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Do you find Techical Analysis to be an effective way of increasing the returns on your investments? This can be either by itself, or in combination with other indicators. If so, what techniques do you use?

What studies exist which show evidence for whether or not different techniques work?

Chris W. Rea
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DanTilkin
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    The Wikipedia page you link has a dozen academic papers covering various sides of the argument, so if you want to know "what studies exist" you can start there. If this is instead meant to be a poll of "do current Money SE participants use technical analysis?" then it's not a very good question, as it will just depend on who happens to answer. – poolie Dec 22 '10 at 07:28

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If you want a book that's a bit more modern than A Random Walk Down Wall Street, try David Aaronson's book, Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals. The author discusses a lot of the evidence for and against certain technical indicators; for example, he discusses how head-and-shoulders indicators are usually worse than random when making trading decisions. I don't have a copy of the book handy, so you'll have to read it and decide for yourself based on the evidence, but it's a more recent and rigorous empirical look at TA.

If you're interested in academic studies, a good starting point is Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation by Lo, Mamaysky, and Wang. Their study finds that several technical indicators, e.g. head-and-shoulder, double-bottom, and various rectangle techniques, do provide marginal value. They also find that although

human judgment is still superior to most computational algorithms in the area of visual pattern recognition, ... technical analysis can be improved by using automated algorithms

Since this paper was published in 2000, computing power and statistical analysis have gained significant ground against human abilities to recognize, and more importantly exploit, technical indicators. This statement isn't necessarily a criticism of TA, but rather a warning against its use by the average day trader in markets where computerized traders are highly active, since high-speed traders can identify and take advantage of signals faster than retail day traders, thus potentially decreasing or removing the potential to gain from the signals.

This applies to a lesser extent in markets where high-speed trading isn't as active or over longer time periods; for longer time periods, however, it's important to understand that some signals (like head-and-shoulders) were found to be detrimental to trading returns. Some anecdotal evidence suggests otherwise, but a) this is anecdotal evidence, and b) even if a signal has a completely random effect on trading returns, there will always be some traders who earn a positive return with it, either on its own or in conjunction with others; such is the nature of statistical distributions. It's why collecting data and backtesting strategies is more important than online testimonials and similar sources (including this post). There are always statistically fortunate people; see my story in this post about pamphlets that predict sports results.

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John Bensin
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    "...a warning against its use in markets where computerized traders are highly active." John do you know that the more people or computers that trade a particular signal the more successful that signal will become. So computerized traders actually help TA signals and triggers eventuate into better trades. –  May 30 '13 at 06:08
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    @MarkDoony You're right, that wasn't exactly clear in my post. I meant that the increasing use of computerized trading can remove opportunities for the average day trader to take advantage of a signal. For example, if a signal indicates that traders should buy into a market and enough high-speed traders buy first (thus driving the price up), this reduces or eliminates the individual day trader's potential for gain. – John Bensin May 30 '13 at 11:05
  • @MarkDoony Also, see the paragraph in this answer under summary; I addressed the point you're making. – John Bensin May 30 '13 at 11:25
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    So if I see a potential set-up and work out what my entry (above a certain price) and exit points will be before the market opens, then also put my stop buy market order and stop loss market order before market opens, will my opportunity be diminished by these high speed traders? Noting that as soon as my price target is triggered my order will be placed immediately onto the market and executed. And the same goes with my stop loss order. This can also be applied to day traders placing there orders prior to their trigger being hit. –  May 30 '13 at 12:38
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    @MarkDoony It depends on a lot of factors, but if HFT's have already acted on the signal (near the end of the previous trading day, since if the signal is there at market close, it's likely there a few milliseconds before the market close too) that you picked up on, the opportunity may have been diminished before you could put in your orders. Over time, as this occurs, the magnitude of the signal-based opportunities on a human timeframe may diminish. – John Bensin May 30 '13 at 13:09
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    @MarkDoony If you follow the debate about HFT and frontrunning-like behavior, that's another factor to take into account. There's a neat study from the CFTC/Booth on this in the context of the E-mini that you might find interesting. If you want to continue the discussion, though, maybe ask a new question or email me, since I've been warned (along with others) about long discussions in comments. – John Bensin May 30 '13 at 13:10
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    John - how can the HFTs have already acted on the signal near the end of the previous trading day if the signal does not happen until the next day? That is the whole point of putting a stop buy market order to be triggered when the signal occurs. So if I have the same trigger as a HFT the orders will both go in at the same time! –  May 31 '13 at 22:25
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    @MarkDoony Two points to make here. 1) Due to latency (e.g. from colocation or lack thereof) and the fact that not all retail brokerages have direct access to the exchange, HFTs can put their orders in faster than retail investors, even if you both submit them "at the same time". 2) Furthermore, HFT's cancel the majority of their orders, which means that an HFT can have orders in the queue before yours, even if the signal hasn't necessarily appeared yet, and then simply cancel them instantly (from your perspective) before they're triggered, thus preempting your order through speed alone. – John Bensin May 28 '14 at 21:32
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The short answer is No.

Read the book A Random Walk Down Wall Street.

Alex B
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Graviton
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  • I have, I was looking for other perspectives. Also, can you remove or edit the image, something that big is a bit obnoxious. Thanks. – DanTilkin Dec 22 '10 at 02:59
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    @DanTilkin, not sure what you mean. Are you saying that you are looking for specific evidence that proves that TA actually works, despite contrary evidence from academic studies? – Graviton Dec 22 '10 at 03:19
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    of course it works for SOME people. High frequency trading is all technical. day traders almost all use technical analysis. "Market Wizards" is also a great read. Shows that it doesn't really matter if you use fundamentals or technical analysis. – Vitalik Dec 22 '10 at 04:28
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    @Vitalik, seems like you are stretching the definition of technical analysis a bit too far. For me TA refers to qualitative past price analysis that involves chart studies only; it doesn't refer to stat arb, or capturing the tiny bid-ask spread ( as done by HFT) or anything that hedge funds engage in. – Graviton Dec 22 '10 at 05:52
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    Great book. Another good one is "Fooled by Randomness". See http://www.amazon.com/Fooled-Randomness-Hidden-Chance-Markets/dp/1400067936 and http://en.wikipedia.org/wiki/Fooled_by_Randomness – Chris W. Rea Dec 22 '10 at 15:04
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    I have to give this -1. You're citing a book originally published in 1973 as evidence. That's a long time in that industry; back then, "asset allocation" was all the rage. Today, most technical traders use highly sophisticated and computationally-expensive algorithms that weren't possible or even imaginable back then. The NASDAQ had just been born in 1971 and straight-through processing didn't exist until I think the 1990s. For counterpoint see Non-random Walk Down Wall Street. – Aaronaught Dec 26 '10 at 02:48
  • Interestingly, the CBOE was created in the exact same year this tome was created - 1973 - so I think it's fair to say that the book also does not take into account the recent proliferation of options and other derivatives now available to ordinary retail traders. While derivatives are not part of technical analysis per se, they're a fairly important part of longer-term TA strategies. Honestly, the only thing that book shows passable evidence for is that incredibly naïve forecasting methods like moving averages don't work. "Random" is an awful misnomer; the market is stochastic, not random. – Aaronaught Dec 26 '10 at 02:53
  • @Aaronaught, first the book you cite is just a compilation of all the studies of superior return using computer analysis-- which is not what TA is all about. Second the studies only show that it is possible to beat the market before transaction cost, but not after. – Graviton Dec 26 '10 at 13:40
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    You can't say that something is "not what TA is all about" without even making a cursory attempt to define what you think TA is all about or how those methods differ. And transaction costs are dirt cheap these days; a $10 round-trip fee is not much of a game-changer. We're not talking about sub-penny arbitrage here; if you make just 1 cent per share on the trade then you only need to turn around 1000 shares to recover the transaction cost, and most trading programs do way better than that. – Aaronaught Dec 26 '10 at 16:17