Pragmatic Criticisms of Financial Technical Analysis

In addition to the theoretical criticisms of technical analysis, there are some pragmatic criticisms of technical analysis.

Some investors incorrectly believe that technical analysis is only for the short-term trader and is not useful to the long-term investor. Because new and relevant fundamental information on a security doesn’t change minute by minute or day by day, a short-term trader must rely more on technical analysis. The short-term trader must rely on an interpretation of market price behavior rather than on news and company announcements. In this instance, technical analysis gives the trader more of an advantage than fundamental analysis. This happenstance has led to the incorrect belief that technical analysis is only for the short-term trader. But technical analysis is the study of price, and people determine prices. People affect long-term prices as much as short-term prices. Analysis of price behavior over the long term is just as valuable to the investor as analysis over the short term is to the trader. Indeed, the professional managers who have been the most successful have been so because they used technical analysis for long-term decisions.

Other opponents of technical analysis claim that, if successful, technical analysis would cancel itself out by being self-fulfilling. A corollary to this claim is that technical rules that worked in the past might not work in the future. Such a criticism assumes that technical analysis will fail when all investors practice it, including the self-same critics. So far, the widespread, ubiquitous use of technical analysis is illusory. Many rules, both technical and fundamental, suffer the fate of becoming too popular. Look at the concept of “diversification” into noncorrelated assets, an idea much touted before the 2008 stock market decline took all noncorrelated assets down at the same time. Another example of this phenomenon is the small capital effect. Historically, smaller capitalized stocks tended to outperform larger capitalized stocks, but this fundamental rule no longer holds true. These are investment fads, not principles. Technical analysis, having been around for hundreds of years, is not a fad. There is no question that methods of pattern analysis seem not to work as well as in the past. This is also a problem with all investment analysis. As markets become more efficient, competition becomes fiercer, and any method having some modicum of success is quickly jumped on until it becomes neutralized. Although it occurs with technical analysis, it is not unique to it. As for technical rules working in the future, who is to say? All rules are subject to change. At least technical analysis works with reliable data; most rules have been tested; and risk levels can be established to limit loss of capital.

An additional criticism of technical analysis is that most technical rules require subjective judgment and are, thus, fallible. On the other hand, what form of investment analysis doesn’t require subjective judgment? Why is technical analysis singled out? Certainly, fundamental analysts must judge whether to buy, sell, hold, or ignore a security they are analyzing. It is true that technical analysis of charts is subjective, and some call it an “art” or “skill,” but the demonstration of data on a chart is just another means of time-series analysis. Most theoreticians also use charts to clarify their hypotheses. One sure aspect of technical analysis, unlike others, is that the data used is as timely and accurate as any data can be. Actually, technical analysis is becoming more “mechanical” as quantitative experts use computers to determine statistical rules for action and money management. Some believe this may “blow up” and denigrate technical analysis or at least drive it back to the subjective rules, as did the LTCM debacle for the EMH about arbitrage, but for now technical analysis is becoming the less subjective of the two major forms of investment analysis.

Source: Kirkpatrick II Charles D., Dahlquist Julie R. (2015), Technical Analysis: The Complete Resource for Financial Market Technicians, FT Press; 3rd edition.