Technical Analysis – Astrology or Lob Wedge?

January 15, 2010 at 2:06 am 13 comments

Investing comes in many shapes and sizes. And like religion (see Investing Religion article), most investment strategies are built on the essential belief that following certain rules and conventions will eventually lead to profit enlightenment. When it comes to technical analysis (TA), a discipline used with the principal aim of predicting future prices from past patterns, some consider it a necessity for making money in the market. Others, regard the practice of TA as a pseudoscience, much like astrology.

I feel  there is a proper place for TA on selective basis, which I will describe later, but for the most part I agree with some of the legendary investors  who have chimed in on the subject:

Warren Buffett: “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”

Peter Lynch: “Charts are great for predicting the past.”

Technical Analysis Linguistics

Fundamental analysis, the antithesis of technical analysis, strives to predict future price direction by analyzing facts and data surrounding a company, industry, and/or economy. It too comes with its own syntax and versions, for example: value, growth, top-down, bottom-up, quantitative, etc.

I do not claim to be a TA expert, however in my many years of investing I have come across a smorgasbord of terms and flavors surrounding the discipline. Describing and explaining the density of material surrounding TA would encompass too large of a scope for this article, but here are some prevalent terms one should come to grips with if you want to become a technical analysis guru:

Technical analysis Approaches

  • Elliot Wave
  • Relative strength / Momentum (see Momentum Investing article)
  • MACD (Moving Average Convergence / Divergence)
  • Fibonacci retracement
  • Dow Theory
  • Stochastics
  • Bollinger bands

Price Patterns

  • Head and shoulders
  • Double bottom
  • Cup and handle
  • Channels
  • Breakouts
  • Pivot points
  • Candlesticks
  • Resistance/Support
  • Dead cat bounce (my personal favorite)

Each of these patterns are supposes to provide insight into the future direction of price. At best, I would say the academic research surrounding the subject is “inconclusive,” and at worst I’d say it’s considered a complete “sham.”

The Lob Wedge

As I’ve stated earlier, I fall in the skeptical camp when it comes to TA, since fundamental analysis is the main engine I use for generating and tracking my investment ideas. For illustrative purposes, you may consider fundamental analysis as my group of drivers and irons. I do, however,  utilize selective facets of TA much like I use a lob wedge in golf for a limited number of specific situations (e.g., shots over high trees, downhill lies, and fast greens). When it comes to trading, I do believe there is some value in tracking the relationship of extreme trading volume (high or low), especially when it is coupled with extreme price movement (high or low). The economic laws of supply and demand hold true for stock trades just as they do for guns and butter, and sharp moves in these components can provide insights into the psychological mindset of investors with respect to a security (or broader market). Beyond trading volume, there are a few other indicators that I utilize as part of my trading strategies, but these tactics play a relatively minor role, since most of my core positions are held on a multi-year time horizon.

Overall, there is a stream of wasteful noise, volatility, and misinformation that permeates the financial markets on a daily basis. A major problem with technical analysis is the many false triggered signals, which in many cases lead to excessive trading, transaction costs, and ultimately subpar investment returns.  Although I remain a skeptic on the subject of technical analysis and I may not read my horoscope today, I will continue to keep a lob wedge in my golf bag with the hopes of finding new, creative ways of using it to my advantage.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own exchange traded funds and various securities, but at time of publishing had no direct position in BRKA/B or any company mentioned in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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13 Comments Add your own

  • [...] conventional methods, for example quantitative models, technical analysis and trend review (read Technical Analysis: Astrology or Lob Wedge). For example in sports, handicappers may only wager on teams with five-game winning streaks and [...]

    Reply
  • 2. Why it’s NOT Different This Time « Investing Caffeine  |  September 29, 2010 at 12:09 am

    [...] Dow 1,000 with the assistance of the not-so ironclad Elliott Wave Theory philosophy (see Technical Analysis: Astrology or Lob Wedge). If you’re in the Prechter camp, either crawl back into your bunker or start digging that dream [...]

    Reply
  • 3. Orvin Five  |  September 30, 2010 at 2:39 pm

    I enjoyed reading your article about the absurdities of technical analysis. In “The Fundamental Error of Elliott Wave Theory” I explain, using logic alone, why the most essential assumption of Elliott Wave Theory (that stocks move in patterns analogous to natural patterns) is wrong. The essay appears at http://www.orvinfive.blogspot.com. -Regards

    Reply
    • 4. sidoxia  |  September 30, 2010 at 4:03 pm

      Orvin Five-

      Thanks for the link!

      I’m still waiting for a technical analyst to pass up Buffett on the Forbes 100 list…I’m not holding my breath.

      ~WS

      Reply
  • [...] tea leaves of investor attitudes is relied upon as a fortune telling stock market ritual (see alsoTechnical Analysis article). Generally these tools are used on a contrarian basis when deciding about purchase or sale [...]

    Reply
  • [...] For individual securities it’s best to stick to your circle of competence with companies and industries you understand – masters like Peter Lynch and Warren Buffett appreciate this philosophy. Once you find an investment opportunity you understand, you need a way of appraising the value and gauging a company’s growth trajectory. As Charlie Munger and Warren Buffett have described, “value and growth are two sides of the same coin.” Cigar-butt investing solely using value-based metrics is not enough. Even value jock Warren Buffet appreciates the merit of a good business with sustainable expansion prospects. As a matter of fact, some of Buffett’s best performing stocks are considered the greatest growth stocks of all-time. If you cannot assign a price (or range), then you are merely playing the speculation game. Speculation often comes in the form of stock tips (i.e.,stock broker or Jim Cramer) and day trading (see Momentum Investing and Technical Analysis). [...]

    Reply
  • 7. Top 10 of 2010 « Investing Caffeine  |  January 7, 2011 at 1:00 am

    [...] Technical Analysis – Astrology or Lob Wedge? [...]

    Reply
  • [...] Others believe that a quantitative black box (see Butter in Bangladesh), or technical analysis (see Astrology or Lob Wedge) can do the trick as a substitute. These strategies may be easier to implement, but as well-known [...]

    Reply
  • 9. canslim  |  June 24, 2011 at 8:06 am

    fundamental analysis alone is a waste. There are too many managers who use those tools and get abysmal results. The best trades will be when the fundamentals and technicals align. Buffett will have no use for TA, because he buys companies, not stocks, and holds them for a long time. Unfortunately most investors don’t have that long of a time horizon.

    Reply
    • 10. sidoxia  |  June 24, 2011 at 8:22 am

      Agree with a lot of what you say, including fundamental analysis is relatively worthless, if you do not have a longer term time horizon.

      Reply
  • [...] less attention to those indicators based on opinions, surveys, and technical analysis data (see Astrology or Lob Wedge). Most of my concentration is centered on those indicators explaining actual measurable investor [...]

    Reply
  • [...] less attention to those indicators based on opinions, surveys, and technical analysis data (see Astrology or Lob Wedge). Most of my concentration is centered on those indicators explaining actual measurable investor [...]

    Reply
  • 13. Day Trading With Your House | Stock Trading Guidelines  |  July 20, 2014 at 6:03 am

    […] readers of Investing Caffeine know I’ve been a skeptic of technical analysis (see Technical Analysis: Astrology or Lob Wedge), but a successful investor has to be open to new ideas, correct? So, if technical analysis works […]

    Reply

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