Fisher Investments Editorial Staff
US Economy, Forecasting

A Recent History of Technical Analysis’ Recent History Lessons

By, 10/18/2010

Story Highlights:

  • Recent technical indicators could easily have caused investors to miss a solid September.
  • Technical analysis can tell you what's recently happened—and only what's recently happened.
  • Investing is not as simple as an if/then equation.
  •  Set aside charts and indicators to focus more on important drivers influencing future market action.

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In July and August, investors were deluged with seemingly ominous technical indicators. From the Hindenburg Omen, to head-and-shoulders patterns, to the death cross, folks seemed to fear chart patterns portended future doom in the immediate future. 

How'd it turn out? The best post-war September on record to cap off a stellar Q3. There have been few subsequent headlines pointing out the costly error following these "indicators" could have triggered (perhaps we missed them?). Or maybe we just misunderstand this whole Hindenburg Omen thing altogether—is it actually a buy signal (the Hindenbull Omen)? Either way, whether bullish or bearish in nature, technical analysis provides little insight as to the market's direction. It's often said a picture is worth a thousand words. Chart patterns are worth a thousand words too—except they're all data mined by a technician to prove whatever point he's likely biased toward. Consider these two headlines from the same source:

US Stocks at Risk for 20 Percent Decline: Technical Analysis, Bloomberg, September 8, 2009

S&P 500 Moving Averages Show ‘Fierce' Rally: Technical Analysis, Bloomberg, September 9, 2009

You read that right. They were written one day apart! Is one analysis better than the other? Or are they both equally about which technical indicator the technician prefers and how he chooses to interpret the picture? We figure the latter.

Technical analysis and charts can tell you what's recently happened (and can be a decent way to illustrate a point about the recent past), but on their own, they hold literally no explanation for why stocks move the way they do—a severe shortcoming. Said differently, stocks don't rise or fall to level X because they previously moved above or below level Y, and there's no secret formula for technical charting success. There are dozens of technical indicators: support and resistance lines, Japanese candlestick charting, and Ichimoku clouds (where technical analysis meets Japanimation). And many more! There are many devout believers in these theories—much like so many believed in alchemy centuries ago, or those who believed witches brought illness and woe to Salem, Massachusetts.

Why don't these work? Investing is not as simple as an if/then equation—staring at any one indicator (or a data-minded combination of indicators) and basing an investment decision solely upon it is a cognitive error. When purchasing stock, investors buy a share of the company's future—not its recent-past price movement plotted neatly with trend lines, volume indicators, or how high or low it was in a randomly selected year. The stock market is a mix of forces together—fundamental, political, and sentiment-based factors comprise the "why" of "what" stocks do. These are the forces investors should weigh looking forward—rationally assessing economic fundamentals, political drivers, and whether sentiment accurately perceives these key components.

Today, on the economic front, retail sales rose beyond expectations, the Empire State manufacturing index jumped higher, and, early in Q3's season, earnings reports have been quite good—adding to a robust global economic recovery. This seems poised to continue given corporate liquidity, steep yield curves with low interest rates, and other key drivers. On the political side, many pieces of widely anticipated and debated legislation have been passed—reducing uncertainty. With midterm elections approaching—and gridlock a likely outcome—political risk aversion seems poised to wane. On the investor sentiment side, gloom still prevails—meaning investors don't fully appreciate the global recovery's strength and decreasing political risk today. All terrifically bullish signs.

When the next techno-babble indicator comes—and if history's any guide, there will be a next one—shelve the fear or greed (or confusion) the name preys upon and realize: These indicators are merely fancy, dressed-up ways to tell what happened in recent history.

 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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