Why investors are reaching for the astrology of finance
economist.com
economist.com
I think the author is a little overly skeptical here. A moving average is by no means voodoo black magic, it's actually very simple. You take the price over the last x periods, for example 50 days, and find an average. Then you do the same with a different amount of periods, say 200 days, and then you compare that to the price. I think it's reasonable and useful to make inferences based on these three pieces of data. Is the price under the two averages? If yes, then it's likely a little low right now and might go up. Is the price way over the average price? If yes, it could go down. That, to me, is a reasonable analysis of data.
Taking it a little further, if the shorter period average is going down way faster than the longer period average, does that indicate something? Maybe that the price has been going down faster recently compared to the average of the longer period of time. Is that not a useful observation to make? If the short term average is going down so fast that it crosses the long term average, and the price is way above the two, isn't that a useful bit of information to know(that's a death cross). Perhaps you don't want to bet your entire life savings on this information, but it's also an exaggeration to claim that finding averages has no statistical merit.
If you then look into things, you'll find a lot technical indicators are derived from simple statistics and especially averages. Consider the very popular MACD, or Moving Average Convergence Divergence. A lot of people like that one, including myself, and it's made some people at least a little bit of money.
For me technical analysis is like the icing on the top of a very tasty fundamental analysis cake. You don't want a cake that's only icing, but if you do get the icing just right, then you can sell your cake for quite a bit more money.
The simplest thing you can do is chase returns. Maybe you do that by looking at assets that have yielded large returns over the past N days. If you do so using total returns (i.e. price appreciation plus dividends, coupons, or whatever) that will bias you towards high yield bonds and high-risk equities. History says that’s honestly not a bad strategy.
If you decide you want to be less prone to buying high-yield assets that usually pay out but that could crumble at a moment’s notice, the next-simplest thing you can do is ask whether an asset has produced a good return relative to its long-term history. There are all sorts of reasons this could happen: maybe it’s a stock in a sector that recently became popular. Or maybe interest rates are falling and it’s a long duration bond.
In any case, it’s not obviously a bad idea to buy assets with recent good performance. “Hop on the bandwagon” works ok as an investment thesis IMO.
The key is that you operate in as many markets as possible and let diversification do the hard work for you. If you eke out a small edge that works across markets, on average you’ll do ok.
That’s my 2c on the systematic technical trading mentality. You don’t need to swallow it wholesale, but I don’t it’s fair to characterise texhnicL traders as a bunch of swivel-eyed loons either.
> Maybe you do that by looking at assets that have yielded large returns over the past N days.
So what is the performance of a technical analysis trading bot using such a simple algorithm for making buy and sell decisions? I don't trust myself to trade with discipline like that but I would totally trust software to do it for me.
I've observed that technical analysis is great when the price is simply oscillating. Plenty of money to be made in that back and forth... The problem is at any moment something can screw up the pattern. Maybe someone comes and places places a massive order worth hundreds of millions and the unexpected change in price wipes out any profits. A bot can probably close the position before it's too late but I'm only human.
Is it really that simple? I'll fully admit that most of my understanding of the stock market is based on intuition and reading books with flashy titles. In other words, I'm far above the moving charalatan average in most aspects of my life, and you also sound like you might actually know what you're talking about based on how definitive your answer is. If you also, for example, back-test a moving average strategy it usually ends up terrible I've noticed--either making almost no money or losing money.
Yet, I really like watching the stock market. It's my favorite hobby in fact. It certainly feels like a death cross is going to be a bad time when it happens, but maybe the truth is more complicated then the cryptic silly lines I gain so much joy from.
You might already know this, but the stock market death-crossed around January and then it went down for a long time after that. But it also doesn't always go down so dramatically every time there is a death cross. I'm not keeping accurate tallies on the whole thing, but it seems like it's often bad when those two lines cross and often good when they cross in the opposite direction--the so-called "golden cross". I did actually put a little money on a stock because it golden-crossed recently and it went way up today, which was pretty exciting news. And I'm also avoiding a lot of stocks because they are about to death-crossed or just have recently on the weekly charts, but you know, I can also understand how the language I'm using might be mistaken for a seance organized by a bunch of teenagers dressed like vampires.
Mostly I listen to smart people like Warran Buffet and buy value stocks with good p/e, price-to-book, lots of equity, less debt, good earnings etc. It would be silly not to listen to the richest man in the world about what kind stocks to buy. Yet, it still feels like there's something else there, even if my little hobby is about as realistic as playing a round of magic the gathering. It's, you know, my little hour of make believe, that I put some money into in order to escape my otherwise mundane and factual existence.
Or reading a vision statement, watching commercials, etc.... Because that is getting less technical and more feely.
With some exception (Tesla), technical analysis has major limitations. I don't really have time to figure out if a CEO has new back pain and started taking opioids.
There's a reason index funds are so popular. You hold a belief that growth will continue. You basically need that belief anyway when investing in individual companies.
Just keep your head down, the crowd is often wrong.
A site that lets you test moving average strategies is Portfolio Visualizer -- a backtest of the 200-day moving average crossover on an S&P 500 index fund is at https://www.portfoliovisualizer.com/test-market-timing-model... . The result is that a trend-following system, compared to buy-and-hold, has had slightly lower returns, 10.57% vs. 11.10%, but substantially lower volatility, 11.48% vs. 15.22%, and thus a higher Sharpe ratio, over the period Jan 1985 - Aug 2022.
By now Technical Analysis is all about reading meaning into white noise (that’s overlaying fundamentals and a general light upwards trend).
That depends on your model. (Because it is your model that defines "long term")
It is possible for markets to trend downward for decades at a time.
"Alpha" is not just some blind thing that happens when you pick <popular_stock> and use it. Yes, in most cases "easy" strategies have been arbitraged out in well covered highly liquid issues.
However, there is significant alpha even in simple trend following strategies in certain time frames, markets, and liquidity. If it wasn't the case we wouldn't have independently verified traders bringing in excess alpha using such simple systems. Dramatic changes in the volatility regime of even a highly liquid issue can make a simple strategy profitable. Timing is often more important than being exactly right. In fact relative to position size a highly active simpler system will tend to produce excessive Sharpe.
The market you trade is more important than the system you use in a lot of cases. Retail traders can generate significant alpha by simply trading where the hedge funds can't see. In fact I've traded a simple seasonal strategy with significant upside profit in several markets using statistical arbitrage. This type of arbitrage is completely captured by variations of the Bollinger band.
Strong EMH is empirically disproven. My post is not a cope post. I would suggest doing more research rather than grouping all methods of technical analysis into the astrology category. Often times these expensive "top tier" quantitative models are nothing more than more complicated variations on moving averages (ARCH/GARCH, etc).
Statistical arbitrage worked well when it was first discovered then faded away.
It is true that if you discover a novel statistical technique, and keep it secret, you can do very well, at enormous risk, for a while.
Look at the history of "pairs trading"
But not knowing you, when you traded or the actual algorithms yu used etcetera I suspect you were trading in a rising market. Beating a rising market is easy, as is beating a falling market. Problem is, you do not know what you are in today until tomorrow.
Here is some advice for free: Buy and hold. Indexed funds. Get rich by working hard.
I don't trade for the money I trade for the challenge. The money is just a point system I use to see if I am winning. The tone of your reply makes me think I am considering myself an expert - which I am not. I am pretty well read on various trading methodologies, the papers being produced about trading, and have quite a lot of time in seat across varying markets including most recently the futures market during the onset of COVID. After paying my tuition to Mr. Market several times I've gained some experience that makes me money.
As for pairs trading that is exactly what I did. I've done it every season for years in several markets both equities and futures, and it has absolutely no correlation with a rising or falling general market. Though I have occasionally lost money when the legs go out of sync and, being a retail trader, do not have prime execution. But alpha is alpha, and one example is enough to disprove OPs conjecture that all technical analysis is bunk.
I can't tell if you're talking down at me or not so I'll be charitable and say I think B&H is great and I do it all the time. In fact, 99% of my money is tied up in tax advantaged B&H. However, I enjoy trading like I enjoy poker. So I spend some of my money on it. It's one of the few places you can get a challenge that tasks you in several different areas and it's better than donating to yet another 501 (c) 3 with a CEO that takes down a questionably large salary.
What is a tax advantaged Buy and Hold?
You can prove you would've made money by backtesting anything.
Yes. It gets you published. and...
No. It is nonsense. I have researched TA. My conclusion is that the efficient market hypothesis, in its weak form, is true.
There are a lot of cognitive biases at work and a lot of wishful thinking.
All information has a cost, that cost is factored into pricing, but it is cheaper for some than for others. That explains some of the effects you see.
Another is trading costs. Transaction costs for most actors in the market are as high as they have ever been (it is a deliberate policy of financial firms, and many costs are hidden, but those gleaming skyscrapers on Wall St? Transaction costs). When yuo see a simulation of TA my advice is to calculate the minimum transaction cost for profit, and then compare that to what is actually available (Transaction costs often reach 200 basis points, and the cheapest I found were in German markets in the nineteenth century. A damning indictment on modern finance)
Yes it has. In its weak form.
More pointedly all the supposed counter examples turn out to be snake oil. People really want to believe there is some magic that can predict the future....
> the reason that it's a hypothesis, and not a theory, is that it's impossible to disprove
It is an hypothesis. It is impossible to prove it, only disprove it. And....
> because all of evidence that disagrees with it is dismissed as spurious.
All the counter examples turn out to be snake oil. I spend years looking, repeating simulations, back testing algorithms.... Snake oil each and every time
People really want to believe....
Like for example there's absolutely significance to "resistance" levels just like certain mkt caps or price targets. Bc people place orders for those prices. Same as how breaking 1b mkt cap usually gets a pop bc it unlocks a lot of institutional capital.
https://www.washingtonpost.com/entertainment/books/thinking-...
If it is public/published, it does not work at all, or it does not work enough of time to make it worthwhile.
PS: former quant
Evander, the Chartist, in a Downside Market
One of my men talks to nobody else in the office except me—and to me only reluctantly. He believes that everyone is out to steal his ideas. He’s Evander Wood, our institutional man, and he locks his desk every night, his key connected to a long chain attached to his vest. Evander is a chartist—or technician, a term he prefers because it sounds more professional. In 1968 he grossed $160,000 in commissions; in 1969, a respectable $90,000. He deals strictly with institutions—mutual funds, insurance companies, trust departments of banks—giving them statistical proof of stock groups that are strong and individual companies in these groups which should be purchased. He has a gimmick, as all successful institutional men must have if their contacts are not purely social. (That is, contacts like your roommate from St. Mark’s who does the buying for Mass. Investors Growth Fund or your fraternity brother from Deke at UCLA who directs Lockheed’s Pension Fund.) People have to be so intimidated by Evander’s charts (he makes a poor personal impression), or so confused by his system, that they buy in self-defense. He has a magic divisor that changes in relation to the volume of the market going up (upside volume) and going down (downside volume), placed in juxtaposition to his own index of glamour stocks plus what the small buyer (odd lotter) is selling short on a given day. Could you follow that? I never could, but he has had fifteen mutual funds who have given him business on the basis of his information—which proves that you can indeed fool most of the people most of the time when it comes to their fascination for money. I’ve always thought Evander would be an ideal star as the tailor who wove beautiful threads out of nothing in “The Emperor’s New Clothes.” When he speaks, he speaks only in charting language, referring to people in the street as having “sloping head and shoulders,” to bald men as having “topped out,” to broad-beamed women as possessing “descending channels” or “falling wedges.” He used to laugh and laugh at his jokes and take orders for 5000, 10,000, 15,000 shares at a clip. Everyone in the office hated him, especially after he took an order. He was a familiar figure in the financial districts, plodding along with his pipe, his professorial air, and his large briefcase filled with charts and magic potions. He’d pick the soft-drink industry for action and Coca-Cola in particular “for a breakout.” Then he’d sell it to the funds on the basis of his number studies. At lunch he’d have a corned beef on rye and a Tab. “What is this junk?” he’d say suddenly.
“That’s Tab,” I’d tell him. “Made by Coca-Cola. You recommended it.”
Evander hasn’t written an order in two months, and we’ve taken him off his $1000 a month draw. He has the desperate look in his eyes of the man who is interviewing with other firms and can’t get a job. Portfolio managers who gave him business are now explaining why their net asset values are down as much as 40 percent this year, and Evander has added more charts to his briefcase and more keys to his ring. I caught a fleeting glimpse of Samuelson’s Economics in his drawer before he slammed it shut.
I see combat fatigue in the lines of his face, and I think he needs Pat O’Brien, not me, for help. Don’t give your money to a chartist, the dying mother said. How To Lie With Statistics was the first book I read in college.
"Brutus" was a pseudonym of John D. Spooner
Click the uBlock icon. Click the "</>" symbol. Click save. Reload.
That luck factor you talk about occurs when the right guru and cycle line up. Then the cycle changes and wipes the floor with the guru.
Society was told for decades that "technical analysis" couldn't work because any advantage would be arbitraged away. Turns out, that was a bunch of BS and we now have very strong evidence for the basis of "technical analysis", momentum, going all the way back to the advent of financial markets.
These two things are not at all analogous.