tech analysis and EMH

I’ve only taken CFA l1 so far, but im curious about the effectiveness of technical analysis and the EMH. If EMH is infact correct, wouldn’t it dispell any use of technical analysis? But i’ve also see that people continue to do tech analysis, so theres gotta be some reward for doing the tough work?

Don’t forget the fact that EMH is a hypothesis

Academic economists love the idea of efficiency. If things are efficient, then there are all sorts of equation manipulations and optimizations that become much more difficult if things aren’t efficient (for one, you have to figure out what kind of inefficiency there is, and how to model THAT). When you think of how many human systems you know about that are actually efficient, it becomes easier to understand why the market efficiency hypothesis may just be an approximation, and possibly not a very good one at that. Now, granted, the market does appear to be reasonably efficient, at least in the large-cap developed world, and in the age of the internet, that’s more plausible than it was 20 years ago. Remember also that TA may be more effective at some time frames than others, in some markets more than others (for example, it’s very hard for the real estate market to be efficient, because of transaction costs and liquidity), and some types of TA may be bogus, while other things work.

what i don’t like about TA is the underlying logic or lack thereof. granted i haven’t read any TA book in full, if somebody can explain to me why after a certain pattern occcurs, another respective pattern is suppose to occur? when i hear a TA on BNN talk about, “the stock has to go down from here, we have seen a consolidation pattern and the candles blah blah blah” i scratch my head and wonder if these people are really serious. Its kinda like predicting a boxing fight based on the colour of the trunks a boxer is wearing. the closest that I’ve gotten to an answer is through socionomics and their Elliot Wave theory. From what I know, they have no underlying reasoning for why that is the case, just that it is said to occur. I believe TA is grounded on the same principles, which is, “it just happens, its the way of the universe, we don’t know why”. To me, its more like data mining. Research shows that TA does not work. Any comments?

I’ve always looked at TA as just colorful lines for idiots. The only logical support for it relies on the volume of people who use it…it’s a self-fulfilling prophecy.

Dont forget, if the market is strong form efficient under EMH or even semi-strong form efficient, fundamental analysis does not work to generate abnormal returns as well as technical analysis. They both are useless. Therefore every portfolio manager and anaylst on the buy side are contributing nothing and will never beat the market. In fact most of them, if not all under-perform adjusting for risk and fees. So they should not have jobs at all as they are not accomplishing anything. But the fact that they have jobs implies the market is not always efficient and is quite irrational at times. I suggest you read a really good book called - “The misbehavior of markets”

malnoll Wrote: ------------------------------------------------------- > I’ve always looked at TA as just colorful lines > for idiots. The only logical support for it > relies on the volume of people who use it…it’s a > self-fulfilling prophecy. I definitely don’t like to call or classify people as idiots. But the people that i have encountered that take TA as gospel, I’m questioning their reasoning skills. they all seem to be people who are unable to do any calculations but are looking for a way to make a easy buck. However, I can’t say the people that I’ve encountered are the best representatives of that school of thought. however, it seems the trading departments of some prestigious firms have TA holding high positions. EVERY TA that i have met claims to have made money and that they’re super talented. When i ask some basic questions, they can’t give an answer. As of now, I view them as purely as speculators. I see them as the type to say, “its going to be a head the next time” simply because tails happen to appear twice.

I completely, utterly believe that TA can make money in markets and I have been around literally billions of dollars in gains from TA. I can answer any of your questions and am willing to do so. Also, “unable to do any calculations” does not apply to me.

JDV, that is good to hear. JDV, I know i should be doing some reading on my own as well but I’ll go ahead and ask away. First of all, why should TA work? is it because everybody does it (self fulling prophecy)? why should we expect to a see a fall in prices if a certain pattern has presented itself. To me, when someone said, “this stock is going to rise/fall because we have seen a consolidation pattern”, i want to ask “why”. what is your opinion on Elliot Wave theory?

Here is some stuff I have written on TA (and other topics) that might interest people. h t t p : / / t i n y u r l . c o m / 3 6 g p 9 o (remove intervening spaces to get to URL - this board occasionally scrambles URLs without the spaces) I’m not too familiar with Elliot Wave theory, and the little I’ve seen sounds strange to me (things like “there are always five waves,” etc.). However, in my mind, patterns correspond to “moods of the market,” and ultimately to the a kind of power struggle between bulls and bears. It’s not so much that one pattern necessarily follows the other, but that some moods are more stable than others. The key signals are actually when patterns fail and one portion of the market - bulls or bears - has to re-evaluate their thinking. Those are the moments that you may be able to catch a trend or countercycle. It’s not recognizing what pattern is forming so much, but recognizing when a pattern has broken.

I was just curious about the topic, as someone from my university is showing the RSI charts of C as the evidence for his shorting of the the stock. I argued back saying that, in the long run, TA will not be more beneficial than hold and behold strategy. Hmm, JDV, can you give some insights to why you said TA will work?

I need to be more awake for this - tomorrow I’ll address those questions

I believe TA is a great complement to active management. Pick a great stock (or sector) and then study the charts to know when to make positions. Also, and I’m sure there will be opposing positions on this, I believe that some of Harry Dent’s theories on economic cycles based on generation life patterns has equal merit.

i just want to understand the underlying logic in TA. Sure, if everybody is going to be selling given certain signals, then great. But if that is the case, then this isn’t investing at all, but a game of a different sort. For instance, why do stocks exhibit the head and shoulders pattern and why should anybody believe a graph of certain resemblance should be an indication of anything at all? we anticipate your reply JDV

OK - A few points here: 1) In some ways Frank is right. There is TA out there done by fools who can’t do anything else - can’t gather data, can’t read a balance sheet, can’t negotiate a trade but they can look at a price stream and say some arcane mumbo-jumbo and issue a buy-sell decision. This is total nonsense and it’s the stuff that gives TA a bad name. 2) TA isn’t magic anymore than any other kind of analysis is magic and I am only claiming that technical analysis can be used as a tool (even the primary tool) in making trading decisions but it is worthless without other tools such as portfolio management, trade execution, risk management, etc… 3) Most “tests” of TA are unfair. For example, the ones I run into the most are the “tests” in “A Random Walk Down Wall St” (a wonderful book, btw) where Malkiel (or whoever) shows sample paths of a random walk to some TA who separates them into buys and sells. Arg. What Malkiel doesn’t mention is that he would be right 50% of the time and all we’re going for here is something like right 55% of the time, or right 50% of the time on lucrative trades and wrong on not very costly trades, or any number of other combinations. TA is useless on random walks but so is everything else. It’s just that some analyst agreed to this deceptive test that caused the problem. 4) I can’t claim that TA works on all asset classes. In particular, TA will not help at all (I guess) in real event-driven trading. TA won’t help at all when a plane hits a building. 5) Everyone believes in TA at some level. Suppose that I show you two price streams that end at $20/share and one is relentlessly declining and one is courageously rising and ask “Which stock would you rather own?”. If you are a true believer in the CFA curriculum, you ought to shrug and say “No opinion”, but your gut tells you otherwise. Does anybody think that their further analysis of this company will not be affected by what their gut (their “intuition”) is telling them? And if this really mundane psychological process happens in everyone, might there be clues in the price stream for how the collective guts are going to price the stock going forward? And if we share this psychological process, might we share lots of others? Is there anything more psychologically cogent than a price stream? 6) TA can work on levels beyond any of this “head-and-shoulders” garbage. Continuing with the previous example, suppose that those two stocks have a correlation of -0.25 because one is a consumer of some commodity and the other is a producer of a maybe-related commodity. If volatility picks up in the commodity markets, what happens to that correlation? A volatility option in the commodity market might cost you some money, but you might be able to produce one using the stocks that doesn’t cost you any money. It’s not close to as clean as a straight volatility option but produce enough of them and you can make a tidy living. 7) Continue with the previous example but get rid of that commodity stuff. Maybe I don’t have any idea why these stocks ought to move together because it’s just not clear what risk or risk perception is shared by these stocks. I can still do the same game and cash in on some vol option in some market that I can’t even put a name to. I don’t really care about it as long as I get paid. 8) If there is plenty of information in price streams to play strategies like above, how many more must be there that I don’t know about?

JDV, thank you for your post. with regards to your (5), my answer would be to look into the companies at hand. I would actually be more suspicious of a stock giong up then going down. I have been brainwashed by graham. Your example is definitely more sophisticatd then what I had in mind. but when you say that you do not care why it happens, so long as you make money, that is when it gets into the speculation area. I have to know “why” it works because you would like to know when it does not work. the people i work with are all saying, “china mobile” because of that convergence triangle". which book would you recommend on this subject? something not too technical but for the layman.

Do you really have to know why? (I’m sympathetic, but you might want to work on this). For example, we know that there are a bunch of factors in stock prices - energy prices, credit spreads, interest rates, land prices, global turmoil risk,… and then a bunch of more ethereal factors like risk aversion, price of delayed consumption, fear of unemployment, etc. I can’t decompose a stock price into these factors in any way that I really believe because of the usual factor problems (I don’t know what they are and I don’t know how many there are and I don’t have good data on the ethereal ones). But maybe that’s just an academic problem and if I can just accept that the exist and are expressed in ways I can make money then the identification problem is left to someone else. The China thing is a good example of something 1-part real and 1-part psychological. You can make money on both parts, but the first part is easier if you are Chinese and the second part is easier if you are around the money saying “China mobile”.

Oh, and what do we have to do to get a Mayweather-Cotto fight? Suppose we all just paid for the pay-per-view before they even scheduled the fight?

I refuse to pay 50 bucks to watch a fight that will be on HBO the following week for free

JDV, mayweather and cotto problably won’t happen in 08. DLH is fighitng mayweather again in september and mayweather wont’ risk it by fighting cotto in June. I put my money on mayweather if he fights cotto. easy. i just hope mayweather gets good odds. last fight with hatton on fight day they had mayweather at 1.52. that is the surest thing out there. i prefer to see cotto vs. Margarito. in terms of asking why, i think that is a very important question. to ignore it is to set yourself up for defeat to me. of course you’re a risk manager so your experience of course says a lot about your level of knowledge and i can respect that.