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6
TECHNICAL ANALYSIS
AND THE RANDOM-WALK
THEORY
Things are seldom what they seem.
Skim milk masquerades as cream.
—Gilbert and Sullivan,
H.M.S. Pinafore
N
OT EARNINGS, NOR
dividends, nor risk, nor
gloom of high interest rates stay the technicians from their
assigned task: studying the price movements of stocks. Such
single-minded devotion to numbers has yielded the most
colorful theories and folk language of Wall Street: “Hold the
winners, sell the losers,” “Switch into the strong stocks,”
“Sell this issue, it’s acting poorly,” “Don’t fight the tape.”
All are popular prescriptions of technical analysts. They
build their strategies upon dreams of castles in the air and
expect their tools to tell them which castle is being built and
how to get in on the ground floor. The question is: Do they
work?
HOLES IN THEIR SHOES AND
AMBIGUITY IN THEIR
FORECASTS
University professors are sometimes asked by their students,
“If you’re so smart, why aren’t you rich?” The question
usually rankles professors, who think of themselves as
passing up worldly riches to engage in such an obviously
socially useful occupation as teaching. The same question is
more appropriately addressed to technicians. Since the whole
point of technical analysis is to make money, one would
expect that those who preach it should practice it
successfully.
On close examination, technicians are often seen with holes
in their shoes and frayed shirt collars. I personally have never
known a successful technician, but I have seen the wrecks of
several unsuccessful ones. Curiously, however, the broke
technician is never apologetic. If you commit the social error
of asking him why he is broke, he will tell you quite
ingenuously that he made the all-too-human error of not
believing his own charts. To my great embarrassment, I once
choked conspicuously at the dinner table of a chartist friend
of mine when he made such a comment. I have since made it a
rule never to eat with a chartist. It’s bad for digestion.
Although technicians might not get rich following their
own advice, their store of words is precious indeed. Consider
this advice offered by one technical service:
The market’s rise after a period of reaccumulation is
a bullish sign. Nevertheless, fulcrum characteristics are
not yet clearly present and a resistance area exists 40
points higher in the Dow, so it is clearly premature to
say the next leg of the bull market is up. If, in the coming
weeks, a test of the lows holds and the market breaks
out of its flag, a further rise would be indicated. Should
the lows be violated, a continuation of the intermediate
term downtrend is called for. In view of the current
situation, it is a distinct possibility that traders will sit
in the wings awaiting a clearer delineation of the trend
and the market will move in a narrow trading range.
If you ask me what this means, I cannot tell you, but I think
the technician probably had the following in mind: “If the
market does not go up or go down, it will remain unchanged.”
Even the weather forecaster can do better than that.
Obviously, I’m biased. This is not only a personal bias but
a professional one as well. Technical analysis is anathema to
much of the academic world. We love to pick on it. We have
two main reasons: (1) after paying transactions costs and
taxes, the method does not do better than a buy-and-hold
strategy; and (2) it’s easy to pick on. And while it may seem
a bit unfair, just remember that it’s your money we’re trying
to save.
Although the computer perhaps enhanced the standing of
the technician for a time, and while charting services are
widely available on the Internet, technology has ultimately
proved to be the technician’s undoing. Just as fast as he (or
she) creates charts to show where the market is going, the
academic gets busy constructing charts showing where the
technician has been. Because it’s so easy to test all the
technical trading rules on the computer, it has become a
favorite pastime for academics to see whether they really
work.
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