Technical Analysis? 5 Reasons To be Sceptical about Charting

Friday, Feb 03 2012 by
14
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 out there somewhere that might work consistently in some market. But if there is, it's 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 that are bandied around are not predictive and should probably be ignored. 

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…

Unlock this article instantly by logging into your account

Don’t have an account? Register for free and we’ll get out your way

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.


Do you like this Post?
Yes
No
16 thumbs up
2 thumbs down
Share this post with friends




12 Comments on this Article show/hide all

zendog 4th Feb '12 1 of 12
6

Just as a matter of curiosity, when did you liquidate your longs and go short before the 2008 crash? Jan 8, 08 for me. Where did you liquidate your longs and go short before the latest break?July 28 for me.
Post your record proving that your method works better than a chart. Put up or shut up.

cordially,
TA author of 8 books.

| Link | Share | 1 reply
emptyend 5th Feb '12 2 of 12
13

In reply to zendog, post #1

TA author of 8 books.

Probably the most reliable way to make money from TA.......

| Link | Share
djpreston 6th Feb '12 3 of 12
3

Too true we.

The distinction between TA and quanta was very sensible. enough money is punted in the city using at least some element of quant/black box trading that there is probably some element of influence but, as the authors have said, can a Joe schmo beat the hedgies etc?

For me,I'll always be an FA man as the central point is that the market is not efficient and all seeing, especially when it comes to fundamentals.

Fund Management: European Wealth
| Link | Share
MadDutch 6th Feb '12 4 of 12
4

Like ee and djp, I am a fundamental investor and very glad I am; it has made all the money I have gained on the stock market over 15 years.

But I do use charts, for example I would not sell when a short term chart is moving up, I wait until it turns.

So why the misleading name "technical" analysis? There is nothing technical about pattern recognition.

I have found a TA investor who forward tests his trades and is honest with his losses. He publishes his trades in 3 or 4 episodes, from entry to exit with progress reports in between. Some trades last over a week.

His name is John Burford and his blog is a free service from MoneyWeek. In my email today, he discusses his short on gold, including what went wrong and what he intends to do now. His graphs are good illustrations of his developing trades, and he tells his readers what he is doing as it happens. He also has some useful video tutorials, which clearly explain different trading methods such as drawing tramlines and Fibronacci. As ee pointed out, some people make money in training; Mr Burford is free of charge, and he does not claim his methods are technical, which inclines me to trust him. Being able to follow his trades is interesting.

I cannot say if his methods work for me; I recognise today's market as a once in a lifetime opportunity and am focused on high dividend blue chips, so have no time for trading games!

MadDutch

| Link | Share
MadDutch 9th Feb '12 5 of 12

From MoneyWeek trader today;
The euro question has been answered

From John C Burford

How the “ultimate contrarian trade” is playing out

In my 4 January email The ultimate contrarian trade to kick off 2012,
I posed the heretical question: Will the euro stage a big rally? I included the long-term chart showing the uncanny tendency of the euro to make major turns at the year-ends.

I suggested that this is one of the most important charts for 2012.

Here it is again: (see the link below)

---ooo000ooo---

As outrageous as my question seemed then, I believe I have attracted a few more converts to my cause with the subsequent 600 pip rally!

Incidentally, last year when all the talk started of a collapsing euro, I suggested – again, against the mainstream of opinion – that an exit of the weaker members could be very bullish for the euro, as it would leave the northern stronger nations who can withstand a strong currency.
I hope this link works so you can read John Burfords article;
http://du109w.dub109.mail.live.com/mail/InboxLight.aspx?n=854170947&fid=1&fav=1&mid=93f49a42-5250-11e1-9695-00237de46158&fv=1#n=1740349833&fid=1&fav=1&mid=60d21656-526b-11e1-9be8-0

I hope this is a useful addition to the debate here.
I do not do this sort of trading. The only one I do is Soco, where I have a fair idea what is likely to happen.

MadDutch.

| Link | Share
snickers 10th Feb '12 6 of 12
3

here's my original-research contribution to the TA debate. question is: should you chase highly traded shares? here's a graph..

aim

the origin is the barely-visible black circle in the thickest part of the tangle. this is data from the LSE AIM monthly statistics, plotting the change in share price (y axis, rising price is upwards) against change in volume (x axis, rising volume is rightwards, log scales) over the previous month. 5 monthly changes, from august to january. so for instance, a company which rose in the month on increased volume contributes a point in the top right quarter.


not really sure what to make of this. i had a small hope of unearthing a winning strategy of following the money, but all lines switch back towards zero, so it could just be that the past is no guide to the future..

| Link | Share
equityplayer 21st May '12 7 of 12
1

This trader thinks he can be 40% right with TA patterns and make money to retire:

http://peterlbrandt.com/chart-trading-for-dummies/

Essentially he is calling you a dummy. He says that when a pattern fails he is not wrong.

Can you write a blog to rebut his assertions? or Not?

| Link | Share
AwarenessForex 24th May '12 8 of 12
2

you could actually remove the charts and trade with both fundamental and technical analysis using only a spreadsheet. But that wouldn't be good eye candy.

I think less focus on pitting two sides of the same coin and more focus on developing profitable strategy, regardless of the adjectives placed on it.

Professional Services: AwarenessForex.com
| Link | Share
wciszak 17th Nov '12 9 of 12
1

I agree that technical analysis is a giant house of mirrors but that doesn't mean that there is no truth to be found in it. The New Zealand study you quoted only tested the 4 oldest and crudest methods, no longer used by any successful trader (these strategies were popularized during the commodity boom of tbe 1970's and were wildly profitable then). We could do a similar study on fundamental analysis and prove that P/E ratios and book value are useless, but would that disprove all of fundamental analysis? What would we have left?
A nice skeptical discussion of this can be found at http://skepticaltradingstrategies.com/index/does-technical-analysis-work/

| Link | Share
Murakami 3rd Dec '12 10 of 12
1

Looks like an interesting book on TA - http://www.amazon.com/dp/0470008741/

| Link | Share
RobertB73 9th Jul '13 11 of 12

Find a method, be it fundamental or technical, that works for you. Don't discredit others, let them get on with it for the simple reason that if you are right, you will make more money from them being wrong. My guess is the best fundamental and technical strategies don't get written about, simply because their inventors are too busy enjoying the high life!

For what its worth, Anthony Bolton who is a great fundamental investor said he'd never invest without looking at a chart, and if he was only allowed one regular piece of information to run a portfolio, it would be a chart book.

| Link | Share
mpat89 9th Jul '13 12 of 12

I don't think this kind of article should be posted on a web site trying to help investors. Both fundamental and technical analysis are powerful tools and it is up to each individual what they do with them. I for one am happy that I understand what support and resistance means.

Professional Services: Web hosting
| Link | Share

What's your view on this article? Log In to Comment Now

You can track all @StockoChat comments via Twitter


About Stockopedia Features

Stockopedia Features

Stockopedia Features covers in-depth stories on strategies, companies and themes that are relevant to online investors. Investing is hard work. We don't try to over-simplify complex concepts - we prefer to try to help you navigate the detail.  more »


Stock Picking Tutorial Centre


Related Content

Let’s get you setup so you get the most out of our service
Done, Let's add some stocks
Brilliant - You've created a folio! Now let's add some stocks to it.

  • Apple (AAPL)

  • Shell (RDSA)

  • Twitter (TWTR)

  • Volkswagon AG (VOK)

  • McDonalds (MCD)

  • Vodafone (VOD)

  • Barratt Homes (BDEV)

  • Microsoft (MSFT)

  • Tesco (TSCO)
Save and show me my analysis
Foliobuilder