not have to be all 5?
I appreciate that it may not be easy (and you may not want to) explain your full approach to your investing here but any pointers for investors looking at sensible combining of ichimoku TA with fundamentals to time buys and sells would be appreciated.
cheers
Carey

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PhilH 5th Aug 35 of 39

In reply to Carey Blunt, post #34

Sorry I'm in deepest Cornwall so don't have the best signal on my phone ...



Ideally 5 bullish signals plus if I look left on the chart I don't want to see any price action above the current price that might interfere with a breakout. This previous price action is/are called 'shadows'. That's why I like stocks that are posting new highs or new recent highs as they have less 'shadows'. This also means that the trailing line (the chikou) has loads of space around it. When this line starts to tangle with the price action it indicates that the stock has started to consolidate. I don't want to purchase stocks that are consolidating. 


For example one stock I've been tracking for a whille is Austevoll Seafood ASA which trades on the Olso exchange with the ticker AUSS. If you bring up the Ichimoku chart ... I've been waiting for a break over 75 Euros due to the shadow cast by the high on May 25.

Kudelski SA which trades on the Zurich exchange is another example I've been tracking waiting for it to break over 20 CHF.

So I run Stocko filters to spit out High Quality & High Momentum selections, then I look at the Ichimoku charts to see if I'm happy with the price action. If not I set a target where I would be and wait. When/If it hits that point, I revisit Checklist feature of Stocko and assess if the stock would still pass my Stocko filter.

Does that make sense?
Phil


Professional Services: Sunflower Counselling
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Carey Blunt 6th Aug 36 of 39

In reply to PhilH, post #35

Hi,
Yes, that makes sense. Thanks for the info, i'll look into it some more. It would be interesting to do some studies into the Ichimoku signals using Stockopedia data.
I wonder what would happen if there was a Stockopedia Screen where all stocks in the index were processed each day and any stock which had just achieved 5 Bull signals and which were at a 3 month price high (or maybe 6 months) were promoted into the screen results. Any which then lost one or more of their bull signals would then be demoted from the screen.

I would be interested to see how that screen would do compared to other Guru screens - maybe a job for Ed Croft and team! :-)

cheers
Carey

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herbie47 6th Aug 37 of 39

I have been looking at Ichimoku charts recently, I have found quite a few with 5 greens that often the share price falls and the ones with 5 reds seems to be a buying signal, whether brexit has caused this I'm not sure as I have only been using them recently. Combining them with 52 week highs I will look into more.

Phil did you buy KUD as it went over 20 CHF?

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PhilH 6th Aug 38 of 39
3

In reply to herbie47, post #37

The Ichimoku Charts give a variety of signals and depending on your trading approach you can select options that suit you.

For example there are two moving averages: the Tenkan Sen (fast MA) and Kijun Sen (slow MA). You can use the crossover of these as buy/sell signals BUT I'd suggest that is very noisy and would result in frequent trades, which is not what I'm after. There is also a strength associated with some signals so again with the MA crossover if the fast MA crosses above the slow MA and that crossover occurs above the Kumo cloud it is considered to be a Strong Bullish signal which makes sense as the current price action is above the recent consolidation and the latest prices are rising above historical prices.

I might also mix styles ... so I'll buy with 5 bullish signals with the current price breaking recent new highs but I'll sell if there is a concerted break below the Kumo (which is usually my notional stop price).

OR if a stock has had a really strong run and the Stock Rank has really deteriorated and the stock is just running on price momentum I'll shift my notional stop loss up the slow MA (Kijun Sen). This enables me to take profits as close to the top as possible.

As yet I haven't bought KUD as I've been away on hols but I have about four or five stocks that look good and I'll try to pick them up in the week.

btw Herbie I wrote some software that d/l'ed uk stock histories and scanned them for 5 bullish signals and used that list as the basis for further investigation. I quickly learnt that it was easier to filter with stockopedia filters first and then look at the Ichimoku signals

Professional Services: Sunflower Counselling
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herbie47 8th Aug 39 of 39

In reply to PhilH, post #38

Phil,
Thanks very much for all that information, I will look into it some more.

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