Over the years my views, comments and evidence against technical analysis have been called controversial by many on the retail side of the business (although most professionals I talk to view them as perfectly reasonable). So, I thought, if I’m to be viewed as controversial I might as well go the whole way and I’m sure that this article will really get the technical analysts reaching for their quills!
I am a big fan of Derren Brown, who for those of you who don’t know, demonstrates psychic readings, hypnosis, conversing with passed loved ones as a medium and other similar skills, yet he does not believe that these techniques have any validity. What he shows is that those who perform these activities do not posses supernatural or psychic powers, rather they have learned certain techniques, often involving an understanding of probability and use of language that makes many people think the performer has these skills of predicting the future or speaking to the dead etc. If you want to learn more there is plenty on YouTube, TV, books etc.
As an example, Derren once asked 15 people (3 groups of 5 in different countries) to provide some basic personal information including date and time of birth and he then went away and wrote a ‘reading’ about them. Twelve of the 15 found the readings to be quite or very accurate analysis of themselves with one person giving it a score of 99 out of 100 in terms of accuracy. Derren then asked the subjects to swap readings to read what others had been given. They quickly found out that they all had been given the same readings. So how could Derren write a reading that most people believed was both deeply personal and valid when it was nothing of the sort?
The answer is that Derren applied a technique called cold reading. Cold reading uses probability and use of language to make statements that many people will wrongly believe are detailed and show predicative powers. For more on cold reading I would recommend reading The Full Facts Book of Cold Reading by Ian Rowland.
Rowland explains many cold reading techniques, one being the “Rainbow Ruse” where a reader (psychic etc.) credits the client with both a personality trait and its opposite. Here is one of Rowland’s examples:
“You can be a very considerate person…but there are times, if you are honest, when you recognise a selfish streak in yourself.” This is one of the types of statements that Derren Brown used in his ‘readings’.
They are clever statements in many ways. Firstly, very few people have simple, clear cut one-way personalities e.g. always selfish or always considerate so many of us would find ourselves agreeing with the statement in its entirety. But even those who don’t entirely agree with that statement would likely partly agree with it. It is a statement which is almost always going to sound accurate yet it is meaningless.
There are a wide range of techniques that cold readers can use to build a very plausible sounding reading that provides colour and explanations for both the past and the future; many people will agree with them while some will always be skeptical. However, we should understand that cold readers likely do not hold predictive powers rather they have learned the cold reading techniques.
So, with correct use of language, we can make statements that can apply to almost everyone or every situation. We can also make statements or predictions that can prove correct no matter what occurs.
So with that short background on cold reading techniques, let’s consider, this typical piece of technical analysis that I recently received:
“The ASX 200 is testing resistance at 5550. Expect a test of 5650/5660. Reversal below 5380/5400 is less likely, but would warn that sellers have resumed control.”
So, we should expect the market to move higher but if it falls then sellers have taken control and the market will fall. Does it sound similar to being considerate and selfish? It will be very hard for this ‘analysis’ to be wrong.
Any of us who receive technical analysis will regularly read similar statements along the lines of– ‘If the market goes above XYZ it is going up but if it falls below FGH it will be a bearish sign and it will retreat’.
I find myself asking the question, what real use are the levels in these statements for surely we could make the same claims for any level or price?
Technical analysts clearly believe that their levels are in some way superior or more valid than any other price level and hence they believe that these statements are valid. However, I do not think we can discount the possibility that some technical analysts may indeed be cold reading the market; using the skills of cold reading to build reputations and of course income.
As I showed in my first book, Technical Analysis and the Active Trader, the more reliable studies have shown technical analysis levels and indicators to be unreliable. I also showed that users can believe that the reliability is higher than it really is as they tend to underweight or even forget failures and overweight in their mind, the successes.
Look at this statement by a technical analyst:
“The Australian Dollar smashed through its 86.4 cent support against the US Dollar and sits at 85.82”
If that statement doesn’t sound completely absurd first time, I’d suggest you read it again.
How can 86.4 have been a support level if the market simply ‘smashed’ through it? Yet now the market is through that ‘level’ our analyst is suggesting it is bearish. Surely it has been demonstrated that 86.4 had no real relevance for the market – if the market proceeds lower, then it can be nothing to with a break of that ‘key level’?
Yet in some ways and to some people, the statement can be shown to be correct. A break of 86.4 was indeed followed by a move lower so to a technical analyst the claim that the level is important might be seen to be true. However, couldn’t we also argue the same is true for 86.5 or 86.7 or 86.2…? Certainly the idea that 86.4 is a level of support was proven to be incorrect because there was no ‘support’ there. Yet our analyst continues to believe in these levels. The clear failure here of his level has not been categorized as a failure and so he continues to follow his belief in support and resistance levels.
It is important to state here that, it Is not wrong for traders to believe that there could be two possible outcomes for the market. In fact this can be a crucial part of any trader’s analysis. For example, in An End to the Bull, I explain the idea that markets price in certain outcomes and we need to work out what they are and what could happen if the market is wrong. Typically though, the only way that market participants can be proved wrong (or right) is by seeing data or news. So we might conclude that stock JKL is pricing in good news ahead of its earnings report and if the report is good the stock may do little but if it is poor, the stock may fall sharply. This analysis shows us two different outcomes, with different risk/reward characteristics but they are not affected by price levels, the outcome will be determined by real information.
Interestingly, let’s say that stock JKL is trading at $5.00 when its announcement is released and the result is poor and the stock falls sharply. Technical analysts may claim that the stock reversed from the $5.00 level which in turn may become a future ‘resistance’ level. I would argue that it was not the price that caused the drop, it was the news. What happens at that price in the future will depend on what is happening at that time and how participants are positioned then. Here we are seeing that using just the price is in fact a short cut that omits context but if we want to use more robust analysis we need to include context.
Traders face similar issues around for example central bank meetings. Bonds and interest rate products may trade one way if rates are hiked for example, and another way if they are left alone. This again is analysis that requires weighing up what is being priced in and what outcomes are possible. It is far more complex than simply saying, ‘ if the market goes up past point X it is going higher but of it falls past point Y it is going lower’.
Thus there is a distinct and very important difference in the way technical analysts provide two scenarios for the market and the way that I suggest and which I know is used by the better traders around the world.
So there are actually two further reasons (In addition to its unreliability) to ignore the types of technical analysis statements such as I have shown. They are a short cut to what is a more complex scenario and they are, perhaps increasingly, showing signs of cold reading the markets; making predictions that are almost impossible to be proved wrong thereby enhancing the reputation of the analyst.
I believe that there are other examples of cold reading strategies being used by perhaps what we might term, the murkier side of technical analysis. Rowland uses the term “Jargon Blitz’ to describe how cold readers (and psychics, tarot readers etc.) use large amounts of jargon, perhaps to impress, or confuse or just to sound more knowledgeable. He explains how astrologers might use words such as “trine”, “ascendant”, “fifth house” and so on and they will then go on to elaborate in what is likely to be simply a combination of words with no meaning.
Reading some “analysis” from a Gann follower I found the following statements:
“Saturn is brought further into emphasis on Gann’s chart by virtue of making no Ptolemaic aspects to any other planets in the chart.”
“WD Gann also had a peregrine Sun in Gemini in the tenth house.”
There follows some kind of explanations of these phrases but can any of us really know whether these are simply made up as Rowland suggests?
I imagine that many technical analysts won’t like my reference to Gann followers and I acknowledge that many technical analysts refuse to use the astrological forms of analysis.
However, I recently encountered yet another technique used by cold readers namely placing different views on different sites, a technique that Rowland calls ‘different place, different prediction’. This is particularly used for making public predictions and after the event you can guess which prediction will be referred to by the analyst.
I recently encountered someone who calls himself an ‘expert market forecaster’ and his technique involves using a kind of wave theory. First, the term ‘expert market forecaster’ should raise the suspicion of any seasoned trader. Second the expert, of course, did not use the existing 5 wave theory (for many already believe that to be unreliable), he has his own theory which of course is harder for us to analyse and disprove.
Our expert forecaster posted on one website thread that the S&P 500 was due to correct by around 6%; he was quite certain. Yet I found on another, site, his opinion was that the market could fall but if it rallied past a certain point then it would rise further. His prediction was clearly different on each thread. The second statement of course is one we now know to be a cold reading technique that cannot be proved wrong. The first was a way to make a name for himself should the market fall. Either way, if he was shown to be wrong in his correction prediction, then he could no doubt refer to his statement on the other thread.
These techniques are common among ‘forecasters’, ‘predictors’ and others who try to make a name for themselves through making bold calls. They have a number of outs if they are shown to be wrong which include making alternative predictions on other forums or saying they are right but the time frame is out or else they would have been right but something else happened that changed the final outcome.
There are a number of people who attract great media attention by making bold predictions and the media certainly love them. They are rarely accurate yet have the range of get outs (as above) for when they are wrong.
They will obviously contest the accusation of cold reading the market but the reality is that their techniques and use of language and probability are too close to those defined as cold reading to be treated otherwise.
I should add that I have worked with many technical analysts over the years although they have all been sell-side rather than buy-side (if you need an explanation read An End to the Bull). Most have a genuine belief in their analysis, even if they are not actually traders committing capital to trades.
However, there are, I believe an increasing number of people who are using techniques that are doing nothing more than cold reading the markets. The media and many retail traders will be attracted to them and their almost amazing ability to predict the future. It is in all of our interests to be skeptical.
Gary Norden can be contacted at Organic Financial Group