Business

Is Technical Analysis BS?

Is technical analysis BS? To save you time, my answer is: Yes, No, and Maybe.

Why did I choose this topic? (because my LinkedIn connections told me to!)

There are a lot of misconceptions and misunderstandings when it comes to technical analysis. It’s not uncommon to see it treated with derision (hence the title), and dismissed and discarded. But is that behavior justified?

Technical Analysis
By Allan Ajifo [CC BY 2.0], via Wikimedia Commons
Technical Analysis

My own research company, Topdown Charts, is sometimes mistaken for a technical analysis shop. I’d say first of all that I will use any and all factors relevant to forming a view, including technical analysis.  I’ve also spent a lot of time studying technical analysis (e.g. CMT program via the MTA).  Even then though it’s still only one factor, and the bulk of my experience is in macroeconomics and more ‘fundamental’ analysis, but I still use it.  Finally, I’ve also worked closely with experienced technical analysis practitioners in a buyside capacity.  So it’s fair to say I can give an informed and practical view.

After giving it some thought I have come up with 3 answers:

  1. No it’s not BS in the sense that it can add value to an investment process.
  2. Yes it is BS (certain elements).
  3. Yes it is BS if:
  4. You don’t understand it.
  5. You misuse it.

Why all the different answers?  I’m not trying to avoid the question or cover my bases, these answers are all make sense and can all apply at the same time.

So let’s go through them.

I’m going to leave you hanging on the first one, as I feel it needs a separate dedicated article (it’s going to be a practical piece with lots of pictures – something like “how TA can add value to your investment process”).

So let’s start with number 2 then “Yes it is BS (but only) certain elements”.  The problem with asking (or saying!) that technical analysis is BS is that the term covers a broad and deep jungle of methodologies, and some are more rigorous than others, some more subjective than others, and some more useful than others.

To help explain this I will provide a classification or stereotype of some of the major tools and schools of technical analysis:

  1. Objective techniques
  2. Subjective techniques
  3. Laws of nature and mythology

Objective techniques include quantitative indicators such as moving averages and oscillators.  They can be programmed into a computer and are formulated using specific, quantitative, testable rules.  These are not BS, and these can add a lot of value to a fundamental focused investor or serve as the primary signals for a short-term trader. Further, there is often some logic or intuition underlying it e.g. crowd psychology. The BS detector barely registers on this end of the spectrum, except where a quantitative tool or rule is developed, tested, and proven to be useless.

Subjective tools are a bit murkier, they are less testable, and while most trained practitioners will look at the same chart and agree on the presence of a certain pattern there is scope for variability in its implementation.

Subjective tools include chart patterns, trend lines, concepts such as support and resistance and waves.  The BS detector starts to beep at varying volumes when passed over some of these techniques.  My view is there can be a lot of value in chart patterns despite their subjectivity as they can help in understanding trigger points and the psychology of the market.

Laws of nature and mythology include various techniques that have nothing more than faith-like belief in certain universal numbers and patterns, astrological events, points and figures, and other forms of esoterica that don’t seem to have any real intuitive reason why they should work.  Maybe people can make money with these techniques, and good on them if they do, but the BS detector tends to start beeping louder as you approach this corner of technical analysis techniques.

So it should be fairly clear that “Technical Analysis” encompasses a diverse body of knowledge and tools – which naturally is going to make the answer nuanced.

On to number 3 – YES it is BS if:

You don’t understand it: It goes without saying that if you don’t understand it you won’t get any value out of it and you won’t be able to determine the useful from the non-useful, the subjective from the objective, or the mythological.  The point is if you haven’t even investigated or studied the basics, it might as well be BS.

You misuse it: A variant of the above, this is like the classic chart you see on the internet with a dozen different lines and all sorts of mark-ups on the chart.  Firstly – rule of thumb: simple is best when making a chart.  The problem comes from people skipping the training and education, it’s like they just start randomly using the tools in a charting package. They lack the basic education, discipline and professionalism.  I’m not saying everyone needs to do the CMT (although it is worthwhile), but people who apply it without knowing what they’re doing do themselves and the field a disservice. Again, it might as well be BS.

So there you have it. But before I wrap up, I will give you something on the first one and a preview for the next article…

Why use it? (or how it can add value)

Price moves faster than fundamentals: There are certain points of the business cycle and the market cycle where fundamentals become practically useless – fundamentals become BS at turning points because they are stale due to lags in data releases, and like price you can only really know the past. With a vacuum of fundamentals-information price-information becomes the next best alternative.

Timing matters: Sometimes you can nail the fundamental view but get completely wiped out due to poor timing; timing inherently requires that you understand what’s going on with price and that often requires tools of technical analysis.

Idea generation: The previous point is basically saying “start with the fundamentals and execute with the technicals” but this one saying “start with technicals to find something interesting and then go see if there’s a fundamental case”.

Conviction: The most valuable material known to portfolio managers is conviction – it determines whether a position is taken and in what size (and therefore risk and return); technical analysis can be used to build conviction.

As you can gather, there are some potentially valuable applications. But there are also pitfalls. Most of all though, there are shades of BS – if you were looking for an easy answer to support your black-and-white view, you should not have found it in this article. I think, and hope, that most readers who came with either a black or white view have been given pause for thought in their view.

Summary

Technical analysis is Not BS in that some techniques can add value to an investment process.  Certain aspects of it can be labelled as BS.  And it might as well be BS if you don’t understand it or misuse it.

This article originally appeared on LinkedIn: https://www.linkedin.com/pulse/technical-analysis-bs-callum-thomas