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Technical Analysis - Is It Really Useful?

March 09, 2010 | About:
Technical analysis, a study of supply and demand with charts as the primary tool, might seem to offer the answer to the question that most of investors want to know – where is the price of the particular investment going to be in the future, preferably in the very near future. If only we could predict these price movements, we could act upon them and get rich beyond our wildest dreams. So instead of looking at particular investments and determining if they make economic sense, technicians choose to focus solely on supply and demand. In other words, they study what everyone else is doing by using tools such as moving averages, leading and lagging indicators, volume, support and resistance. As long as they see buyers coming into the market, they will buy because they hope that the new demand will push prices higher. When they see strong selling pressure, they will sell simply because everyone else is selling.

To me, this kind of stuff never made any sense, and maybe this is because I like to think that I have my own brain and can think for myself. Wouldn’t it be logical to study a particular investment, whether it is a publicly traded company or a piece of income-producing property, and determine whether it is a good business selling at a reasonable price despite what everyone else is doing? To me it would, but that’s not how the majority of investors think. They are so focused on price and how the behavior of other investors affects that price that they simply ignore what is underneath the ticker symbols. In early 2009, I studied Tech Resources (TCK) when it was trading for around $3 per share. There were investors who scrutinized all the technical indicators trying to predict the company’s future price. I ignored it all. The only thing that mattered to me was that the price of this stock was way below what I thought it was worth, and I bought it for $3.33 per share. I did not care if the next day it dropped to $2 per share simply because other investors wanted to sell, putting downward pressure on the price of the stock. Investors who were waiting for the moving averages or other indicators to align properly missed out big time because the stock is trading for $40 per share today. Did it really matter if you paid $3.33, $5.00 or even $10.00 per share for this stock? I don’t think so.

Technical analysis tells you only one thing – what other investors chose to do in the past. It doesn’t tell you anything about what they will do in the future, but even if it did, then buying or selling investments simply because others are doing it without thinking for yourself is just a dumb investment strategy. Would you tell your children to do drugs just because their friends are doing them and that drugs must be good for people simply because everyone is taking them? I wouldn’t think so. Then why would you use technical analysis to tell you what others did in the past with the hope of finding out what they will do in the near future? Determining whether something is a good investment is not the job of your computer, nor of the host of your favorite investment show, nor of your follow investors. It is your job.

About the author:

Mariusz Skonieczny
Mariusz Skonieczny is the founder and president of Classic Value Investors, an investment management firm. He is also the editor of Ultimate Value Finder, a monthly newsletter that features three underfollowed, unknown, and undervalued companies ignored by Wall Street.

Visit Mariusz Skonieczny's Website


Rating: 3.0/5 (8 votes)

Comments

kfh227
Kfh227 premium member - 4 years ago


The technical analysis hall of fame consists of an empty room.
adamcz
Adamcz - 4 years ago
"The technical analysis hall of fame consists of an empty room."

That's my impression as well. It appears that millions of investors participate in this type of analysis (often as their primary method), and yet none of the millions compound at high rates for years and rise to the top of the Forbes lists. Where is their Warren Buffett?
Amit Chokshi
Amit Chokshi - 4 years ago
TA can help in conjunction with fundamental analysis. TA in isolation is not useful but a lot of quant hedge funds use TA in conjunction with a quant approach to fundamental analysis. No TA guy will touch WEB, WEB's wealth has been due to him being an outlier and also reducing tax leakage, that's the biggest driver of his wealth. TA prob yields more short-term trading so you are being taxed at ordinary income in most cases vs half that tax rate or with WEB and his long-term time horizon, none.
eboro
Eboro - 4 years ago
Let me make this clear from the start: I am not strictly a technician, nor am I strictly a fundamentalist. I have, however, studied and used both in depth.

Your view on technical analysis is not an uncommon one, especially in the realm of value investment. And I've always found it quite odd that individuals with little experience or knowledge of a certain discipline believe that they can provide poignant, or even interesting, commentary with regards to said discipline. The truth is that most value investors have never studied technical analysis in depth: their comments are simply repetitious rhetoric, which they've usually acquired from other value investors. As such, their analysis of the discipline is often ill informed, and lacks any meaningful substance. Fortunately, the general stigma associated with TA by value investors is what assures it will continue to work. If everyone believed in it, then many attractive setups would become much more efficient, thus reducing the potential for profit.

Statements such as, "technical analysis only tells you one thing - what other investors chose to do in the past; it doesn't tell you anything about what they will do in the future", are simply inaccurate. From an empirical standpoint, the statement shows a poor understanding of market structure. In aggregate, investor buys and sells of a given stock in the past will affect their buys and sells in the future: this is basic common sense. The only true constant in financial markets is the participants. Humans tend to act, react, and overreact similarly in certain situations that are repeated often within markets. For instance, lets consider a stock which has fallen from $20 to $0,50 over a period of about a year, and has started to oscillate between $0,50 and $2 (meaning there is demand entering around $0,50 and supply entering around $2. This is a period in which bulls and bears are fighting for control, and often a period during which accumulation occurs. By examining the charts, we notice that the price dropped dramatically, on high volume, during the 4 months prior to the oscillation, with very little demand, falling quickly from $7 to $0,50 (this will be shown as large red candles, on multiple timeframes). This lack of demand signifies that there were very few aggressive buyers during this period, and many more aggressive sellers. Often, after large declines, the aggressive buyers prior to the decline are the ones that sell when price reaches their former buy price. The explanations for this are psychological in nature - have you ever bought a stock convinced it was going up (for whatever reason), watched it decline in price, and yearned to sell out for what you paid for it? Even if you haven't, many investors have - these are common human reactions, and result in areas where shift in supply and demand can be clearly measured. For the example stock, the result is that, in the region between $2 and $7, there will likely be fewer aggressive sellers, as there were few aggressive buyers in this region in the past who will now unload. Sure, there are shareholders that are still holding the stock from prices much higher than the $7 range, but from a psychological standpoint, those players aren't going to want to take a large loss, and as the price starts moving up, are more likely to wait it out (why would they sell at a substantial loss if price is no longer dropping?). Either way, we get to a "zone", where there is likely going to my much less supply, and therefore even moderate demand will push price higher. Once it is confirmed that demand has outstripped supply in the $0,50 to $2 range, and breaking out above there, there is a high probability, but not certainty, that the stock will be able to move without much resistance through the $2 to $7 area. This is not to say that it will move in a straight line...but, overall, the sum of the increases will be higher than the sum of the decreases, yielding a nice uptrend. Here are some charts in which this can be observed (these are from actual trades of mine):

http://content.screencast.com/users/eboro/folders/Default/media/e69d62c1-2399-46fa-8a8d-13c1ffb4adf4/BLC%20Buy.JPG

http://content.screencast.com/users/eboro/folders/Default/media/e57bd766-18c7-4038-9bc2-41fded6a0afc/BLC%20Sell.JPG

From a more theoretical standpoint, although this has been shown both theoretically and empirically, "the past in the teacher of the future". Understanding history, whether it be history of price or other, has serious implications with regards to the future. The basis of this type of analysis has longstanding roots in the social sciences, specifically, economics. We attempt to understand the present, for the future will inevitably retain compelling aspects of what now exists. The present, however, is profoundly a product of the past. So, as far as economists are concerned, what we will see in the future is partially a product of the past. Only as these are perceived - only as we view the past as regards to prices, and production, employment and unemployment, the distribution of income and wealth, saving, banking and investment, the nature and promise of capitalism and socialism - can the present, and therewith, in some slight measure, the prospect, be understood in any appreciable way. This type of deductive reasoning has been applied to economics for centuries, and yet, when applied to financial markets, it is, for some reason, considered to be esoteric. The evidence, I'm afraid, indicates that technical analysis, and the use of charts, has serious predictive value. In your commentary, however, you pose the question: "Is TA useful?", and then mention none of the studies with regards to its use. Empirical studies by individuals such as Charles Kirkpatrick or Thomas Bulkowski have shown, over extremely large sample sizes, that technical analysis has predictive value, and can be used extremely profitably, in various market contexts. I know of almost no value investors, however, that have read any of their findings. Most value investors, in fact, become victims of the type of heuristic biases they often try to avoid: anchoring bias, cognitive dissonance bias, availability bias etc...

The definition and description of technical analysis is often misunderstood, too. Make no mistake: the primary role of the technician and trader is that of a risk manager. Successful traders and technicians are "skeptics" by nature, always looking over their shoulders, assessing risk objectively, and then focusing on potential reward. Good technicians don't think: "If only we could predict these price movements, we could act upon them and become rich beyond our wildest dreams". Instead, they think: "Given the current state of supply and demand, what is the potential downside in this stock, and how does that relate to potential reward". The investment game, as described by Michael Mauboussin, is a game of probabilities. Technical Analysis, in truth, allows individuals to approach the markets probabilistically, and objectively. Much like value investing, technical analysis is not about "buying at the bottom and selling at the top". For the technician, the idea is to buy when the probability is greatest that the stock is going to advance, relative to risk. Understanding areas of substantial shifts in the supply and demand in an asset allows one to do just that. The "Margin of Safety" that value investors so often discuss is also present in technical analysis and trading, but it is quantified in a much more visual way. So, for instance, with BLC, my margin of safety was my stop price, which I had set at $2,15 (the top of the candles prior to the breakout). So, given my buy price, I was risking around $0,40, for a potential realistic reward, in my view, of $3 or more - a reward to risk ratio of about 7 to 1. I won't get into how I calculate the expected value of each trade, as this involves an understanding of patterns etc...just remember, the value of technical analysis is not to predict every move, but to make sense of price movement via market sentiment, and to act when it indicates that a certain scenario offers good expected value and controlled risk.

Fundamental analysis deals with the information, but it does not tell us the potential extent to which this information has been discounted, and it does not tell us how others are currently interpreting the information. Technical analysis, on the other hand, allows us to view investors interpretation of, and response to, the information. We could say, as John Murphy once did, that "Fundamental analysis deals with the 'cause' and technical analysis deal with the 'effect'. In my opinion, understanding both cause and effect is extremely important. For instance, with TCK, would it not have been more interesting, whilst retaining your thesis on its intrinsic value, to determine when, in all likelihood, others were beginning to agree with your assertion, thus pushing up price? No matter what the analysis of the intrinsic value of a company yields, the investment will only yield a profit when others agree with your assertion, and act upon this agreement, thus pushing up price. If others never agree with your thesis, the stock will stagnate, or even decline, possibly for long periods, even if it is selling far below intrinsic value. Sure, the price which offers the greatest margin of safety, in value investing terms, will likely occur at a moment when the majority disagree with your estimation of intrinsic value; but understanding when the tide is turning could be extremely beneficial. Why not attempt to buy when others are just beginning to agree, when the "trend" is just beginning to turn from down to up, a demand begins to outdo supply. In a field in which opportunity cost is such an important facet of success, I would think that reducing draw-down periods, and periods of stagnation, would be extremely valuable.

Finally, your statement "I have my own brain and can think for myself" seems to be quite ironic. Most value investors, in actuality, do not think for themselves. Most value managers end up buying the same stocks, although they won't admit that they were influenced by each other. This is readily observable with many managers such as David Einhorn, William Ackman, Daniel Loeb etc... and this is quite apparent with your investment TCK. I could be wrong here, but based on the price at which you bought, it seems as though you were strongly influenced by the purchase of Mohnish Pabrai, who also bought the stock during the same period. Although you may believe that your analysis was objective, it has been shown, time and time again, that "framing" and other heuristic biases play an extremely large role in making investment decisions. Your analysis was likely largely influenced by Pabrai's, and although, in hindsight, it seems like you did it "thought for yourself", in truth you simply followed someone else, albeit by doing your own due diligence. The only difference, in this case, between you and a speculator using TA, is that you followed someone that, at the time, was a contrarian...

All of this was simply to say that, whilst investors may believe technical analysis to be useless, they should not write articles entitled "Technical Analysis - Is it really useful" unless they study technical analysis in depth and try it. Remember, what works for some, may not work for others, but that doesn't make it useless in aggregate. I hope this explanation has been informative.

P.S. "The technical analysis hall of fame consists of an empty room. Where is their Warren Buffet? etc..." are also quite ignorant statements. When actually examining the forbes list, you'll notice names such as Paul Tudor Jones, Steve Cohen, Bruce Kovner, George Soros, James Simmons or John Arnold, all of which are/were traders that use technical analysis extensively, in addition to macro analysis. Most of these investors have outperformed many of the well known value guys in terms of annualized returns. In fact, over recent years (the past decade), there are very few, if any, that have outperformed John Arnold.

Thanks for reading. If anyone has any questions, don't hesitate :)

eboro

adamcz
Adamcz - 4 years ago
"_When actually examining the forbes list, you'll notice names such as Paul Tudor Jones, Steve Cohen, Bruce Kovner, George Soros, James Simmons or John Arnold, all of which are/were traders that use technical analysis extensively, in addition to macro analysis."

I thank you for sharing names, but do you also have info on their results? It's very difficult to obtain the long-term results of hedge fund managers (be it value or technical oriented), and their net worth is often a function of the 2/20 fees they charge their clients as much as it is the result of extraordinary results.
DaveinHackensack
DaveinHackensack - 4 years ago
romario,"Technical analysis tells you only one thing – what other investors chose to do in the past. It doesn’t tell you anything about what they will do in the future"

You could make a similar criticism of value investing, in that both involve extrapolations from past data.

Dizzy,

Good points. Some predominantly fundamental investors use TA to help pick entry points, for example.

Eboro,

[/i][i]"The explanations for this are psychological in nature - have you ever bought a stock convinced it was going up (for whatever reason), watched it decline in price, and yearned to sell out for what you paid for it? Even if you haven't, many investors have - these are common human reactions..."

This is essentially the point Vitaliy Kastenelson made about TA in his book, and it makes intuitive sense. It's why some investors (e.g., William O'Neil) like to buy stocks making new highs, because there won't be the resistance caused by shareholders like that trying to get out.

Adamcz,

"It's very difficult to obtain the long-term results of hedge fund managers (be it value or technical oriented), and their net worth is often a function of the 2/20 fees they charge their clients as much as it is the result of extraordinary results."

It's probably impossible to become a billionaire as a hedge fund manager, as some of those guys are, without producing extraordinary returns, even if most of your wealth is coming from the fees.

eboro
Eboro - 4 years ago
You are right about the difficulty in obtaining the actual results of these managers. The reason that they have such large net worths can be directly tied to their extremely high fees, which in turn can be tied to their incredible results. Most of these managers do not charge the regular 2/20; they charge 3/30 or 3/50. The only reason they can do so is because they have amazing returns. Also, they seem to be able to raise capital quite easily, which in conjunction with their returns, leads to huge increases in wealth. They also reinvest most of these fees back into the fund etc...

Based on various monitoring sites, and fairly recent articles, Steve Cohen has returned north of 30% annually over the past 15 years, after fees (his fees are 3% of assets and 50% of profits). Paul Tudor Jones and George Soros, from what I've read, are in the 20 to 30% range over a 20 year period. James Simmons runs Renaissance, and his medallion fund is rumored to have returned 40% annually from its inception in 1988 until he retired from active management of the fund in 1999. John Arnold, from what I've gathered, has never had a year below 50% returns net to investors (the fund was started about 8 years ago). In 2006, his fund was up over 300% and in 2008, it was up over 80%. I'm not sure about Kovner's results, but his fund was up around 14% in 2008. Ed Sekoyta is rumored to be one of the best traders in history, with 60% annualized returns, in various accounts, over a 30 year span (he managed smaller amounts though). He notoriously turned $5000 into $15 000 000 over a 12 year period. There are many other names likes Michael Morris (a disciple of Sekoyta and teacher of Kovner), David Druz, Jason Dekker, and Jason Russell (I could name many more). I suggest you research these names yourself. Here are some resources.

http://www.ritholtz.com/blog/2010/03/sac-30-gains-annually-for-18-years/

http://money.cnn.com/2009/11/23/news/companies/centaurus_john_arnold.fortune/

http://www.turtletrader.com/trader-simons.html

http://www.turtletrader.com/trader-seykota.html

So when investors say that there are no Warren Buffets from the technical analysis/macro/trading world, they are mistaken. There are plenty, however they are secretive and private individuals who don't release publicly accessible market letters and certainly don't do regular interviews on CNBC. Also, given the stress involved in trading, most don't have 50 year careers, and retire quite early.

Thanks,

eboro
batbeer2
Batbeer2 premium member - 4 years ago
Hmmmm....

I do not understand TA and I do understand value investing. There may be some merit to TA for all I know. Out of curiosity couple of questions....

I have never seen a paper or explanation wherein a certain TA technique was limited to this or that instrument or this and that market.... the techniques seem universal. Many instruments trade on multiple markets though (other exchanges dark pools etc etc.) If TA deals with supply and demand...

1) how does the analyst deal with markets that are partly invisible ?

2) Are TA techniques usefull in all markets and for all instruments ?
DaveinHackensack
DaveinHackensack - 4 years ago
Batbeer,

I'm not knowledgeable enough to answer definitively, but I do know that some of the techniques and terminology used by technical analysts go back to a Japanese rice trader hundreds of years ago, so that may give you some idea of the broadness of the applicability of TA.
eboro
Eboro - 4 years ago
Traders generally share the view that trading in the direction of the trend is the most effective means to be profitable in financial or commodities markets. John W. Henry,Larry Hite,Ed Seykota,Richard Dennis,William Eckhardt,Victor Sperandeo,Michael Marcus and Paul Tudor Jones(some of the so-called market wizards in the popular book of the same name by Jack D. Schwager) have each amassed massive fortunes via the use of technical analysis and its concepts. George Lane, a technical analyst, coined one of the most popular phrases on Wall Street, "The trend is your friend!"

Most of the in depth research regarding technical analysis isn't in the form of articles or essays, but in books. Thomas Bulkowski has a few that have extremely insightful findings. To my knowledge, there is a Federal Reserve working paper regarding support and resistance levels in short-term foreign exchange rates; the study "offers strong evidence that the levels help to predict intraday trend interruptions, although the predictive power of those levels was found to vary across the exchange rates and firms examined." (http://www.ny.frb.org/research/epr/00v06n2/0007osle.html)

TA can be used in any market which deals with relatively liquid assets (I wouldn't recommend, for instance, using TA when analyzing mortgages). But in terms of currency markets, commodity markets, equity markets and certain areas of fixed income, TA can be extremely useful. In fact, many of the aforementioned traders use them primarily in the currency and commodity markets.

I'm not quite sure what you mean by "partly invisible markets".
eboro
Eboro - 4 years ago
Traders generally share the view that trading in the direction of the trend is the most effective means to be profitable in financial or commodities markets. John W. Henry,Larry Hite,Ed Seykota,Richard Dennis,William Eckhardt,Victor Sperandeo,Michael Marcus and Paul Tudor Jones(some of the so-called market wizards in the popular book of the same name by Jack D. Schwager) have each amassed massive fortunes via the use of technical analysis and its concepts. George Lane, a technical analyst, coined one of the most popular phrases on Wall Street, "The trend is your friend!"

Most of the in depth research regarding technical analysis isn't in the form of articles or essays, but in books. Thomas Bulkowski has a few that have extremely insightful findings. To my knowledge, there is a Federal Reserve working paper regarding support and resistance levels in short-term foreign exchange rates; the study "offers strong evidence that the levels help to predict intraday trend interruptions, although the predictive power of those levels was found to vary across the exchange rates and firms examined." (http://www.ny.frb.org/research/epr/00v06n2/0007osle.html)

TA can be used in any market which deals with relatively liquid assets (I wouldn't recommend, for instance, using TA when analyzing mortgages). But in terms of currency markets, commodity markets, equity markets and certain areas of fixed income, TA can be extremely useful. In fact, many of the aforementioned traders use them primarily in the currency and commodity markets.

I'm not quite sure what you mean by "partly invisible markets".
Sivaram
Sivaram - 4 years ago


Eboro,

I agree with you that, if technical analysis were to work at all, it would be in capturing the psychological elements of investing (there is also another possibility which I'll mention below.) But the verdict is still out.

Yes, there are some technical analysts who have been quite successful but it's not clear if it's due to luck, some sort of insider knowledge--such as the whole controversy of invesment banks' front-running--or something like that. The fact that most of these guys are secretive, as you suggest, doesn't help their case.

One other thing to keep in mind is that many hedge funds use leverage. I don't know about the successful ones you listed but one of the reasons I still consider Warren Buffett to be the best investor, perhaps in the last 100+ years, even though many hedge funds have posted results even better than Buffett during his prime (when he ran a hedge fund), is because he doesn't use leverage (unless you count insurance float as leverage--even then it's not heavy leverage like many hedge funds are rumoured to use.)

Another reason technical analysis may work, if it does at all, is because it may involve arbitrage-like investing. Traders themselves, using technical analysis, may not realize it but they may be profitting off arbitrage-like scenarios. Since many technical analysts appear to be very short-term-oriented, they may simply be profitting off arbtrage-like outcomes. Similar to how an importer of foreign goods is sort of profitting off arbitrage--differing goods prices in other countries--some of the technical analysis may be similar.

Anyway, I think technical analysis will be considered alchemy until the successful ones can describe their techniques and make it into the so-called Investment Hall of Fame. As long as they stay in the shadow world using little-understood methods, their art will be considered more alchemy than chemistry.
eboro
Eboro - 4 years ago
It is clear, simply by the vast number of traders that have been extremely successful using technical analysis, over periods of up to 30 years, that it is not just "up to luck" or insider trading. Luck is, of course, very much present in financial markets, especially over the short term - there is no denying it. But long term consistent profitability is more often due to skill than anything else. It's extremely unlikely that a trader could just be "lucky" for 20 years.

One reason why you won't see many of these guys come forward relates to the fact that technical analysis is, by its very nature, more of an art than a science. It is definitely subjective, and therefore very hard to measure objectively. Furthermore, the success of many of these investors is largely due to their temperament: they have impeccable emotional control, money management skills etc...As these skills are mostly innate (even if they are learnable, it would take immense amounts of self awareness, determination, and time), these traders have nothing to come forward with. This explains in part why there are only a handful of studies regarding the predictive value of technical analysis (the ones that do exists clearly show its value). Many of these traders have found a methodology that works very well for them, and may not work for others. But even if it did work for others, they probably wouldn't want to teach it, because of the competition that multiple successful traders would bring.

Throughout your comments, you seem to act as if there is no way of knowing it TA works. Aside from the evidence viz. the multiple successful traders who have used TA for years, I know that TA works because, unlike most value investors, I've used it extensively. I myself started as a value investors (deep value), and gradually started incorporating technical analysis into my investing in order to limit downside. Eventually, I developed two portfolios: one for my longer term value investments, and one for shorter term swing trades (I never day trade). Whilst I have had success in both, my technically based trading has vastly outperformed my value investing. This could be considered more a statement of my inability as a value investor than my ability with regards to technical analysis and trading, but my value investing account has outperformed the S&P quite handily since I started it years ago.

In my opinion, the reason for the trading account outperformance has to do with loss control. I have a strict stop loss of 10%, based on short term support below my buy price, for each one of my trades. I often know when the market proves my thesis wrong, and get out quickly. Given my position sizing, I can lose no more than 1 or 2% of total capital on any given trade. And yet, with proper consideration of expected value and reward to risk, I have had multiple trades which have gained triple digits. The implication here is that, even with an average accuracy in terms of my predictions, the nature of risk management with TA and trading allows for outperformance. Above average accuracy can lead to outstanding profits. Whilst stop losses can also be set with value investments, it is quite counterintuitive. Price action is of little importance to the value investor, and therefore, as long as intrinsic value does not decline, investors aren't unhappy with 20 to 30% declines or more. These can often lead to portfolio draw down periods, or periods of stagnation, and extends the time needed for the investments to become successful. As is the case with many value players, investments which stagnate for long periods are sometimes cut with losses that are quite large. Not only has time been taken up by these investments, but so has capital. With TA and trading, the idea is to cut losers quickly, and let winners run. I think that, over the long run, if you take care of your losers, the winners take care of themselves. It is losing less that eventually leads to winning more.

I once read an excellent interview by George Soros, a man who uses technical analysis, and is most definitely one of the best investors to ever have lived. It has definitely influenced the way I approach markets. He said, "Try to be an investor in the late stages of bear markets, and the early stages of bull markets, and a speculator during the late stages of bull markets, and the early stages of bear markets". I find this to be an excellent goal for market participants, although by no means an easy one to achieve. Nevertheless, as the market has been in what many consider to be a secular bear during the past decade, traders and technical analysis have performed quite well, relative to value investors.

Technical analysis is, in my opinion, a much better method for analyzing and measuring risk, and a much better way of preserving capital. "A speculator is someone who takes risks of which he is aware, and an investor is someone who takes risks of which he is not aware” JM Keynes

During periods of extreme volatility, it offers advantages that value investing does not.

P.S. I don't really understand the comment about leverage. Leverage is simply a tool which, if used properly, can enhance profits. Would you criticize the manager of a certain company because his capital base was made up more of debt than equity? Is a company operating with almost no debt, such as Apple, a better company than one that operates with a decent amount, say Microsoft? As long as the manager or trader is able to use leverage to his advantage, I do not see why makes a difference. Making money is making money, whether you do it with or without leverage. Buffet may use no leverage, and Soros may use a lot, but regardless absolute return is absolute return, regardless of how it was achieved.

eboro
DaveinHackensack
DaveinHackensack - 4 years ago
Another old saying, I forget by whom: "An investment is a trade gone bad".

Also worth checking out Vector Vest, which has a free trial. Their system incorporates technical as well as fundamental analysis. I used it to set stops on some positions recently.
fk
Fk - 4 years ago
Eboro,

Thanks for sharing those interesting ideas on TA. What's the difference between your value portfolio and your pure TA portfolio? I presume you would still be applying many of your TA ideas to your value portfolio.

I can believe that TA or some other methodology could detect some trading patterns based on animal spirits and human psychology, but what about times of extreme dislocation such as the credit crisis of 2008 and the lows of march 2009? Was TA useful then?
batbeer2
Batbeer2 premium member - 4 years ago
I'm not quite sure what you mean by "partly invisible markets".

Well first let me say a savvy technical analyst could have made some mony when VW got squeezed. Value investors would have been at a loss with the whole situation.

Now take Posco.... how do you do a technical analysis of the ADR ? A lot of the volume is presumably in the home market so how do you get an idea of supply and demand ?

If you deal with the graphs do you use the home currency or dollars ?

If you are looking at the mental impact of nominal ammounts what basis would you use. If memory serves, a Posco ADR represents half a share. I think there are a lot of poeple out there doing technical analysis on the Posco ADRs.

That is one example of analysis where part of the market is "invisible".

I know for a fact that there are poeple doing technical analysis of GE as listed in france..... because their broker offers the tools; I don't get it.
eboro
Eboro - 4 years ago
Hello fk,

In terms of the difference between my value portfolio and my TA portfolio, are you speaking of portfolio construction and company types? My value portfolio is made up mostly of Graham "net-net" opportunities. I find that those types of setups offer huge margins of safety and usually perform extremely well when bought during deflationary environments, such as 2008. Although buying "great companies", a la Buffet, is a great method, I find that those stocks are sold less than "net net" companies during bear markets, and so, in relative terms, will offer less appreciation potential and lower margins of safety. Cigar butt investing doesn't make most people feel good, and during bear markets, investors become nervious and emotional and will sell anything that makes they uncomfortable. In general, but especially during bear markets, investors shy away from poor/average companies, with average earnings etc... that are selling at large discounts to intrinsic value In fact, they tend to overreact causing such a large discount that such stocks become great opportunities. This is why many net net stocks were completely oversold in 2008 (two examples would be TCK and TX, both of which moved up over 1000% from their bottom price).

My TA portfolio is made up of "swing" trades, which means that I hold positions from weeks to months (most traders are day traders, and hold positions for hours or days).The only requirement for my TA portfolio is that the companies have current ratios above 2 and a debt/equity below 0,3. This is simply to protect against the companies that I trade suddenly going bankrupt. Aside from that, I look to analyze price action, and I do so via trend lines, support and resistance levels, bar chart formations and candle stick formations. I then relate this to volume and indicators, on multiple timeframes, in order to uncover market sentiment about a given stock. Being successful at trading involves being patient enough to wait for a clearly defined situation, which occurs when we have an alignment of multiple factors. This is to say that, when a bullish bar chart pattern forms, on a long term chart, in conjunction with a bullish candle stick formation, increasing volume and moving average crossovers etc...there is a clear indication that demand is soon going to outweigh supply (which means a high probability that the stock will increase in price). Here are some examples of proper alignment from some of my trades:

http://content.screencast.com/users/eboro/folders/Default/media/e69d62c1-2399-46fa-8a8d-13c1ffb4adf4/BLC%20Buy.JPG

http://content.screencast.com/users/eboro/folders/Default/media/0cf2fd35-16ed-4684-b341-cfa416acd3c5/NLST%20Buy.JPG

http://content.screencast.com/users/eboro/folders/Default/media/9dc7fbf7-1ed4-4963-9ea5-106014326b8e/PFAP%20Buy.JPG

http://content.screencast.com/users/eboro/folders/Default/media/20b890a9-022e-47f5-a2aa-e9a1f6816eaf/TA%20Buy.JPG

and here are the results:

http://content.screencast.com/users/eboro/folders/Default/media/e57bd766-18c7-4038-9bc2-41fded6a0afc/BLC%20Sell.JPG

http://content.screencast.com/users/eboro/folders/Default/media/a0564e80-0f69-48cf-b626-d5609be18083/NLST%20Sell.JPG

http://content.screencast.com/users/eboro/folders/Default/media/66f0d70e-b952-4593-b97f-f46a77141820/PFAP%20Sell.JPG

http://content.screencast.com/users/eboro/folders/Default/media/52dda9bf-487a-46c1-9022-22bd4cf3a961/TA%20Sell.jpg

As I said in a previous post, the goal is not to buy at the bottom and sell at the top: this is, mostly, not possible. The idea is to buy when the probability is greatest that the stock will move up, relative to risk.

As for 2008, TA was very useful, and the main reason that I didn't lose money. My value portfolio was mostly in cash at that point. My TA portfolio was made of up shorts, with a few longs. As well as being able to chart individual stocks, TA is also very useful with regards to the general indexes, no matter what type of condition the market is in. Certain breadth and momentum indicators were clearly indicating that stocks were poised for large declines in 2008. By understanding how to spot long term uptrends and downtrends, many traders were able to see that the markets broke their uptrend, and moved into a downtrend at the start of 2008. Here are some examples of those indicators on a chart from early 2008:

http://stockcharts.com/h-sc/ui?s=$INDU&p=W&st=2005-01-01&en=2008-02-01&id=p71927267952&a=193792832

As you might notice, when stocks are trending upwards, moving average crossovers are bearish (red and blue lines). They aren't quite as bearish when markets are moving sideways (like in 2004 and 2005). Given the fact that the market was clearly in an uptrend from 2005 to 2007, without any moving average crossovers, the crossover was a very bearish signal in early 2008. Although it didn't necessarily indicate that a huge drop was coming, it did indicate the need for caution. If you combine this with formations such as the double top, the head and shoulders, lower highs and lower lows, volume climax etc...TA gave a clear indication that supply was outweighing demand quite a bit. If some of these terms aren't clear, you can research them online and you'll find plenty of information.

There are multiple other indicators, but I like to keep things simple. For value investors wanting to use TA, I would recommend using very long term charts, and very long term indicators. Using short term charts with short term indicators will only serve to cause confusion.

I hope this answers your questions. If anything is unclear, don't hesitate to ask

eboro
eboro
Eboro - 4 years ago
Hello Bat,

Although I prefer charting domestic companies, one can also chart ADRs. They will usually reflect price action and volume from their respect markets. Here is the chart for your stock:

http://stockcharts.com/h-sc/ui?s=PKX&p=W&yr=3&mn=0&dy=0&id=p68082193648&a=193796575

Remember, the value of TA is not to predict every move, but to make sense of price movement. Based on price movement in this chart, I would expect it to have some difficulty in the region around $150, as this was a former large resistance area. Using price analysis, once could have definitely traded this successfully over the past few months though. I encourage you to briefly research some of the patterns I mention on the chart, and make your own conclusions.

eboro
GigaBubble
GigaBubble - 4 years ago
Rather than volume, it is much more important to compare the ratio of transaction volume at the Bid versus Ask price.
eboro
Eboro - 4 years ago
Gig,

That's true for short term traders, but much less so for swing traders. For day traders, it's not just about price and volume, but "who" is doing the volume and at what price. For swing traders, the general trend of volume is most important.

eboro

adamcz
Adamcz - 4 years ago
"Steve Cohen has returned north of 30% annually over the past 15 years, after fees (his fees are 3% of assets and 50% of profits)."

How can this be true? If he has returned 30% to his clients after taking 50% of the profits, that means his investment gain was actually 60%? And people said Madoff's returns were "too good to be true"?

I'm tempted to grab the calculator and work backwards from his current net worth to see what his fund must have started with 15 years ago at 60% gains per year. Must have been less than a million, right?

batbeer2
Batbeer2 premium member - 4 years ago
I encourage you to briefly research some of the patterns I mention on the chart,

I will, right after I'm done with a booklet I came accross.... Security Analysis :-)
eboro
Eboro - 4 years ago
Adam,

Steven Cohen is considered by many to be the best large scale trader alive today, and it is indeed said that his fund has returned more than 30% annualy net to investors over the past 15 years. However, it is unlikely that he has 100% of his net worth invested in the fund, and so would not have gained 60% a year personally. Second, you didn't take taxes into consideration. He has a net worth of $6,5 billion, after all the years of extremely high taxes. Finally, his current fund includes 150 traders, all of which require good salaries and massive bonuses. Cohen is responsible for a large percentage of the firms profits, and has been for years, but there are still tons of expenses.

Also, don't forget that many traders like Cohen use leverage (Cohen is said to use 4 to 1 leverage, on average), and so given their huge amounts of skill, it is unsurprising that their funds have returned 60% + per year gross. Take a look at John Arnold...8 years of 50% plus net returns per year to investors....NET.

eboro
fk
Fk - 4 years ago
Eboro,

Thanks for the response to my question above. I wonder if TA could help in determining favorable times to accumulate or trim positions in something like BRKA or BRKB(before recent split)? Around this time a year ago, I was feeling disgruntled by my BRKB holdings (which constitutes a large portion of my retirement account), which had just experienced a lost decade. In other words, I've held that position for over a decade, the price of BRKB in 2009 was close to if not lower than my cost basis, and no dividends to show for it. In fact today I trimmed my BRKB position.
adamcz
Adamcz - 4 years ago
eboro, your numbers don't pass the smell test. No investor has ever created long-term results like the ones you are describing. 60% gross for 30 years (assuming your capital base is more than a couple hundred dollars) is an absurd figure, and I have to assume that you are a very gullible individual to believe something like that. Consider that if he is capable of achieving those same alleged results in the future, he should within just two or three decades have more money than all other humans combined.

Those numbers are several orders of magnitude better than Bernie Madoff's.
eboro
Eboro - 4 years ago
First, I didn't say 60% gross for 30 years; I said 30% net, or over 60% gross, for 15 years. And it's actually probably more than that in terms of percentage gains. I can understand that value investors find this hard to believe, but it's the truth, and I provided links for reading in a previous post. HEre are more links, and even a thread on gurufocus that discusses it. Some articles claim that he has done ever better than the round 30% net number that I gave:

http://www.marketfolly.com/2009/01/sac-capital-steven-cohen-hedge-fund.html

http://www.gurufocus.com/forum/read.php?3,33946

http://www.bloomberg.com/news/marketsmag/mm_0410_story1.html

Your are mistaken when you state that no investor has ever created long-term results like the ones I'm describing. Perhaps you should read more about the quant/hedge fund industry. Funds like Quantum, run by George Soros, returned 4200% net over their first ten years, which is an annual rate of over 45%. Given their fees, that exceeds the 60% gross (or 30% net) that Steve Cohen has achieved.

http://www.fool.co.uk/news/investing/investing-strategy/2009/04/09/investment-greats-george-soros.aspx

Why is it so hard to believe that someone could return 30% net (60% gross given his fees) over a 15 year period? Read the above article (there are many articles with George Soros' results)...31% net over the past 30 years!!

It wasn't madoff's returns that were questionable, it was the lack of volatility on a quarter per quarter basis. He achieved 15%+ returns annually without ever having a down quarter. Some managers like Cohen and Soros have had huge down months, probably due to their leverage. This same leverage is what has aloud them, in combination with their skill, to have such amazing returns.

Please do some research before criticizing some else's posts in the future.

eboro

eboro
Eboro - 4 years ago
http://en.wikipedia.org/wiki/Renaissance_Technologies

I forgot to mention James Simons. If you read the "History" section, you'll see that the Medallion fund has returned 35% annually net to investors for 21 years. And that's after their fees of 5% of assets and 36% of profits.

eboro
adamcz
Adamcz - 4 years ago
eboro, I guess we'll see. If he is getting 60% gross on his own money, and 50% of his clients profits, he will be #1 on the Forbes list in just a handful of years.
eboro
Eboro - 4 years ago
Adam,

I understand that his results don't pass your "smell test", but this is not a "we'll see" situation. It has already been seen, as many of his own investors, as well as various extremely well respected financial news and reporting firms, such as bloomberg, are confirming his returns. I've provided enough links...

I question your reading abilities. I clearly stated in a previous post that it is unlikely that Cohen has 100%, or even near 100%, of his net worth in his fund. Why would you then go and say that he is getting 60% gross on his own money, and 50% of his clients profits?

Also, it is as if you aren't aware of a basic investment premise: the larger a manager's capital base, the more difficult it is to outperform. Cohen started with $25 million in 1995, and today manages over $12 billion. Surely, he will not be able to perform as well in the future as he did in the past, because putting $12 billion to work poses various restrictions. And we never once discussed his future performance; we were talking about his results to date. So why then would you assume that he can continue performing as he has, and that he will therefore be at the top of the forbes list in a few years? I will point out, however, that his net worth is $6,5 billion. He managed to build this from very little - in relative terms, in only 15 years. I wouldn't be surprised to eventually see him at the top of the list.

Instead of arguing about his, just accept that you were misinformed, and try to learn about how these investors have achieved their returns. There is no "right" or "wrong" when it comes to investing, and there is a whole other part to investing outside of "value" investing. It's continuous learning over time that gives an investor the best chance of improving results. Most value guys are extremely close minded though. Have you ever asked yourself why Buffet, who had all the advantages of working with Graham and learning from him, went and started a partnership that was different stylistically from his mentor's? The reason is that he didn't remain close minded, and evolved, learning new skills and methodologies. In the same way, investors who don't break out of the "Buffet shell" will never be able to have outsized returns...they will do what most other value guys are doing, and will get the same results, average results.

eboro

billspetrino
Billspetrino - 4 years ago
as a person who always shunned technical analysis I can honestly say that it is best used with fundamental analysis

Buying a stock with good fundamentals should be the focus

However investing is 50% art and 50% science as most of you know.
adamcz
Adamcz - 4 years ago
These are the Forbes estimates that I was able to find for Steven Cohen.

2010 - $6.4 billion

http://www.forbes.com/lists/2010/10/billionaires-2010_Steven-Cohen_PZMO.html

2009 - $6.4 billion

http://www.forbes.com/lists/2009/54/rich-list-09_Steven-Cohen_PZMO.html

2008 - $8 billion

http://www.forbes.com/lists/2008/54/400list08_Steven-Cohen_PZMO.html

2007 - $6.8 billion

http://www.forbes.com/lists/2007/54/richlist07_Steven-Cohen_PZMO.html

Where does all the money go? I am indeed skeptical about these unbelievable returns, because nobody in the audited/verifiable world has ever been able to produce them, and his net worth doesn't appear to increase in line with the reported results of his firm. I saw the mention of his results in your links, but what steps did they take to audit these results that are different from the reporting these same media firms did of Madoff's results?
DaveinHackensack
DaveinHackensack - 4 years ago
In the same way, investors who don't break out of the "Buffet shell" will never be able to have outsized returns...they will do what most other value guys are doing, and will get the same results, average results.

Actually, they might get worse results than they think, for a couple of reasons:

1) Following Buffett's current, mega cap picks, instead of investing in the sort of companies that got him higher returns in the past.

2) Over-weighting "guru bargains". I'd love to see empirical data on this, but I'd guess that buying the guru buys that have gone up after the gurus bought them would outperform the bargain strategy, because the bargains include a higher percentage guru duds.

billspetrino
Billspetrino - 4 years ago
Buying and holding value is a great thing especially as you begin to manage a lot of money

In buffett's case how does he liquidate 11billion dollar Coke position even if he wanted to?

However by taking 15% of your money and using options to"trade in and out" of positions can give you outsized returns and with the low margin rates help you juice your returns

No 2 gurus are alike

I never followed WEB into WFC or COP because those industries are not my thing

Web's record on consumer good companies that are congruent with my own formulas and filters have done real well ( BUD being the best)

However its all about how much you are managing

eboro
Eboro - 4 years ago
I'm done arguing about this Adam. I've provided substantial evidence of something that is widely accepted within the financial industry. His results have been verified by numerous investors that have been with his fund since the start - as well as ex employees, and major news reporting firms. Steven Cohen is considered by many to be one of the best investors in the world, and your inability to accept this is not of my concern. His fortune doesn't oscillate in perfect tandem with his fund's results because he doesn't have 100% of his net worth in the fund. Also, the decline in wealth recently is probably due to the fact that the % of his net worth that he does have in the fund declined by 18%, as SAC was down that amount in 2008. Even with this down year, his only down year in 15 years, they have still have achieved the results I posted.

Your statement that "nobody can get those kinds of returns" is false, given both George Soros' and James Simons' results. Unless, of course, each of these men are fraudulent...which is extremely unlikely.

eboro
adamcz
Adamcz - 4 years ago
I've provided substantial evidence of something that is widely accepted within the financial industry.
You've provided references to the existence of evidence; not actual evidence itself. Pretend for a moment that this is a company we're discussing, and not an investor. What would you think if you came across a company who's financial statements claim that cash flows are coming in at an unbelievable pace, except that year after year the balance sheet looks exactly the same? Maybe a technical analyst wouldn't care in the slightest, but a value investor would demand that these two documents be rectified. That's what I'm doing here - posing the same questions that I would pose of I were looking at a security.

His fortune doesn't oscillate in perfect tandem with his fund's results because he doesn't have 100% of his net worth in the fund.


Does he have any of his net worth in the fund? I'll use oversimplified math because the accuracy here isn't so important to make my point. In 2009, he was reportedly worth 6.4B, and ran a 14B fund.

Let's say only 25% of his own net worth (1.6B) is in the fund, and the other 12.4B belongs to other investors. He makes 60% gross as you said. From his own 1.6B, this generates 1B in return, or .65B after taxes. From the clients' 12.4B, he generates 7.4B, keeps 3.7B for himself, and after taxes is left with 2.4B. All in all, his net worth should have gone up around 3.4B this past year... but it didn't go up at all. In fact it didn't go up at all over the past three years. His net worth reported by Forbes, and his investment performance and fees reported by your various sources cannot possibly both be true.

eboro
Eboro - 4 years ago
This is quite comical...I never said that he generated 60% gross returns, every year. ON AVERAGE, SAC has returned over 30% net per year, or PRESUMABLY over 60% gross, over a 15 year period. That could mean that they were up 200% one year, 20% another etc...Why would you assume, as you did via your calculations, that SAC was up 60% last year? Also, why would you assume, completely arbitrarily, that he has 25% of his net worth in the fund?

It is commonly accepted that calculating an individual's net worth is highly subjective, and more of an art than a science. Furthermore, Cohen is not like Buffet, whose stake in Berkshire is publicly available, and whose wealth is therefore quite easy to determine based on his own admission of the % of his net worth that is in Berkshire stock. As much of the information regarding Cohen's ownership of SAC is not publicly accessible, Forbes data are are likely to be approximate. You have assumed that Forbes is 100% accurate in measuring his wealth; there is no way of knowing whether or not this is the case.

Your comparison between Steven Cohen's fund and a public company which has publicly accessible records, is not relevant. SAC is not a public company, it is a close ended fund. You, as an individual, will not be able to get your hands on investor letters or financial statements. But rest assured than one of wall street's largest funds, that is responsible for between 2 and 3% of the daily NYSE volume, is heavily scrutinized, and has been audited on multiple occasions, especially after the Madoff fiasco. In addition, Steven Cohen was a trader long before he started SAC, and had unbelievable results even before he started the fund. This add legitimacy to his returns. Madoff, for instance, had no prior record as a money manager, but instead only a respected reputation via his roles in the SEC etc...

Furthermore, whilst SAC's letters and statements are not available to the public, they have surely been made available to interviewing insitutions such as Bloomberg, and have surely been verified by such institutions. Laws such as Libel and Slander assure that respectable reporting institutions, especially ones such as Bloomberg, must research information in detail before printing. These have been enforced even more in the financial industry, especially after the Madoff scandal. We can assume, therefore, in a rational way, that there publication of his 30%+ annualized returns is well informed. Not to mention the hundreds of publications that have reviewed information and printed it regarding his results. We can also assume that the plethora of investors in his fund have reviewed his results, and that not every fund confirming the results is lying, or misinformed.

Finally, I've noticed that you've failed to address the issues of Soros or Simons, which are just as relevant to your assertion about the impossibility of achieving outstanding results as Cohen. What do you say with regards to funds like Quantum or Medallion? Are their results untrue as well? Can no investor have better long term returns than Buffet?

I'm happy to discuss technical analysis if you have any questions about that. I'm sorry, but I'm not going to detract from the thread any longer. This thread was a discussion regarding technical analysis, and has now gone off track. Some individuals actually want to learn about TA. If you would like to continue this discussion privately, that's fine.

eboro
batbeer2
Batbeer2 premium member - 4 years ago
But rest assured than one of wall street's largest funds, that is responsible for between 2 and 3% of the daily NYSE volume,

The fact that it generates a lot of volume does not mean the fund is large. I know that is not what you wrote, but the point is easily missed.

We can assume, therefore, in a rational way, that there publication of his 30%+ annualized returns is well informed.

It is quite possible to have a 30% annualised return and not grow to an overwhelming size. You keep your base small by returning capital to shareholders. Leucadia did a partial liquidation when they had fewer ideas than they had capital. It's rare.

If someone is generating high returns, taking 20% of profits (or more) and not putting much of his net worth to work in the same fund, you better not have a significant part of your net worth in that fund.

You could do it yourself. Start an index fund, add enough leverage to get 30% returns most of the time. Charge 20% of all profits and you are in business. No need to do a Madoff.
Sivaram
Sivaram - 4 years ago


It still doesn't seem that any of these traders are any better than Warren Buffett. If Cohen is earning 60% gross and using 4x leverage--eboro says this is what the rumour is--then that's like 15% unleveraged. Still below Buffett's long-term average of around 20%.

But it all comes down to how one perceives leverage. If you think leverage doesn't matter and the investor can manage it properly then someone like Cohen is indeed 3x better than Warren Buffett. But if you think leverage cuts both ways, all these over-leveraged traders aren't as good as they seem. Wait until the sword swings the other way and see what happens.

I personally wouldn't discount returns based on leverage if the leverage was less than, say, 50%. But all these traders are way over that. Simply speaking, if you use a 4x leverage then a 25% loss is a total wipeout.

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