On the whole, successful investors have little truck with technical analysis. Alistair Blair casts a sceptical eye over a practice many believe has as much credibility as astrology
Most people chuckle at the suggestion that by looking at a share price chart, you can forecast whether the next move will be up or down. Yet 'technical analysis' has thousands of adherents, one or two of whom are as wealthy as Croesus.
The Society of Technical Analysts counts 600 members. It's a safe bet that only the barest handful would be seen dead across the table from an astrologist. Yet many serious investors consider astrology and technical analysis as being from the same, batty, stable. Here's John Train, renowned investment writer (and no mean investor) on the subject: 'It is not knowable from what a stock did last month or last year how it will do next month or next year ... pronouncements on the subject are tea-leaf reading; fakery.'
Alternatively, consider this other view:
'If I were on a desert island and allowed just one investment tool, it would be the chart', the verdict of Anthony Bolton of Fidelity Investments.
One of the UK's most successful fund managers, Bolton is a fundamentalist at heart. But he still doesn't make any form of investment unless he reads the chart as pointing upwards.
It's easier to find successful investors who don't subscribe to technical analysis - Warren Buffett and George Soros for a start - than ones who do. But look hard and you'll find some impressive accomplishments on the technical side of the fence. According to Managed Accounts Review, a journal which monitors the performance of hundreds of US trading funds over a five-year period up to 1991, Mr Monroe Trout achieved an annual average return of 67%. Subsequently, his performance slipped but it's nothing that you'd sniff at: in the four years to May 1996, he averaged around 16% a year across two funds. And he rarely loses any money: only in about one month in 15.
Vic Sperandeo, another US trader, clocked up an average annual gain of 72% over the 18 years to 1989. He had no down years.
It would be a hard judge who said his 1990 result - he lost 35% - invalidated what went before. For years, the US investment journal, Barrons, audited the results of Gil Blake, a private money manager who looks after $50 million on behalf of a small number of clients. Since 1980, he has made an average annual return of 42% and has never made less than 15%.
The patterns which most non-adherents associate with technical analysis are the selling signal, a 'head and shoulders' (when a rising stock hits minor peak (left shoulder), followed by a higher peak (head) and then a new lower peak (right shoulder)), and the buying signal, a 'triple bottom' (when a falling stock makes three consecutive troughs at about the same level).
Few professional chartists would deal on the basis of these basic patterns alone. At the very least they'd look for confirmation from one or more secondary indicators. There are dozens of these, from simple volume (amount of business done in the share or market) through to 'stochastic' theory (an upward trend is about to reverse when closing prices tend towards the bottom of the daily range) and Maximum Entropy Spectral Analysis (not worth less than a book to explain).
Many of these were devised by chaps with qualifications that would get them into NASA, where they may well have been better employed. A strange enthusiasm to tell the rest of the world about their golden geese is often matched only by reticence on the subject of their own investment success. But investors who can't make any of that lot work could turn to point and figure charting, Japanese candlesticks, Elliott Wave Theory, Fibonacci numbers, the Kitchin cycle, to suggest just the barest contours of the technical landscape. With such a diversity of techniques, it's not surprising that technical analysts can come up with diametrically opposed conclusions from the same data.
It's easy to send up technical analysis, but in truth, few of us are as clean of it as we might believe. You buy a thousand shares in Blue Chip plc on the soundest of fundamental grounds. They then go down. You're disappointed. They go down some more. You re-examine the fundamentals and find the positives still in place. They go down again. Come off it. You sell. Selling because the price has gone down is just technical analysis at its most simplistic.
But do you have what it takes to turn technical analysis to your advantage?
Unlikely. You're likely to want to know, 'Why?'. Why does it work for the very few people who can make it work, consistently? It's the wrong question. Trout, Sperandeo and Blake don't spend a lot of time asking, 'Why?'. They ask, 'What's working at the moment?'.