I NEVER BELIEVED IN “TECHNICAL ANALYSIS”

I NEVER BELIEVED IN “TECHNICAL ANALYSIS”

Matt HealeyMonday,19 November 2012

The Snap

I have been watching the financial networks quite a lot recently as the fiscal cliff issue is very interesting to me. The main reason for this is that I think there is going to be a lot of selling based on both well thought out calculations and unreasonable panic selling. Regardless, I think there will some good buying opportunities as companies get beaten down. The problem is that every once in awhile they will feature someone who specializes in “Technical Analysis”, which, in my mind is on par with tea leaves, astrology, homeopathic medicine, and the power of prayer.

The Download

For those that do not understand technical analysis, it involves looking for patterns in the stock charts. There are a variety of patterns, the “head and shoulders”, moving average, etc. Near as I can figure, the way that you do technical analysis is to draw lines of a chart until they fit your predetermined conclusion. The Onion described it best with the following headline: “Blue Line Jumps 11 Percent”. The premise of technical analysis is based on a fundamentally incorrect assumption. That is that individual stock movements follow a pattern. They do not. They move in reaction to news and events that the market perceives as having an effect on the future earnings of the company. While that is a very simple statement, it incorporates a lot as most events that happen in a day can be seen to affect future economic conditions. Numerous studies have demonstrated that technical analysis is horseshit.

Yet technical analysis still remains. It is my feeling that the reason for this is human brains are wired to find patterns in random noise. This arose through evolution, which given the acceptance rate of evolution in the U.S. may explain why technical analysis is still popular. The cost of seeing a threat when it was not there is that you ran away from nothing. The cost of not seeing a threat when it is there was becoming lunch for a predator. So we developed a tendency to see more patterns than actually exist. This is known phenomenon that you can witness every time to you set foot inside a casino. You will find someone who genuinely believes that if black has come up 5 times in a row, red is “due”. I usually ask that person a question – how does the plastic ball know it has landed on black 5 times in a row? So when picking stocks or deciding when to invest, look at the company’s fundamentals, their product line, the quality of the management, their strategy, the financial statements, the industry they are in, etc. rather than technical analysis, tea leaves, astrology, or advice from your imaginary friend.

Hat Tips

The OnionTim Minchin on evolution in AmericaTim Minchin Tony The FishThe Need to find patternsWhy We Make Mistakes, Image Credit: Wikimedia Commons

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  1. […] I was doing the research for my “Technical Analysis” article I had to find The Onion’s article on the blue line. I had remembered it from about […]

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