on why technical analysis is (largely) bullshit

No, I am not certified to give financial advice, but here’s an amateur assessment on a common trading tool.

Technical analysis is based on analyzing past prices/volume, as means to forecast future prices. People generally believe that they can predict events if given enough time and analysis, seeking to extrapolate trends and patterns. Of course, we don’t aspire the next financial guru but we generally like the predictability and stability of everyday life. In the context of TA, we would very much like to know where prices are heading, for obvious reasons.

1. I seriously doubt the MACD line or any other indicators would converge and give a clue about what happens today. If we have had 9/11 numero dos today, do you open your charts and look at the preceding trends? TA does not discount new information. I think a good stop-loss strategy is miles ahead in importance.

2. Fancy names like ‘shooting stars’ and ‘technical rebounds’ in actual fact, produces little predictive value. For example, yes, stock XYZ yesterday could have tested the support of 98 cents, at a resistance of perhaps $1.04. That was yesterday, noting the retrospective element; the only truth is the current price, met by supply and demand and the current market interest in a given security. You are better off reading the sales tape, which reveals market direction and interest upon inspection. The sales tape also reveals which bugger decided to offload $2 million worth of shares at the bid price, which provides more credence than incomprehensible lines (which you spend 5 minutes reading and missing the boat).

3. History tells us that we are horrible predictors of events. The presence of ‘black swan events’, as coined by Nicholas Nassim Taleb, renders many forecasting tools, especially Value-At-Risk, suspect. When 9/11 hit, we were asking ourselves this: why the fuck didn’t we see that coming?

4. Empirical evidence points towards inconsistency in generating economic profits based on TA, due to the joint hypothesis problem, where the ambiguity lies in 1) whether the market is inefficient and 2) the market model capturing risks is wrong. Economic profits, if any, are usually wiped out by the large transaction costs involved in buying/selling upon signals (like when the ST moving average crosses the LT moving average etc).

5. However, many traders (mostly retail/liquidity) really heavily on such technical indicators. As such, if a significant portion of the market execute trades pegged to the technical resistance, it will create a price reference reflecting the average position of the market and hence, a self fulfilling prophecy.

6. Point 5 is my own point of view, not meant to generate any sort of controversy. Adding on to point 5, if I were a major hedge fund/bank/securities firm, such a trend could be exploited. If I hold a large inventory of a particular stock and knowing the support level, I could perhaps say, unwind my position (taking profits) and match the bid price. As supply exceeds demand, the prices will fall (even to the point where it breaks the support level). After the dust settles, I could then buy back the stock at a significantly lower price (a common trick used by the big boys) and of course, report a much higher yield to your clients.

You shouldn’t be surprised that your own securities firm takes an offsetting position against you; how do you think they account to their own shareholders? I had a chat with my broker once and I told her my views; she gave a hearty laugh without disputing my comments. Not too sure as to what that means but, something for thought.

In short, technical analysis has gaps large enough that a truck could drive through it. If you know enough about it though, like the big boys, you could exploit the predictable behaviors of people.


3 thoughts on “on why technical analysis is (largely) bullshit

  1. Technical is simply bulls***. Even astrologists are more realistic or the Mayans had been more convincing till the end of 2012. It is scientifically proved by Eugene Fama that even in weak form of efficient markets, trading with the historical prices data can not make one gain excessive profit. You can do the same profit in roulette, in other words technical analysis only works when you are lucky. Just use technical analysis if you are lazy and do not have risk aversion.

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