I love clearing the air with a single dismissive answer to a seemingly complex question. Short, dismissive retorts are definitive, but arrogant. It reminds readers that I am sometimes a smart a*ss.
Is technical analysis a reasoned approach for investors to predict future value of an asset?
In a word, the answer is “Hell No!”. (Actually, that’s two words. Feel free to drop the adjective). Although many technical analysts earnestly believe their craft, the approach has no value and does not hold up to a fundamental (aka: facts-based) approach.
One word arrogance comes with an obligation to substantiate—and, so, let’s begin with examples of each approach.
Investment advisers often classify their approach to studying an equity, instrument or market as either fundamental or technical…
- Fundamental research of a corporate stock entails the analysis of the founders’ backgrounds, competitors, market analysis, regulatory environment, product potential and risks, patents (age and legal challenges), track record, and long term trends affecting supply and demand. A fundamental analysis may study the current share price, but only to ascertain the price-to-earnings ratio compared to long term prospects. That is, has the market bid the stock up to a price that lacks a basis for long term returns? Does fundamental research include an analysis of history and trends? Sure; a bit. For example, a good market analysis takes into account the evolution of consumer demand and the likelihood of continued demand. But this is very different than the “trends” that interest technical proponents.
- A Technical approach tries to divine trends from recent performance—charting statistics and pointing to graph traits such as resistance, double shoulders, candlestick patterns and number of reversals. This approach eschews a fact-based analysis of customers, products and market demand. Rather, it is based on past unit value—astrological hypotheses and superstition related to numerology. (If the tone of this definition seems sarcastic, it is because technicians try too hard to frame their alchemy as a serious art—and many have deluded themselves).
Do you see the difference? Fundamental analysis is rooted in SWOT: A study of Strengths, weaknesses, opportunities, and threats. Technical analysis dismisses all of that. If technical jargon and approach sound a bit like a Gypsy fortune teller, that’s because it is exactly that! It is not rooted in revenue and market realities. Even if an analyst or adviser earnest, the approach is complete hokum.
I have researched, invested, consulted and been an economic columnist for years. I have also. But until now, I have hesitated to call out technical charts and advisers for what they are…
Have you noticed that analysts who produce technical charts make their income by working for someone? Why don’t they make a living from their incredible ability to recognize patterns and extrapolate trends? This rhetorical question has a startlingly simple answer: Every random walk appears to have patterns. The wiring of our brain guarantees that anyone can find patterns in historical data. But the constant analysis of patterns by countless investors guarantees that the next pattern will be unrelated to past ones. That’s why legitimate economists call short term movement a “random walk”. Behaviorists and neuroscientists recognize that apparent relationships of past trends can only be correlated to future patterns in the context of historical analysis (i.e. after it has occurred).
TIP: If you still believe in technical
analysis, reread that last sentence
Decisions based on a technical analysis—instead of solid research into fundamentals—is the sign of an inexperienced or gullible investor. Some advisers who cite technical charts know this. Technicals have no correlation to long term appreciation, asset quality or risks. They only point to short term possibilities. Even here, there is no correlation.
The problem with focusing on short-term movement is that you will certainly lose to insiders, lightning-fast program trades, built in arbitrage mechanisms and every unexpected good news/bad news bulletin.
If you seek to build a profit in the long run, then do your research up front, enter gradually, and hold for the long term. Of course, you should periodically reevaluate your positions and react to significant news events from trusted sources. But you should not anguish over your portfolio every day or even every month.
- Know your objectives
- Set realistic targets
- Research by reading contrarians and skeptics (helps avoid confirmation bias)
- Study comparables and reason through the likelihood that another technology or instrument poses a threat to the asset that interests you
- Then, invest only what you can afford to lose and don’t second guess yourself frequently
- Use dollar-cost-averaging. It reduces risk of end-point volatility
- Reevaluate semi-annually, when significant new information arises, or when meeting with direct sources of solid, fundamental information
Finally, if someone tries to dazzle you with charts of recent performance and talk of a “resistance level” or support trends, smile and nod in approval—but don’t dare fall for the Ouija board. Send them to me. I will straighten them out.
Who says so? Does the author have credentials?
I originally wrote this article for another publication. Readers challenged my credentials by pointing out that I am not a academic economist, investment broker or financial adviser. That’s true…
I do not have a degree as economist, but I have certainly been recognized as a practical economist. Beyond investor, and business columnist, I have been keynote speaker at global economic summits. I am on the New Money Systems Board at Lifeboat Foundation, and my career is centered around research and public presentations about money supply, government policy and blockchain based currencies. I have advised members of president Obama’s council of economic advisers and I have recently been named Top Writer in Economics by Quora.com.
Does all of this qualify me to make dismissive conclusions about technical analysis? That’s up to you! Wild Duck is an opinion Blog. My opinion is dressed as authoritative fact, because I have been around this block many times. I know the score.
2020 Update: More about Pattern Recognition
It is easy to be lured into believing in technical analysis, because our brains are wired for pattern recognition. Where they fail us, is in the deceptive ease with which they try to project those patterns onto future events. It is “deceptive” because an analysis of past pattern repetition leads a reasonable person to conclude that the patterns have some regularity and are therefore predictable.
But here’s the problem.
a) If you zoom in our out of any random-walk chart plotted against time, you will always find repetition of patterns, but they have a different time or magnitude expansion. This makes investor predictions utterly useless.
If the patterns are not random, then they are either:
b) driven by fundamentals, which undermines the entire art of technical analysis
c) driven by the technical analysis of others attempting to out-guess your next move. It is a fool’s errand to the max—even if you use tools of AI, fuzzy logic and chaos theory.
co-chairs , hosts the New York and is keynote speaker at . He sits on the of Lifeboat Foundation. or consulting engagement.