Technical Nonsense

I read as much as I can about the world of finance and economics. And though I consider technical analysis to be fortune telling, it shows up everywhere. So I often skim it anyway, just to see what the witch doctors are saying and observe whether some of them are actually right with any consistency. The last few months have been rather amuzing in how the technical analysts spun the reading of tea leaves. Here’s how it went:

Exhibit A: The Range (S&P500 index)

As the nice guidelines point out, the market was “stuck in a range”. Nothing particularly special about this, investors are simply waffling, waiting for more data to see where the world is headed. TA looks for ”breakouts” from the range.

Exhibit B: The Breakout

When the line of “support” is broken, it is considered a “breakout”. A “downside breakout” to be more precise. This supposedly indicates the market is breaking down, sell now and protect capital. Once support around 1220 on the S&P was “broken”, chart watchers issued orders to head for the lifeboats.

And it worked! For a few days. It does appear that a lot of selling was triggered which actually helped push the market lower into the first few days of October. A bit self-fullfilling, don’t you think? But it didn’t last long.

Exhibit C: The Bear Trap

The market promptly reversed and climbed instead- almost in a sprint- right back to the top of the range. Were the chart readers wrong? Of course not! The sell signal was quickly labeled a “Bear Trap” in hindsight that only the amateurs stepped in. Sort of like when the fortune teller asks if one of your parents was “sick”? Well, yeah, Dad died from cancer/heart disease/old age. Fortune teller: you must be careful because you will inherit many of your father’s genes/traits. You: I was adopted. Fortune teller: I meant your biological father [then changing the subject] I see someone whose name starts with ’M'…

So the market rallied. Up 10%, in fact, between the sell signal and the top of the range. When the S&P “broke out” of the range on the upside, they yelled “buy”. This rally has promptly faded to back below the line. I saw at least one “sell” get issued today.

TA fans like to say this is art as much as science. I like to say that drawing lines on top of other lines is art- the kind you find in coloring books. To be fair, if enough people listen to the same witch doctor, there *might* be some small effect. Certainly not an effect repeatable and believable enough for me to put any capital behind- Except to know that when a major threshhold is broken, causing TA to issue a sell for example, AND valuations are high AND fundamentals are bad, the TA trend may help reinforce what ought to happen anyway (“may help” because it might not- just like in this case). That wave of selling by the witch doctor congregation is certainly not going to help anything. This says nothing for the other 85+% of the time and its only a reinforcement, not a cause in and of itself.

One more thing is clear from the way TA works, illustrated perfectly above: did you notice that TA buys after the price rises and sells after the price falls. Isn’t the object of investing to buy low and sell high? Seems backwards to me.

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