May 17, 2013 – If only I had a nickel for every TA-based prediction that failed to materialize...
By The Cerebral Aesthetic Vagabond
Over the years I’ve examined hundreds of fairly worthless technical analysis (TA; not to be confused with a similar abbreviation for elements of female anatomy) charts, leading me to rather unfairly characterize TA as a sort of “voodoo,” or akin to the practice of ancient witch doctors reading their “signs.”
Recognizing that prices fluctuate, often under the influence of unscrupulous human beings, I have never relied on TA and have always preferred to understand the fundamentals. Whereas in a “stable” and organic investment climate, TA might be able to offer some guidance on where a price is headed, it’s at best short term guidance and can be instantaneously rendered irrelevant in an investment climate that’s hypersensitive to any news headline, even those that are mere rumors. Understanding the fundamentals tells one where things are headed in the long term, short term fluctuations and manipulations notwithstanding.
For example, the high price of oil today was predictable years ago from an understanding of a simple supply-demand relationship: the global production (supply) of oil has plateaued for at least the last five years, which could have been predicted if one believes the peak oil theory, whereas the global human population (demand) has steadily increased for the last five years; the reason the oil price is not even higher today is because of falling demand resulting from the deepening global depression, which is offsetting the rising demand from the growing human population. During the last five years the price of oil has fluctuated greatly, and perhaps TA might have been able to anticipate a few of those short term fluctuations, perhaps even in spite of undoubted price manipulation, but anyone investing in oil for the long term would have profited from the fundamentals alone.
Although I frequently deride TA as “voodoo,” it has a sound basis in human psychology, for human beings respond in predictable ways to prices. For instance, a low price usually stimulates humans to purchase the cheaper good, increasing demand and eventually causing the price to rise, which is the mechanism for the “bottom” in TA terminology. Conversely, a high price usually causes humans to sell and book a profit, decreasing demand and eventually causing the price to fall, which is the mechanism for the “top” in TA terminology. What constitutes “low” and “high” prices to human beings is purely subjective, based on human whim, contemporary economic conditions and myriad other intangible factors.
There are many different mathematical methods employed in TA, none better or worse than any other. None of these mathematical analysis techniques are “magic bullets,” but merely imperfect, crude guides. Actually, TA is akin to pattern matching, something humans excel at: we humans discern a price trend and then search for a mathematical model exhibiting a pattern mirroring that of the price trend; then we act as though prices adhere to the mathematical model, when in fact it’s the other way around: the model was chosen because of its similarity to the price trend. Despite the manner in which their charts are deified by some TA acolytes, prices are absolutely not dictated by the mathematical models.
The thing that amuses me most about TA is the way some people seem to worship it, which is why I refer to it by the semi-religious moniker “voodoo.” They will make failed prediction after failed prediction based on their TA voodoo, always ignoring all their past failed predictions, yet continuing to lay the groundwork for future embarrassment by making new predictions based on their numerous mysterious and colorfully named “signs” (such as the ominous sounding “Hindenburg Omen”), never once pausing to ask themselves if their beloved charts are actually useful.
Today, computerized trading algorithms account for something like 90% of stock market trading and presumably a significant portion of trading in other markets as well. So human psychology, the original basis for TA, is no longer the driving force in the markets, except insofar as the computer algorithms may encapsulate elements of human psychology. Nevertheless, computer algorithms cannot experience the emotions of fear and greed the way humans can, and those are two of the principal aspects of human psychology that govern human reaction to price trends.
Moreover, it may be argued that TA is utterly useless in a marketplace where all prices are manipulated for different reasons, some profit motivated, some politically motivated, the recent trends in precious metals prices exemplifying both. So unless TA takes into account the motivations of the manipulators, TA cannot be an accurate predictor of the price.
The crude TA methods in use today may be suitable in simple, stable investment climates, but are – in my opinion – useless in our complex investment world, which is affected by so many external variables, including price manipulation, computer trading algorithms, institutionalized currency debasement and a globalized financial system.
In order for TA to be useful it needs to become far more sophisticated, taking into account all the factors cited above. In short, what’s needed is a virtual simulation of the entire marketplace that takes into account not only price trends, like TA does now, but also manipulative motivations, computer trading algorithms and everything else and weights those factors appropriately. For instance, if computer trading algorithms account for 90% of the trading activity and humans account for only 10%, then in such a proposed simulation the influence of the computer algorithms should have nine times the weight of the influence of human psychology.
To some extent, investors are beginning to incorporate such insights into their investment models, if not yet into their TA charts. For example, it’s crystal clear to investors in the U.S. stock market that the Federal Reserve is helping to drive it upward, which is one form of politically motivated manipulation. That investors are at this point expecting a continuation of that manipulative influence shows that they have incorporated at least that much of the manipulative influence into their investment planning.
Similarly, when the powers-that-be seek to manipulate prices, especially those of precious metals, they rely on the predictable behavior of computer trading algorithms to amplify their manipulation, so they too have begun taking some of these modern market influences into account in their planning. What remains lacking is the incorporation of these factors into TA charts, so people who rely solely on traditional TA charts are missing a large part of the investment picture.
While I still take a dim view of TA, it has, or used to have a valid basis in human psychology for predicting short term price trends; long term price trends are better predicted using fundamental analysis. However, in light of computer trading algorithms and politically motivated manipulation of all markets today, traditional TA is useless. A modern approach to TA is needed, one based on computer simulation techniques, and which incorporates insights about human psychology, computerized trading algorithms and profit and politically motivated manipulation.
Here’s an essay titled The Sell-Off In The Precious Metals and Mining Stocks Is Just Plain Silly Now that reinforces my arguments above, the quotation below comprising the principal support:
The key to understanding relative value is not found in charts, "technical" indicators, CNBC, Bloomberg News, any Wall Street research, Barron's, chat board, etc. Realistic and honest assessment and study of fundamentals is nowhere to be found in any of those sources. None. Zero.