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

zendog 4th Feb '12 1 of 39
11

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.

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emptyend 5th Feb '12 2 of 39
18

In reply to zendog, post #1

TA author of 8 books.

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

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djpreston 6th Feb '12 3 of 39
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
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MadDutch 6th Feb '12 4 of 39
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

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MadDutch 9th Feb '12 5 of 39

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.

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snickers 10th Feb '12 6 of 39
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..

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equityplayer 21st May '12 7 of 39
3

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?

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AwarenessForex 24th May '12 8 of 39
3

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
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wciszak 17th Nov '12 9 of 39
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/

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Murakami 3rd Dec '12 10 of 39
1

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

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RobertB73 9th Jul '13 11 of 39

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.

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mpat89 9th Jul '13 12 of 39

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
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Frankyboy 2nd Aug 13 of 39
2

I just came across this irritating article and thought that perhaps the tone of these articles might be changed with the forthcoming charting enhancements in Stockopedia. Why bother investing time and money improving the charting aspect of Stockopedia if charting has been shown to be so cr**ap!! :) I've been a 'chartist' 20+yrs and my particular problem is with overtrading, NOT with the charting itself.
I decided to look at fundamentals more, (hence my recent membership of Stockopedia) but am shocked at how fundamental estimates appear to be chronologically detached from, or even in opposition to, what is happening to the price chart. Any price reaction to fundamental wizardry is often months or more apart....in either direction!
Also fundamental data, by its nature, is usually MONTHS out of date, (except for profit warnings!!) and is only available bi-annually in the UK.  IF you're lucky the company reports may even be accurate AND honest !! (think Tesco!). 

I believe that the only reason why investing, using fundamental data, might APPEAR to be more effective is that, due to its nature, investors are much more likely to be longer term holders and much less prone to overtrading.... which, bizarrely, can be more fun than making money!! :) :)

Take Powerflute Oyj, for example....enthused by a ninety niner type ranking in March, I bought it 'technically' on March 11th 2016 as it was hovering around on support.  It didn't hold, so I sold it on March 24th.  This is an example of what I am saying; great fundamentals but the share has just continued down steadily whilst merrily ignoring the great fundamental ranking and all the fundamental chat.  This is NOT untypical and sure, the share will turn around EVENTUALLY and this is why a fundamental holder might hold on, BUT you've lost the TIME....and in investing, time can and should be money!  I was tickled by a fundamental investor who said that he had held a particular share 'since the beginning of time' !!! :)  'One day your Pri(n)ce will come!! Good that.... just made it up! :)

As it happens Powerflute OMG :) was a CLEAR and OBVIOUS technical buy mid 2013, as it broke out of a long term, 5+ yr, resistance which started at the end of 2009.  You could have bought it at around 25p and sold it technically when it broke down through resistance in Feb 2016... a 3 bagger.  Just taking this share as an example of one I've bought recently due to glowing ranking and impatience, I would say that over the last number of years, Technical Analysis beats Fundamentals hands down.  I wonder what the fundamentals were at the break out at the end of 2009..... must see if I can work out how to find that.

The POWR share price has been in a steady decline for ten months and I suspect that it will have been a 90+ ranking stock all that time.  WHY tie up your money in such a stock, for all that time, when all you need to do is to watch for a proper turnaround....and by then the fundamentals might have deteriorated!!  I was too premature and impatient and dazzled by the high ranking. :)

Now, if you find good TA breakouts etc COMBINED WITH good rankings THAT is the way to go...IM fairly HO.

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Frankyboy 2nd Aug 14 of 39

Forgot to note that a (TA) price/RSI divergence just occurred....so there's a 60-70% chance that POWR is near a turnaround..... not that I believe in that sort of thing, for around 30-40% of the times it happens... :)

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PhilH 2nd Aug 15 of 39
1

In reply to Frankyboy, post #13

You won't hear any complaints from me about integrating TA. My personal choice is using Ichimoku to time purchases and sales of companies that pass my Stockopedia filters. I also use Point n Figure Charts to generate price targets which help me assess risk/reward.

To all the detractors I just ask to see their performance in comparison to my publicly available 22% 3 year annualised return. Perhaps consider asking yourself ... "Of the people I chose to 'listen' to, how much do I know about their investing performance?"

Now, if you find good TA breakouts etc COMBINED WITH good rankings THAT is the way to go...IM fairly HO.

Absolutely. Here's a few corkers I've caught in the last 3 months ...

Meet Me up 109% in last 3 months ... I've got a 118% profit since purchase in May. Currently StockRank 79 which has dropped since I bought it in early May

H & R AG up 55% in last 3 months ... I've got a 32% profit since purchase in June, Currently StockRank of 99.

Saracen Mineral Holdings up 54% in last 3 months ... I've got a 60% profit since purchase in May, Currently StockRank of 77 dropped since purchase in May.


Harboes Bryggeri A/S up 29% in last 3 months ... I've got a 28% profit since purchase in June, Currently StockRank of 95

Astec Industries up 25% in last 3 months ... I've got a 32% profit since purchase in May, Currently StockRank of 90

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.

Hey ho, each to their own.

Best of luck
Phil

Professional Services: Sunflower Counselling
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imranawan 3rd Aug 16 of 39

In reply to PhilH, post #15

Hi Phil

Do you have any books about charting in particular Ichimoku and Point n Figure charts that you would recommend.

TIA.

Imran.

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PhilH 3rd Aug 17 of 39
2

In reply to imranawan, post #16

Hi Imran,

These are my two reference texts but it was a few years ago when I first bought them.
I was able to write my won charting software from both of these texts so they are very detailed in terms of explaining how the charts are constructed and why/how that's useful.


Point n Figure

The Definitive Guide to Point and Figure: A Comprehensive Guide to the Theory and Practical Use of the Point and Figure Charting Method

Ichimoku Charting

Trading with Ichimoku Clouds: The Essential Guide to Ichimoku Kinko Hyo Technical Analysis

I hope that helps
Phil

Professional Services: Sunflower Counselling
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PhilH 3rd Aug 18 of 39

In reply to PhilH, post #17

Hello again,

I'm certainly not a cheerleader for a pure TA based approach. I've tried that and it was just as unsuccessful as following story cheerleaders on forums.


However for me an integrated Fundamental & Technical approach has worked really well. Using fundamental Stockopedia filters allied with some TA to identify breakouts, supports and resistance levels.


To those that think this must produce an inherently risky portfolio here are the 3 year portfolio profiles of my investments. I can't provide overall stats for the consolidated investments so I'll provide the constituents.


My SIPP

57a1b2bef061eSIPP_returns.png
57a1b16cc7038SIPP_stats.png


My ISA
57a1b2a48e019ISA_returns.png
57a1b02ccda62ISA_stats.png

Partner's ISA


57a1b04e64db7KJ_returns.png
57a1b059046feKJ_stats.png

Generally I've been able to generate high alpha with low beta, low information error and generally high Sharpe ratios. R-Squared also indicates that the portfolios are not overly linked to the performance of the underlying index.

The data is provided directly from my YouInvest portfolios.

I hope that helps
Phil

Professional Services: Sunflower Counselling
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Ramridge 3rd Aug 19 of 39

I don't understand the black or white view of TA versus fundamentalists. It isn't a "either or" choice. A sensible investor will do both.
My own method is to identify a share through fundamental analysis first. If it passes my filters at this stage, then I look at the technical chart. I have set up my technical chart to show Keltner channels; 50, 100, 200 EMA lines and as indicators RSI, MACD, Fast Stochastics and Williams R. I have changed some of the parameters to suit my style.

So if a share passes muster on both counts, TA and fundamental analysis, then it is a buy. If the TA shows amber lights, then I park it and wait until the TA signals are right. Sometimes for months.
Last year, I was sitting in my conservatory and watched how a spider works. Once he has set up his web, the spider sits and waits at one corner keeping a low profile. Sometimes he sits all day patiently. But when he strikes it is usually to catch a large juicy fly tangled in his web, 5 times its size. Method and patience wins the day.

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