Wednesday, January 23, 2013

Academia vs Technical Analysis

The reformed broker (aka Josh Brown) has an interesting post on technical analysis and why academia is wrong about its effectiveness.  (Incidentally - Josh has an excellent blog - well worth checking out).

Finance academics as a group take a fairly dim view of technical analysis because, for it to work, you have suspend belief in weak-form market efficiency (the idea that past stock prices cannot predict future prices).  This is the finance equivalent of thinking that the earth is flat.

In his post, Josh quotes Phil Pearlman who states, among other things that:
Its a bias on the part of finance academia against technical analysis from a community that is still trying to prop up EMH and has moved so far  from the reality of markets they fail to acknowledge critical tools their students will be using in the future. 
The good thing is that it is becoming easier for those learning asset management to find educational material in books and on the internet and so universities are only risking moving themselves further from being relevant much less essential.
So let me get this straight - technical analysis should be taught because it is becoming easier to find out information on it on the internet and in books.   This statement might be fine if we are talking about, say capital budgetting, where there are standard approaches that can be used to create value.  But technical analysis is different.

The point of technical analysis is to beat the market - to use past trading patterns to predict where the market is going.   For this to happen you have to assume that you are the only person who has ever figured this out.   But if the technique can be found in your local Barnes and Noble, you can guarantee that the technique won't work - because prices will have adjusted to reflect all the past information. (they have Barnes and Nobles near Wall Street).

Another way of thinking about this is to ask yourself the question - if you were a brilliant technical analyst, why would you ever write a book on the subject and share your tips?  That is, unless you stand to make more money as an author than as a trader.   Of course you could just be doing it because you made your millions and you want to help other people get rich too.

Just because lots of professionals use technical analysis, doesn't mean that it works.  Actually it does work, just only about 50% of the time.   Unfortunately, despite how many books or web pages you read you'll never know which 50%.  

So  I don't spend much time teaching technical analysis - for the same reason astronomy professors don't spend much time teaching astrology.