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A Contrarian's Viewpoint Of Technical Analysis In Today's World

InvestorEducation / Learn to Trade Jan 25, 2009 - 07:38 AM GMT

By: Submissions

InvestorEducation Best Financial Markets Analysis ArticleFred Carach writes: When I broke into the stock market in 1961 if you wanted to learn technical analysis you were immediately pointed to Edwards & Magee's book," Technical Analysis Of Stock Trends" which was the bible of the industry from its first edition in 1948 until its last edition in the 1970s. Of course technical analysis really got its formal start with the publication of the famous "Dow Theory" in a series of articles written by Charles Dow in the Wall Street Journal between 1900 and 1902.


However, until the 1970s technical analysis was frowned on by the street as being somewhat akin to astrology. Then for reasons that I don't pretend to understand it suddenly became respectable. This respectability has come at a high cost. As a contrarian I regard today's popularity of technical analysis as a curse and not a blessing.

The founders of technical analysis regarded it as a tool for an elite minority in a world in which fundamental anlaysis reined supreme. They regarded themselves as savvy predators who would hide in the weeds and knock off the big game fundamentaltists as they came thundering by with their high powered technical rifles.

As many Wall Street professionals are only too well aware of, the more popular a market indicator becomes the more useless it becomes as a profit making indicator as every Tom, Dick and Harry jumps on the hitherto sucessful indicator and beats it to death. To put it simply what everybody knows isn't worth knowing. It is what everybody doesn't know that is of decisive importance.

Regretably, the current over popularity of technical analysis is not its only problem from the contrarian viewpoint. Other very ugly problems exist. The worst of these problems is today's overwhelming domination of moving average charts. This domination is recent. The final edition of Edwards & Magee's book contained a remarkable 324 charts of which only 49 charts were moving average charts. These were stuck on at the end of the book as a sop to the growing power of the moving averages crowd. The earlier works contained far fewer moving average charts.

Technical analysis was regarded by the old masters as an art that had to be mastered. In those days before the triumph of moving averages swept everything before it a technician was an expert in "pattern recognition analysis." He was someone who had a hard earned ability to analyze bullish or bearish chart patterns. Among the more common types of patterns that technicians had to be able to master were head and shoulders, tops and bottoms, W patterns,triangles,rectangles,wedges, fans and gaps.

The trouble with moving averages is that they are way too popular and even worse way too easy to analyze. Let's be honest! How much talent does it take to analyze a moving average? Not much. And everyone who looks at a moving average sees the same thing. The stock is either above the moving average or below the moving average.

The triumph of technical analysis and moving averages has resulted in the worst of all worlds. A world in which everyone sees the same thing and what is truly ugly acts on it.

If you are technician who uses moving averages what is your edge?

The edge that the founders of technical analysis once had is now gone. Even worse there is reason to believe that technicians are now the prey of choice for a new group of predators who are hiding in the weeds and who's favorite big game animal is the technicians who are now kind enough to show the world their poker hand.

Or is it just my imagination that stocks are no longer breaking through their moving averages with the power and authority that they used to? Those long decisive runs which are the bread and butter of technical analysis seem to occur less and less. Could the reason be unseen predators?

How difficult is it today for savvy predators with enough capital behind them to lie in wait until the final minutes of trading and then "paint the tape" with their concentrated action creating a false breakthrough. Knowing full well that many technicians will fall into the trap like plump pigeons. After the trap is sprung of course the stock reverts back to its old mean.

What is to be done?

I have two answers and you are not going to like either of them.

As a contrarian I am obsessed with seeking out and finding valid metrics that are either ignored or unknown by the public. If you see what everyone else sees you have no edge. At all costs you must find an edge. You must find metrics or indicators that are valid and don't appear on everyone's radar scope.

My first suggestion is to use Point & Figure charts. I know what you are going to tell me. Point & Figure charts went out with the horse and buggy. They are way too simple. Why they don't even have Bollinger Bands or MACD. No serious technician would consider using something that pathetically simple in today's modern world.

Exactly! That's the whole point. I would like to remind the reader that technicians were using Point & Figure charts with success for generations until moving averages swept away all the alternatives.

To the best of my knowledge the most recognized proponet of Point & Figure charts today is Jim Dines of the highly regarded Dines Letter. The dean of investment letters Richard Russell also uses Point & Figure charts on a fairly regular basis.

If you thought my first suggestion was horrifying. You are going to love my last suggestion. As I am writing these words I have a comical image of a hardcore technician blasting out of his chair in outrage and doing a triple summersault and bouncing on his head three times.

My last suggestion is that when a stock drops below its 200 day moving average it should be regarded as a bullish rather than a bearish event. There I said it.

Before going nuts I challenge the reader to pick at random a dozen 5 year, 200 day moving average charts and to see them for the very first time. Ask yourself a revolutionary question. Why isn't it better to buy a stock when its selling below its 200 day moving average rather than above its 200 day moving average. Study the charts and see them for the very first time.

I told you I was a contrarian. We are always told that we should buy low and sell high. Now is your chance.

When we buy above the 200 day moving average we are buying high in the hopes of selling to an even greater fool. Think about it!

By Fred Carach

Fred Carach is the author of the recent book "Forty Years A Speculator." His blog is fortyyearsaspeculator.blogspot.com

Copyright © 2009 Fred Carach - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


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