Is Technical Analysis For Real?

I used to believe in technical analysis. It went against the mainstream, it was easy to implement, and it had strong, compelling arguments to support its validity. Or so I thought. For example, if Stock A is selling for $8 on Monday and goes up to $12 by Wednesday, many investors will regret not having purchased the stock for $8. If the stock price drops back down to $8 by Friday, all those investors who didn't invest the first time around will leap at the second chance to buy. The $8 becomes the floor for the stock.

In theory, I wouldn't have to know anything about the fundamentals of a company to trade its stock. (Investing would require a combination of technical and fundamental analysis, but I digress.)

After a while, I became frustrated with technical analysis because I never knew where to draw the lines. My floor may not be the next person's floor. It all seemed so arbitrary to me. And within a year of trying to master this approach, I abandoned it in favor of fundamental analysis...

...until now when suddenly, technical analysis is cropping up again. If everyone believes the economy is humming, plan for a recession! And with the economy hobbling along, maybe the Dow will reach 14,000! Just go against the grain!

So how valid is technical analysis? Can it stand alone or does it need fundamental analysis to be of any use?

Hedge Fund Interview Course

  • 814 questions across 165 hedge funds. Crowdsourced from over 500,000 members.
  • 11 Detailed Sample Pitches and 10+ hours of video.
  • Trusted by over 1,000 aspiring hedge fund professionals just like you.

Comments (35)

Apr 1, 2012 - 1:36pm

The richest guys in the world aren't trading solely on technicals...

It definitely has some validity to it and works in lots of situations but you can't abandon fundamental analysis altogether. My opinion on the best way to implement a strategy is to start with fundamentals, and once you've decided you have a good company in a decent price range on your hands, you can utilize some technical analysis to find a solid entry point for your investment. So like an 85%/15% split in favor of fundamentals, never the other way around.

I hate victims who respect their executioners
  • 1
Apr 1, 2012 - 1:59pm

As previously mentioned, I would start with fundamental analysis to find an equity trading below intrinsic value, then, and only then, would I implement technical analysis to find an appropriate entry point.

However, if you are a day trader (lulolool), technical analysis would probably be your chief (maybe sole) analysis tool.

I only implement a few technicals:
RSI
MACD
SMA
Bollinger Bands
Fibonacci

The difference between successful people and others is largely a habit - a controlled habit of doing every task better, faster and more efficiently.
Apr 2, 2012 - 2:27am

Most of TA is just dressed-up mean regression and momentum strategies. Read some papers- the vast majority of TA strategies do not work today.

mhurricane:

I only implement a few technicals:
RSI
MACD
SMA
Bollinger Bands
Fibonacci

This all seem easy to backtest and implement algorithmically, which makes me wonder how they could possibly be profitable.

As a STEM graduate, I had to laugh when I read the wikipedia article for Fibonacci retracement. What the fuck is the theoretical basis for using Fibonacci ratios? Sure, the Fibonacci numbers pop up in nature, but not at random- there are real reasons why you expect to see them pop up in certain situations. "Fibonacci retracement" sounds just science-y enough to dupe people into buying long-winded books written by snake-oil salesmen.

"'In summary, people are morons and who cares. Make a shit ton of money. I've never seen a Ferrari paid for by what people think.' - ANT" -rufiolove
Apr 2, 2012 - 4:40am
acronym:
Most of TA is just dressed-up mean regression and momentum strategies. Read some papers- the vast majority of TA strategies do not work today.
mhurricane:

I only implement a few technicals:
RSI
MACD
SMA
Bollinger Bands
Fibonacci

This all seem easy to backtest and implement algorithmically, which makes me wonder how they could possibly be profitable.

As a STEM graduate, I had to laugh when I read the wikipedia article for Fibonacci retracement. What the fuck is the theoretical basis for using Fibonacci ratios? Sure, the Fibonacci numbers pop up in nature, but not at random- there are real reasons why you expect to see them pop up in certain situations. "Fibonacci retracement" sounds just science-y enough to dupe people into buying long-winded books written by snake-oil salesmen.

dude 9/10 people in the markets would of course agree fibonacci are ridic. which, of course, implicitly condones their use (think about it)

legitimacy is not the only reason to use TAs...

Moving tonnes of product. Making fat stacks.
Learn More

300+ video lessons across 6 modeling courses taught by elite practitioners at the top investment banks and private equity funds -- Excel Modeling -- Financial Statement Modeling -- M&A Modeling -- LBO Modeling -- DCF and Valuation Modeling -- ALL INCLUDED + 2 Huge Bonuses.

Learn more
Best Response
Apr 1, 2012 - 2:05pm

I think you need to use both in most situations. I have a 100% fundamental background but even I use some technical analysis sometimes. For example, if I'm looking to short something, I will often notice patterns in which the stock traded up over a series of days after the banker (false research analyst) from one of the wire houses put out an upgrade note to "defend" the stock (don't buy the hype - the global settlement is dead). That doesn't tell me to short the stock or not on it's own, but it does tell me what some of the expectations are in the stock, and if I can prove within a degree of confidence that the reason for the upgrade is BS (sounds like hope with no substance, or his model is wrong, or he doesn't mention something important like increasing competition, etc.), then I know some investors are going to be disappointed when they figure that out, and the stock will in fact go down.

In general, the market is not as efficient as people like the believe. The price of most stocks fluctuates between X and Y, where the range represents the consensus view between two accepted likely outcomes (this could be based on guidance, historicals or any number of other things). If the reality doesn't match the X to Y dynamic, the price will exceed that range in either direction depending on the nature of the news revealed to the market. There's more than one way to skin a cat, but the ability to make money in the stock market basically comes down to finding mispriced bets where you have a high degree of certainty that X to Y is not the correct range over your expected holding period, and that you have a degree of margin of safety when getting involved. In general, the larger the stock, the more efficient it is.

So the point is, technical analysis doesn't tell you everything you need to know on your own, but it might be an important 10-20% if the puzzle. The patterns are noisy but usually not 100% random. Gapping stocks in particular are demonstrating very important information (the market was obviously substantially wrong about something in either direction), which in some cases can reliably demonstrate a coming up or down trend (though I would only trade those based on some fundamental backdrop -- i.e., the stock gapped up on some new product gaining traction, but the market is still discounting that new product, and your research shows that it should actually grow for the next 5 years or whatever, and therefore the stock should sell for higher in the future -- meaning that the gap is only the first move but doesn't fully reflect likely intrinsic value).

Apr 1, 2012 - 4:25pm
Ravenous:
I think you need to use both in most situations. I have a 100% fundamental background but even I use some technical analysis sometimes. For example, if I'm looking to short something, I will often notice patterns in which the stock traded up over a series of days after the banker (false research analyst) from one of the wire houses put out an upgrade note to "defend" the stock (don't buy the hype - the global settlement is dead). That doesn't tell me to short the stock or not on it's own, but it does tell me what some of the expectations are in the stock, and if I can prove within a degree of confidence that the reason for the upgrade is BS (sounds like hope with no substance, or his model is wrong, or he doesn't mention something important like increasing competition, etc.), then I know some investors are going to be disappointed when they figure that out, and the stock will in fact go down.

In general, the market is not as efficient as people like the believe. The price of most stocks fluctuates between X and Y, where the range represents the consensus view between two accepted likely outcomes (this could be based on guidance, historicals or any number of other things). If the reality doesn't match the X to Y dynamic, the price will exceed that range in either direction depending on the nature of the news revealed to the market. There's more than one way to skin a cat, but the ability to make money in the stock market basically comes down to finding mispriced bets where you have a high degree of certainty that X to Y is not the correct range over your expected holding period, and that you have a degree of margin of safety when getting involved. In general, the larger the stock, the more efficient it is.

So the point is, technical analysis doesn't tell you everything you need to know on your own, but it might be an important 10-20% if the puzzle. The patterns are noisy but usually not 100% random. Gapping stocks in particular are demonstrating very important information (the market was obviously substantially wrong about something in either direction), which in some cases can reliably demonstrate a coming up or down trend (though I would only trade those based on some fundamental backdrop -- i.e., the stock gapped up on some new product gaining traction, but the market is still discounting that new product, and your research shows that it should actually grow for the next 5 years or whatever, and therefore the stock should sell for higher in the future -- meaning that the gap is only the first move but doesn't fully reflect likely intrinsic value).


what about futures? aren't futures, especially commodity futures, more conducive to trading off technical analysis and trends?
Apr 1, 2012 - 4:17pm

I'd wager that technical analysis has modest predictive power, but only when used in concert with fundamentals.

"When I was young I thought that money was the most important thing in life; now that I am old I know that it is." - Oscar Wilde "Seriously, psychology is for those with two x chromosomes." - RagnarDanneskjold
Apr 1, 2012 - 4:41pm

The firm I interned at was 100% technical analysis and beat the market since inception. They used a swing trading approach and held 2 weeks-2 months

Daytrading based off candle patterns and shit like that is for suckers.. I did it for years

Regression channels and MACD are the main 2 indicators, imo

Apr 2, 2012 - 8:31pm
WSOWill:
The firm I interned at was 100% technical analysis and beat the market since inception. They used a swing trading approach and held 2 weeks-2 months

Daytrading based off candle patterns and shit like that is for suckers.. I did it for years

Regression channels and MACD are the main 2 indicators, imo

That is just a crude/rough way of having some kind of mean-reversion strategy. Nothing inherently wrong with it, but there are much more objective ways to achieve the same thing and not leave yourself nearly as open to the random noise inherent to TA.

Apr 1, 2012 - 5:17pm

A few things.

First, I absolutely believe in the validity of technical analysis. What gives it a bad rep are people who rely on it solely, and try to make it seem that technical analysis will predict the future. That is not true. What technical analysis really represents is simply the behavior of market participants in graphical manner, and chart patterns correspond with certain emotions being reflected in the market. Better understanding the emotions that have prevailed in the market can help you form your forward looking expectations.

Second, my opinion is that technical analysis is more valid for foreign exchange, commodities, and interest rates. A large part of technical analysis is self-fulfilling, and there are simply many more believers in macro markets versus the equity market. I believe that a part of the reason why is that equities have clear benchmarks on valuation that can help guide decision-making. But in commodities, there are no multiples, what does $6 corn vs. $8 corn really mean? Yes, there will be demand destruction at $8 corn, but how do you really quantify that? My point is that macro markets are a lot fuzzier, which lead them to be more psychological, thus making technical analysis more relevant.

Third, technical analysis feels like it is simple and easy, but I firmly believe that it is an art that takes a significant amount of experience to use effectively. You're right, everything is very ambiguous in techs, which is what makes it an art, not a science.

Apr 1, 2012 - 6:29pm

Jim Rogers describes himself as a "horrible trader." It looks like things turned out ok for him.

Competition is a sin. -John D. Rockefeller
Apr 1, 2012 - 7:46pm

I use alot of technicals, more for information then anything else. For example every morning I have a report that tells me what products have tbroken 50 day, 100 day or 200 day moving averages...its not because I neccesrarily think that one can make money trading these signals but rather because these crosses just mean that something is happening and I want to investigate what it is. When u r trying to follow so many different markets these type of things can help you not to miss anything.

Apr 4, 2012 - 7:19am
Bondarb:
I use alot of technicals, more for information then anything else. For example every morning I have a report that tells me what products have tbroken 50 day, 100 day or 200 day moving averages...its not because I neccesrarily think that one can make money trading these signals but rather because these crosses just mean that something is happening and I want to investigate what it is. When u r trying to follow so many different markets these type of things can help you not to miss anything.

I do the same thing...it's a great indicator of changes and sectors that can be making changes..ie if you see multiple tech companies pop up, maybe shift one way or another

I eat success for breakfast...with skim milk
Apr 1, 2012 - 8:56pm

"For example, if Stock A is selling for $8 on Monday and goes up to $12 by Wednesday, many investors will regret not having purchased the stock for $8. If the stock price drops back down to $8 by Friday, all those investors who didn't invest the first time around will leap at the second chance to buy. The $8 becomes the floor for the stock.

In theory, I wouldn't have to know anything about the fundamentals of a company to trade its stock."

if this is the general idea you started with, its probably the reason why you failed to utilize it properly.

Apr 2, 2012 - 3:47am

I have been in the markets for a fairly long time, and I have seen many victims of the TA snakeoil. If it was that simple everybody would be rich

Apr 2, 2012 - 7:13am

This is a great post, I myself have pondered the validity of technical analysis myself.

At the end of the day, macro's post most closely resembles my take on the matter. Some markets lend themselves to technical analysis more than others (if only because the % of said market's participants that utilize TA is higher than other markets).

Being a sell-side equities guy, I don't consult the charts before making my buys/sells... but once fundamental analysis have given me 3 or 4 equities of interest, I then utilize technical analysis for entry/exit points.

Patrick Bateman would eat Eddie Morra's lunch (and probably his brains).
Apr 2, 2012 - 8:14pm

From all the comments above, I can say with strong conviction that there isn't a single person on this thread who works in asset management.

Array

Apr 2, 2012 - 8:31pm
ERGOHOC:
From all the comments above, I can say with strong conviction that there isn't a single person on this thread who works in asset management.

Including Bondarb? You need to do more research on the commentators before you make such a blanket statement.
"Sincerity is an overrated virtue" - Milton Friedman
Apr 3, 2012 - 1:35am
ERGOHOC:
From all the comments above, I can say with strong conviction that there isn't a single person on this thread who works in asset management.

enormous fail

Moving tonnes of product. Making fat stacks.
Apr 4, 2012 - 7:26am
ERGOHOC:
From all the comments above, I can say with strong conviction that there isn't a single person on this thread who works in asset management.

you say that, but everyone trades and makes decisions differently..some firms are holding companies predominantly, where as some traders may not hold and may be making more trades

I eat success for breakfast...with skim milk
Apr 4, 2012 - 1:33pm

TA is just like voodo, it's inherently self destructive, if the crowd knows that something is going to happen, any potential opportunity would quickly vanish. For those who used it and it "worked" for them, they may just suffer from illusion of validity, in other words they tend to discard the instances when TA did not work. The authors of the tons of books on TA they cannot be as selfless as to sell shovels instead of digging for gold.

Apr 4, 2012 - 6:48pm
Cromwel:
The authors of the tons of books on TA they cannot be as selfless as to sell shovels instead of digging for gold.

That's a lot like saying becoming a surgeon can't be lucrative, because if it were no surgeon would write a textbook used to help med students learn the field...

Cromwel:
if the crowd knows that something is going to happen, any potential opportunity would quickly vanish.

It can also be argued (just a hint: this is my argument) that if that "crowd" all buys because their TA tells them to... then the price will likely rise (simple supply/demand)...

Patrick Bateman would eat Eddie Morra's lunch (and probably his brains).
Apr 6, 2012 - 7:32pm

I worked at a firm that used technical analysis, specifically to determine timing in commodities/indices. I always questioned the validity of TA (I still generally agree with Cromwel's comments above in regards to people overstating the accuracy or value of TA) but over time realized that a lot of people are using TA, particularly short term (this includes a lot of guys on the floor at CME and NYMEX). This alone makes TA makes it a self-fulfilling prophecy, especially at 'significant levels'.

Having said that, fundamentals drive the market; it was rare to see the general direction of the trading day determined by technicals. TA certainly seemed to have value in timing entry/exit for short term trades, but I always stuck with the basic indicators mentioned by others to provide a more general view of the markets, rather than direct trading decisions.

davel5
Apr 9, 2012 - 7:14am
davel:
I worked at a firm that used technical analysis, specifically to determine timing in commodities/indices. I always questioned the validity of TA (I still generally agree with Cromwel's comments above in regards to people overstating the accuracy or value of TA) but over time realized that a lot of people are using TA, particularly short term (this includes a lot of guys on the floor at CME and NYMEX). This alone makes TA makes it a self-fulfilling prophecy, especially at 'significant levels'.

Having said that, fundamentals drive the market; it was rare to see the general direction of the trading day determined by technicals. TA certainly seemed to have value in timing entry/exit for short term trades, but I always stuck with the basic indicators mentioned by others to provide a more general view of the markets, rather than direct trading decisions.

I am in complete agreement. I am still inclined to think that TA DOES have validity on higher time frames as well (days/weeks/months) in certain markets. Currency markets in particular. But your general assertion that TA becomes more and more relevant the further down in time frames you go (seconds/minutes/hours) is a fair one.

Patrick Bateman would eat Eddie Morra's lunch (and probably his brains).
Start Discussion

Total Avg Compensation

April 2021 Investment Banking

  • Director/MD (9) $911
  • Vice President (34) $348
  • Associates (182) $232
  • 2nd Year Analyst (104) $151
  • Intern/Summer Associate (95) $145
  • 3rd+ Year Analyst (26) $145
  • 1st Year Analyst (388) $131
  • Intern/Summer Analyst (317) $82