Technology has revolutionized the way business is done around the world, including many aspects of trading during the last 30 years, but has it really produced any innovations in technical analysis for today’s global, 24-hour electronic markets?
Some new ideas in technical analysis have certainly surfaced throughout the years, as chronicled in these pages. Welles Wilder introduced the relative strength index (RSI) in 1978: “RSI: A momentum oscillator that can help you spot market turns,” (Commodities, June 1978); Louis Mendelsohn wrote about backtesting software concepts (three articles in 1983); Steven Nison introduced candlestick charts to the Western world in “Learning Japanese-style ‘candlesticks’ charting, December 1989; and John Murphy advocated the use of intermarket analysis, to name a few technical analysis developments. (See “Indicating profits,” below.)
But aside from moving concepts from hand-drawn charts to calculators to computers that are ubiquitous in trading today, what has technical analysis done for traders lately? Where are today’s Charles Dows, R.N. Elliotts or W.D. Ganns with original analytical ideas? Ask some of the people who have played prominent roles in the marketplace about the state of technical analysis today and you’ll get a wide range of answers.
SAME OLD THING?
“Technical analysis today is not that much different than it was 25 years ago,” says Mendelsohn, president of Market Technologies LLC and developer of VantagePoint intermarket analysis software. “The only difference is that the charts have different dates and the computer’s ability to produce these charts quickly and easily is vastly improved.”
New technical analysis ideas are still being generated by hedge funds and proprietary traders using their extensive resources to develop advanced trading methods, but the institutional traders are keeping these proprietary secrets to themselves. If there is a new technical analysis genius or concept, no one will ever hear about it.
But Mendelsohn doesn’t think most of these sophisticated traders are any better at analysis than the individual trader. “You would think that with so much money involved and the incentive that money managers have to produce profits, they would have the best state-of-the-art analysis possible, but that’s not so,” he says, noting the poor performance of many public futures funds (47 funds down an average of 4.49% through October, according to Futures). However, most of the high-end system development talent has gravitated to private placement hedge funds and commodity trading advisors.
PLENTY OF TOOLS
John Bollinger, whose extensive study of market volatility resulted in the concept of Bollinger Bands, believes traders still have “an awfully good set of technical analysis tools available to them.” However, with the type of market participants and trading around the clock around the world today, the character of the data has changed.
As part of his ongoing research, he has found it instructive to feed a data series with technical patterns to an indicator to see how it responds, noting the behavior during steady market moves and during periods of price deceleration.
“What traders really need to do is understand the response characteristics of the indicator tools they are using better than they do now,” he says.
What he suggests is not necessarily discovering new indicators but using today’s computational power to mine the ideas from analytical work before the 1960s more thoroughly. “Like the automobile, the basic problem (of analysis) has been solved. Now it’s more about finesse,” Bollinger says.
“Look at the old masters and their techniques. There’s still a ton of information there, especially in analyzing the micro structure of the market.”
MAKING INDICATORS WORK
One analyst who is using techniques he developed more than 25 years ago to trade systems successfully is Welles Wilder, whose 1978 book, New Concepts in Technical Trading Systems, introduced the Relative Strength Index, Directional Movement Index, Volatility Index, average true range and a number of other technical tools that are now included in most analytical software.
Wilder spends most of his time in New Zealand and is also known for his Delta Society systems, which incorporate several concepts from the book with his Delta turning point analysis and have produced profits averaging $50,000 a year, he says. One of the techniques, the Volatility System, is mostly overlooked, but he says it may be the best stand-alone system in the book, illustrating that sound analytical techniques from the past do not go out of date.
The Parabolic System also is standing the test of time in helping traders get out of a position once profits are built up, he adds.
LOTS OF ‘MUMBO-JUMBO’ Whatever type of technical analysis is in vogue these days, most of it is “mumbo-jumbo,” contends Larry Williams, an author/trader whose accomplishments include turning a $10,000 account into $1 million in a year and writing a number of popular trading books including The Right Stock at the Right Time and Long-Term Secrets of Short-Term Trading.
“I am not enamored by technical analysis and I have probably beaten up the numbers as much as anyone,” says Williams, whose name is often associated with the %R indicator but whose books have made a transition from a technical focus in his early trading days to mostly fundamental in recent years.
“What has stood the test of time is that trend matters,” Williams empha sizes. “If prices move from 10 to 50, it’s due to fundamental conditions. You don’t forecast 50 with an indicator. First, you have to see the condition (or trend) of the market, then you can use a timing tool like %R to buy on a pullback or sell on a trendline breakout. It’s pretty simple. I see no value in that artsy-craftsy stuff like Elliott Wave or Gann.”
Williams compares markets to a boat ride. “You don’t want to be looking backward at the (technical indicator) waves to see where the boat went. You want to keep your eye on where the pilot (conditions) is steering the market,” he explains.
Williams, who hasn’t gotten into electronic trading but submits orders to his broker by e-mail, does find value in a couple of old technically related tools that are still reliable, the Commitment of Traders report and seasonal patterns, which he views as market fundamentals or conditions. Another old analytical standby, volume, has not kept up with the times in futures trading, however, because arbitragers, long-term program traders and investable indexes are behind huge spikes in volume every 90 days at expiration in many markets.
“This volume is not reality. It does not reflect the real supply/demand situation,” Williams says. “Volume is dead as an indicator. Or if it’s not dead, it’s not the same as in the past.”
John Murphy, whose books Technical Analysis of the Financial Markets and Intermarket Analysis are among the bibles of modern technical analysis, doesn’t even like the premise of an article on the status of technical analysis.
“It implies that technical analysis hasn’t kept up with the times when the exact opposite is true,” he says. “Why not write an article asking why economists and fundamental analysts missed the end of the Nasdaq bubble in 2000 when it was clearly seen on the charts? Or why the fundamental community didn’t see the spectacular rise in oil prices over the last couple of years when the chartists did? Or why Wall Street has completely missed the secular bull market in gold and other commodities over the last three years while chartists didn’t?
“I think a more pertinent article would be about how well technical analysis has done in the new global environment and why the economic and fundamental communities haven’t kept pace,” he suggests.
ADVANCES TO COME
Whatever the view of current technical analysis, there’s not a lot of incentive to come up with innovative ideas, Mendelsohn says.
“The largest numbers of traders are newcomers to the market and that’s the way it will be forever,” he notes. “It’s like they are all starting kindergarten and learning how to read. The teacher knows how to read, but the students have to go through a learning process. There’s no incentive for the industry to innovate as long as it can keep giving new traders old things.”
Mendelsohn’s VantagePoint software uses neural network technology and intermarket analysis to give a new look to an old indicator. The software, using prices of 10 related markets, attempts to turn a moving average from a lagging to a leading indicator to produce predicted moving averages for a target market. The predicted moving average often turns ahead of simple moving averages (see “Getting a heads up,” below). One issue with this is that intermarket relationships tend to change and can actually reverse (see “Intermarket analysis: What works today,” February 2006). Mendelsohn’s program’s are able to adapt to this.
Mendelsohn says traders need to blend technical and fundamental analysis into a synergistic approach and the next analytical advance will come when fundamental data is formatted so it can be combined with technical data in one analytical package.
Technical analysis’ low stature today may be a victim of a general bull market, according to Bob Prechter, one of the foremost advocates of Elliott Wave theory. He sees a sharp setback ahead for the U.S. stock market. In a bear market everyone looks to technicians for explanations and the timing of buy signals. In a bull market Wall Street firms apparently decide the market will go up forever so they don’t need technical analysts, as shown by the downsizing or elimination of technical analysis departments in recent years.
“The firings of technical analysts in 2005...is a great big sell signal for money-center banks and a buy signal for the field of technical analysis,” Prechter writes in Elliott Wave Theorist. “(Technical analysis’) new uptrend has a long way to go.”
Darrell Jobman, senior market analyst for www.TradingEducation.com, is a former editor of Futures magazine and has been writing about financial markets for more than 35 years.