This is a question that has been around since early 20th century, on the first notes of the Dow Theory: Does technical analysis work? And by “work” I mean, can you get consistent profits using technical analysis?
On this latest publication we answer this question using data, simulations… and science.
If you wonder what is technical analysis, or TA, you might not know what it is, but you must certainly have seen their proponents on day time television staring at the camera barking buy and sell commands at you and yelling terms like resistance, support, momentum and trends, pointing to charts of time series and price variation of an asset with overlapped lines.
At first sight they make as much of a sense as black magic, or tea leaves reading.
Another common trait of TAs is that they usually (if not always) try to convince investors to assume the same long or short positions they recommend – what should damage the profitability of their own strategy. There are also some TA blogs in the web advertising consistent gains in the range of triple digits in a year. Yes, that is right… if you doubt google it. And use your common sense to judge it.
Technical Analysts is all about formalization of visual patterns. Indeed TAs refer so often to charts that their detractors call them “chartists”.
Since I mentioned their detractors, let me list them, the way I see it. People going around trying to figure out how to make money in financial markets using computers in one way or another is divided in three sects: technical analysts, fundamentalists and quantitative analysts.
Fundamentalists believe that value is given by intrinsic economic features of the environment associated to the underlying. If an underlying is issued by a corporation some of the features could be product and market placement, quality of management, competition, and culture. If the underlying is issued by a sovereign government: interest rates, geopolitics, public policies. Names like Warren Buffett and Philip Fisher follow fundamentalist strategies.
Quantitative analysts look at statistical properties of price movements, individually or in correlated pairs or groups, trying to predict future price movements.
Lastly, to the sect we care about on this study, if we navigate past all the terms they use and get to the basics, technical analysts believe they can predict future value of a price path by looking at past features of a chart. They believe for example that if a price movement hits something like a resistance line it has a tendency to fall, or on the other hand if a price hit a support line you can nowhere but up.
So, which sect teachings is more profitable? Who should you listen to?
If I move my personal biases aside I will have to say that the answer so far has actually depended on who you ask, the personal beliefs and biases of that individual.
Like I said before, with this publication we push aside beliefs and biases and look solely at method and data. We use quantitative techniques to dissect and back test technical analysis, answering one simple question using science and data: does technical analysis really work?
The original bootstrap of this work is a FRACTI notebook dissecting the crown strategy of technical analysts: the momentum strategy. You can follow the analysis step by step in there, or you can download and execute it yourself.
From November or 2015 until now we have been having internal discussions at the CCFEA on the structure and content that generated 22 different revisions of this publication.
And now, after a year, the first version is out for public review. That means it’s now your turn. We should be submitting it to external peer review and publication over the next few weeks and we welcome your insights and ideas. This is the essence of our research, FRACTI: transparency, collaboration, data and method.
I don’t want to give any spoilers, you can skip all the formalization and the math and go straight to conclusions. But the ending might surprise you…