What is the logic behind "Technical Analysis is like reading tea leaves"?

[pianodoctor]

Another question I've been wondering about: So there are these Technical Analysis people who make good arguments about the value of T.A. and how it really gives you an advantage trading/investing. I've read a lot of these arguments at this point and I think I get the gist of it.

But I've also read some pretty respectable people who say that at the end of the day T.A. is really "tea leaf reading" and the market is just too unpredictable and that no real advantage over the market average can be gained with T.A.

However I have not heard any kind of detailed logical argument from the anti- T.A. people why their view should prevail. Just broad declarations that 'it is so'.

Can anyone here explain the anti- T.A. position clearly?

Thanks!

[FRED]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

Another question I've been wondering about: So there are these Technical Analysis people who make good arguments about the value of T.A. and how it really gives you an advantage trading/investing. I've read a lot of these arguments at this point and I think I get the gist of it.

But I've also read some pretty respectable people who say that at the end of the day T.A. is really "tea leaf reading" and the market is just too unpredictable and that no real advantage over the market average can be gained with T.A.

However I have not heard any kind of detailed logical argument from the anti- T.A. people why their view should prevail. Just broad declarations that 'it is so'.

Can anyone here explain the anti- T.A. position clearly?

Thanks!

There's a decent write-up here on Portfolion.com:

Incidentally, academic studies of technical analysis have yielded mixed results: Many have found that its techniques can provide market-beating results, but they’ve also shown that once the added risk of using technical analysis is accounted for, the gains are wiped away. And other studies have shown that even if you don’t account for the additional risk, gains offered by technical trading techniques have largely disappeared since the 1990s.

[vinoveri]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

There's a decent write-up here on Portfolion.com:

Incidentally, academic studies of technical analysis have yielded mixed results: Many have found that its techniques can provide market-beating results, but they’ve also shown that once the added risk of using technical analysis is accounted for, the gains are wiped away. And other studies have shown that even if you don’t account for the additional risk, gains offered by technical trading techniques have largely disappeared since the 1990s.

So if Technical Analysis trading is suspect or a crap shoot, and as we see now that fundamental analysis is also coming up short (note past 7 month gains in equities absent 'fundamentals'), what's left to base an investment/trading decision .... ?

Maybe it's more simple now ... "Bernanke analysis" or a simple metric of quantitative easing/printing

[pianodoctor]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

Thanks FRED,

I also just found the article copied below.

I recently acquired an expensive, dictionary-sized "bible" of Technical Analysis. I'm trying to decide if it's worth all the time it's going to take to learn about it. I'm not trying to be an active trader, I just want to have better assurances the few trades I do make are wise.

So far, T.A. seems like a very UNcompelling field of study for that.

http://www.bloomberg.com/apps/news?p...eOo&refer=home

"Stock Charts Fail Forecast Test in Complete S&P Miss (Update3)

By Michael Tsang and Eric Martin
May 4 (Bloomberg) -- John Bollinger, inventor of the “Bollinger bands” system of predicting stock movements with price charts, says technical analysis works.
“I don’t know what people are saying when they say somehow indicators have broken down,” Bollinger, president of Bollinger Capital Management, said in a telephone interview from Manhattan Beach, California. “It’s like somehow saying streetlights don’t work anymore. As long as people obey them, streetlights work.”
Ever since the Standard & Poor’s 500 Index peaked in October 2007, six of eight strategies -- which are supposed to make money whether stocks rise or fall -- failed, according to back-testing data compiled by Bloomberg. As the bear market erased $11 trillion from the value of U.S. equities, buy and sell signals from those six technical indicators produced losses of as much as 49 percent, the data show.
“Technical analysis on its own as a discipline does not work,” said Diane Garnick, the New York-based investment strategist at Invesco Ltd., which oversees $348 billion. Using it in isolation is “the fastest way to lose money,” she said.
Of the eight strategies, stochastics, Bollinger bands, relative strength, commodity channels, parabolic systems and the Williams %R indicator generated buy and sell signals that resulted in losses between the S&P 500’s peak of 1,565.15 on Oct. 9, 2007, and its March 9 trough, the data show. They did worse as the index then rallied 30 percent through last week.
No Help
The systems failed to protect investors last year, when the S&P 500 had its biggest decline since 1937, as price swings reached a record, according to William Stone, chief investment strategist at PNC Financial Services Group Inc.’s wealth management unit, which oversees $96 billion in Philadelphia.
Bloomberg’s back-testing model purchases the S&P 500 when an indicator signals a “buy” and holds it until a “sell” is generated. At that time, the index is sold and a short position established and kept until a “buy” is triggered.
The S&P 500 added 3.4 percent to 907.24 today, erasing its decline for 2009, after home sales beat forecasts and manufacturing in China expanded.
Bollinger bands are designed to alert investors when a security rises too high or falls too low by comparing its price to the average level over the past 20 days. If the stock gains or drops enough from the average -- two standard deviations -- a turnaround may be at hand, Bollinger’s system says. Moves of two standard deviations are defined as occurring 5 percent of the time or less in a statistical model.
Financial Stocks
When used to determine when to buy or bet against S&P 500 financial stocks, the technique produced a gain through mid- September of $28,588 on a $100,000 investment, when banks retreated 37 percent, data compiled by Bloomberg show.
Profits evaporated in less than a month and turned into a loss of $64,388 as the strategy failed to trigger any sell signals during the rest of the bear market, when banks and brokerages plummeted 72 percent.
John Bollinger says that methodology is too simple and his bands should be used in conjunction with data on trading volume to create “set-ups” and “confirmations” for investment decisions. His fund, which aims to profit in any environment, made money sometimes during the bear market. He declined to comment on specific returns.
Stochastics predicts a security’s movement based on how close its price is to the highest or lowest levels. Stochastics would have left anyone who started with $100,000 at the October 2007 peak with $75,881 by March 9, a 24 percent loss, according to data compiled by Bloomberg.
False Buys
The trades were undone by the buy signals, which on eight occasions suggested that the S&P 500 had fallen too far, too fast, based on data compiled by Bloomberg that exclude trading costs and unexpected price fluctuations at the moment of the trade. Stochastics told traders to buy on Oct. 6 last year, three weeks after Lehman Brothers Holdings Inc.’s bankruptcy. The S&P 500 lost 14 percent in the following month.
Burton Malkiel, whose 1973 investment text “A Random Walk Down Wall Street” argued that price movements aren’t predictable, says chart-based investing worsens returns.
“People who think they are going to make excess profits with technical analysis are kidding themselves,” Malkiel said in a telephone interview from Princeton, New Jersey. “Most of the people who say this is pretty good have some ax to grind.”
Traders shouldn’t use charts without other technical data, and choosing the most appropriate ones can both mitigate losses and produce gains, said Katie Townshend Stockton, chief market technician at Greenwich, Connecticut-based MKM Partners LLC.
Cut Losses
Each of the eight strategies would have cut losses for investors benchmarked to the S&P 500. The directional movement indicator and the moving average convergence/divergence indicator flashed signals that made money even during the worst financial crisis since the Great Depression.
Directional movement is a theory developed by J. Welles Wilder in 1978 that measures how far a security moves from an average price range calculated from second to second. The system is designed to gauge who is more eager to trade a security, buyers or sellers.
The so-called DMI generated a gain of 24 percent. The moving average convergence/divergence indicator, which bases trades on the difference between 12- and 26-day moving averages, provided profits of $25,896 from a $100,000 investment.
In both strategies, the signals that directed traders to sell and then short the S&P 500 made more money than their buy signals lost. Short sellers typically borrow shares from a brokerage and then sell them on a bet they will be able to repurchase the stock at a lower price.
Value Investors
Returns also exceeded those of many who follow the principles of value investing, the practice popularized by Warren Buffett, the billionaire chairman of Omaha, Nebraska- based Berkshire Hathaway Inc. He searches for the cheapest companies relative to earnings or assets.
Buffett told shareholders at Berkshire’s annual meeting on May 2 that “many” U.S. stocks have fallen to levels where they are cheap relative to their intrinsic value. He said the housing market is the biggest drag on the economy and remains “very hard” to forecast.
Bill Miller, whose Legg Mason Value Trust beat the S&P 500 for a record 15 straight years through 2005, produced a loss of 72 percent, including dividends, during the bear market.
David Dreman was fired this year by Deutsche Bank AG’s asset management unit after his flagship $2.62 billion DWS Dreman High Return Equity Fund lost 65 percent. Both managers piled into stocks such as Freddie Mac and American International Group Inc., misjudging the severity of the financial meltdown.
‘A Little Misleading’
“It’s a little misleading to be looking at any indicator in a vacuum,” said MKM’s Stockton. “It’s a matter of knowing which ones to combine and knowing what environment you’re in.”
None of the technical indicators produced a bigger return than S&P 500’s 30 percent rally from its 12-year low on March 9.
Five sent signals that have resulted in losses of between 1.9 percent and 8.3 percent during the eight-week climb, which added $2.29 trillion to the value of U.S. equities, data compiled by Bloomberg show. The Williams %R indicator, which calculates the difference between a security’s closing price and its highest price and then compares the result with its average over 14 days, handed traders who heeded its buy and sell signals an $8,286 loss on $100,000 invested at the trough.
Only one technical indicator, moving average convergence/divergence, made money for investors during both the bear market and the subsequent rebound.
“Some of the indicators might work at given times, but that’s not where I put my odds,” said PNC’s Stone, a certified market technician who learned to read charts on the trading floor of Salomon Brothers Inc. in the early 1990s. “You zigged when you should have zagged.”


Ranked Performance of Eight Technical Indicators

Indicator 10/09/2007 - 3/09/2009

Relative Strength Index -49.0%
Williams %R -41.7%
Commodity Channel Index -38.7%
Parabolic Systems -36.6%
Bollinger Bands -31.5%
Stochastics -24.1%
Directional Movement Indicator +24.0%
Moving Average Convergence/Divergence +25.9%

S&P 500 -56.8%

--------

Indicator 3/09/2009 - 5/01/2009

Commodity Channel Index -8.3%
Williams %R -8.3%
Bollinger Bands -6.6%
Stochastics -3.3%
Directional Movement Indicator -1.9%
Moving Average Convergence/Divergence +7.8%
Parabolic Systems +8.2%
Relative Strength Index +21.8%

S&P 500 +29.7%

--------

Indicator 10/09/2007 - 5/01/2009

Williams %R -43.1%
Commodity Channel Index -40.3%
Parabolic Systems -34.3%
Relative Strength Index -34.1%
Bollinger Bands -22.2%
Stochastics -21.8%
Directional Movement Indicator +9.0%
Moving Average Convergence/Divergence +24.6%

S&P 500 -43.9%
To contact the reporters on this story: Michael Tsang in New York at mtsang1@bloomberg.net; Eric Martin in New York at emartin21@bloomberg.net.
Last Updated: May 4, 2009 16:08 EDT

[jk]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

So if Technical Analysis trading is suspect or a crap shoot, and as we see now that fundamental analysis is also coming up short (note past 7 month gains in equities absent 'fundamentals'), what's left to base an investment/trading decision .... ?

Maybe it's more simple now ... "Bernanke analysis" or a simple metric of quantitative easing/printing

7 months is too short a time to judge fundamental analysis, or at least what I mean by fundamental analysis. what i mean, before all else, is asset allocation based in economic analysis. if you are an investor, with substantial holding periods, most of your gains or losses will derive from your choice of asset classes, not from your choice of individual assets. i.e. the biggest decision is whether or how much to be in e.g. stocks, NOT which stock to buy.[some people apply the term fundamental analysis to individual stock selection.]

t.a. is of more application if you want to trade.

[pianodoctor]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

Appending my post above- On the other hand, in my work, I visited this man who daytrades from home using T.A. techniques. His trading station must have had 8 monitors going at once. I asked him if he'd mind talking about what he does.

He said he's been at it for 12 years, full time. He said he's clearing about $250,000/year now, using a $50,000 trading nut. He said it took him this long to get this good, but he never lost money overall in a year.

So he's either lying about all that stuff or he isn't. His house was very expensive and I know for a fact he is a generous benefactor of a certain charity. There's money coming from somewhere.

Is it possible that T.A. trading is one of those things where 95% of the people doing it really can't beat the market because they just aren't skilled enough (for whatever reason), but the 5% who are really really good at it (consistently) are a different story? Or is the man I describe above like someone who makes a really convincing presentation he's got a perpetual motion machine he invented.....?

[cjppjc]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

Appending my post above- On the other hand, in my work, I visited this man who daytrades from home using T.A. techniques. His trading station must have had 8 monitors going at once. I asked him if he'd mind talking about what he does.

He said he's been at it for 12 years, full time. He said he's clearing about $250,000/year now, using a $50,000 trading nut. He said it took him this long to get this good, but he never lost money overall in a year.

So he's either lying about all that stuff or he isn't. His house was very expensive and I know for a fact he is a generous benefactor of a certain charity. There's money coming from somewhere.

Is it possible that T.A. trading is one of those things where 95% of the people doing it really can't beat the market because they just aren't skilled enough (for whatever reason), but the 5% who are really really good at it (consistently) are a different story? Or is the man I describe above like someone who makes a really convincing presentation he's got a perpetual motion machine he invented.....?

Sure it's like any other form of gambling. Some are very good at it. Use disipline and never take it personally.

[karim0028]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

Appending my post above- On the other hand, in my work, I visited this man who daytrades from home using T.A. techniques. His trading station must have had 8 monitors going at once. I asked him if he'd mind talking about what he does.

He said he's been at it for 12 years, full time. He said he's clearing about $250,000/year now, using a $50,000 trading nut. He said it took him this long to get this good, but he never lost money overall in a year.

So he's either lying about all that stuff or he isn't. His house was very expensive and I know for a fact he is a generous benefactor of a certain charity. There's money coming from somewhere.

Is it possible that T.A. trading is one of those things where 95% of the people doing it really can't beat the market because they just aren't skilled enough (for whatever reason), but the 5% who are really really good at it (consistently) are a different story? Or is the man I describe above like someone who makes a really convincing presentation he's got a perpetual motion machine he invented.....?

TA works for trading, not really for "investing". The timeframe is the difference here, traders look at secs and mins... Just look at support and resistance on any chart, you will find it uncanny that price stops at a specific point....

It kind of simulates human behavior/emotions. Its also very akin to gambling, its all about numbers, you leave emotion out of it and never let a loss run.... If price doesnt move your way it doesnt matter how much you fundamentally believe it should, you take your loss and get out....

Completely different mindset from investing.

[metalman]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

TA works for trading, not really for "investing". The timeframe is the difference here, traders look at secs and mins... Just look at support and resistance on any chart, you will find it uncanny that price stops at a specific point....

It kind of simulates human behavior/emotions. Its also very akin to gambling, its all about numbers, you leave emotion out of it and never let a loss run.... If price doesnt move your way it doesnt matter how much you fundamentally believe it should, you take your loss and get out....

Completely different mindset from investing.

bingo! there are guys who make millions gambling at cards in vegas. it's a skill. has zip to do with investing.

[Spartacus]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

I went deep into trading systems in about 1995, trying to implement some of my own as well.

Even at that time, trading systems based on TA had been studied to death.

Hang out at any good university's math department. Almost everyone who ever got a PhD in math, and tons who got one in statistics has tried to set up systems to beat the markets. Every mathematical technique / sub-specialty has been tried for this by the researchers who first developed it.

Game theory? you bet
topology - ditto
genetic algorithms, information theory ... any mathematical idea you can name, and of course all the old school visually - inspired but rigour-challenged and math-challenged ones (head & shoulders, cup & handle, and on and on and on ..)

Some of these folks eventually talk or write about it - there have been a bunch of PhD theses looking at it from all angles, and the end redulst is always: 'does not work for any reasonable length of time'

There was one study in the 70s that scoured the trade rags for all the systems that claimed to make money, applied real data feeds to the systems. Findings:

almost none made money consistently

Of those that made money, all LOST money for realistic trading (bid/ask spreads, the occasional "no fill", after taxes, etc ...)

Another question I've been wondering about: So there are these Technical Analysis people who make good arguments about the value of T.A. and how it really gives you an advantage trading/investing. I've read a lot of these arguments at this point and I think I get the gist of it.

But I've also read some pretty respectable people who say that at the end of the day T.A. is really "tea leaf reading" and the market is just too unpredictable and that no real advantage over the market average can be gained with T.A.

However I have not heard any kind of detailed logical argument from the anti- T.A. people why their view should prevail. Just broad declarations that 'it is so'.

Can anyone here explain the anti- T.A. position clearly?

Thanks!

[Spartacus]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

8 monitors?

if technical analysis gave him a system, if he actually had a __system__ none of that would be necessary.

if it's a system, program it & let a trained monkey watch the blinking lights.

As the infomercials say, "set it and forget it". Then paint your hair with some couvre, eat some rotisserie chicken & get some wonderlube for your car.

EDIT: sorry, just rememberd, as some of you who had sleepless nights in the late 90s, it was Duralube - haven't watched late night infomercials for 10 years.

He's using some kind of judgment, NOT a system. ( if he is making net profits out of it - I'm assuming the money reports are truthful)

if he claims that it is TA but he cannot program it I almost guarantee he's learned something, doesn't know exactly what and mistakenly attributes it to TA.

Like a chess grandmaster who might claim he has a system, but no one who's tried to program it can get it to do what the GM does - the GM might genuinely think he's following a system, but he's not. It's down to his judgment in the end.

Appending my post above- On the other hand, in my work, I visited this man who daytrades from home using T.A. techniques. His trading station must have had 8 monitors going at once. I asked him if he'd mind talking about what he does.

He said he's been at it for 12 years, full time. He said he's clearing about $250,000/year now, using a $50,000 trading nut. He said it took him this long to get this good, but he never lost money overall in a year.

So he's either lying about all that stuff or he isn't. His house was very expensive and I know for a fact he is a generous benefactor of a certain charity. There's money coming from somewhere.

Is it possible that T.A. trading is one of those things where 95% of the people doing it really can't beat the market because they just aren't skilled enough (for whatever reason), but the 5% who are really really good at it (consistently) are a different story? Or is the man I describe above like someone who makes a really convincing presentation he's got a perpetual motion machine he invented.....?

[Chris]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

don't forget that most technical systems that work are never published in the public domain (until they don't work). I have seen statistical trading systems that work but the timeframe on trades is minutes.

[pianodoctor]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

Spartacus: I didn't ask him whether he used a system or not. He did say a lot of the screens were for researching potential "setups" (or somesuch) and he did say he subscribed to something like a private online network where these voices were coming in talking in real time about the action- I got the impression it was something like a coach or team leader helping a group of traders trade.

I guess he was trading, researching, and networking with a group simultaneously.

[karim0028]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

TA works for trading, not really for "investing". The timeframe is the difference here, traders look at secs and mins... Just look at support and resistance on any chart, you will find it uncanny that price stops at a specific point....

It kind of simulates human behavior/emotions. Its also very akin to gambling, its all about numbers, you leave emotion out of it and never let a loss run.... If price doesnt move your way it doesnt matter how much you fundamentally believe it should, you take your loss and get out....

Completely different mindset from investing.

And just to give an example im attaching a chart of the 30yr treasury bond from this morning..... Look at where support and resistance are, and see how price reacts there and simply following support/resistance and trendlines this is VERY tradeable....

Short resistance and break of trendline or buy support with a stop underneath..... Its not always this clear but, you have to watch it to know what you want to trade....

Again, don't ever mistake this for investing, this is purely trading price.

[ThePythonicCow]

Re: What is the logic behind "Technical Analysis is like reading tea leaves"?

Another question I've been wondering about: So there are these Technical Analysis people who make good arguments about the value of T.A. and how it really gives you an advantage trading/investing.

In my view, T.A., including Elliott Wave analysis, is useful in the way that understanding the Pantheon of Greek Gods would be useful if one wants to understand what some ancient Greeks are saying. It provides terms and concepts to describe things both past and anticipated. T.A. terminology is flawed for lack of a perfectly valid conceptual basis, but it is still useful for forming and conveying thoughts on financial markets. Technical Analysis doesn't predict, but some good (and bad and lucky) predictors can Technically Analyze.