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The Perils of Technical Analysis

|Includes: BAC, BP, Citigroup Inc. (C), F, JPM

Today was a good day in the markets. The price of the benchmark 10-year note was down a about half of a point. The Dow Jones Industrial Average was up over 200 points. These are signs of strong economic data. There is one problem. There was no such data released today. Oh sure, the Empire Manufacturing data was better than the prior report, but it missed street expectations to the down side. Besides, is manufacturing data from the New York region (not exactly a manufacturing hotbed) a good overall economic indicator? No, today's rally was not based on fundamentals. It was due to (I hate this) technical levels.

Technical analysis has become very popular during the past decade. When fundamentals do not provide reasons to buy or sell securities, technical analysis is used to provide those reasons. Technicians will look for trends and repeated phenomena to predict market behavior. Although technicians can be and have been correct, technical analysis can lead to trouble down the road.

Trading or investing using technical analysis may lead to self fulfilling prophecies. In other words, if technical analysis says market levels should rise further in dramatic fashion if a certain market level is reached and people enter that market to buy because of said analysis then the analysis appears valid. The prophecy was self fulfilled.

The problem with this is fundamentals eventually come into play. At some point, real life, actual data, matters. Ask the modelers who created asset backed deals using historical data and trends or economists who have been warning of a return to double-digit interest rates for years because of some trend found by cherry picking a historical time period. Peter Sorrentino told Bloomberg News:

“No one disregards technical analysis now. If they do so, they do so at their own peril."

I counter, those who rely too much on technical analysis while ignoring fundamentals do so at their own peril. Reality always wins out in the end.


Disclosure: Long TBT, F, BAC, C, FREprZ, SIRI

Disclosure: Long TBT, F, BAC, C, FREprZ, SIRI