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Is technical analysis any use to investors?

  • 10 June 2010

The case FOR technical analysis

Chartists use technical analysis to help judge when to buy and when to sell. It's particularly valuable for short-term traders who need to gauge the prevailing sentiment. "Technical analysis enables traders to gain a vision of the market and make the right move at the right time," explains Dima Vonko , CEO of Alyuda Research, a company that develops advanced TA software.

One of the most widely used measures by longer term investors is the 200 day moving average . When the S&P 500 closed above this on the 2nd of June 2009, a number of firms including Harris Private Bank took it as a sign that the bear market was over. "That's proven to be a fantastic signal," said Jack Ablin , their chief investment officer.

At the time the S&P 500 was trading at 943. The buy signal remained in place until the 19th May 2010 when the index finally dipped back below its moving average. By then it had reached 1115 for a gain of 18%.

 

 

S&P 500

 

Arguably the TA technique with the best track record is the Coppock indicator . This is designed to provide buy signals for longer term investors. Jim Stack of InvesTech says that when applied to the Dow Jones over the last 50 years "Only 4 false signals have occurred. That's an 83% accuracy rate." 

The Coppock Indicator provided a buy signal on the S&P 500 in May 2009. This would have allowed chartists to make a lot of money, but it's now warning that the market may be overbought and heading for a correction.

The case AGAINST technical analysis

Perhaps the most damning verdict on TA comes from the sage of Omaha, Warren Buffett. When he first started out he spent eight years trying to get it work before ditching it in favour of fundamental analysis . "I realised that technical analysis didn't work when I turned the chart upside down and didn't get a different answer." 

An industry insider who blogs under the moniker of The Prince has witnessed first hand that the top hedge fund managers don't use TA. "So if the most sophisticated instructional investors don't believe in it why should you as an individual investor subscribe to technical analysis?" 

This partly chimes in with my own personal experience. As a financial journalist I get to talk to a lot of fund managers and have never come across anyone that puts more emphasis on TA than fundamental analysis, although off the record a few acknowledge that they do have a quick look at the charts before investing.

One of the most outspoken critics of TA is Tom Winnifrith, the founder of t1ps.com. He describes charting as cobblers and when he was asked to review a book on the subject said: "Being able to predict how shares will perform in the future by examining historical price information sounded to me about as credible as being able to predict next week's lottery numbers by looking at which numbers came up in the previous week." 

 

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