The case against technical analysis

(Praveen Shekhar) #103

the “stop loss” as many wrongly think is some fixed level at which one should exit a failing trade. I feel it’s a question one should be asking himself. 'What is my tolerance to loss on this trade". If my total portfolio is 1 crore, i may even keep a 90% SL for a new 50k trade and be willing to lose 45k without batting an eyelid. Fundamentals will more often than not remain intact even when a stock is going thru technical correction, depending at what level its is. If a stock has been bought at peaks, even after 20-30% technical correction FA will be intact. Doesn’t mean technical point of entry was correct to start off with!!. That difference may diminish at 2-3 year lows where both FA and TA will seem extremely attractive provided the stock is good fundamentally. @bandlab1 has summed it beautifully and that is what i have been following for years. War between FA Vs TA will never be over. Best is identify fundamentally good stocks at excellent valuations and ALSO at quarterly lows on charts. great combination. If that support also fails technically, then it is you said. Since we gave good thought fundamentally before entering technically; any more downside will just make the stock even cheaper and all the more attractive !!! Final word i feel is, without discipline and a fixed system, pointless attempting anything.

(LearningToFly) #104

Some Random thoughts::

Don’t get me wrong but I think Warren Buffets’ books do a lot of damage to investors/traders. Not because the books are bad; they are great. However, more than anything else, Warren Buffet is an extraordinary businessman. He can make money out of railroad which nobody on earth can. You can put him in the league of “all time greatest” in the human history. We are not.

The problem is as Warren Buffet himself stated, “when people meet Bill Gates, they never think they can become like him. But when they meet me, they think they can easily become like me if they follow some fundamental stuff”.

Someone said, history repeats itself is ludicrous. I mean this is the only truth. After all, how do you find undervalued stocks using FA if history doesn’t repeat. The very fact that a stock is undervalued shows human fear. TA does the same thing. It plays into human emotions like greed and fear. It is just that it converts these emotions into numbers which we cannot grasp so easily.

The other thing is as TA says, all the information is anyway incorporated into price. What is wrong in this statement. It will be very strange of us if we think we can do some fundamental analysis of stocks which nobody is currently doing and buy the stock “chupke se”.

To each his own.

(Dinesh Sairam) #106

With due respect, nobody thinks they’ll become the next Warren Buffett. Rakesh Jhunjhunwala is an excellent trader, uses crazy levels of leverage and also has invested in some good companies early on. However, he’s nowhere close to Mr. Buffet in terms of wealth. I’m not saying this to undermine Mr. Jhunjhunwala. He will always remain one of the best, if not the best, investor in India. So clearly, even after a lifetime of great investment, we can only hope to be at least 10% as wealthy as Mr. Buffet. Even that is stretching it a little bit.

If you’re suspicious about Warren Buffet’s books, read his Letters to Shareholders. You don’t need anything else. Here’s what he said in one of the letters and follows to this day:

These are things everyone can do, regardless of whether they are minority or majority Shareholders.

(LearningToFly) #107

I am not suspicious about Warren Buffet and his books. His books are great. I am more concerned about the habits that we develop as a result of misinterpreting the books. For example, even when some stocks go down, we sit tight saying this is for long term. But that does’t solve the problem. There could be some inherent problem in the company which we did not find out or could not find out simply because we neither have access nor transparency in many cases.

Value investing, i.e. buy cheap sell high is another concept that does lot of damage unless we know the company very well, inside out. Why something is selling cheaper is the question to probe into.
Remember that India is a growth country and things will be little expensive here. In such scenario, finding a good company at cheaper valuation is extremely difficult. We tend to miss lot of opportunities.

Moreover, we ignore Charlie Munger’s contribution. He us never for value investing. He is more like growth investing. He is one responsible for introducing Warren Buffet to buy expensive but high growth companies which Buffet wouldn’t have bought.

So to summarize my thoughts: Warren Buffet is a great investor and businessman. Probably, we are not getting his message right.

(LearningToFly) #108

Regarding technical analysis, let’s discuss what is the most important concept in economics. It is simply demand supply. The most basic curve we learnt is also the most important. The price of everything depends on demand and supply. In such a scenario, intrinsic value loses its meaning. Some people may say, intrinsic value depends on growth prospect and a high demand will increase the prospect thus increasing its value. This is also a point well considered.

Technical analysis works on the demand supply premise and that I think is fine. Dismissing it would not be wise.

(phreak) #109

I think equity investing/trading can be broken down into three distinct parts

  1. What is the company doing?
  2. What are your fellow shareholders doing?
  3. What are you doing?

(The 4th one can be the macros of what the economy/country/world is doing but it is mostly noise)

For 1, you need fundamental analysis which can lay a map of the terrain you need to navigate. For 2, you need technical analysis which is a beautiful tool to interpret the madness of crowds that inhabit that land over time in the most efficient way. For 3, you need behavioural analysis of yourself, sort of running yourself in debug mode. I feel all three are equally important and require equal emphasis and none of them should be frowned upon.

(HIMSHAH) #110

Very true good explaining

(Dinesh Sairam) #111

The only thing I can wrap my head around in Technical Analysis is support and resistance levels. I understand why they exist. Say, a stock has bounced back from Rs. 500 levels a couple of times, it indicates that there’s a considerable amount of buying interest in the stock for Rs. 500 i.e. A lot of people think Rs. 500 is a reasonable price to pay for the stock. Same for resistance levels.

What flies completely over my head are the gazillion tools that exist to interpret weekly or monthly movements, which in my opinion are nothing but noise. What’s worse? You show me a tool which says a stock is a ‘Strong Buy’ and I can show you another tool which would indicate a ‘Strong Sell’. If I didn’t know any better, I’d say it’s madness.

With Fundamental Analysis and Valuation, you have subjectivity, which is fine. Technical Analysis tools are supposed to be facts (At its heart, Technical Analysis is looking at only Price and Volumes). And I can’t for the life of me understand how two completely polar facts can come from the reading of the same chart.

(ORION) #112

One fact I want to add that technical analysis provides reason to act…and nothing else…it removes psychological pressure from the trade…but I’m more than 100% sure it wont guarantee you a PROFIT…

(Devaki Nandan Tripathy) #113

It’s due to different mindsets. In FA, one buys a stock when one is reasonably sure that a stock is undervalued, either from a present perspective or from a future perspective.

In TA, one is never sure of anything. If one does enough backtesting, one can assign a probability of winning; but one can never be sure whether any particular bet is right one, except in hindsight. If one trade goes wrong, we just hope our stop loss gets triggered so that a small loss does not become a large one.

Another thing, when we buy something fundamentally, a natural corrolary to that assumption is - we know better than the market. However in TA, market is always supreme and knows far more than any individual participant, no matter however smart he/she is.

Both methods have produced highly successful investors, and neither is superior to the other.

(Dinesh Sairam) #114

Am I to understand that TA helps only traders? If yes, then that’s understandable. Trading is a different animal. Often, an individual has very little advantage over institutions and their massive capital base in order to capture even the smallest of inefficiencies in the quickest of ways.

In the context of investing, how does TA help, apart from plain vanilla support and resistance levels?

(Devaki Nandan Tripathy) #115

Most of the time when people buy some business fundamentally, they seem to believe they are buying a piece of great business whereas in reality, they just want to buy an investment for a specified period of time where that asset price will show maximum appreciation. If you do not agree, consider this hypothetical test.

Let’s take a group, say 100 best fundamental investors of India and ask them to choose the best company to invest in India for next ten years. For the sake of simplicity, let’s assume they all choose HDFC Bank. But before investing, this group is provided a rare chance to time travel to 2028 and when they reach there, they find HDFC Bank has grown 3x but some shoddy company like, say, RCOM or Vakrangee has become 100x. Now when they return to present, how many will invest in HDFC Bank and how many of them will invest in Vakrangee?

So, is FA wrong if most people choose Vakrangee? Of course not. But FA is not the one and only ultimate tool for investment. It is just one among many tools that are available.

(Dinesh Sairam) #116

What’s the probability of your example happening? In the long term, how much have shady companies returned Vs how much have decent or good companies returned?

The very basis of fundamental analysis is making sure one invests in a company that’s good at creating value, for its customers and shareholders alike. The few and far between cases where shady companies rally a lot are nothing compared to the hundreds of cases where fundamentally good companies have created similar or better value.

(Devaki Nandan Tripathy) #117

But hundreds of highly rated fundamentally strong companies have also destroyed investor wealth. Take the recent examples of DHFL and Yes Bank. Both are AAA rated companies. Lupin was considered the gold standard of corporate governance and innovation till it crashed to one third of peak value. Bosch is one the bluest of blue chips having significant intellectual property both in ICE and EV. HUL remained stagnant in 2000-2008 when every second stock became a multibagger. I can show far more examples, but it’s redundant.

In all those cases, TA threw exit signals even before it became apparent fundamentally. But
if the fundamental investors had trusted the market wisdom and acted with humility, it would have saved most of their hard earned capital.

I am not saying let’s invest in kachra cap if you thought that’s what I am indicating. All I am saying is - even in fundamentally strong companies too, technical entry and exit signals do matter.

(Dinesh Sairam) #118

Without enough data, we’re just going to keep going back and forth. The examples you quoted are still outliers / fewer. You honestly ask yourself the question “How many decent / good companies can I name that have destroyed / stagnated wealth?” Vs “How many mediocre / bad companies can I name that have stagnated / destroyed wealth?” The answer should be apparent.

In this context, all I’m trying to understand is, what can TA offer when an investor has already done Fundamental Analysis and basic support/resistance analysis?

PS. If you can, please let me know what was the ‘exit signal’ given in both Yes Bank and DHFL. Both of them fell because of very specific issues. I doubt they were captured in TA before their initial fall. If they were, I’d be interested to look at that. Do chime in. I can’t comment on Lupin as I don’t follow that space.

(phreak) #119

A tool is only as good as the operator using it. You pick and choose your tools, not just based on your strengths and weaknesses but based on the job that requires doing. A wrench or duct tape while being very good tools, can’t inflate a flat tyre. TA is a stochastic art and so is probabilistic in nature and not deterministic. Don’t let anyone tell you otherwise.

(Dinesh Sairam) #120

Let me lay down my doubts about TA and perhaps someone can help me solve each of them.

  1. If TA is probabilistic in nature, then it should not be highly skewed. I can understand if someone gave a price target and someone else giving a +/- 20% price target around it. But my contention is that TA has thousands of tools (As opposed to the handful in FA), with varying levels of results ranging from very positive to very negative. In such a case, how does this help the probability?

  2. I understand that TA helps in trading. I also understand how trading can help institutions or big investors benefit using their otherwise idle massive capital. My contention is, how does TA help the individual investor?

  3. Say, by valuing a company, you find that it is undervalued at Rs. 100. If it drops to Rs. 80 suddenly, FA would indicate that the purchase became more lucrative. But several TA indicators would indicate otherwise i.e. ‘A negative change in trend’. How can something you already think is cheap, becoming cheaper, be a negative news to you?

  4. This is a hand-to-heart question, so difficult to answer with actual data. How many people do you know who have become rich with solely TA? Vs How many do you know who have become rich with FA (+ basic resistance/support analysis)?

(learning) #121

My two cents.

  1. Multiple ways to achieve return in Fundamental analysis as well. But every great investor talks about temperament being the difference maker - not the approach (Value/growth/Special sits…). So I don’t think at a basic level it should matter much if we have TA added to it.
  2. I think - TA helps capture human behavior, which is difficult to capture in a Fundamental analysis. So, it should complement a good fundamental investor or even otherwise also, as long as one is disciplined enough.
  3. Well, In TA if you find crowd wants something at 100 and wants more at 120 then one makes money faster. whereas in you case one has to wait patiently for years for price to come to your level. In some cases it may never come.
  4. Counter question could be how many Disciplined TA investor have not made money? TA has a limitation that it hits a top as an approach very soon as difficult to put large some of money to benefit for a long period of time.

If one is disciplined then the approach should not matter IMHO

(Dinesh Sairam) #122

That’s my problem as well. If size limits TA, isn’t that similar to trading? Why is it that TA works for Rs. 10 lakhs, but not for Rs. 1 Crores? In other words, why is TA so sensitive to 10-20% movements in stock prices? In FA, once you’re convinced about a company, and wait for enough Margin of Safety, you are not worried if the stock moves up 10% or so during your purchase (Maybe a little worried, but I digress). But in TA, a sudden 10% movement makes all the difference, whether it is downside or upside. That was one of the questions I posed earlier as well.

In this case, I can ask “How can something you think is dearer, becoming more dearer, be positive news to you?” That is, if something moves up 20% while you are purchasing it in tranches, TA indicates a positive change in trend, doesn’t it? That completely goes against common sense.

(LearningToFly) #123

Nice discussion.
I would rather like this forum participants to mention who made money using TA/FA. If anyone can say this with certainty. For example:
I did FA/TA of company ABC and I made x% in y number of months/years. This would make things more practical.
I did FA/TA and I am at x% notional loss/gain at this point of time.

I bet you will find success rate of both FA/TA almost equal.