Technical Analysis (Investing)

Jason Quintana's picture
Submitted by Jason Quintana on Tue, 2006-02-14 19:21

I have never understood the draw of technical analysis. Making investment decisions based upon this or this or trend or indicator doesn't strike me as a prudent investment method. In fact, I wouldn't call it investment at all. I would call it speculation. I also think that day trading is silly. Does anyone out there employ these techniques and do you believe that they actually work?

- Jason


( categories: )

Technical Analysis

Sam Erica's picture

I've been doing technical analysis for many years and invested in perhaps over a thousand stocks. I have tracked my performance in a detailed manner from March 2002 to June 2005 and the results are as follows:

Outperformed the DAQ by 6%

Outperformed the DOW by 10%

Outperformed the S&P500 by 5%

You may consider this significant, or not, for over a period of some three years. It requires a lot of work but if you have a significant amount of capital to work with it may be rewarding.

It is essential that you get a broker who charges minimum fees if you're trading actively, otherwise your profits will be completely eaten up by commissions.

Daytrading is a completely different thing and requires totally different techniques to tie in fractional gains for each trade. I recommend

http://clearstation.etrade.com/ for free charts delayed 20 minutes

and

http://www.quote.com/qc/livecharts/default.aspx? for trial 20 minute delayed charts or pay for live charts.

The rationale behind technical analysis is that all that is known about a stock at a particular time is reflected in the price and volume and that one can identify trading opportunities by observing the patterns.

Investment Strategies (Part B)

Ashley Chan's picture

3. Invest directly in smaller cap stocks outlined in 2a) or 2b) above VERSUS investing large caps or in mutual funds who invest directly in these stocks

a) investing directly involves a lot of research/study time, when one could be out and about with friends, holidaying, relaxing...e.g. in 2a) example, suppose you wanted to invest in oil & gas stocks, you would likely have to clue up in a general sense on all ?100 (or is it 200) or so companies with size $10b or less listed in the US & Canada....and we ignore the hundreds listed in the UK and Australia!
Lots of week night & weekend time used up, if you are not doing stock research for your day job!

On the other hand, you could specialise in following companies in sectors that you like following as a personal interest...e.g. all the surfing/snowboarding retail stocks that are listed on any stock exchange around the world

b) alternatively, you could pick an actively-managed mutual fund that invest in oil & gas juniors, plus hold an index fund that holds the large cap energy index or hold the v large/large/mid energy companies directly.

However, with 3b), you shouldn't underestimate the skill it takes to pick a good active manager who can pick good (undervalued) stocks.

4. Doing 3a) does provide you with a reason for a GOOD broker to have you as one of his/her clients....a GOOD broker will have 50-100 clients who are expert or interested in one particular field, so it means the broker then gets good ideas from one client which he can share to the rest of his clients....so if you said, for example, that you did not have $1m to invest, but only a few ten $k, but pretty much followed the entire zinc companies that were listed around the world and following the zinc market, a GOOD broker will likely sign you up as a preferred client and cut you in on any deals/IPOs/private placements that will hopefully make you tens of $k in exchange for your jedi thoughts on the zinc market:)

Hope all of this is reasonably clear...just typing out my thoughts as they come!

Investment Strategies (Part A)

Ashley Chan's picture

Adam

There are a number of conflicting or reinforcing investment strategies to consider...

1. Investing small amount (every year), so that by the time you end up with a large lump sum (at age 30/40/50/60, from cashout of start-up, selling business, company bonuses, company redundancy payout etc) you

a)i) have been through a number of market cycles (+200%, -75% etc) and have lost a few $k on stocks that went to zero, so that you reduce the chances of losing a packet when you personally invest your say $100k lump sum, and increase your chances of making a packet.

a)ii) know you have no jedi skills in investing based on your experience with investing a small amount of dosh, so are happy to hand the responsibility over to a professional

VERSUS

b) investing as much as possible each year, because you don't want to miss out on once-in-a-generation stocks that are grossly undervalued (e.g. see 2a) below)
--- of course, with 1b any stupidity attacks:) will do more harm to the absolute size of your investment portfolio

2. Investing on a logical theme VERSUS investing in any undervalued stock:

a) for example, you may decide to invest in energy, resources, commodities, because "China and India are only going to industrialise once"

b) you may decide to invest in any sector that is undervalued, not just resources in the 2a) above, because there is greater chance of a mania, and hence greater volatility in prices, of "theme" stocks

Technical Analysis

Ashley Chan's picture

Jason

If I had to make a (tenuous) argument in favour of TA in relation to stocks I would say that TA is a (semi-OK) short-cut to being able to view the company's shareholder register and observe every single trade.

Suppose in this mythical scenario you were told in advance that one fund manager holding 4% of a company you liked was was wanting to exit --- but there were few if any buyers. Then you, with your squillions of dollars, would probably approach the fund manager and say you'd take the 4% at some discount to the last traded price.

Now in the more real scenario with no mythical buyer and no knowledge that the fund manager is wanting to sell out...the share price is going to tank in the short-term with high volumes as the fund manager drip-sells on market his/her entire 4%...TA should/might pick this up, and alert short-term traders to avoid buying the stock even though fundamentally there is everything to like about the stock.

[Oh dear, I hope this doesn't start an argument about TA investors being short-term oriented and therefore lacking in objectivist values!:)]

Ashley

Mr. Henrikson's suggestion

Merlin Jetton's picture

Mr. Henrikson's suggestion to invest in ETFs is a good one for diversifying and keeping expenses low, provided one doesn't trade often.  ETFs have much lower management fees than mutual funds. However, brokers generally charge commissions on ETF trades like they do for individual stocks. Therefore, using ETFs for day trading can help expense-wise only in reducing the number of positions held, compared to a larger number of individual stocks. Trading often still runs up the commissions.

Look into trading ETF's they

Charles Henrikson's picture

Look into trading ETF's they are like mutual funds(diversification-wise), but they don't have all the fees involved. They are also optionable.

look for them at:

www.amex.com
www.ishares.com
www.holdrs.com

Adam you have it exactly right

Jason Quintana's picture

The financial markets are ruled by second handers. The greatest investors have always been the ones who understand this.

- Jason

Speculation

Jon Letendre's picture

Has anyone read The Education of a Speculator by objectivist Niederhoffer? Were you able to finish it? It’s agonizing. The glorious defenses of the speculator and stories about his uncles are good, but I couldn’t finish the book.

A year or two after my giving up the book, I read that after making hundreds of millions for himself and his clients, he lost it all.

I've been advised to do the

Adam Buker's picture

I've been advised to do the opposite of what most people do as far as investments are concerned. Instead of diversifing, I'm going to concentrate only on a few stocks (less than five) and watch those with scrutiny. I haven't made my picks yet as I'm still doing research to narrow my list down. I don't give a damn for most of the noise that stock analcysts make, I would rather stick to something I've figured out for myself.

TA & day-trading

Merlin Jetton's picture

I assume by "technical analysis" you mean charting prices of stocks, and deciding where the price will go next based on the chart and its patterns.  It is trying to predict future prices based purely on past prices.

A few years ago I computer-tested different recommended timing strategies on historical price data for stock indexes. While a given strategy might work well for one index in one time period, it will typically do much worse for other indexes and different time periods.

I believe day trading is a losing proposition. From what I've read, more than 90% of the people who try it don't last more than a year and less than 2% who try it make money consistently.  I believe it is about as scientifically sound as astrology or a ouiji board.

Beside the difficulty of guessing future prices, a big problem day trading faces is the expense. Suppose you have $50,000 to invest initially and use a discount broker who charges a $7 commission per trade. If you do only one round trip per day, that is 250*2*$7 = $3500 per year. That is 7% of the portfolio and a conservative amount of trading. Chances are you are going to hold more than one position at a time to diversify. Assume 5 positions, and your trading expense goes to $17,500.

In addition there is the bid-ask spread. Assume an average spread of 0.25%. This is representative of the NYSE; the average spread on small cap stocks is much higher. 250*$50000*.0025 = $31,250. Wow! This isn't a "hard-dollar" cost like commissions, but it is something that must be overcome by gains in stock prices.

When you look at these kind of numbers, it is easy to understand why so many fail.

Agreed

Jon Letendre's picture

It depends how broad a meaning you give to “technical.” Certainly it is a mistake to look at a chart, see up-down-up-down, and conclude that it will now go up, without any other knowledge.

But if a stock you own disappoints with an earnings announcement, it may be worth looking to the past in order to find the punishment it received for past disappointments. Some analysis will be required in order to isolate the punishment from other market-wide factors. This will imply that today’s punishment has either just begun (consider selling some), or has been overdone (don’t sell.)

I have never bothered investigating into what are these theories that day traders think they are onto, so I suppose this means I agree with you.

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