From the July 01, 2011 issue of Futures Magazine • Subscribe!

The Evolution of Technical Analysis

Book Review

The Evolution of Technical Analysis: Financial prediction
from Babylonian tablets to Bloomberg terminals
By Andrew W. Lo & Jasmina Hasanhodzic
Bloomberg Press (an imprint of Wiley),
September 2010
$29.95, 212 pages

In “The Evolution of Technical Analysis,” Lo and Hasanhodzic examine the origins and development of technical analysis that seeks to divine trends, reversals, cycles and other predictable patterns in order to forecast prices. Often misconceived as a form of gambling or magic, technical analysis can be seen as a universal phenomenon that is deeply ingrained in human psychology, and is a value-added tool for those trading in financial instruments.

Andrew Lo, director of MIT’s Laboratory for Financial Engineering, and coauthor Jasmina Hasanhodzic, trace the origins of technical analysis to ancient Babylonians and track its use and progress through to the ubiquitous Bloomberg terminal that adorns many traders’ desks and cubicles. What is particularly striking to the reader is the sheer staying power of technical analysis in today’s skeptical, practical, computerized world.

The eponymous Charles Dow, publisher of the famous Dow Jones Industrial Average, was the father of the modern form of technical analysis. His trading principles are as relevant in 2011 as they were more than 100 years ago when practiced by Dow and his immediate successors.

The principles advance the theory that markets move in trends, some major such as bull and bear markets, lasting for years, others minor, often over in a day, but persevering over time. However, the techniques have become increasingly sophisticated. Lo and Hasanhodzic review the tools technicians use to recognize market developments and talk about how changes on Wall Street have directed technicians to reinterpret their craft.

The reader gets the impression that technical analysis is the heart of international financial trading whereas computers and science form the brain. As such, the analysis adds a human touch in an increasingly rational, informed and explicable system of investing. “Technical analysis is still a human game,” the authors say, quoting directly from Robert Farrell, a founder and first president of the Market Technicians Association.

The arrival of decimalization of stock price quotes in 1997, as a way to authenticate bid/ask spreads, diluted the value of high/low statistics making it possible to translate a one-cent gain in the price of a stock into a 12-month high. But the whole technical analysis game changed with the advent of the computer that could rank and filter a large number of stocks and subsequently allow for automated data collection.

If there is one criticism, more an annoyance really, that could be leveled at the book, it would be the modern method of numbering footnotes. This technique occasions the reader to flip back and forward between the 23 pages of footnotes that lie between the end of the text and the index. I would advise the reader to bookmark the Notes section that runs from pages 167-193 for ease of flipping back and forth.

Patrick Kelly is a freelance writer with a background in commodity market reporting.

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