Why Technical Analysis is Nonsense
Whenever I ('The Prince') hear bloggers or financial âprofessionalsâ reading charts and talking about breakouts, support, momentum, resistance, chart patterns, or any number of goofy names for the shapes that charts make, I immediately begin to smile. I do admit that there is useful information to be gleaned from charts such as the number of buyers and sellers or the volume of a stock. Screens of stocks that are near their 52-week lows or 52-week highs can be useful for finding stocks that are good values or overvalued. However, the Prince does not buy into technical stock trading or the day trading that many technical traders partake in.
The truth is most institutional investors and real Wall Street professionals know that technical trading is absolutely hogwash. Now, Iâm not the first person to attack technical trading, and I wonât be the last, but hopefully what follows will be educational or at least thought-provoking. The Prince doesnât believe he is offering any new arguments against technical analysis but he is offering new evidence that may be more compelling when combined with old arguments against technical analysis.
First, a few disclaimers so I donât hurt too many feelings or egos in the blogosphere. There are many intelligent people online who prescribe to technical trading strategies. My intention with this blog post is not to belittle them, as many of them may even make quite a bit of money. Yet, ultimately those that do perform well on a ârisk adjusted basisâ are the exception to the rule.
Those that do perform well are deceiving themselves when they think that their prowess in reading charts is leading to their out-performance. In the end, their returns are nothing more than throwing darts at a board and getting lucky, but thinking they have a sure way to always hit a bulls-eye (in the language of day traders have their âwinners outnumber your losersâ).
Now, there are plenty of con-artists on the Internet selling get ârich quick," âeasy money,â and âguaranteed profitsâ technical trading schemes like how to trade penny stocks, or use my âstock-trading robot.â This post is not directed at them because The Prince doesnât think they deserve his attention.
This article is for all investors that vehemently believe in the power of technical analysis but donât realize that on a risk-adjusted and tax-adjusted (ahâ¦this is very important), they are not outperforming the market. It is meant to educate investors about the tenets of technical analysis, and then make a case for why it is not taken seriously, or even practiced by Wall Street professionals.
No Bid for Technical Trading in the Institutional Investor Marketplace
Letâs start this argument with an applicable example that I think will get any amateur investor who believes in technical analysis some pause. Not too long ago, The Prince was working on a Primebrokerage sales team for a large Wall Street bank. Letâs just say that this Wall Street investment bank has the number one franchise on Wall Street for Primebrokerage. For those who donât know what Primebrokerage is, let me give you a little introduction.
It is one of the hottest businesses on Wall Street with the juiciest margins and the highest top-line growth. Basically, it is the business of servicing hedge funds which essentially means lending stock for short sales and cash for leverage to hedge funds. This is a very sticky business because if a hedge fund is Primed at a bank they are more likely to trade through that bankâs desks. They are also more likely to use that bankâs investment banking services if they do private deals. Banks that have built successful Primebrokerage practices have seen their businesses flourish.
I spent two summers working in a Primebrokerage division before I entered investment banking. During my time working on the capital introductions team and the sales team I got to see inside some of the largest hedge fund launches of the past few years. The Prince got to work on launches that were so secret and so large they went by code names and only the most worthy investors were allowed to invest. The Prince is talking about multi-billion dollar launches by guys with amazing pedigree (i.e. ex-SAC, ex-Goldman Sach Prop Desk, ex-Maverick, etc.) and successful track record managing large amounts of money.
In other words, The Prince got to see how real experiences hedge managers launched their businesses and brought in large amounts of institutional capital (corporate pension funds, endowments, state pension funds, high net work individuals, etc.). During these two summers he got to see the offering documents and marketing materials for over 500 of largest most respected hedge fund firms on the Street. His firm was a Primebroker for roughly 90 of the firms on Alpha Magazineâs Hedge Fund 100, as ranked by Assets Under Management or AUM.
Needless to say, The Prince became very familiar with hedge fund industry dynamics, the strategies employed by most hedge funds, fee structures, compensations structures, hedge fund power dynamics, what it takes to start a successful fund, the pedigrees of a-list hedge fund managers, and the desires of institutional investors. Do you know how many funds The Prince ran across that professed to use technical analysis to make investments? Zero. Thatâs right, not one fund. There simply is no bid for this baloney strategy from institutional investors. Most successful hedge fund investors are fundamental investors and The Prince will always believe in fundamental value and contrarian investing.
So if the most sophisticated instructional investors donât believe in it why should you as an individual investors subscribe to technical analysis? Do we every see Steve Cohen, James Simons (click here for a great Bloomberg profile of Simons, RenTec is one of the best kept secrets from the public eye in the hedge fund industry), or the like coming out and claiming to use technical analysis. Of course not. Now some people may be under the illusion that quantitative or statistical arbitrage funds use technical analysis but they are not readying charts. They are analyzing enormous amounts of data to try to find market inefficiencies and then exploit these inefficiencies.
Do you think Renaissance Technologies keeps hundreds of PhDs in hard sciences on staff to read charts? Of course not. Quantitative firms prescribe to a scientific-based investment strategy that couldnât be further from reading the tea leaves of charts using technical analysis. The Renaissance Medallion Fund, which redeemed all outside investors a few years ago before jacking up fees to 4% management and 40% incentive fee, did not return an average of 35% per annum after fees since 1989 and rise to become the most consistently successful hedge fund in the industry by using technical analysis. So why would you use technical analysis?
Whenever I ('The Prince') hear bloggers or financial âprofessionalsâ reading charts and talking about breakouts, support, momentum, resistance, chart patterns, or any number of goofy names for the shapes that charts make, I immediately begin to smile. I do admit that there is useful information to be gleaned from charts such as the number of buyers and sellers or the volume of a stock. Screens of stocks that are near their 52-week lows or 52-week highs can be useful for finding stocks that are good values or overvalued. However, the Prince does not buy into technical stock trading or the day trading that many technical traders partake in.
The truth is most institutional investors and real Wall Street professionals know that technical trading is absolutely hogwash. Now, Iâm not the first person to attack technical trading, and I wonât be the last, but hopefully what follows will be educational or at least thought-provoking. The Prince doesnât believe he is offering any new arguments against technical analysis but he is offering new evidence that may be more compelling when combined with old arguments against technical analysis.
First, a few disclaimers so I donât hurt too many feelings or egos in the blogosphere. There are many intelligent people online who prescribe to technical trading strategies. My intention with this blog post is not to belittle them, as many of them may even make quite a bit of money. Yet, ultimately those that do perform well on a ârisk adjusted basisâ are the exception to the rule.
Those that do perform well are deceiving themselves when they think that their prowess in reading charts is leading to their out-performance. In the end, their returns are nothing more than throwing darts at a board and getting lucky, but thinking they have a sure way to always hit a bulls-eye (in the language of day traders have their âwinners outnumber your losersâ).
Now, there are plenty of con-artists on the Internet selling get ârich quick," âeasy money,â and âguaranteed profitsâ technical trading schemes like how to trade penny stocks, or use my âstock-trading robot.â This post is not directed at them because The Prince doesnât think they deserve his attention.
This article is for all investors that vehemently believe in the power of technical analysis but donât realize that on a risk-adjusted and tax-adjusted (ahâ¦this is very important), they are not outperforming the market. It is meant to educate investors about the tenets of technical analysis, and then make a case for why it is not taken seriously, or even practiced by Wall Street professionals.
No Bid for Technical Trading in the Institutional Investor Marketplace
Letâs start this argument with an applicable example that I think will get any amateur investor who believes in technical analysis some pause. Not too long ago, The Prince was working on a Primebrokerage sales team for a large Wall Street bank. Letâs just say that this Wall Street investment bank has the number one franchise on Wall Street for Primebrokerage. For those who donât know what Primebrokerage is, let me give you a little introduction.
It is one of the hottest businesses on Wall Street with the juiciest margins and the highest top-line growth. Basically, it is the business of servicing hedge funds which essentially means lending stock for short sales and cash for leverage to hedge funds. This is a very sticky business because if a hedge fund is Primed at a bank they are more likely to trade through that bankâs desks. They are also more likely to use that bankâs investment banking services if they do private deals. Banks that have built successful Primebrokerage practices have seen their businesses flourish.
I spent two summers working in a Primebrokerage division before I entered investment banking. During my time working on the capital introductions team and the sales team I got to see inside some of the largest hedge fund launches of the past few years. The Prince got to work on launches that were so secret and so large they went by code names and only the most worthy investors were allowed to invest. The Prince is talking about multi-billion dollar launches by guys with amazing pedigree (i.e. ex-SAC, ex-Goldman Sach Prop Desk, ex-Maverick, etc.) and successful track record managing large amounts of money.
In other words, The Prince got to see how real experiences hedge managers launched their businesses and brought in large amounts of institutional capital (corporate pension funds, endowments, state pension funds, high net work individuals, etc.). During these two summers he got to see the offering documents and marketing materials for over 500 of largest most respected hedge fund firms on the Street. His firm was a Primebroker for roughly 90 of the firms on Alpha Magazineâs Hedge Fund 100, as ranked by Assets Under Management or AUM.
Needless to say, The Prince became very familiar with hedge fund industry dynamics, the strategies employed by most hedge funds, fee structures, compensations structures, hedge fund power dynamics, what it takes to start a successful fund, the pedigrees of a-list hedge fund managers, and the desires of institutional investors. Do you know how many funds The Prince ran across that professed to use technical analysis to make investments? Zero. Thatâs right, not one fund. There simply is no bid for this baloney strategy from institutional investors. Most successful hedge fund investors are fundamental investors and The Prince will always believe in fundamental value and contrarian investing.
So if the most sophisticated instructional investors donât believe in it why should you as an individual investors subscribe to technical analysis? Do we every see Steve Cohen, James Simons (click here for a great Bloomberg profile of Simons, RenTec is one of the best kept secrets from the public eye in the hedge fund industry), or the like coming out and claiming to use technical analysis. Of course not. Now some people may be under the illusion that quantitative or statistical arbitrage funds use technical analysis but they are not readying charts. They are analyzing enormous amounts of data to try to find market inefficiencies and then exploit these inefficiencies.
Do you think Renaissance Technologies keeps hundreds of PhDs in hard sciences on staff to read charts? Of course not. Quantitative firms prescribe to a scientific-based investment strategy that couldnât be further from reading the tea leaves of charts using technical analysis. The Renaissance Medallion Fund, which redeemed all outside investors a few years ago before jacking up fees to 4% management and 40% incentive fee, did not return an average of 35% per annum after fees since 1989 and rise to become the most consistently successful hedge fund in the industry by using technical analysis. So why would you use technical analysis?
