The case against technical analysis

Please read Edwards & Magee on TA. It’s a big book but covers the topic in-depth. I especially liked the fact that the authors explain the rationale behind the theory – not just the ‘what’ but the ‘why’ of it. Though I am not a technical analyst, I do use some of the ideas mentioned in the book as a supporting input. When both fundamental and technical factors converge towards a decision, you can act with more confidence and the strike rate improves.

1 Like

thanks
somewhere i read - technical analysis of financial markets by murphy is good for beginners

The strongest argument against technical analysis is that all books on technical analysis starting from Edwards and Magee tell us how retail investors, through technical patterns, can know about the actions of the more informed market players / institutions/ operators and benefit from that knowledge…by either buying or selling the stocks.

From this it is very clear that Technical analysis, cannot be of much use to the institutions / big market players etc.

It is only a technique that enables the retail investors to ride the shoulders of giants by timing their market actions…incidentally, value investing to recognizes this strategy of …riding the shoulders of giants. Mohnish pabrai has discussed this strategy in detail in his book on value investing - the dhando investor.

and now we come to the final and most important question…why are value investors so averse to technical analysis…when its just a variation of a legitimate value investing strategy?

1 Like

I’ve no opinion on TA. But the process of Value Investing (as described by Graham, & Klarman), and riding on the coattails of successful investors (as described by Pabrai - It’s just an approach he has adopted.), are different.

It has to be noted that Amateur investors, when they try to copy the stock picks of successful investors tend to rely on borrowed conviction, which isn’t going to be successful in the long run. As the saying goes, “Copycats are successful only till the cat is around.”

Tech Analysis is a tool for retail investors to follow the actions of big players. So obviously, its not of much use to the big boys

There is no set pattern in which the value investing as taught by graham is implemented. As Buffet has pointed out in his lecture.The Super Investors…even Grahams disciples have successfully implemented value investing in different ways.

And I may buy a stock on my own conviction. But does that make the stock to go up in price? It only goes up when a large section of the market develops conviction in that particular stock. So what use is my conviction till market participants are sceptical and conversely, of what use is my scepticism if the market participants are convinced.

Through a combination of fundamental analysis and technical analysis, we try to find out if the market too is convinced with a particular stock about which we are convinced.

4 Likes

My views:

The word technical analysis limits the spectrum of speculation. If you are talking about trend or even KPI’s like Fibonacci, Donichian channel etc it refers to method of entering into a stock or popularly called as entry method for many. However speculation is much more beyond entry method and includes key elements as money management, risk management and position management. It may not be necessarily complex. I will paste one of Speculation set up currently I am using but before that we need to understand couple of things clearly 1. Stock price includes a portion of speculation and no matter wherever you go in world it cannot be avoided in place of demand and supply. 2. Crowd influence speculation and there buying and selling can throw vital information 3. It is up to an individual how to use a speculation analytics into their decision making i.e. even you can use for long term investing.

It’s not true a speculator plays only for short term, he plays as long as stock is profitable and even the holding period can go way beyond years and years.

Here is one pure market price ( you can say technical analysis) related ‘Speculation set up’ I currently use:

Name: Early Stage Breakout (ESB)

Market Direction: Only uptrend (major indices), in case of range bound market sector must be in up trend.

Universe: Either price has appreciated by more than 20% in 1 Month or 30% in 3 Month

Filters: 1. 10 day average volume more than 10K 2. CMP>50 3. MCAP>100 Cr

Entry conditions:

  1. There is a breakout above resistance and 30 WMA
  2. Desirably there is a pullback after breakout
  3. Price appreciation post breakout is restricted to 50%
  4. Breakout volume is 2 times more than previous 4 week average volume
  5. The stock is above 30 WMA line post breakout
  6. Stock is making higher high and lower high post breakout
  7. The stock is out performing the sector (relative strength line)
  8. Sector is in uptrend
  9. Extra catalyst: a.break out volume for the week increase 9/10 times over 4 weeks average b. Rising relative strength c. price momentum (highest price for week is among highest in last four weeks subject to 10% than first week high price).
  10. The stock is at all time high or multi year high

Original Stop Loss:

Average true range multiplied by 2 times. Not Applicable for testing position.
If daily Volatility is less than 3% then then multiplication factor (MF) is 2.
If Volatility is between 3-4% then MF is 2.2
If Volatility is between 4-5% then MF is 2.4
If volatility is beyond 5% then MF is 2.5

Trailing stop loss

Profit between 1R-3R: Give back 1 R
Profit between 3R-5R: Give back 1.25 R
Profit between 5R-8R: Give back 1.5 R
Profit between 8R-12R: Give back 2 R
2R is maximum.

Position management (pyramid- scaling in and out)

Initial Position: Max 24000 Risk, Max Pos Size-3 Lacs
Trade 1: Max 24000 Risk, Max Pos Size- 3 Lacs
Trade 2: Max 18000 Risk, Max Pos Size- 2.25 Lacs
Trade 3: Max 18000 Risk, Max Pos Size- 2.25 Lacs
Trade 4: Max 12000 Risk, Max Pos Size- 1.5 lacs
Trade 5: Max 12000 Risk, Max Pos Size- 1.5 lacs
Trade 6 on wards: Max 12000 Risk, Max Pos Size- 1.5 lacs

Exit Plan:

  1. Poor reaction to good news
  2. Declines more than 5% with high volume
  3. RSI levels above 80- except fresh breakout trend.
  4. Stock is more than 500-800% with analyst coverage, media etc
  5. Trend is over- lower low, a new 50 day low, below 100 DMA, below 50 WMA
  6. When a stop loss is hit. SL is calculated basis END OF DAY PRICE. Intraday fluctuations to be ignored.

These terms are widely used terms, please reach out to me if you need a clarification at suvendurath@yahoo.com. Not very frequent to other places these days other than work, sorry.

Now you can use fundamental aspects within set up as well like I created a set up called ‘super stock’ which includes entry conditions such as :
Weighted Fundamentals
1.Consistent quarterly EPS and revenue growth. YOY revenue-20% and EPS -30%
2. New catalyst
3. PE less than 15 (Quarterly PE 3.75)
4. QOQ earnings and revenue growth
5. Promoter buying in open market
6. Low float -less than 50 lacs shares for retail public

You can even include competitive advantage if you can manage ( I found it difficult considering reaction time, may be will look for a short cut in future).

Even I was using a set up with entry conditions 3 months back which is 2 lines 1. Break out of 4% during day 2. The stock is hitting new 50 days high. Don’t think it doesn’t work, in raging bull market breakout reflects traders trying to change the trend.

The entry conditions can be complex as well if you wish to like multiple moving averages with compression/expansion analysis.

However complexity doesn’t necessarily guaranty extra fire power. What saves your day is combine and use all elements of speculation i.e. entry conditions to filter, risk management to money management.

Of course over arch is behavioural finance, one has to grind the axe for themselves for getting control over behavioural finance.

One need to intertwin strongly risk management, money management and position management to investment philosophy. In case of trading you will get thrown out unless you follow i.e. rules are god there. However the opinions are diverse in case of business investing say value/growth etc, personally I feel the rules help long term investing also, one need to customize the threshold accordingly not to get whipsawed unnecessarily!

4 Likes

I am not a Fundamental Analyst or Technical Analyst Registered with SEBI
but i have some Knowledge in both , both are very good there is no doubt
because it shows only past facts only fundamentals or Technicals
History repeats is true , Lessons are same but shape is change in my view

so many times i proved in other free public forums in Technicals and fundamentals are giving accurate results
almost … some limitations are there , some times failure also there , that is why Technical Analysis is a
Science and also Art

i was given full details with charts for discussion and study purpose , evidence is Time stamp date and time only prove it

it is not moral to show those forum links … i am expressing my apologize to Admin for this
i will not repeat same in future … my main intention is both analysis are giving good results

but i want to prove Technical Analysis is also great …

one forum is there … named " Rakesh - jhunjhunwala dot in " … in that " stocks talk " section …
in that section " Ask A Query About Your Stock Picks And Portfolio "
in that " FUTURE MULTI BAGGER COMPANY ANALYSIS " thread crated by me
in that page number 32 , post no 634 dated nov1 2016 , with my post Excel sheet is also there
page no : 35 , post no : 689 and 690 is the evidence for technicals also giving good results

Thank You Very much … My English is poor but my intention is Pure

ALL THE BEST Members

3 Likes

An interesting metaphor

5 Likes

A Picture for illustration…it seems reverse cup and handle pattern is emerging here…plz confirm…

In my opinion- It is neither a reverse cup and handle nor a proper cup and handle. Plus it is appearing in a downtrend. The handle length is too long too. I have in the past made the mistake of not being able to differentiate between correct and faulty patterns. This looks to me like a cup and handle trap. Strictly my views.

1 Like

dont overcomplicate things i think. its simply lower lows and lower highs…

1 Like

In my humble opinion…the stock is in a downtrend…on all time frames…

1 Like

In my opinion it is going to form a double bottom near 850, retracement to 850 should be slower than previous jump from 850

Disc: I am not an expert and this only my personal opinion and I can be wrong.

I have been thinking of a strategy that makes use of both long term investing and short term trading. Here is what I have come up with.

Lets say you have 10 lac in capital that you would like to invest

  1. Allocate 20% of your INITIAL capital to short term trades. This can be day trading, swing, or positional. So in my case I allocate 2 lacs to my day trading strategy
  2. Based on past performance of your strategy, decide on the position size that give you a max drawdown of around 20-30%. For my strategy its 4 lots of NIFTY Futures.
  3. Buy great stocks using the rest of your capital. These are going to be long term investments. So in my case I allocate 8 lacs to stocks.
  4. As soon as the day trading strategy gives you a profit of more than 50000. Transfer that money to you investment pool. Buy more great stocks for long term or increase positions in existing ones.
  5. When the day trading strategy gives you a loss of more than 30%(60k). Transfer money from your bank account to the day trading account. Never reduce or increase the position size in the day trading strategy. Just stop trading until you are able to get it back to the original amount(2 lacs)
  6. Never sell your long term holdings to to finance your short term account.

So Money flows this way
(Bank) --> (Trading Account) --> (Investment Account)

I think this will make sure that I don’t lose too much money because of greed in my trading account as my position size is always the same. Any profits will be taken directly to my long term investment account.

Obviously the trading strategy needs to have a positive expectancy and good backtested results for this to work.

What do you guys think?

1 Like

Hi there
A plan like this would require an extreme amount of tempremental discipline which is difficult to master even for seasoned practitioners. Mastery of emotions is easier said than done in my opinion. I follow a variant of your plan for my portfolio allocation and i can tell you from experience it frequently tests my levels of courage.

I dont day trade but i do some basic technical checks before deciding entry points for investment candidates. Also long term requires you to have an extensive grasp of the business and its evolving future. This again is easier said than done but time spent in this direction is more likely to offer you better sleep.

From my reading of various books by seasoned and successful traders one thing is clear - even the experts are right only about half the time in technical calls. If you have a hit ratio of 50% over a long time in tech calls you are considered very good provided you have the necessary courage to cut losses.

Plus beginners luck is always there. The first few calls will always yield you a profit. I dont know how but thats just the way it is. This creates a false impression in your mind that you are onto something. Over time luck dissappears along with your faith in investing altogether.

Best
Bheeshma

3 Likes

Agreed on most of your points. Technical calls just dont make sense to me. A nice uptrend in the 5 minute chart might be a pullback in an hourly chart and a downtrend on the daily one. If all the charts are saying the same thing then probably the trend is already over.
However, trading systems are not just about entry signals. A proper system will cover eveything from money management, risk reward ratios, general market trend and Exit strategy. I think a system with positive expectancy will always give results as long as you don’t run out of money.
Also, a day or swing trading strategy will work on downtrending markets. In fact, when the markets are crashing down, a short term trader will be making more money than ever. This is one reason why I don’t want to rely completely on my long term strategy.
With the technology that we now have, it is easily possible to automate the trading process so that you can take the emotional content out of it. I am using Zerodha’s kite apis to autotrade while I am busy at work. It has almost become like investing as most days I dont even look at the charts.

Hi Reacher,
I have just completed reading of recommended books like Pat dorsey, Peter Lynch and Fisher.
Can you share any suggested paths on how to learn TA?
Any recommended books or videos should i watch to hone the skill?

Thanks in Advence
Preet

My problem with Technical Analysis lies in the fact that there are more than 150 prominently used tools to identify ‘patterns’. You give me Tool X, saying the price will go up and I can give you Tool Y saying the price will go down. If there was a logical way to combine the tools or some way to include/exclude a tool based on an idea, maybe TA would make sense. There nearly isn’t. There’s a possibly of combining maybe 4-5 tools. But that’s it.

This is one of my favorite articles on the subject:

That being said, I agree that momentum works. If there is a lot of talk about the FMCG sector getting for FIIs (Say), it makes sense to try and trade that rumor for news (But transact before the actual news - because you have no idea what the news is going to be). Then again, this is largely in the short or medium term. It doesn’t work for the long or very long time periods.

Thank you for that.

I completely agree that momentum and rumours, combined with a knack for position sizing and risk management can very well be used for successful trading.

However, my qualms are with charting, which I believe is a little too much and therefore, nothing.