Does Technical Analysis Work?

Dec. 11, 2008 2:06 AM ETDSCM, AGNC13 Comments

There are three general opinions of technical analysis: (1) it is a science that works, (2) it's a pseudoscience that works because its practitioners all do the same thing when a chart is a certain way, or (3) it's a bunch of hogwash.

I'm somewhere between (2) and (3), but am more open to (1) after tracking Adam Hewison's predictions on spot gold for a couple of months. I would like for (1) to be true, as would most people, for obvious reasons.

Certain chart and volume patterns are supposed to foretell a stock's (commodity's, ETF's, etc) future price movement. Occasionally, if I come across such chart patterns I'll post about them. Then, I'll check back after a while to see how the predictions turn out. With enough such experiments, it'll hopefully be possible to either confirm or deny (3).

Since a stock can go either up or down from any given point, there's a 50% chance for each prediction to turn out correct (I'm ignoring the possibility that it'll stay the same). If technical analysis doesn't work, predictions should be right around 50% of the time. If it works, predictions will be right or wrong the significant majority of the time. What constitutes a significant majority of the time will be determined by the number of predictions made. If it seems wrong to say that technical analysis works if it's wrong almost all the time, remember that it is just as hard to be wrong most of the time as it is to be right most of the time when you have a 50% chance of being right or wrong. Put another way, if it's wrong most of the time, technical analysis can be very useful, as we can do the opposite of what it predicts.

A major

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Devin Hobbes is the author of the soon to be updated Dividends: Pros, Cons, Sources, and Strategies.

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