2023-01-07

Technical analysis

Technical analysis, the studying of price history charts, like the Ancient Romans studied the entrails of animals or palmists study lines on one’s palm, has an ancient pedigree.

Like fortune tellers, the best chartists study fundamentals and the macroeconomic environment as deeply as any market participant. Classic books on the subject emphasize the primacy of a compelling economic case for a price move above mere graphical formations.

The reality of trading is that the market doesn’t know that you’ve worked out why a security is mispriced. Tesla equity has been mispriced for a very long time, but it would be suicidal to short the stock until there was evidence that the bulls had finally capitulated. Really, the only evidence for this is in the price.

Clearly, hard facts are important. But when trading in deep and liquid markets, the marginal seller and buyer are extremely well informed, to the point that it’s hard to prove that trading skill makes a difference. It’s like very skillful sports such as soccer. The results of competitions between the very top teams are almost random, not because the players are not skillful, but because they are all so highly, and equivalently skilled, that skill counts for little in determining the final result. (This is different for basketball, where height is such an important factor that there is a bigger dispersion in skill levels between players and teams.)

Even with the best regulation, inside information about a company’s prospects leaks out, and is traded on, and makes profits for those insiders. I won’t comment on the tremendous trading success of members of Congress. The source and use of this information can be kept secret, but not the actual trading, whether of the underlying security, or some derivative of is, or even as some sort of proxy trade. All this trading does affect the price level, at the margin, and this signal is transmitted through price charts. Could I recognize a characteristic pattern of price movement resulting from the use of inside information? No! But can I imagine that a skilled person could learn such a thing. Probably, yes!

So, to summarize, I’m still not a believer, when it comes to the dark arts of technical analysis, but I am not an atheist either. Let’s say that I’m an interested agnostic, and will take a look at a chart now and then.