The Heretics of Finance 30 comments
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I’m not against technical analysis per se, at least not anymore. I don’t think I understand it well, but after reading The Heretics of Finance, I’m not sure anyone really does. Let me explain.
When I wrote for RealMoney, I often thought it was two sites in one. Technical analysts on one side, and Fundamental analysts on the other. Little interaction, except to snipe at each other every now and then. I’m happy to say that I stayed above the fray, because as a corporate bond manager, technical analysis helped me manage market risk better. I wasn’t sure how to apply it to equities, though, particularly post-decimalization.
I posted something like this three times on RealMoney, and aside from one private response from Helene Meisler, no one ever bit on my questions regarding technical analysis:
  | | David Merkel |
| The Two Questions on Technical Analysis | ||
| 2/22/2008 12:15 AM EST |
I received some e-mails from readers asking me to post the questions that I mentioned in the CC after the close of business yesterday. Again, I’m not trying to start an argument between fundies and techies. I just want to hear the opinions of the technicians. Anyway, here goes:
1) Is there one overarching theory of technical analysis that all of the popular methods are applications of, or are there many differing forms of technical analysis that compete against each other for validity (and hopefully, profits)? If there is one overarching method, who has expressed it best? (What book do I buy to learn the theory?)
2) In quantitative investing circles, it is well known (and Eddy has written about it recently for us) that momentum works in the short run, and is often one of the most powerful return anomalies in the market. Is being a good technician just another way of trying to decide when to jump onto assets with positive price momentum for short periods of time? Can I equate technical analysis with buying momentum?
To any of you that answer, I thank you. If we get enough answers, maybe the editors will want to do a 360.
Position: none
That’s where I’m coming from. In The Heretics of Finance, I received half an answer to my first question, and no answer to my second question. Now, I enjoyed the book a great deal; it is well-designed. The book begins by interviewing thirteen well-known technical analysts:
- Ralph J. Acampora
- Laszlo Birinyi
- Walter Deemer
- Paul Desmond
- Gail Dudack
- Robert J. Farrell
- Ian McAvity
- John Murphy
- Robert Prechter
- Linda Raschke
- Alan R. Shaw
- Anthony Tabell
- Stan Weinstein
Each chapter asks them a bevy of similar questions. As I read the first thirteen chapters, my growing conclusion was many of them all do different things, but they all call what they do technical analysis. I did get a half answer to my first question, in that many of them pointed to the books, Technical Analysis of Stock Trends, 8th Edition
The next seven chapters ask all of the interviewees the same questions, allowing them to agree or disagree with each other. The questions were asked to each person separately, in interviews from 2004-2005. It would have been more interesting to have them all in one room, so that they could debate more, and question each other.
That said, many of the questions were interesting:
- Does lack of academic support bother you?
- Can TA be learned from books, or only through experience?
- Are there universally valid TA rules?
- Is it an art or a science?
- How big of a role does luck play?
- Do those that incorporate astrology into TA harm the discipline?
- How much can TA be mechanized?
In the introduction, the authors, Lo and Hasanhodzic, saw increasing acceptance of TA by academics, sometimes directly (challenging the weak form of the efficient markets hypothesis), or via behavioral finance (how value investors do TA).
There was no answer to my second question, as to whether TA is just a way of implementing a momentum strategy. Surprising to me, Lo and Hasanhodzic did not think to ask the question. (My opinion: aside from a few technicians that like to try turning points, yes, TA is a way to implement momentum investing.)
Who Would Benefit from this Book
If you want a taste of a wide number of accomplished technicians, this book will give you that. It will also give you jumping-off points into TA literature and TA-friendly academic work describing Technical Analysis. If you are into some of the main characters in TA, this tells their stories, and elucidates the attitudes of disciplined appliers of TA.
You can buy it here:The Heretics of Finance: Conversations with the Leading Practitioners of Technical Analysis
PS — Not many book reviewers read the books that they review. They read the summary that the PR flacks send, and rely heavily on that. I throw away those summaries, and read the books. That takes time, but I like reading books, and when I wrote for RealMoney, I often missed reading books. Now I read them more, and you can benefit from that, because I don’t always endorse the books that I review.
I don’t have a tip jar, but if you buy anything through Amazon, after entering through one of the links here, I get a small commission, and your costs don’t go up. I like taking the fees out of Amazon, and not out of my readers.
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This article has 30 comments:
Re your question:
"Can I equate technical analysis with buying momentum?"
The answer may not be so straightforward. Sometimes the real benefit of using Technical Analysis is to identify opportunities in the markets where there are divergences between price and momentum. Some of the best trades exploit these anomalies where price and momentum (MACD and RSI) are not aligned.
Many traders and fund managers are fixated on looking for confirmations or validations of a particular view that they have about the future direction of the market in general, or a particular stock, and confirmations are sometimes supplied by the markets at exactly the times when the contrarian view is most warranted. One is more likely to have an edge in trading by noticing a divergence and acting upon it ahead of the majority of traders than waiting for a breakout to be confirmed.
As for ailing companies the major issue these days is political (will get they bailouts or will the government take a stake or buy up their illiquid assets etc. This also has no technical aspect to it making any ratio analysis worthless.
Last with the governments free cash policies then tight money policies like buying up all the banks cash by offering interest for Fed Funds deposits (presumably so they can afford to buy bank loans and guarantee every investment known to man including ones that are more gambles than investments) and buying up all the cash overseas for the same purpose or just to burn dollar shorters it is hard even for companies to get a good economic pulse these days.
I suppose this is why there is a distinct lack of stability currently. Likewise, technical analysis isn't a precise science simply because it changes with the times and accounting rules. And lastly, because management and employees are typically more important than cash on hand or historic earnings. Looking back has bever been a perfect way to look forward. Try driving by looking through your rear view window and you'll see what I mean (I don't reccomend it to absove myself from any liability in that statement lol).
Which proves another point, even in stable economic times TA will not help you with technological advancement or legal issues like patents and antitrust suits thus making it a crude science at best. It is in essense a good minimum threshold for you to make value judgements (banks with no cash is not good, companies with no earnings tends to be volatile, companies that don't grow need to have either a decent dividend or some future growth driver going forward they didn't have before, etc.)
The market right now is almost completely technical. People are in a state of panic, and traders are ruling the floor.
That is: you're looking at a system which is far too complex for a hard, mathematical analysis. So all you can do is look for features of that system you can identify consistently and then test then statistically to see if they relate to something that has deeper meaning.
To a strict fundie, when a stock goes down, it gets more attractive. But that assumes something and forgets something else. First, the fundie's analysis assumes that he has all the objective facts available. Not so. Other people may have better facts. And when a stock goes down it is also *going* down, meaning that the stock is being rejected by a significant number of humans who potentially the same or better knowledge and intelligence. Seeking to observe those humans and observe whether there a new consensus is developing about the stock is the same as looking out for new information.
My take is that by choosing the time scale or diddling with some parameter one can get a technical analysis to support (pun intended) a wide range of outcomes that are mutually exclusive.
In plain English: It is all rubbish and vodoo.
It is like any other science, you can't operate as experienced surgeon does even if you are graduate of best medical university.
Same regarding trade, you can't make money if you don't have a working experience.
It is known that technical analysts make money selling their services on CD's, subscriptions, books- They don't make money out of their knowledge.
I came upon hundreds of websites that sell magic software promising fast buck, but I ask: If your software is so powerfull that makes a lot of money, why you sell it? Why you don't use it yourself?
I found that only people who know the markets are 60-80 years old and they often don't know what is Fibonacci, Elliot Waves or Kondratief's cycle but living long enough on earth they know that markets are driven by greed, fear and pressure and they exploit this simple mass instincts for their investment decisions.
They buy when you are broke and bankrupt, they sell when you are excited.
Don't trust any technical analyst, trust any 80 years old investor instead.
Simply speaking: I do not get into the argument between the value of
fundamentals and technical approaches.
Neither are mutually exclusive.
If you intend to long a stock, it is sbest you study the financials(fundamental... and its current place in the market(technicals) relative to sector.
I use indexes as a macro, and fundamentals and technicals as a micro approach.
Professional TAs, I think, focus on more esoteric indicators than most traders. You've got to know the formations and indictors the way antique and jewelry dealers memorize catalogs. Not many people have such memories or work ethics, and I don't know that the TAs out trade the rest of us. Indeed, there is research that shows they usually don't. See David Aronson's great book, Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals. www.amazon.com/Evidenc...
The other question you have to ask, TA of what? The next tick, minute, hour, day, week or year? I look at charts to see daily, weekly and monthly action intending to swing trade for nice gains, not to scalp the market.
How do TAs use their knowledge and experience---for day trading, swing trading or value investing?
seekingalpha.com/artic...
Interesting blog. Folks should take a look. And hire you. :)
On Jan 24 09:27 PM nickgogerty wrote:
> I thought the book was a total disaster and waste of andrew Lo's
> time. I had high hopes as Lo is very good. I posted a critique which
> may be of interest here. nickgogerty.typepad.co...
the world of financial markets.
to me the fact that a typical day will reveal a 10-15 percent move in
many a mid cap stock these days, and perhaps a 20 percent move
over the course of a typical week, means anyone not paying attention
to the technicals is lying or clueless.
to me technical analysis equals nothing more nor less than the study of price movements over time.
how one studies price movements is the methodology of technical analysis. why one uses certain tools over others is tied to theories
of these price movements.
i do not believe technical analysis and its role in financial markets can
be denied.
fundamentally, the reason a trader or investor needs to understand some basic concepts of technical analysis is because the financial markets are largely run by people relying on technical analysis for their trading decisions.
of course, every day one sees that part of what makes markets move up and down is the time of day.
a trader not paying attention to the time of day when assessing price action will not last very long.
Spend a day watching price and volume action on a screen. Using say a 5 minute time frame watch as price is painted on the screen. (I prefer candlesticks though bars will do just fine.)
You'll notice several things: firstly, there is no way (in my opinion) the fluctuations, even on a quiet day, are driven by anything other than emotion (and emotion is not random). Prices go up or down and then after a while when the emotion is washed out they stabilize and are range bound. And then after some cogitation the market moves again. (This is the approach argued by Sam Weinstein.)
And so it goes. Of course, the EMH suggests these movements are random, but they are not. Prices tend to frequently stop or reverse at levels - support and resistance - because everybody else is looking at the same levels. And often previous support becomes resistance and resistance support as traders 'remember' areas where they should have got in or got out.
Perhaps the simplest form of TA is the moving average. I use a 45 period moving average on the weekly S&P as my overarching direction indicator. It clearly shows that there had been a directional change in late 2000 and again in late 2007. I got out of the market relatively unscathed using this approach in late 2007 and rode the market down with QID quite profitably. (I suppose this is a kind of momentum play, but even with momentum plays entries and exits are important.)
I make no claim that TA is the holy grail of trading, but I do find that it provides a simplified intellectual framework for looking at the market that Fundamental Analysis does not.
My view is that TA is closer to painting than to some yet to be discovered scientific principles for the market. The market, like art, is driven by what one sees and experiences. And no two people see it the same and yet, inexplicably, some paintings and artists produce consistently good or even great art.
So it is with trading using TA.
The realy big moves will happen in a stock when fundamental analysis coincides strongly with the TA. From experience i know to be realy wary of trading on positive fundamentals when the TA is showing opposite signs, though the opposite can not be said. TA definately rules the roost for the big players IMO.
Conventional investing wisdom states that you should never let emotion enter into your investment decisions. We all know that, and at one time or another, we all break that rule. It is human nature.
The way I approach an investment or a trade, is to use both FA and TA. When you stop and think about it, they are giving you different perspectives on the same investment. Sooner or later, if you try to fight fundamentals, you lose. The same can be said about sentiment in the short term. In the long run, investors will catch on to what is happening at the company and sentiment will reflect that, and it will revert to the fundamentals. In the near term, and I am suggesting a period of up to two quarters, it can be just as foolish to fight sentiment (read TA), because irrational or not, the pain of watching your position deteriorate can still put you out at the bottom.
because momentum is a high tendency to repeat, TA can identify that. with a sideways market, caught between relatively stable extremes, TA oversold and overbought has a predictive nature of movement back and forth between extremes, or predictive that the momentum will not continue in its current direction at the extremes.
time frames are independent. . meaning the concepts can be applied to many different time frames.
This gets into the question of "private information" and its impact on market prices, though, because if TA could foreshadow bad news (or good news) coming out, who was doing the selling (or buying) and how did they make their decision?
My own experience leads me to believe luck has an incredible impact on a trader's performance. That said, I do like TA because it gives me an objective way of setting a stop and limiting my risk.