Let’s Get Technical

Ninety percent of science fiction is crap, but then ninety percent of everything is crap.”   

-Theodore Sturgeon

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Yesterday morning, Portfolio’s Felix Salmon had a post "Adventures in Technical Analysis, Jim Cramer Edition."

I cannot put aside the fact that Cramer is not, and has never been, any sort of technician. We do not dismiss medicine because accountants cannot do open heart surgery, so it seems kinda odd to use a bad technical call of Cramer’s — an admitted non-technician — as proof that technicals are worthless ("astrology!"). 

But what really caught my attention were the following paragraphs, which amount to the standard criticism of Technical Analysis:

"They all do it: even much smarter and much more analytical traders like
Barry Ritholtz do it too. Do what? Resort to "technical analysis",
which is the art of drawing lines on charts and extrapolating from them
what the market is going to do next.

Whenever you hear words like "overbought" or "oversold" or "momentum"
or "support" or "resistance", it means that whatever you’re hearing is
garbage. But it also means that the person you’re listening to has no idea
what’s about to happen, and is therefore resorting to the financial
equivalent of astrology. In such cases, it’s worth ignoring the message
completely, but it’s also worth having some serious thoughts about the
messenger, too."

There are so many different ways to take this down, its hard figuring out where to start. Let’s begin with a definition of what technical analysis is not:

Technicals are not magic. They are not a way to forecast the future, nor are they a guarantee of future profits. They are not based on
someone’s estimate of what future earnings might be, nor do they
require you to guesstimate management’s skill set or presume the
desirability of a new product. Pure Technicians don’t even listen to conference calls or even talk to management.

Technicals can be, however, far less squishy than fundamentals. Technicians use the data that is generated by the markets itself: Price and volume to start, then many other data points and derivatives thereto.

From this basic data, there are many variations of Technical Analysis:

• Trend followers believe markets exhibit persistence, mostly due to big institutional purchasers. This leads to buying uptrends and selling or shorting downtrends. John Henry and Richard Dennis are classic examples of trend follwoers

• Quants use a variety of mathematical data points. A goods example is the fund Renaissance Technologies.

• Contrarians use Sentiment data to determine when markets have moved to far in one direction or another. The goal is to anticipate a major reversal. See Jason Goepfert as a prime example.

• Pattern recognition traders look for various pictures — pennants, flags, cup & handles, head & shoulders, etc.  I find that this last form of TA — Pattern Recognition — to be especially prone to Sturgeon’s law above.

There are lots of other types of technicals, but this isn’t meant to be an exhaustive survey (feel free to discuss Elliot Wave, Fibonacci, and other forms of technicals in comments).

The question as to whether technicals "work" or not is actually framing the wrong issue. There is as much Art as Science in the application of TA. That some people
are lousy technicians proves only that it requires skill.

A better question to ask is "What information do charts and related data provide, and how can this be used by investors and traders?"

I posit that, when used appropriately, charts and data can provide tremendous insight:

-Provides a statistical approach to investing, one that describes the probabilities of various outcomes (versus making predictions)

-Charts show you if we are in a bull or bear market, allowing you to manage risk appropriately;

-Trends can keep you away from the wrong sectors (Housing, Autos, and Finance are obvious examples) or keep you in the right sectors (eg., Energy and Ag)

-Developing good risk/reward analyses;

-Tracking what the institutions are doing;

-Identifying specific stocks that might be appealing;

The bottom line is that TA is merely a tool, albeit one used more skillfully by some than others.

Finally, consider this question: If you could look at one and only
one
source before buying your next stock or fund, which would you choose: a
fundamental analyst’s report (with no charts in it), or any chart of
your choosing? While I like having access to both, I cannot ever
imagine buying something without first looking at the chart . . .

Note: We previously addressed these issues a few years ago in Tracking the Elephants (Part I and Part II).

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Category: Contrary Indicators, Financial Press, Markets, Psychology, Trading

Case Shiller Index Falls 15.3%

Category: Real Estate

10 Year VIX versus SPX

Category: Contrary Indicators, Markets, Psychology, Technical Analysis, Trading

Most U.S. Stocks Retreat, Led by Financials on Credit Concern

click for video

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Excerpt:

U.S. stocks retreated, sending financial shares to their lowest level in five years, on a deteriorating outlook for bank earnings. Rising oil prices pushed crude producers higher, leaving the Standard & Poor’s 500 Index and Dow Jones Industrial Average little changed.

Merrill Lynch & Co., Morgan Stanley and Lehman Brothers Holdings Inc. helped lead the drop after Bank of America Corp. cut income estimates for brokerages and Goldman Sachs Group Inc. advised selling bank shares as credit losses linger into 2009. Oil’s second day of gains pushed down Home Depot Inc., General Motors Corp. and United Airlines parent UAL Corp., while sending energy shares to their first advance in four days. American International Group Inc., the largest insurer, tumbled to the lowest since 1997 on Barron’s recommendation to sell the shares.

Almost two stocks fell for each that rose on the New York Stock Exchange. The S&P 500 rose 0.07 point to 1,318. The Dow decreased 0.33, or less than 0.1 percent, to 11,842.36. The Nasdaq Composite Index slipped 20.35, or 0.9 percent, to 2,385.74.

Source:
Most U.S. Stocks Retreat, Led by Financials on Credit Concern
Eric Martin
Bloomberg, June 23 2008
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aZ3JNXU3j5vg

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Category: Markets, Video

Post # 6,000

Category: Weblogs

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Category: Markets, Psychology

Harvard’s State of the Nation’s Housing 2008

Category: Data Analysis, Real Estate

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Category: Contrary Indicators, Markets, Psychology, Technical Analysis

Did Bank of America Write the Housing Bailout Bill?

Category: Credit, Politics, Real Estate

George Carlin (1937 – 2008)

 

Seven Words You Can’t Say on Television

And the Supreme Court decision relating to the above: FEDERAL COMMUNICATIONS COMMISSION v. PACIFICA FOUNDATION, 438 U.S. 726, 98 S.Ct. 3026 (1978).

Other videos after the jump . . .

GeorgeCarlin.com Home Page:

Other remembrances:

George Carlin, Splenetic Comedian, Dies at 71 (NYT)

Say
It Ain’t So: George Carlin Dies
(Village Voice)

George Carlin: American Radical (The Nation)

How
George Carlin Changed Comedy
(Time)

From our files: The
nonconforming George Carlin
(Christian Science Monitor)

The complete works of George Carlin

All_my_stuff_geroge_carlin_2

Read More

Category: Video