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* Extract written by André Gosselin published in
his book "Investir ŕ l’aide de l’analyse technique".
The technical analysis strategies, whereas they
are numerous and diversified, are mainly based on the four following
proposals, as stated by Edwards and Magee, authors of Technical Analysis of Stock Trends, by far the
technical analysis book the most read in the world.
We find in the four following proposals the
essence of what I call the common doctrine of the technical analysis,
which is the oldest and the most widely shared by the technicians:
1. The value of a security in the market depends
on supply and demand.
2. Supply and demand are controlled by several
factors, some rational and some irrational ones.
3. The market is very efficient and fast to
incorporate, in the price of the securities, all the rational (profits'
annoucements) and irrational factors (rumors, panics, etc.) who
influence the investors.
4. The prices of the stocks evolve according to
trends which appear as well in the very short term as in the very long
term.
Supply and demand
The first proposal does not have anything very
revolutionary or eccentric. Almost all the investors, technicians or
not, accept the idea that the price of stocks is determined, among other
factors, by the balance between supply and demand. The question is to
know which weight to give to this factor in his theory or his market
concept.
The fans of the fundamental analysis and of the
strategies based on the value or the growth of the companies consider
that there are factors more significant than the investors' supply and
demand to judge valuation of a stock. The technicians estimate that it
is the main factor to be taken into account if your objective is to
obtain the maximum return from your investments. In any case, it is the
most accessible and practical factor for the investment decision.
What is the supply and demand, when these two
phenomena are considered in the financial markets context? The supply is
all the investment decisions which derive from a pessimistic fundamental
analysis of a given stock and from its value; on the contrary, the
demand is made of all the investment decisions which derive from an
optimistic fundamental analysis of a given stock and from its value. All
things considered, the technical analysis is the equivalent of what is
called, in economic science, macroeconomics, because the analyst is
interested first and above all in the aggregate supply and aggregate
demand, i.e. in the offer of all the investors together and in the
demand of all the investors together.
The rational and the irrational
The second proposal of the common doctrine of
the technical analysis evokes the idea that the markets are controlled
by individuals who use sometimes their intelligence, and sometimes their
emotions and feelings. Sometimes, the markets seem to evolve roundly and
the investors appear to be guided only by the cold calculation and the
pure intelligence; sometimes, the markets look a sport game, or even a
gambling game, where all the moves are allowed and where the low
instincts dominate. In this last case, it is like attending a race
against the clock, in a zone where a weather alert has been announced,
with the demonstrations of panic, the anxiety, the rescue attempts and
the "deaths" that includes.
In short, the financial markets demonstrate the
best intelligence and the worst instincts of the mankind. The technical
analysis fans consider that the market is 10% logic and 90%
psychological. The fundamental analysis fans affirm on the contrary that
the market is 90% logic and 10% psychological.
The markets efficiency
The third proposal, as you may have noticed, is
a pretty direct charge against the claims of the fundamental analysis.
Several followers of the technical analysis, as I said, do not hesitate
to refer to the scientific authority to fustigate the fundamental
analysis.
Stan Weinstein for example, the author of a well-known
book about technical analysis and the editor of a very popular financial
letter, write this:
"You will never be able to beat the market with
constancy by reading today fundamental news in the newspapers and by
acting on the faith of this information. It is a passport for failure, a
small amount of mortal poison that the beginner administers himself
without realizing it [... ] It is not either while following the
economic and financial news that you will turn your investments into
winning bets. In a society saturated with computers and instantaneous
information, the financial markets react to the last developments well
before you are informed about it in the press."
It is like to read an academic convinced by the
theory of the efficient markets or a researcher buying the conclusions
of one of the many studies showing the uselessness of public
information, accessible to all, at least in an investment strategy which
aims at beating the market.
To some extent, Weinstein is not wrong. However,
the technicians are proven wrong, when they forget to mention at all one
of the works of the economists on one of the rules of the technical
analysis. They get out of this dead end by affirming, like Weinstein,
that the technical analysis is more about art than science. Their
position is to say that you can make a fortune with the Stock Exchange
by being right only half of the time, or even once out of three times,
considering that you let the profits run and that you cut your losses
quickly. The position of the scientist is to say that a method which
does not work more than once out of two times is not valid.
Thus, the two sides have different criteria to
judge a method: the scientist will say that it is valid if it succeeds
at least more than once out of two, the technical analyst will say that
it is not necessary that a method succeeds more than once out of two and
that it is acceptable and useful as long as it brings back enough money
to who follows it.
The prices trend
The fourth proposal of the technical analysis
common doctrines is the most significant. As Martin Pring, author of Technical Analysis Explained, explains, the
objective of the technical analysis is to determine the changes or the
reversals in the stock prices, thanks in particular to indicators and
simple mathematical ratios on the state and the economic situation of
the markets. The markets evolve in trends, in a given direction, either
upwards, or downwards; sometimes flat, as if the market has taken a
pause and that
the investors have entered in a phase of indecisiveness.
These intermediate periods have their importance
for certain technicians, because, as soon as the market takes a clearer
direction, with upwards or downwards, it is possible to take position in
order to take the train on time. It is all about the art, the difficult
one, of the technical analysis.
André Gosselin
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