Why Technical Analysis Doesn't Work


  • Santa Claus came early this year.
  • At least, that is the case if you happen to be the happy owner of shares in financials, health care, industrials, coal, railroads, and construction stocks.
  • For a brief few minutes a week ago, the S&P 500 was showing a 2% loss for 2016. We are now back at a 6.8% gain.

If you had taken Cunard's round-the-world cruise three months ago, as I recommended, you would be landing in New York about now, wondering what the big deal was.

Indexes are unchanged since you departed.

In August, when the economic data was ok, the market crashed.

In October, global economic growth started to improve, and the government boosted its growth forecast to a more robust 2.9%. Shares rocketed.

Of course, it's the election, stupid. We are probably seeing the biggest market turnaround and sector reallocation in a century.

All of the sectors I listed above made their entire gains for the year in just the past four trading days!

It makes you want to throw up your hands in despair and throw your empty beer can at the TV set. All this work, and I'm delivered the perfectly wrong election conclusions?

At least you are not a large hedge fund that paid independent political consultants $100,000, only to be led astray.

Let me point out a few harsh lessons learned from this most recent melt down, and the rip your face off rally that followed.

Remember all those market gurus poo pooing the effectiveness of the "Sell in May and go away" strategy? This year it worked better than ever.

This is why almost every Trade Alert I shot out for the past five months has been from the short side. It is also why I was so quick to cover my most recent shorts for a small loss.

We are now moving from a "Sell in May" to a "Buy in November" posture.

The next six months are ones of historic seasonal market strength (click here for the misty origins of this trend at "If You Sell in May, What To Do in April?".

Most importantly, this year's "Sell in May" got you out of the best performing sectors of the year at their highs.

The other lesson learned this summer was the utter uselessness of technical analyses. Usually these guys are right only 50% of the time. This year, they missed the boat entirely.

When the S&P 500 (NYSEARCA:NYSEARCA:SPY) was meandering in a narrow nine point range, and the Volatility Index (VIX) hugged the $12-$15 neighborhood, they said this would continue for the rest of the year.

It didn't.

When the market finally broke down last Tuesday night, cutting through imaginary support levels like a hot knife through butter ($198? $192? $185?), they said the market would plunge to $175, and possibly as low as $158.

It didn't do that either.

The biggest losers?

Algorithms, which used the decisive break of the S&P 500 $208 level to go heavily short.

If you did, you lost your shirt. The market just kept going, and going, and going.

This is why technical analysis is utterly useless as an investment strategy. How many hedge funds use a pure technical strategy? Absolutely none, as it doesn't make any money.

At best, it is just one of 100 tools you need to trade the market effectively. The shorter the time frame, the more accurate it becomes.

On an intraday basis, technical analysis is actually quite useful. But I doubt few of you engage in this hopeless persuasion.

This is why I advise portfolio managers and financial advisors to use technical analysis as a means of timing order executions, and nothing more.

Most professionals agree with me.

Technical analysis derives from humans' preference for looking at pictures instead of engaging in abstract mental processes. A picture is worth 1,000 words, and probably a lot more.

This is why technical analysis appeals to so many young people who are entering the market for the first time. Buy a book for $5 on Amazon, and you can become a Master of the Universe.

Who can resist that?

The problem is that high frequency traders also bought that same book from Amazon a long time ago and have designed algorithms to frustrate every move of the technical analyst.

Sorry to be a buzz kill, but that is my take on Technical analysis.

Hope you enjoyed your cruise.
spyxlixlvbaccatJohn in Owner

Correction? What Correction?

This article was written by

John Thomas is a 50-year veteran of the financial markets. He spent 10 years as a financial journalist, ten more years trading for a major investment bank, and another decade running the first dedicated international hedge funds. Seeing the incredible inefficiencies and severe mispricing offered by the popping of multiple bubbles during the Great Crash of 2008, and missing the adrenaline of the marketplace, he returned to active hedge fund management. With The Diary of a Mad Hedge Fund Trader, his goal is to broaden public understanding of the techniques and strategies employed by the most successful hedge funds so that they may more profitably manage their own money. He publishes a daily research newsletter, and offers one of the most successful trade mentoring services in the industry. He currently has followers in 134 countries. In his free time, John Thomas climbs mountains, does long distance backpacks, practices karate, performs aerobatics in antique aircraft, collects vintages wines, reads the Japanese classics, and engages in a wide variety of public service and philanthropic activities. His career has taken him up to 20,000 feet on Mount Everest, to the edge of space at 90,000 feet in the Cockpit of a MIG-25, and to the depths of a sunken Japanese fleet in the Truk Lagoon. Why they call him "Mad" he will never understand.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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