On March 17 ValueWalk reported on a white paper that drew the conclusion that individual investors lost money using technical analysis.  This was followed by other articles on the topic in the Financial Times and Business Insider.

Technical Analysis

Now comes a rebuttal from J.C. Parets, Founder & President of Eagle Bay Capital and co-chair of the New York city chapter of the market technicians association.  Parets makes the points that individual investors speculating with options and using a short term time horizon typically lose money regardless of the analytical method, fundamental or technical.

Technical analysis: Not comparing apples to apples

“Individual investors lose money on average, especially those that trade options,” he wrote. “This is the case regardless of how they come to their conclusions (technical or fundamental).”  Options provide investors the right but not the obligation to purchase an underlying stock at a future point in time.  They are leveraged derivatives whose price can be influenced by a number of factors such as market volatility and time decay, not just the underlying movement of the asset.

“Fundamental analysis focuses on backward looking information (i.e. last quarters earnings release),” Parets said in an interview. “Technical analysis focuses on the market itself, which is a leading indicator.”

Perhaps Parets’ most significant argument came when he addressed the time frame in the study. The Dutch study essentially compared fundamental trades with a longer term investment time horizon to those using technical analysis, which had a shorter term focus.  Short term trading “is a money losing strategy, regardless of discipline,” Parets notes.

Time frame is key

“One of the best parts about technical analysis is the ability to apply our tools across various time frames,” he wrote.  “Our ability to start with longer-term trends and work our way down to short-term charts for entry and exit points is a huge advantage. Focusing on just the short-term makes you blind to bigger trends.”

Parets thinks the study misses the point on the use of technical analysis.  “Most importantly, we use technical analysis and price behavior to manage risk. This is what it’s all about,” he wrote.  Where is the study wrong?  “Technical analysis is the best way to properly manage risk. Without looking a price, how would you be able to do that? Clearly, these Dutch retail investors are focused on hitting home runs through options, rather than just managing risk while participating in the strongest longer-term trends. That’s a problem.”

Understandable explanation

“Technical analysis focuses on price,” Parets said in an interview. “If you ignore price, how can you possibly manage risk? Where do you know your thesis is wrong if you don’t look at price. Technicians know before they enter any position, where they are wrong and what the target is. For risk management purposes, I don’t know how it would be possible if you ignore price.”

Then Parets moves to put the difference in a simple format: “In a shopping mall, a fundamental analyst would go to each store, study the product that was being sold, and then decide whether to buy it or not,” he said in the interview.  “By contrast, a technical analyst would sit on a bench in the mall and watch people go into the stores. Disregarding the intrinsic value of the products in the store, the technical analyst’s decision would be based on the patterns or activity of people going into each store.”