{"id":47018,"date":"2021-08-19T05:16:00","date_gmt":"2021-08-19T09:16:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=47018"},"modified":"2021-09-01T15:53:09","modified_gmt":"2021-09-01T19:53:09","slug":"does-technical-analysis-work","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/does-technical-analysis-work\/","title":{"rendered":"Does Technical Analysis Work? Here’s Why It Doesn’t"},"content":{"rendered":"\n

What is the best method for predicting the movement of stock prices? Does technical analysis work?<\/p>\n\n\n\n

Technical analysis uses the past movements of stock prices to predict future prices. For example, if a stock has risen over the course of a day or several days, a technical analysis will show confidence in the stock. Technical analysts argue that stock prices tend to follow trends, meaning they can sometimes be susceptible to the irrational optimism of other investors. <\/p>\n\n\n\n

Does technical analysis work? Find out below. <\/p>\n\n\n\n\n\n\n\n

Does Technical Analysis Work?<\/h2>\n\n\n\n

Does technical analysis work? The answer to this question is complicated. On the one hand, portfolio managers argue that technical analysis does work. But, the evidence seems to suggest otherwise. <\/p>\n\n\n\n

As established by their role in speculative bubbles, professional portfolio managers, for all their experience and expertise, are as susceptible to castle-in-the-air thinking as the rest of us. \u201cBut,\u201d a portfolio manager might say, \u201cin the long run and on average, we manage risk for our clients and provide returns that beat the market<\/strong>\u2014that\u2019s why so many Americans trust us with their life savings and why we deserve our fees and commissions.\u201d<\/p>\n\n\n\n

Unfortunately for portfolio managers, academics have compared managers\u2019 returns with those provided by a market index fund\u2014a mutual fund with holdings that replicate a market index\u2014and found that portfolio managers simply aren\u2019t worth the money<\/strong>. That is, no investor can do better in the long run than a market index fund<\/strong>.<\/p>\n\n\n\n

Why can\u2019t portfolio managers consistently outperform index funds? Fatally flawed methods of analysis.<\/strong><\/p>\n\n\n\n

What Is Technical Analysis?<\/strong><\/h3>\n\n\n\n

Security analysts typically use one of two methods for predicting the movement of stock prices: fundamental <\/em>analysis and technical <\/em>analysis.<\/p>\n\n\n\n

Technical analysis relies on stock charts\u2014graphs of past price movements and trading volumes\u2014to predict <\/strong>future <\/em><\/strong>price movements<\/strong>. (Because of their reliance on charts, technical analysts are also called \u201cchartists.\u201d) Technical analysts subscribe to the castle-in-the-air theory of asset valuation: They believe that stock prices are more a product of investors\u2019 psychology<\/strong> than a sober accounting of a firm\u2019s profit-making potential.<\/p>\n\n\n\n

Technical analysts adhere to two primary principles: (1) that all economic data\u2014revenues, dividends, and future performance\u2014are reflected in a stock\u2019s past prices<\/strong>; and (2) that stock prices tend to follow trends<\/em> (if a price is rising, it will continue to rise<\/strong>, and vice versa). It\u2019s completely inconsequential to the chartist what industry a company is in or what\u2019s happening in the world at large. To the chartist, all that matters is past and future price changes<\/strong>.<\/p>\n\n\n\n

In practice, what this means is that technical analysts will study a stock\u2019s charts to deduce trends. If there\u2019s an \u201cuptrend\u201d\u2014in other words, the stock price has risen over the course of a day or several days\u2014then the chartist will be bullish on the stock. A head-and-shoulders pattern\u2014where there\u2019s a rise and fall, a greater rise and fall, and then a rise and fall similar to the first\u2014indicates that a stock may have reached its \u201cresistance level\u201d and is due for a downturn. But does technical analysis work? Here\u2019s why it might.<\/p>\n\n\n\n

Does Technical Analysis Work? A Case for Technical Analysis<\/strong><\/h3>\n\n\n\n

Despite its seeming arbitrariness, technical analysis does indeed have a logic.<\/p>\n\n\n\n