Do you believe in the validity of chart analysis or is it all mambo jumbo and all a confidence trick?

Question

Those who make presentations on the subject are of course "predicting the past" and are always right !
But whenever I try it on current prices, I find that the lines can be drawn any way you like.

What is your opinion?

Answer 1

Several years ago, I gave several 'technical analysts' a group of stocks charts with the names and dates blanked out, and with the last 18 months data blanked out too. I asked them to give me buy or sell recommendations. Results were slightly worse than random.
I wouldn't call it mumbo jumbo or a confidence trick, just self-delusion.

Answer 2

What a lot of people get caught up in is the argument of one being better than the other. For instance, the posters that say fundamental analysis is the way to go or the be-all-end-all can be deceptive. For example, during the late 90's the fundamental data said that gold should have been a buy. Why? gold was trading below it's production costs and gold demand was outpacing supply by 2000 to 2500 metric tons per year for several years running. But, gold prices kept falling.

Both Technical & Fundamental analysis have their good points and bad points. Neither is the Holy Grail. What you must remember is this: all trading is is probabilities. A good trader is looking at the probability that something will happen in the market.

Let's take a none trading example: Let's say that a friend of yours tells you a girl likes you and would like to go out with you. Now, what is the probability that that is true? We'll, unless the girl specifically told your friend directly, we don't know. But let's say, in addition to your friend, 4 other people say the same thing and when you see her, you notice that she brightens up when you walk into the room. Now, what is the probability that she does indeed like you? Very high. Granted, there is always the chance that everyone is wrong and what you're witnessing is a misinterpretation, but with that much positive data coming at you, the chances are very high that she does indeed like you.

The same thing applies to trading. I am a technofundamental trader, I use both. I use the fundamentals to guage my long term perspective of the market. I use technicals to time my entry and exit points.

For example, let's say that the fundamentals are telling you that gold is a good buy because of the geopolitical tensions, central banks have halted their gold sales and demand is spiking. That gives you a good long term perspective as to what gold should be doing. Now, you look at price charts and you see that according to the COT numbers, the commericals are now net long on their purchases, Open interest in falling, prices have made a double bottom, momentum indicators are making higher lows and price action has broken strongly above key resistence. All this data is a strong indication that the probability is high that gold prices should rise. Yes, there is a chance it won't, but if there are multiple data points telling you that prices should rise, the chances are much higher that they'll rise as opposed to fall.

When I write options, I use a probability calculator to determine if I want to take a trade. For example, if I'm looking at an option that expires in 3 weeks and based on the price of the underlying, the implied volatility, time till expiration and price of the underlying relative to the strike price and it says that there is a 83% chance the option will expire worthless (in options writing, you want them to expire worthless) than I'm probably going to take the trade if the reward is high enough. If the calculator says there is a 72% chance, now, I'm going to have to look closer as will the potential reward outweigh the increased risk.

The bottom line is neither technical analysis or fundamental analysis is the be-all-end-all. Anyone that tells you that one or the other is "IT", they are myopic in their views.

I've used technical analysis with great success, but I do know that it is just a tool and not that holy grail of trading. The same thing with fundamental analysis. I've used fundamentals to guage long term views with great success, but again it is just a tool. I've seen where both of have been right and where both have been wrong.

I don't trade against the fundamentals and I look for multiple technicals to confirm whether the trade has a high probability for success.

The best tool you have at your disposal for trading is your brain. Don't get trapped in the notion that there is a sure shot methodology or that fundamental is superior to technical or vise versa. They are just tools. A hammer in the hand of a master violinst is of no use, but in the hands of a master carpenter it is.

Answer 3

I've read a lot of TA books, I think people have a strong tendency to pick "patterns" out of randomness but there is definitely some validity to it. For one, it works because people think it works, self-fulfilling. There are PLENTY of hedge funds who use TA to make trading decisions and do very very well. Trading in my opinion is about setting extremely rigid rules, convincing yourself that whatever setup you're using does have a tendency to work, and never deviating from your plan. If the patterns you're using can't be identified with numbers instead of lines, then it probably won't work for you because it will be way too ambiguous. A good exercise with TA is to look at a chart and point out all the ways that the pattern does NOT hold up. Your mind has the tendency to do the opposite and that's why most people fail. If you prove why it doesn't work, you're on the right track. And get all the Market Wizards books by Jack Schwager, those are really entertaining and informative, lots of discussion about TA. Overall I think anybody who dismisses it completely is definitely wrong, but if you're just using it to draw trendlines and you don't have rigid rules that identify the chart setups, you won't do well.

Answer 4

I would not totally discount technical analysis. In my opinion, one should first look at the fundamentals and then at the technicals. If the fundamental appear sound and the technicals also appear sound, then chances are that it will be a good investment. If the fundamentals appear sound but the technicals are weak, in my opinion there is some problem that is not recognized in the fundamentals.

There are litterally thousands maybe tens of thousands of traders that trade on the technicals. They all can not be loosing money, or there would not be such a following.

I have purchased technically weak stocks based on good fundamentals. 7 times out of 10 I closed out a loosing position.

Answer 5

Chart analysis can be useful and pretty accurate; it really depends on what type of analysis you use. For example, for stocks, MACD, money flow, and stochastics are pretty good indicators for when to buy and sell. It's part of what InvesTools are based on, and so far I'm generating pretty good returns. However, nothing is foolproof or 100%, use common sense. For example, if a company has declining revenue (ie losing money), it doesn't matter how much chart analysis you do, you're probably going to lose money if you invest in that company.

Answer 6

Chart analysis helps in selecting your entry price or rate + Stop Loss or Take Profit level.

ou should start off by looking at the fundamental first. For example if you are looking to buy EUR against USD, you will have to focus on issues like interest rate differential, geopolitical issues etc. After you decide on the direction or view, you use chart to find the ideal entry level.

remember, pure chartist do not bother about fundamental at all.

There are always things, which I will classified as 'Event Risk' that could swing the market.

http://www.dreamsatwork.com

Answer 7

Wow. I can hardly believe what I am reading. Technical Analysis doesn't work???
Omigod. Did you people just fall off the truck or what? I don't know who you have been talking to or who these PhD types are that can't read a chart but reading a chart is as simple as it can be.
The Japanese candlesticks tell the story for you and, following the trends, you can see where the next few months lie. Not necessarily tomorrow or today but soon, anyway.
Using Technical Analysis for day-trading is silly, I would agree. But for longer term trends, you have to look at the charts.

One chart is worth a thousand financial statements.-
Old School Wall Street (mighta been Dow himself...)

Answer 8

You can probably lose as much money with technical analysis as you can with fundamental analysis.

Neither are very good about predicting the future, and both are subject to considerable subjective interpretation and bias.

I am not a fan of how technical analysis usually gets presented and/or described and/or critiqued.

But technical analysis can be very useful for money and position management.

Answer 9

There is a reason why technical analysis isn't taught in MBA or PhD finance classes.

There is some predictability in stock prices (momentum) -- but it is minimal, and mainly seen in small companies with little or no analyst coverage. But studies find that information -- especially good information -- works its way into price very quickly.

Technical analysis works about as well as a random walk.

Answer 10

Technical analysis does hold some validity. TA can help a great deal in timing your entry and exit points. Most of the mistakes made due to TA is using to many TA indicators at once, not having a system of confirmation, and simply not having a system at all.

Answer 11

The only way they would work would be as a self fulfilling prophecy. You have so many "traders" that buy and sell with the charts that the stock might might move with their buying and selling. I'm think it's a useful tool, but basically believe in fundamental analysis.