Historically, there has been much debate between investors and traders who operate based on fundamental market information and those who operate based on price action and technical levels in the stock. In Benjamin Graham and David Dodd’s time, this latter tribe was referred to as the "chartists" due to the reliance on the patterns supposedly seen in stock charts.
One only needs to crack a book on technical analysis to be bombarded with talk of falling knives, false tops, morning stars and other such exotic creatures. Supposedly, the use of technical strategies provides an alternative to determining the intrinsic value of a security. What did the authors of "Security Analysis" think about such techniques?
Not a science
Unsurprisingly, Graham and Dodd were of the opinion that chart reading cannot provide the analyst with enough certainty to make consistently correct trading decisions. They came to four conclusions regarding the practice. First, that chart reading cannot be a science. Second, its empirical record (at least at the time the authors were writing) could not be considered satisfactory. Third, the theory it was based on was logically faulty. And fourth, even though it is an upgrade over "haphazard speculation," its efficacy diminishes as more and more people adopt it.
“That chart reading cannot be a science is clearly demonstrable. If it were a science, its conclusions would be as a rule dependable. In that case everybody could predict tomorrow’s or next week’s price changes, and hence everyone could make money continuously by buying and selling at the right time. This is patently impossible. A moment’s thought will show that there can be no such thing as a scientific prediction of economic events under human control. The very 'dependability' of such a prediction will cause human actions that will invalidate it.”
The authors argued any method of chart reading that allowed the practitioner to derive consistent profits would quickly become widely adopted and, thus, its efficacy would be quickly diminished simply by virtue of the large number of market participants using it. Try asking a professional trader how they derive their edge in the market - it's safe to say they will refuse to divulge that information. What this means is not that technical analysis can never be successful. It means the technical strategies you are likely to hear about are not the profitable ones. Contrary to what many resources will say, there are no shortcuts to successful investing.
Graham and Dodd also noted the chart readers' analysis is necessarily backward-looking, as it is based on historical price action. Past performance is not a solid guarantee of future returns, and the authors illustrate this with a comparison to horse racing:
“You may learn a great deal about the technical position of a stock by studying its chart, and yet you may not learn enough to permit you to operate profitably in the issue. A good analogy is provided by the 'past performances' of race horses, which are so assiduously studied by the devotees of the race track. Undoubtedly these charts afford considerable information concerning the relative merits of the entries; they will often enable the student to pick the winner of a race; but the trouble is that they do not furnish that valuable information often enough to make betting on horse races a profitable diversion.”
They concluded by saying the most successful technical traders adhere to the belief chart reading is an art, not a science. In practicing this craft, they rely heavily on their own intuition and gut feelings. As such, technical trading cannot be distilled to a simple set of rules to be easily followed by any given person.
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