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Has technical
analysis kept up
with the (Dow) Jones’?
Markets have taken
advantage of technology during the last 30 years, but where are the
advances in analyzing price movement?
By Darrell Jobman
Technology has
revolutionized the way business is done around the world including
many aspects of trading during the last 30 years, but has it really
produced any innovations in technical analysis for today’s global,
24-hour electronic markets?
Some new ideas in
technical analysis have certainly surfaced throughout the years, as
chronicled in these pages. Welles Wilder introduced the relative
strength index (RSI) in 1978: “RSI: A momentum oscillator that can
help you spot market turns,” (Commodities, June 1978); Louis
Mendelsohn wrote about the backtesting software concepts (three
articles in 1983); Steve Nison introduced candlestick charts to the
Western world in “Learning Japanese-style ‘candlesticks’ charting,
December 1989; and John Murphy advocated the use of intermarket
analysis, to name a few technical analysis developments. (See
“Indicating profits,” right.)
But aside from
moving concepts from hand-drawn charts to calculators to computers
that are ubiquitous in trading today, what has technical analysis
done for traders lately? Where are today’s Charles Dows, R.N.
Elliotts or W.D. Ganns with original analytical ideas? Ask some of
the people who have played prominent roles in the marketplace about
the state of technical analysis today and you’ll get a wide range of
answers.
SAME OLD THING
“Technical analysis today is not that much different than it was 25
years ago,” says Mendelsohn, president of Market Technologies LLC
and developer of VantagePoint intermarket analysis software. “The
only difference is that the charts have different dates and the
computer’s ability to produce these charts quickly and easily is
vastly improved.”
New technical
analysis ideas are still being generated by hedge funds and
proprietary traders using their extensive resources to develop
advanced trading methods, but the institutional traders are keeping
these proprietary secrets to themselves. If there is a new
technical analysis genius or concept, no one will ever hear about
it.
But Mendelsohn
doesn’t think most of these sophisticated traders are any better at
analysis than the individual trader. “You would think that with so
much money involved and the incentive that money managers have to
produce profits, they would have the best state-of-the-art analysis
possible, but that’s not so,” he says, noting the poor performance
of many public futures funds (47 funds down an average of 4.49%
through October , according to Futures). However, most of
the high-end system development talent has gravitated to private
placement hedge funds and commodity trading advisors.
PLENTY OF TOOLS
John Bollinger, whose extensive study of market volatility resulted
in the concept of Bollinger Bands, believes that traders still have
“an awfully good set of technical analysis tools available to them.”
However, with the type of market participants and trading around the
clock around the world today, the character of the data has changed.
As part of his
ongoing research, he has found it instructive to feed a data series
with technical patterns to an indicator to see how it responds,
noting the behavior during steady market moves and during periods of
price deceleration.
“What traders
really need to do is understand the response characteristics of the
indicator tools they are using better than they do now,” he says.
What he suggests is
not necessarily discovering new indicators but using today’s
computational power to mine the ideas from analytical work before
the 1960s more thoroughly.
“Like the
automobile, the basic problem (of analysis) has been solved. Now
it’s more about finesse,” Bollinger says. “Look at the old masters
and their techniques. There’s still a ton of information there,
especially in analyzing the micro structure of the market.”
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INDICATING PROFITS
Innovations in technical analysis in the 1970s and 1980s
included candlesticks showing price action and three
indicators: RSI, DMI and average true range introduced by
Welles Wilder. Are there more such developments ahead?
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MAKING INDICATORS WORK
One analyst who is using techniques he developed more than 25 years
ago to trade systems successfully is Welles Wilder, whose 1978 book,
New Concepts in Technical Trading Systems, introduced the
Relative Strength Index, Directional Movement Index, Volatility
Index, average true range and a number of other technical tools that
are now included in most analytical software.
Wilder, who now
spends most of his time at his home in New Zealand, is also known
for his Delta Society systems, which incorporate several of the
concepts from the book with his Delta turning point analysis and
have produced profits averaging $50,000 a year, he says. One of the
techniques from the book, the Volatility System, is mostly
overlooked, but he says it may be the best stand-alone system in the
book, illustrating that sound analytical techniques from the past do
not go out of date.
The Parabolic
System also is standing the test of time in helping traders get out
of a position once profits are built up, he adds.
LOTS OF
‘MUMBO-JUMBO’
Whatever type of technical analysis is in vogue these days, most
of it is “mumbo-jumbo,” contends Larry Williams, an author/trader
whose accomplishments include turning a $10,000 account into $1
million in a year and writing a number of popular trading books
including The Right Stock at the Right Time and Long-Term
Secrets of Short-Term Trading.
“I am not enamored
by technical analysis and I have probably beaten up the numbers as
much as anyone,” says Williams, whose name is often associated with
the %R indicator but whose his books have made a transition from a
technical focus in his early trading days to mostly fundamental in
recent years.
“What has stood the
test of time is that trend matters,” Williams emphasizes. “If prices
move from 10 to 50, it’s due to fundamental conditions. You don’t
forecast 50 with an indicator. First, you have to see the condition
(or trend) of the market, then you can use a timing tool like %R to
buy on a pullback or sell on a trendline breakout. It’s pretty
simple. I see no value in that artsy-craftsy stuff like Elliott Wave
or Gann.”
Williams compares
markets to a boat ride. “You don’t want to be looking backward at
the (technical indicator) waves to see where the boat went. You
want to keep your eye on where the pilot (conditions) is steering
the market,” he explains.
Williams, who
hasn’t gotten into electronic trading but submits orders to his
broker by e-mail, does find value in a couple of old technically
related tools that are still reliable, the Commitment of Traders
report and seasonal patterns, which he views as market fundamentals
or conditions. Another old analytical standby, volume, has not kept
up with the times in futures trading, however, because arbitrageurs,
long-term program traders and investable indexes are behind huge
spikes in volume every 90 days at expiration in many markets.
“This volume is not
reality. It does not reflect the real supply/demand situation,”
Williams says. “Volume is dead as an indicator. Or if it’s not
dead, it’s not the same as in the past.”
WRONG TARGET?
John Murphy, whose books Technical Analysis of the Financial
Markets and Intermarket Analysis are among the Bibles of
modern technical analysis, doesn’t even like the premise of an
article.
“It implies that technical analysis hasn’t
kept up with the times when the exact opposite is true,” he says.
“Why not write an article asking why economists and fundamental
analysts missed the end of the Nasdaq bubble in 2000 when it was
clearly seen on the charts. Or why the fundamental community didn’t
see the spectacular rise in oil prices over the last couple of years
when the chartists did? Or why Wall Street has completely missed the
secular bull market in gold and other commodities over the last
three years while chartists didn’t?
“I think a more pertinent article would be
about how well technical analysis has done in the new global
environment and why the economic and fundamental communities haven’t
kept pace,” he suggests.
ADVANCES TO COME
Whatever the view of current technical analysis, there’s not a lot
of incentive to come up with innovative ideas, Mendelsohn says.
“The largest numbers of traders are
newcomers to the market and that’s the way it will be forever,” he
notes. “It’s like they are all starting kindergarten and learning
how to read. The teacher knows how to read, but the students have to
go through a learning process. There’s no incentive for the industry
to innovate as long as it can keep giving new traders old things.
Mendelsohn’s VantagePoint software uses
neural network technology and intermarket analysis to give a new
look to an old indicator. The software, using prices of 10 related
markets, attempts to turn a moving average from a lagging to a
leading indicator to produce predicted moving averages for a target
market. The predicted moving average often turns ahead of simple
moving averages (see “Getting a heads up,” page 51). One issue with
this is that the intermarket relationships tend to change and can
actually reverse (see “Intermarket analysis: What works today,” page
54). Mendelsohn’s program’s are able to adapt to this.
Mendelsohn says traders need to blend
technical and fundamental analysis into a synergistic approach and
the next analytical advance will come when fundamental data is
formatted so it can be combined with technical data in one
analytical package.
Technical analysis’ low stature today may
be a victim of a general bull market, according to Bob Prechter, one
of the foremost advocates of Elliott Wave theory. He sees a sharp
setback ahead for the U.S. stock market. In a bear market everyone
looks to technicians for explanations and the timing of buy signals.
In a bull market Wall Street firms apparently decide the market will
go up forever so they don’t need technical analysts, as shown by the
downsizing or elimination of technical analysis departments in
recent years.
“The firings of technical analysts in 2005
. . . is a great big sell signal for money-center banks and a buy
signal for the field of technical analysis,” Prechter writes in
Elliott Wave Theorist. “(Technical analysis’) new uptrend has a
long way to go.”
Darrell Jobman, senior market analyst for
www.TradingEducation.com, is a former editor of Futures Magazine and
has been writing
about financial markets for more than 35 years. |
