Bloomberg is running an interesting article on the ‘failings’ of technical analysis. Here’s an extract.
Stock Charts Fail Forecast Test in Complete S&P Miss
May 4 (Bloomberg) — John Bollinger, inventor of the “Bollinger bands” system of predicting stock movements with price charts, says technical analysis works.
“I don’t know what people are saying when they say somehow indicators have broken down,” Bollinger, president of Bollinger Capital Management, said in a telephone interview from Manhattan Beach, California. “It’s like somehow saying streetlights don’t work anymore. As long as people obey them, streetlights work.”
Ever since the Standard & Poor’s 500 Index peaked in October 2007, six of eight strategies — which are supposed to make money whether stocks rise or fall — failed, according to back-testing data compiled by Bloomberg. As the bear market erased $11 trillion from the value of U.S. equities, buy and sell signals from those six technical indicators produced losses of as much as 49 percent, the data show.
“Technical analysis on its own as a discipline does not work,” said Diane Garnick, the New York-based investment strategist at Invesco Ltd., which oversees $348 billion. Using it in isolation is “the fastest way to lose money,” she said.
Of the eight strategies, stochastics, Bollinger bands, relative strength, commodity channels, parabolic systems and the Williams %R indicator generated buy and sell signals that resulted in losses between the S&P 500’s peak of 1,565.15 on Oct. 9, 2007, and its March 9 trough, the data show. They did worse as the index then rallied 30 percent through last week.
Bloomberg’s back-testing “method” involved buying the S&P 500 when indicators signalled a ‘buy’ and holding it until a ’sell’ is generated. Then the position is sold and a short position established until another ‘buy’ is triggered. In other words, looking at the indicators in a total vacuum. No other financial info allowed.
Condor Options has some typically lively commentary on the Bloomberg story:
It’s actually kind of difficult to respond to this. In the first place, it’s hardly remarkable that a set of widely known, off-the-shelf vanilla indicators didn’t outperform in one of the strangest and most volatile markets in recent history. Neither did buy-and-hold, nor value “investing,” nor most long/short hedge funds, nor etc. And I’m actually inclined to cheer coverage like this, in spite of all its flaws, if it causes even one individual to scorn untestable and subjective forms of technical (or any other) analysis: verificationism may have failed as a standard for academic metaphysics, but it’s an absolute necessity for the analysis of any financial time series. A prediction that cannot be tested empirically is neither technical nor analytic: it is faith-based finance. Still, Bloomberg reporters Tsang and Martin have created and destroyed a particularly combustible straw man.
In fact what Bloomberg buries in its report is that the S&P 500 actually fell 56.8 per cent in the period in question, Oct 9, 2007 to March 9, 2009. The ‘worst’ of the technical indicators produced a return of -49 per cent. Not exactly great but still an “outperformance” of the S&P 500, in hedge fund parlance.
Ranked Performance of Eight Technical Indicators
Indicator 10/09/2007 - 3/09/2009
Relative Strength Index -49.0%
Williams %R -41.7%
Commodity Channel Index -38.7%
Parabolic Systems -36.6%
Bollinger Bands -31.5%
Stochastics -24.1%
Directional Movement Indicator +24.0%
Moving Average Convergence/Divergence +25.9%
S&P 500 -56.8%
Now, we’re not huge fans of technical analysis. It has often been likened to reading tea leaves — allowing investors to see what they want to see. But, as a quick and easy indicator of where prices are heading, technical analysis can serve a purpose.
Some indicators are clearly better than others at predicting limits and momentum (moving averages are a particular FT Alphaville favourite, and are highlighted in the Bloomberg story as the best performers) but in general, technical analysis can provide added confirmation for, or cause to doubt, a particular investment theory — one that’s presumably (hopefully) been premised on a variety of other factors and financial info.
But then, a story about “Stock Charts in Conjunction with Financial Analysis” would not have been as easy to write, we imagine.
Related links:
Afraid to Trade - Technical analysis blog
Technical analysis fails to give you a pony - Condor Options
