If Technical Analysis works, why isn't there a mutual fund for it?

I've thought about that, and I can't rule that theory out entirely. The problem with it is, whatever effect occurs should be predicted and pre-empted by sharp traders. Let's say a cup-and-handle pattern really does predict future prices, and everybody buys around the 5th day of the handle, causing the price to go up. Well, after I figure that out, I'll start buying on the 4th day of the handle, before the price goes up. Pretty soon everybody'll start doing that, and I'll have to start buying on the 3rd, and so on until there's no handle anymore.

The more predictive these patterns are, the greater the pressure to exploit them earlier and earlier, until the patterns are no longer predictive.

[bobman0330]

A good point. How about this:

TA is basically parasitism on the trading actions of more informed investors. For example, the cup and handle pattern (I assume) results as an undervalued stock recovers. The really smart investors start buying when the stock is at the bottom of the cup, driving the price up. Once the price makes a minor recovery, investors who have been in the stock for a while and got "trapped" by the decline in price get out, causing a slight decrease in price, after which the company's strong fundamentals move the price ever upward.

Even if you lack the skill or information to target an undervalued stock, the information to spot a recovery pattern is helpfully assembled for you by the market.

I suppose this theory suffers from a lot of the same preemption problems as the last. Maybe the answer is just that dumb traders outnumber the sharp ones?

Those are good points, too.

We could probably speculate all day about possible mechanisms for TA to work. A more basic question is whether it works at all. I see two ways of testing it.

1) Use historical data from 1990-2003 to identify price patterns which appear to predict future performance. Then test those patterns on data from 2004 to see if they continue to predict that performance. Some academic has probably done this, but I'm not aware of any such studies. The evidence presented in A Random Walk Down Wall Street strongly suggests that, although TA strategies can be developed which backtest successfully, they can't predict future movements.

2) Look around the real world for evidence that anyone is using TA as a successful strategy. As I argue in my original post, professionals who did so would have strong financial incentives to share their performance with the rest of the world, so if it's happening reliably, we should know about it. There are no such funds (if there are, someone please point them out to me), which is evidence against TA's usefulness.

[Dan Mezick]

There may not be a mutual fund dedicated to techical trading systems. This does not prove anything about prediction of prices. The best technical system traders are typically trend followers. Many of them run hedge funds and are commodity trading advisors (CTAs).

You might consider John W Henry, owner of the Boston Red Sox, in your argument. He seems to invalidate it. Here is a place where Accredited Investors can actually expose money to systematic technical trading systems that seem to work.

Let's focus the discussion on John W Henry. Let's discuss his philosophy and results. Is he a freak of nature? Is his system simply lucky? No one wants to discuss the results of John W Henry. It's clear why.

I notice his approach does not attempt to predict anything at all.

John W Henry

[squiffy]

Technical analysis is largely B.S. Stock prices generally follow actual and/or expected future earnings. To predict future earnings you need to understand the qualitative factors that bring the company success.

[Sniper]

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I have no doubt that the market is influenced by technical considerations.

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If this is true then you are simply refusing to believe what you already know to be true!

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What I doubt is that any of this is useful in predicting the future price of anything.

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No one has a crystal ball, all you can do is use the knowledge that you can gain from price patterns to give yourself an edge. In much the same way as you can't predict with 100% certainty that you will win any given hand that you are dealt AA, even though it is fundamentally the best pre-flop hand in poker.

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So, please, answer the question in my original post: why don't we see one (or many) funds which strictly exploit technical analysis?

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I did answer your question, technical analysis is used every day by traders at the mutual funds.

Read William O'neill for some great analysis on the use of both fundamental and technical analysis to put the odds in your favor. He has done extensive historical testing on what parameters all successful stocks share in common.

If you don't understand how other market participants play the game, you are shortchanging yourself, in the stock market and in poker!

[Sniper]

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Technical analysis is largely B.S. Stock prices generally follow actual and/or expected future earnings. To predict future earnings you need to understand the qualitative factors that bring the company success.

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Stock prices move based on supply vs demand. Charts show you the results of the daily battles between buyers and sellers. If you don't understand all the factors that participants use to make their buy/sell decisions you are shortchanging yourself.

To quote William O'neill: "Investors who train themselves to properly decode price movements on charts have an enormous advantage over those who either refuse to learn or just don't know any better... Fortunes are made every year by those who take the time to learn to properly interpret charts... Professionals who don't make use of them are confessing their ignorance of highly valuable measurement and timing mechanisms... Universities that teach finance or investment courses and dismiss charts as irrelevant or not important demostrate their complete lack of knowledge and understanding of how the markets really work and how the best professionals operate." - How to Make Money in Stocks (3rd Ed) by William O'neill p. 123

[squiffy]

Fine. Give some specific examples in which technical analysis helps you make money in stocks.

Many people are really just trading on inside info, but not getting caught. I think they are just using technical analysis as a b.s. cover.

I don't doubt that there are trading patterns. For example, trading might slow at lunchtime or over the summer holidays, etc. Or stocks might jump based on info released in a CNBC news report.

But you cannot simply look at a chart pattern and predict future movements based on the chart pattern. You need underlying info about what is happening in the real world.

Real info. At 2 pm. CNBC is going to report earnings of Marths Stewart Living Omnimedia. Or at 2 pm. CNBC is going to report results of verdict. Etc.

Here is a loopy snoople squiggle doodle. Whenever you see that there is a 75% chance the stock will go up without regard to earnings reports, jury verdicts, etc. That's garbage.

Present some evidence.

I know fundamental analysis works. Last year ODP earned x dollars from y number of stores. They have a new CEO who has trimmed costs, increased advertising, opening stores in new areas, etc. So this will increase profits.

That's the kind of info you need to know.

You can test technical info by giving a technical analyst charts from the Australian stock market in an undisclosed time period and asking him to predict the movement of say 1000 stocks from 1940, 1950, 1960, 1970. He won't be able to do it with any kind of reliability or accuracy.

And if he could, he sure as hell wouldn't tell anybody how to do it!!!!!

[Sniper]

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Many people are really just trading on inside info, but not getting caught. I think they are just using technical analysis as a b.s. cover.

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ROFL... at this point, I'm not sure if this is a serious post or not!

In the grand scheme of things the number of people with access to tradable inside information is relatively small.

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But you cannot simply look at a chart pattern and predict future movements based on the chart pattern. You need underlying info about what is happening in the real world.

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First, there are some people that trade chart patterns without knowing anything about the company they are trading, including its name.

Secondly, a successful trader factors many pieces of information into their decision making process.

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Here is a loopy snoople squiggle doodle. Whenever you see that there is a 75% chance the stock will go up without regard to earnings reports, jury verdicts, etc. That's garbage.

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Do you also believe that EV charts are useless in poker, because any two cards can win?

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And if he could, he sure as hell wouldn't tell anybody how to do it!!!!!

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This is just wrong... and your posting it on a Publishers website makes it even sillier!

[squiffy]

Many examples of successful investors who use fundamental analysis and valuation. Warren Buffet, Peter Lynch, John Neff, Ben Graham, Phillip Fisher.

Show me the technical analysts who have made 60 billion dollars looking at charts.

How much money have you made from technical analysis?