Technical Analysis: Useless?

Posted by: Ben Steverman on August 13, 2008

This study is the latest suggesting that technical analysis provides little value to traders and investors.

For those who don’t know, technical analysts give advice on buying and selling by ignoring fundamentals (such as the earnings power or a company, for example) and instead focusing almost entirely on an asset’s price movement in the market. It can get very complex as technicians puzzle over 200-day moving averages and look for particular shapes in stock charts (like the supposedly promising “cup and handle” that Investor’s Business Daily founder William O’Neil loves.)

(If you want to learn more about technical analysis, this Investopedia page might be helpful.)

The study focused on global stock markets. From the abstract:

While we cannot rule out the possibility that technical analysis compliments other market timing techniques or that trading rules we do not test are profitable, we do show that over 5,000 trading rules do not add value beyond what may be expected by chance when used in isolation.

The CXO Advisory Group blog has good summaries and analysis of this study, and a previous study that focused on U.S. equities.

As a reporter, I talk to technical analysts all the time. I find them very useful. Yes, their predictions are suspect, but so are all predictions. Technicians can be valuable because they often do a good job describing what’s happened in the stock market in the past day or week or month.

They keep close track of volume and price movements, which means they know where the money is flowing and how enthusiastic buyers are or how pessimistic sellers are. That helps give real insight into the shifting moods and strategies of the investing community. But it’s a way of looking back, not forward.

What do you think of technical strategies? Unfortunately, saying “they work for me” isn’t proof that they do work — it might be proof you got lucky. But many investment houses keep technical strategists on their payrolls, so maybe, despite academic studies to the contrary, there is some value in this sort of analysis. I would love to hear your thoughts.