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Technical analysis won't make you wealthy! - Views on News from Equitymaster
 
 
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  • Dec 23, 2010

    Technical analysis won't make you wealthy!

    He wears the halo of an astrologer. But you can also liken him to a heart surgeon. He quietly sits in front of a computer screen; his eyes fixed. He wears the halo of an astrologer. But you can also liken him to a heart surgeon. He quietly sits in front of a computer screen; his eyes fixed intently on the zigzag chart patterns before him. Then without turning his gaze and with the solemn look of a prophet he delivers his revelation. With an esoteric mix of words, you are finally given what most people want: a company name with a buy price and a target price. Familiar sight?

    We're not at all hinting that technical analysis is a hoax. In fact, we're quite in agreement with its underlying philosophy. Collective processes in nature do go through similar repetitive, though not identical, patterns over time. This quite applies to stock markets which are a playground for collective behaviour. And history is witness to all the cycles and booms and busts that have conspired over centuries.

    So the point that we're trying to drive across is this: Technical analysis is great in theory but not in application. We will share our reasons.

    Indian markets don't have enough depth

    Technical analysis has its roots in crowd psychology. It presumes a large number of participants. But given the Indian scenario, the markets do not have enough depth. Especially, smallcap and midcap companies have very low volumes. These stocks are often vulnerable to manipulation by operators. So chart reading becomes quite a redundant exercise.

    Risk of getting trapped in shady stocks

    Technical analysis pays heed neither to the company's profitability nor to the quality of its management. In view of the many unethical and unscrupulous management practices that we often witness, looking merely at price movements and volumes does not at all seem a safe bet.

    Retrospective riches, imaginary air castles!

    Technical analysts often point at the sheer amount of opportunities that long term investors miss by not playing on market volatility- buying on dips and selling at peaks. Fancy idea, isn't it? But the truth is not very encouraging. One, the so-called 'missed opportunities' become apparent only in retrospect. Only on a historical chart can you identify peaks and troughs. Second, it is practically impossible to buy right at the bottom and sell at the top. So what remains for the trader are thin slices of profits here and there. And it is not unusual that a string of small profits gets wiped off with a single wrong move.

    There is little scope to ride multi-baggers

    Technical analysis can help you with betting on short term price movements of stocks. But the long term trends become evident only in hindsight. So while you could enjoy some short term gains, you would miss out the big picture.

    You have to be right too many times

    Then if you want to create substantial wealth, you have to be right innumerable times. Even the world's most successful investors have admitted that it is an impossible mission. A quote by the legendary investor Warren Buffett sums up the entire point, "Even Charlie and I decided long ago that in an investment lifetime it's too hard to make hundreds of smart decisions. That judgement became ever more compelling as Berkshire's capital mushroomed and the universe of investments that could significantly affect our results shrank dramatically. Therefore¸ we adopted a strategy that required our being smart - and not too smart at that - only a very few times. Indeed, we'll now settle for one good idea a year."

    When you're too much into the market you're tempted to do too much

    Technical analysis demands that you actively follow the markets. But the markets are like a drinking bar. The more you see of them, the more you want to taste the wine. And the more you taste the wine, the more you end up drinking. And we all know the happy ending where your broker becomes a rich man.

    Moral of the story...

    We're skeptical about technical analysis as a technique to build substantial wealth. We believe that the key to lasting wealth in stock markets is to invest in companies with robust fundamentals and at a price that offers you a good margin of safety.d intently on the zigzag chart patterns before him. Then without turning his gaze and with the solemn look of a prophet he delivers his revelation. With an esoteric mix of words, you are finally given what most people want: a company name with a buy price and a target price. Familiar sight?

    We're not at all hinting that technical analysis is a hoax. In fact, we're quite in agreement with its underlying philosophy. Collective processes in nature do go through similar repetitive, though not identical, patterns over time. This quite applies to stock markets which are a playground for collective behaviour. And history is witness to all the cycles and booms and busts that have conspired over centuries.

    So the point that we're trying to drive across is this: Technical analysis is great in theory but not in application. We will share our reasons.

    Indian markets don't have enough depth

    Technical analysis has its roots in crowd psychology. It presumes a large number of participants. But given the Indian scenario, the markets do not have enough depth. Especially, smallcap and midcap companies have very low volumes. These stocks are often vulnerable to manipulation by operators. So chart reading becomes quite a redundant exercise.

    Risk of getting trapped in shady stocks

    Technical analysis pays heed neither to the company's profitability nor to the quality of its management. In view of the many unethical and unscrupulous management practices that we often witness, looking merely at price movements and volumes does not at all seem a safe bet.

    Retrospective riches, imaginary air castles!

    Technical analysts often point at the sheer amount of opportunities that long term investors miss by not playing on market volatility- buying on dips and selling at peaks. Fancy idea, isn't it? But the truth is not very encouraging. One, the so-called 'missed opportunities' become apparent only in retrospect. Only on a historical chart can you identify peaks and troughs. Second, it is practically impossible to buy right at the bottom and sell at the top. So what remains for the trader are thin slices of profits here and there. And it is not unusual that a string of small profits gets wiped off with a single wrong move.

    There is little scope to ride multi-baggers

    Technical analysis can help you with betting on short term price movements of stocks. But the long term trends become evident only in hindsight. So while you could enjoy some short term gains, you would miss out the big picture.

    You have to be right too many times

    Then if you want to create substantial wealth, you have to be right innumerable times. Even the world's most successful investors have admitted that it is an impossible mission. A quote by the legendary investor Warren Buffett sums up the entire point, "Even Charlie and I decided long ago that in an investment lifetime it's too hard to make hundreds of smart decisions. That judgement became ever more compelling as Berkshire's capital mushroomed and the universe of investments that could significantly affect our results shrank dramatically. Therefore¸ we adopted a strategy that required our being smart - and not too smart at that - only a very few times. Indeed, we'll now settle for one good idea a year."

    When you're too much into the market you're tempted to do too much

    Technical analysis demands that you actively follow the markets. But the markets are like a drinking bar. The more you see of them, the more you want to taste the wine. And the more you taste the wine, the more you end up drinking. And we all know the happy ending where your broker becomes a rich man.

    Moral of the story...

    We're skeptical about technical analysis as a technique to build substantial wealth. We believe that the key to lasting wealth in stock markets is to invest in companies with robust fundamentals and at a price that offers you a good margin of safety.

     

     

    Equitymaster requests your view! Post a comment on "Technical analysis won't make you wealthy!". Click here!

    8 Responses to "Technical analysis won't make you wealthy!"

    ChartRules

    Jan 7, 2011

    Hi Vedant
    Learning TA well enough to apply it to make money takes about 1-2 years. So think about that before getting into it. Most of the people you see (including some on TV and print media) are of the 'analyst' types. they know just enough to give out calls. Unfortunately that is a requirement of the broking business and hence low quality people in both TA and FA are finding room in research departments.
    Start with a basic course. Apply the learning. Read well. Then go for an advanced course (very few people can offer this currently in India). Read a lot more. then apply the learning again. All this takes about 1-2 years.

    Like 

    Vedant

    Jan 5, 2011

    Hi, ChartRules,

    Thank you for the detailed explanation regarding TA. I started actively trading 2 months back, have been doing both Value Picks, Day Trading and 2 day to 1 week short term trade. Your views are quite interesting. The idea of running various prtfolios ('books' as you mentioned) for each type of trading is interesting. Could you suggest a course for mastering TA?

    Thank You

    Like 

    illuminaty

    Jan 5, 2011

    I think technical analysis can not replace long term investing and vice versa basically they can be used in great coherencies. If the r used in that manner it can do wonders. It is more about mastering one's emotions than mastering chart. the person who can hold cash should do that. Money management matters a lot in trading. Its true that people become addicted to trading but it is their fault not of TA's. It is not satta, it requires lot of study and tenacity. To trade one needs nervs of steel and temperament as solid as rock. So, please do not take extreme view. Foe Ex. if one has holding of 1000 Shares of some company, one can make rounds i.e. trade on 100 or 200 shares and not put entire holding at stake. It increases profits and reduces average holding cost. I have been doing it for many yrs. Sure it helps, may not all the times but many times.

    Like 

    deepak sharma

    Jan 3, 2011

    Dear sir
    I think niffty try to cross 6234 and then it will touch 6332 or38 if it not cross then it will come to 6042

    Like 

    swati shevade

    Jan 3, 2011

    I feel we should select the stock in fundamental basis and then for entry and exits we should use TA as the movements can be caught in TA.

    Like 

    ChartRules

    Jan 1, 2011

    I want to present a point by point rejoinder to what I think is a fairly shallow-research on the subject of TA. The author of this note displays a remarkable lack of common sense and seems more of an arm-chair analyst rather than a real world one. So, here goes.
    Markets have no depth: No dispute. But a glaring error here is what about Large Caps? Do they have no depth? Most of them are over-researched from FA perspective and hence there is little to differentiate. Their moves happen owing to buying and selling of large institutional players and warehousing action by operators/bulge bracket brokers and individuals. Such actions can be caught ONLY by TA. Such actions are about 10x the moves occurring out of events (like quarterly nos etc). Market is all about tapping opportunity. If you miss 6 of 10 opportunities that exist you better be damn accurate on your forecast on the other 4- a probability that I would give very low odds, no matter how much of the midnight oil you burn reading your balance sheets and modeling the XL sheets.
    In the case of small caps, the amount of fundamental info available is so limited (not to speak of unreliable) that the only way to go is to catch the action of large players as they begin accumulating or distributing this stock. Even in small and mid cap stocks, there is a phase when the volumes are decent or large. Participate then to reduce the problems related to lack of volumes.

    Imaginary Castles: Part of this is addressed above. A good TA does NOT attempt to catch tops and bottoms. The meat really lies in the middle (as the Big Mac ads tell us) and that is what is captured. Momentum investing is a great way to participate. Of course it means that you should know how to read the changes in the momentum so that you can exit appropriately too. That is why a good TA will do this not the run of the mill chartists. If you end up with the patty in the middle, the bun and the lettuce leaves dont really matter so much. And your returns will average about 5-10% ever 2-3 months. Momentum investing is not an all-year game, as you seem to imply. There is no need for an all-year, all-the-time-in-the-marekt type of approach. It is your misconception that TA approach means trading EVERY move- whatever gave you that idea? There are many things said in theory in all subjects. Only a part of it is truly applicable. TA is no different. I run a large portfolio devoted only to momentum investing and I average a return of nothing less than 25% for the past 10 years in row, investing in spurts of about 1-2 months at a time and staying out for more than half the year!

    Multi Baggers: One of the biggest misconception of non TA people is their view that TA is for short term. You can spot multi baggers far ahead of time, when they are beginning or have just begun. To give you just one example, I got into Jain Irrigation around 30-35 levels in July 2002, pyramided it all the way till 2007 end to exit. For the present, here is another one I will give you just to prove that Jain is not a retro fit. I am into JB Chem from around 65 levels in Jan 10 and still holding at a 100%+ gain currently. For me it will be a 4 bagger stock. I have at least another 5-6 more stocks that will range between 5-10 baggers, all picked on the basis of my charts.
    If you dont know the depths of a subject, dont display your ignorance in public.

    You have to be right too often: True- for a day trader. But where does it say that TA means day trading or in-out approach all the time? It is your misconcption revealing itself again. The rule is simple. If you transact often, your risk of ruin goes up exponentially. this is true for any transaction in the makret, whatever the method. Inability of fundamental approach to enable frequent transaction is not a virtue. it is a weakness. Markets are not forever into an uptrend. That is true at a conceptual level across super cycles of centuries. Get real. As an investor you need to deal with every single piece of news that comes flying at your whether you want it or not. You have deal with it. Ignoring it is also a way of dealing with it. Most FA practitioners believe that they need to ignore noise of the day. But noise of the day collectively becomes the noise of the week/month/year. So what will ignoring get you? Only delay. By then damage is done. In 2008, people realised that it wasnt noise after all only around August. Then they sold all the way down till end October! Day traders are there by choice. They have to deal with being right more often than being wrong. That comes with the territory. It is not a shortcoming of the subject. The rules are the same whether for 5 min chart or for a decade chart. Application of the rule is the skill part. Day traders lack skills. So they lose money. Those that learn or develop the skill, stop losing. Those who progress to understanding and apply the skill, make money in day trading too. I run another trading book, which is purely on 1-3 day trades. It has had only 1 losing month in whole of 2010. Records available for verification if someone wants to take up the challenge of showing similar results. Returns of 5-7% on margin deployed every month.

    Too much temptation: you take a human weakness and portray it as a subject's weakness. Pity you.

    Cheers for 2011.

    Like 

    guhan

    Dec 27, 2010

    i feel technical analysis help us to usto spot the right time to buy a stock and not the right stock

    Like 

    Chris

    Dec 23, 2010

    Technical Analysis requires that the volume of the stock should be high. So be it any market ( India or any other) or any stock ( MidCap, LargeCap or SmallCap) - it will not work.

    The mid-way is to use Technical Analysis to decide entry and exit points of Fundamentally Strong Stocks.
    You do not want to buy a stock which is falling day by day

    Like 
      
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