Technical Analysis is Bullshit

R
R
Mar 5, 2016 · 7 min read

Fucking charlatans have been proclaiming that they can tell the future for ages. We’ve had the hags in rags reading tea leaves. The prophet that offers advice based on comets. The sages that rage on about your longevity through the creases of your palms. The men in suits drawing colorful trend lines on a chart. You cannot find a shred of difference between them all — they are all fucking charlatans.

This article will try to examine what is technical analysis, why people seek to believe in technical analysis, and will end off with an advice. If you are a chartist, please read no more. We will find no common ground and reading this will only serve to create bad blood.

What is technical analysis

Other than being bullshit, there is no real definition for technical analysis. The believers will suggest that it is the forecasting of future price movements based on an examination of past price movements, and that it does not result in absolute predictions about the future.

The fact that these practitioners (being really kind here by calling them that) even dared to use the word ‘analysis’ in the mumbo jumbo they are up to is downright daring. What are they analyzing, you ask? Well, there are a fuckton of stuff you can analyze.

Moving averages of all kinds: standard ones, weighted to more recent data etc. There are oscillators, number sequences, and other basic pattern recognition shit. I would love to go through what each and every one of them does, but then again, if we wanted to find out about bullshit, we might as well tune in to Fox news.

Why people believe in this shit?

Randomness

Firstly, some people think that price is not random. Cool.

Information

Secondly, price distills information. Practitioners believe that the price of a stock, currency, herd of cows etc. fully reflects all information. These people believe in a strong or semi-strong market efficiency theory. They believe the market price reflects the sum knowledge of all investors. Cool.

Simple

Thirdly, technical analysis practitioners believe in focusing on price and only price. Probably the most direct, simplistic approach. Technical traders believe it is best to concentrate on what the price is, and not pay attention to why the price is so. Perhaps these guys just cannot handle information, or would not want to sieve through the information themselves, or calculate the value of new information, either because they are lazy, incompetent or both.

Pattern recognition

Humans are pattern recognition machines. Pattern recognition is important to humankind. We recognized the patterns in the stars to navigate ages ago, the characteristics of friends and foes in the wild, the fauna and flora we should consume and avoid.

Pattern recognition is also a big component of IQ tests, simply because its what sets us apart in intelligence. Try taking an IQ test, the last few questions are usually patterns and you’ve got to figure the next one in the sequence.

My theory is that pattern recognition gives us two reasons why technical analysis is even being practiced. Firstly, its easy to figure out a pattern (or various patterns). You see the price moving up, you draw a trendline confirming that. Ok awesome. The mongoloid homosapien has now recognised a pattern.

Of course, its more complicated than that — they claim. There are death crosses, gold crosses, cup and handle, head, shoulder, neckline. All kinds of terminologies to describe how the tea leaves settled at the bottom of the cup. Let me show you.

Not my cuppa tea

Technical analyst: Oooooh, ooooh, I’ve seen a cup & handle on USD/AUD, time to all in.

Technical analyst: Aiyah, shit. The cup and handle thing did not turn out well because the wind speed in South Africa was too low. However, there is a possible H&S formation. Divergence starting to creep in, or perhaps we are in a consolidation phase here. Advice is to take profits now. Yada yada.

You see, its easy for people to understand technical analysis. You have all these interactive charts functions where you can simply add them on, then you try to divine the future through pattern recognition. Its not hard to tell how people can love technical analysis.

Education

Our education is a pattern recognition confirming one. In the non-humanities, mostly all the tests you will get is based on some pattern recognition. In mathematics its recognizing the symbols, numbers and functions, and being able to replicate the significance of these, given a slightly similar set. Same for physics and chemistry.

There’s not so much of questioning per se. We do not go to math class and question the number 0. Why does it exist, what function does it serve, how it improves our lives, and is it an even number — if so, why? (Find out here) We go to math class, the teacher tells you on day 1 what 0 is, and you never question that again. Whenever you see the round shaped digit, you recognise that pattern and you act accordingly. Its deterministic, or should I say, dogmatic.

My second hypothesis is technical analysts assume technical analysis is deterministic, just like how their education was. A dogmatic approach to investing (or speculation), for a person with a dogmatic education.

Its simple to have a certain set of chart rules, that when it happens, the result must be what was expected. When that happens, the whole technical analysis community goes on a round of circlejerking, triumphant dance and loud hailing on social media to let the world know that once again their approach is the golden key to untold riches and successes. And when the result is unexpected despite the chart behaving in a certain way, they will blame it on some world news.

Astrology, Perpetual motion, Technical Analysis

These mentioned are pseudosciences. These are fields where practitioners approach technical analysis as if its a science. They give every phenomena a term, like the death cross (when the long term average breaks above the short term average). They hypothesize that this particular image in a chart will determine such and such result. Then they will go back to past data and see if it works. Process is called backtesting. Sounds legit right?

I doubt it. In doing so, there is the implicit assumption that markets are not adaptive. That there is a universal law that governs the behavior of stock markets. This is simply not true, we are not talking about physics or mathematics. We cannot apply backtesting to markets and then claim that it is scientifically rigorous. God is watching you, you motherfucker, stop lying!

Oh by the way, perpetual motion has been debunked because it violates laws of thermodynamics. Yet, we still have people trying to create a perpetual motion system in the world.

Same way, technical analysis is doomed to fail by the statistical fact that stock prices are nearly random; the market’s patterns from the past provide no clue about its future. Not suprisingly, studies conducted by academicians at universities like MIT, Chicago, and Stanford dating as far back as the 1960s have found that the technical theories do not beat the market, especially after deducting transaction fees.

Investing or speculating

There is a clear difference. If you buy a share, say ExxonMobil (XOM), you are purchasing into the company. You own a small bit of that business. If you intend to buy into the business, you better know more than what the price is.

Technical analysis focuses on trading securities. Does not matter what the underlying is, with enough price point data, you can make a chart. However, my opinion is that the market is there to serve you, not to instruct you. The market is there to provide you the data you need, not for you to follow its bidding like a dog.

Technical analysis is also chronically open to interpretation. For example, two technical traders can look at a chart and tell two different stories and see two different patterns. You can even turn the chart the other way round and perhaps the recommendations are still the same. The chart’s interpretations are in the eye of the beholder.

Cold hard facts

If you are still unconvinced, then I have to drop the rhetoric and use cold hard facts.

  1. Chartists see patterns in randomness (Malkiel, 2007)
  2. Past prices are extremely poor indicators of future prices (Kida 2003: p. 122)
  3. Turning points cannot be predicted (Sherdan, 1997)
  4. Increased sophistication does not improve accuracy (Sherdan, 1997)
  5. Technical analysts see ‘illusory correlations’ (Bender et al. 2013, pp 625–652)

The list goes on man. Honestly, they’ve been doing research since the 60s and there is nothing to prove that technical analysis is worth less than the paper you wipe your ass with.

How do we STILL have technical analysts?

Technical analysts are usually hired at brokerage firms, because they generate a lot of trades and that generates commission for brokerage firms. Brokerage firms probably know deep down that technical analysis is hogwash, but it brings them money, so they continue to fuel this pseudoscientific pursuit to more complicated nonsense, and develop more tools for you to ‘study’ them.

Advice

Stop listening the moment someone comes up to you and brag about their technical analysis prowess. It doesn’t lead to long term risk-adjusted, tax-adjusted outperformance.

Perhaps that clueless dirtbag did have a good run. Well, the probability is always there. Given enough time and enough monkeys randomly bashing on the keyboard, one would eventually, out of randomness, be able to write a Shakespearean play. It’s possible, yet highly improbable.

If you are a technical analyst and have managed to survive the barrage of rhetoric I’ve put in this article, then I have an advice for you too. Find a real profession or keep your mouth shut.

R

These views are personal opinions of the writer and not of his employer.

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