The Power To Perform: mhj3.com Managing Investing Judgment Since 1989

Investing Fool's Tool (other than a glance) #9: @!%#&* Technical Analysis
If a thermometer happened to store prior temperature readings on a daily basis, you certainly would not retrieve that information and use it to predict tomorrow's or next week's temperature readings — 'It rained yesterday; therefore, it will rain today because it rained yesterday?'

Think about it: 'Past investment performance is not an indicator of future investment results' is a required, responsible, and absolutely true investing footnote, an investing fact that anyone who has spent more than a nanosecond in the financial markets would or should know, and an investing law designed to protect the investing naive, innocent, and unsuspecting.

Then why would one blindly place his/her trust in the present and his/her hope for the future in a mythical investing science — Modern Portfolio Theory and all of its illegitimate relatives such as Monte Carlo Analysis, Efficient Frontier Analysis, Beta, Brinson's Asset Allocation, Pie Charts, and a distant relative, Technical Analysis (worth a glance) — that relies solely on past performance investment data to feed hypothetical and contrived investing algorithms in a misguided effort to predict future investment results?

All are just other ways to record and to illustrate investment history without valid analytical, interpretive, deductive, predictive, or directional investment value.

If this nonsense were valid, there would be no need for investing analytics, forecasting, or guidance of any kind — research, analysis, opinion, advisors — and one would simply select investments based on past performance without regard to suitability, quality, structure, or risk.

Explained another way, a thermometer measures temperatures in degrees as the weather changes.

A thermometer is a recording device not a forecasting one and, therefore, it cannot be used to predict future temperature levels.

Standard Deviation, Efficient Frontier, Beta, VaR, and Sharpe Ratio are much like a thermometer; merely means to measure past (contrived) relative investment performances between investment variables and neither the cause of nor the predictor of either.

Furthermore, if a thermometer also happened to store prior temperature readings on a daily basis, you certainly would not retrieve that information and use it to predict tomorrow's or next week's temperature readings.

As one would have to analyze the weather-changing causal variables that affect weather, such as humidity and barometric pressure, to predict future temperature levels.

The same holds true for historical Standard Deviation, Efficient Frontier, Beta, VaR, and Sharpe Ratio readings as a basis for predicting the investing future.

Future investment values and associated investment/investing risks can only be meaningfully understood and predicted based on one’s correct understanding and interpretation of the fundamental performance changing, causal investment performance variables that actually affect an equity’s behavior.

Keep in mind, there is no theory — modern or otherwise — that can be ordained, no computer that can be programmed, no software that can be designed, no investing tool that can be 'imagineered,' no technical analysis voodoo methodology that can be contrived, and no equation that can be divined to quantify, evaluate, and predict the primary forces that drive the sublime chaos of the financial markets and investment prices; human consensus, mood, and behavior; intelligent and not, knowledgeable and not, reasoned and not, rational and not, and logical and not.

Investing Technical Analysis

Investment technical analysis (though worth a glance as a small part of the ongoing investing decision making processes) is more a self-fulfilling trading style than a legitimate, independent means to predict future price behavior of an equity in that its own universal rules and its own phalanx of followers become the value by making the rules, following them, and, thus, occasionally, again because of the number of chartists checked in that day, possibly having a small contrived impact on creating the results in conjunction with the more substantive stock market price affecting variables; current market conditions, the market outlook, relative investment values, investors, fundamentals, etc.

It would seem technical followers, chartists, are participating in a game where the number of players following the rules and the amount of dollars they have will determine the outcome.

Every technical rule has an exception and every exception has a rule.

Nothing is tied to what the company is doing fundamentally other than being a possible reflection of it.

As a chartist you are simply hoping that enough members of the technical analysis club have paid their dues, are members in good standing, and that they will believe what they see, according to club rules, and that they will simply take the correct technical buying and selling action along with the rest of the herd.

Technical analysis has an advantage over many other forms of investment analysis because the seeming complexity of the technical terms used and the overwhelming splendor of technical charts associated with these terms could only lead one to believe in the underlying value, significance, and importance of investment technical analysis.

How could one not be mesmerized by terms such as the A's and a few of the B's from an alphabetical listing of technical analysis terms: Above the Market, Absolute Breadth Index - ABI, Accumulation/Distribution, Actuarial Analysis, Advance-Decline Index, Advance/Decline Line - A/D, Alpha, Andrew's Pitchfork, Appraisal Ratio, Arithmetic Mean, Arms Index - TRIN, Aroon Indicator, Ascending Channel, Ascending Tops, Ascending Triangle, Autoregressive, Average True Range - ATR, Ax, Backspread, Bar, Bar Chart, Basing, Bearish Belt Hold, Bearish Engulfing Pattern, Bearish Harami, Blow-Off Top, Blowoff, Bollinger Band, Box Size, Breadth Indicator, Breadth of Market Theory, Breakaway Gap, Breakdown, Breakout, Breakout Trader, Broadening Formation, Bullish Belt Hold, and the latest and greatest Bullish Abandoned Baby.

The terms are so complex and the chart is so colorful, it all has to be true!

Yes, complex, colorful, and true; as in unnecessarily complex, colorful as in Fantasia, and true as being yet another way to record and present price history and nothing more; as in what is currently happening or what will happen:

In 1991, Dr. Gary Hirst began to look at technical analysis. He spent huge sums on computers and programming, analyzing a variety of technical analysis systems. Let me quote him on the results of his research:

"I had heard about technical analysis and chart patterns, and looking at this stuff I would say, what kind of voodoo is this? I was very, very skeptical that technical analysis had value. So I used the computers to check it out, and what I learned was that there was, in fact, no useful reality there. Statistically and mathematically all these tools -- stochastics, RSI, chart patterns, Elliot Wave, and so on -- just don't work. If you code any of these rigorously into a computer and test them they produce no statistical basis for making money; they're just wishful thinking. But I did find one thing that worked. In fact almost all technical analysis can be reduced to this one thing, though most people don't realize it: the distributions of returns are not normal; they are skewed and have "fat tails." In other words, markets do produce profitable trends. Sure, I found things that work over the short term, systems that work for five or ten years but then fail miserably. Everything you made, you gave back. Over the long term, trends are where the money is."

Keep in mind that all technical analysis techniques have programmed rules and exceptions that define a trend and all are trying to predict changes in a trend; up, down, and sideways; however, the fact that there are so many technical analysis techniques should be proof enough that nobody has gotten it right yet.

Think about this:

A line is a line is a line. There are many bits of data that make up the dots on a line. You can do a lot with a line made up by data dots; square it, divide it, multiply it, average it, square root it, time or volume weight it, intercept or triangulate it with lines that are iterations of the primary line; but, you cannot determine or predict where the next data dot will be on the line because of the position or value of the prior data dots that make up the original line anymore than any data dots that came before the latest new data dot could have been predicted by the data dots that came before them; other than, as stated earlier, to the extent that others are looking at the same line as you are and are using the same artificial rules that you are to divine where the next dot will appear:

Step 1: Reflects the closing price of a stock on its first day of trading based on the net pluses and minuses of stock market price affecting variables.

Step 2: Illustrates two days' closing prices with day two's closing price being determined by stock market price affecting variables and not because of the position of the first day's price data dot.

Step 3: There is no basis whatsoever to suggest that the price of a stock will close @ A, B, or C on the third day based on the position of the prior two days' closing prices; the fatally flawed leap of faith assumption that technical analysis would have you accept.

Technical analysis also mistakenly makes much of the reflective not predicative relationship between a stock's daily price and any one of a number of moving averages, 20 Day Moving Average illustrated below, for example.

Daily Prices and a 20 Day Moving Average of those prices are nothing more than mathematically connected by the algorithm used to calculate a 20 Day Moving Average generated by, a function of Daily Prices

To suggest that a day's future stock price will behave in a particular way because of its relationship to its moving average — which is simply a different 'view' of itself — is absurd.

Stock prices and moving averages are simply ways to record trends; but, neither predicts trends.

The following was posted when NYX was @ $65.00 to predict that and explain why NYX was headed back to $60.00:

"If you look at the coagulation trend of the binary supply indicator over the twin averages across the field of volatility you will acknowledge that NYX has a coefficient of 2."

NYX went directly to $82.00 over the next ten days from that moment.

This example of technical analysis price predictions is not the exception; but, rather the rule.

For technical analysis aficionados and technical analysis wanabes, take the following simple technical analysis test and grade your own paper:

Take a random number of charts. Delete the names of the companies. Turn them upside-down and shuffle them. Select one and cover the chart with a piece of paper. Turn the selected chart over. As you slowly uncover the chart with the cover paper from left to right, applying all the charting rules you have learned, predict the buy and sell points ahead; results, absolutely no better than 50/50.

I have given this test to many expert technicians and I have never met a person, who has taken this test, to get a passing grade.

Oh I know, you like they, after you have taken the test and failed, will be able to go back to the test charts and explain how, at each wrong turn you made, you simply applied the wrong tool, or used it incorrectly, or selected the wrong version of it; If I had only just spotted the convergences of the divergences in the Bearish Belt Hold in conjunction with the merging of the Appraisal Ratio and the Bearish Harami with the added Blow-Off, I would have gotten a perfect score, so please just let me take the same test again!

Investment technical analysis is much like watching an ant cross a table towards a real or imagined granule of sugar and trying to predict where, how, and when it will arrive at the granule on the table based on what the ant has done up to that point.

There is no basis whatsoever to conclude that either the footprints of an ant or the trail of an equity's price history are indicators of the future path for either; speed, direction, or destination.

Now to contradict myself, but only slightly.

This is not to say that there are never secondary reasons to buy and sell technically on occasion because chartists are a force to be reckoned with.

By knowing a few technical analysis rules, or even by not knowing any chart rules and by going to a chart site that offers charts that are interpreted for you with, possibly, a comment and certainly price predictions, one may gather a small piece of significant information as to where future prices may tend to go especially if the chartists are playing the same game at the same time along with you.

For example, if you are thinking about buying Apple @ $66.23, go to a site like StockCharts.com that generates many types of charts, many of them interpreted for you, such as the P&F chart below, and take a look with the hope that the chart might confirm your opinion; trend down, sell and don't buy and trend up, buy and don't sell.

In this case, the chart is bearish and is projecting a price of $52.00.

Perfect, no, but maybe you should watch and wait a little bit longer.

The Force of the Chartists may not be with you and you may want to think twice before going against it; especially if you have another equity you are also considering that you also want to buy and its chart is telling you to buy.

Note that from about this date on, Apple essentially headed directly to the $90's, went back into the $50's, and is now back into the $180's.

The primary decision(s) to buy and to sell should be based more on the fundamentals of a company, relative values in the financial markets, and the investment disciplines of the investment selection and management process than just the day to day price movements generated by The Royal & Ancient Order Of Chartists.