Want To See Voodoo? Talk to a Techincal Stock Analyst

Stock charts can be fun. There’s all kinds of lines, shapes, colors, arcs, rainbows.

You name it, there’s a chart pattern for it.

Head & Shoulders. Double top. Double  bottom. Sounds like a shampoo or soap commercial.

But at it’s core technical analysis – or the attempted interpretation of an assets price/volume movements & trends in effort to select future position in that asset for profit – amounts to voodoo. And it’s not really investing in any sense of the word. It’s a pure speculation in hopes one can outguess other participants moves based on historical patterns of activity.

From a time/fund allocation standpoint it’s completely absurd.

You look at a stock chart…it’s like trying to read the tea leaves.

“What’s the market going to do?” you ask the tea leaves.

With technical analysis, you’re pretty much saying that the past price and volume behavior of the stock market can tell you the next move it will make. You will often be wrong. But that’s OK, say the technical analysts, the stock is just ‘resisting’ a certain price point. As if the buyers and sellers of the particular security were only using price to determine whether to buy or sell, instead of the underlying fundamentals of the asset or myriad other reasons.

Technical analysis can work wonders if you live in the land of self-fulfilling prophesy-ville. Here’s what I mean:

You can take any chart pattern in the past and make it suit your analysis. Head & shoulders? Double top? Just give me a chart and I will show you how to prove it true.

Here’s an example of what a “double top” would look like.  A clear bearish sign, right?

Here is a cross section of an AAPL chart from 2011. If we looked at the chart around late March of 2011, we would have (maybe) spotted this “double top” and sold.

Well, here is how that played out over the next 6 months:

You can see the cross section from which we took the “double top.” We could save sold at perhaps $360/share in late March and thereby avoided a collapse to….about $315/share by late June (about a 13% slide). But…here’s the rub…the stock rallied to $420 within only a few months of this imminent “bearish” chart pattern. Where was the “buy signal” to get back in? Not found according to any conventional technical analysis wisdom.

All I am trying to illustrate here is that you can look at historical charts and invent all kinds of reasons & rationale for the markets action on any given asset. You can find similarities and draw conclusions…but this is only with the gift of hindsight bias.

Also, if you want to look at the past and use it for a indication of future results, you have to assume that all factors and situations that were present when the past decisions were made will repeat themselves perfectly as well. This never happens.

“Oh…but Adam, it doesn’t have to perfectly replicate…it just has to have some similar characteristics.”

Indeed, with technical analysis, you’re saying you are going to be able to make money in the market because you will be able to out-guess all of the other  participants buying and selling action. If you can just ‘stay in front of the curve’ you can skim a few points in profit.

What a hard way to try to eke out a living. Maybe it’s more exciting then slogging through 10-K footnotes, but it’s not as profitable.

Instead of learning to evaluate and purchase an interest in a business or loan money to that business, technical chartists  try to make money by guessing what a bazillion other computer algorithms and Pepto-Bismol chugging Bloomberg terminal addicts will do. Good luck with that.

Studying price and volume ultimate tells you nothing about the underlying asset. It only tells you what the a market’s opinion is.

Technical analysis lies in the ether between value investing and the EMT (efficient market theory) schools of thought. If you’re a value investor, you don’t care what the price/volume action is if you are purchasing a significantly undervalued asset. If you are an EMT subscriber, the asset is efficiently priced given all publicly available information, and thus looking at price/volume action will tell you nothing.

 

 

 

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