So I had prepared this presentation - if you're not a financial market person then you're probably not going to understand most of this.
In which case you can look at the pretty pictures.
I LOVE the pretty pictures!
I was all excited for the presentation because I got to draw.
And I realized I love drawing.
Okay I knew I love drawing.
But this convinced me even more.
And I realized it makes me so so happy.
Like I could forego a cupcake to draw.
That’s how happy.
We're talking some serious happiness here.
So if you like the pretty pictures, and you want pretty pictures too…
Then give me a shout.
I'd love to draw you.
Or for you.
Or draw you for you.
Or draw you drawing you.
I'm stopping that now.
I can't promise I'll be any good… but I could try!
Here's the presentation to give you an idea.
It was precisely one and a half years ago that I was introduced to Technical analysis as a discipline - worthy of study.
That's really difficult for me to accept, because I have spent my entire life engrossed in finance and economics. I've learnt about everything from derivatives pricing to financial market modeling, yet... it wasn't until I started working in a bank that I found that people actually had a career as technical analysts.
Even then I joined the research wing which only served to perpetuate my illusion that I knew everything there was to know about the markets.
I knew exactly why the markets were behaving the way they were. If the markets rallied it was on the back of strong economic data, if they fell it was because of inflation expectations. I knew the reason behind everything.
However, despite my years of study, despite my omnipotent knowledge, and the high intellectual ground it had afforded me... there was always a nagging feeling that irritated me during my days at the bank.
At discussions and briefings with traders, there was this under-stated, underlying, concealed but very present impatience when we would talk to the gathering. Like the traders would seem to be looking out of the window, or staring vacantly into space … while we were telling them about our outlook, our understanding of what was happening and what would happen next. I mean this was important stuff… and somehow .. It felt like they couldn’t wait for us to just…. get over with it.
And then the technical analyst would talk… and he'd be talking - what sounded to me- like gibberish at the time… because it was a bunch of numbers and jargon like consolidation phase and resistance levels… and for no understandable reason .. People would be paying attention.
I learnt to ignore this difference in attention span and life went on and a couple of years later I quit to pursue other careers and hobbies. And then when I decided to come back to finance, I was directed to the IFTA course. The CFTe.
I was told:
'It's just a different angle of looking at the markets… it makes your knowledge complete'.
For the first time in my years of education, I was introduced to a subject that was so different in nature from any subject I'd actually studied.
And as I read book after book, little by little… it dawned on me that the complicated mathematical and econometrical models, the optimization theories, the complex non linear equations that described the world so perfectly… all paled in comparison to the simplicity, open-mindedness and humility of Technical Analysis.
So today, after having given the CFTe exam and being awarded the Bronwen Wood award in the only subject, the only discipline that makes sense to me anymore… I want to try to raise questions on why TA hasn’t been given it's due in academia.
My guess is that it's a combination of at least three factors: Concreteness, simplicity and irrationality.
As a human race, we love certainty. We love concreteness. We love numbers and we love the feeling of knowing exactly what the future holds. We love predictions and projections.
One thing that struck me when I started reading technical analysis books is how unusual it was that there were no theories. There were explanations and observations from the market to provide evidence of the claims the book was making… but nothing was 'concrete'.
When the book described the head and shoulders pattern, for example… I found it exceedingly annoying that they always said that this pattern is LIKELY to result in trend reversal.
I mean what does that mean?!? Either it does or it doesn’t.. Right?!?
I'm not studying this book to know what is LIKELY to happen.
I wanted to know exactly what to expect when I saw the pattern.
This was my economist mindset talking. This was actually the human mindset talking.
But now I know, that what I mistook as noncommittal, was actually wisdom.
The wisdom to know that nothing is an absolute certainty.
The wisdom that of Dr. Nassim Taleb's best-selling book the Black swan seems to be talking about.
Of all the books I read in my preparation for the CFTe exam, not one of them pointed to the infallibility of the subject. The underlying thread was always that history has taught us some stuff but even so, nothing is a certainty. The wisdom in expecting the best but being prepared for the worst.
The black swan says:
'One cannot assert authority by accepting one's own fallibility. Simply- people need to be blinded by knowledge.'
Every Technical Analyst worth his salt - in making 'predictions' about the future always has qualifications. If this support is broken then we are looking at risk of more downside. The first resistance level is XYZ and if that's broken we could look for a rally up to ABC.
This language doesn't satisfy the human need for certainty- a need that can never be fulfilled because of the nature of uncertainty itself. So we need to be fed fictional numbers- which… the fundamentalists furnish.
'You lower your anxiety about uncertainty by producing a number- like an object to hold onto in the middle of a vacuum.'
And that's why fundamentalists enjoy the high intellectual status they do as opposed to us technicians.
They provide numbers. So what if they are seldom on the mark.
So what if these numbers mean nothing in times of crises.
They provide concreteness.
The Black Swan says, quite explicitly:
Traders rarely hire economists for their own consumption, but rather to provide stories for their less sophisticated clients.
It cites studies which showed that brokerage house analysts predict nothing- ie.
The fundamentalists predict nothing more than the naïve predictions of anyone else who takes figures from one period as predictors of the next. Additionally, there are other problems like herding and underestimation of errors. Empirically, it's been shown that there was no difference in prediction results whether one had a PhD or an undergraduate degree.
I can't shake the feeling that I probably should have read the book a long time ago. The ideal time should have been kindergarten … before I started high school. Because one by one, the author-demolishes each theory that I had based my intellectual beliefs on.
Another reason for why Technical analysis has low "intellectual" appeal, is the very reason I love it. The simplicity.
Humans, like complexity.
'We love the scholarly sounding verbiage, the Gaussian economist, the mathematicized nonsense, the pomp, the Harvard Business School, The Nobel Prize, the dark business suits with white shirts and Ferrogamo ties. We are naturally shallow and superficial and we do not know it.'
Unfortunately, the mathematics behind most of our technical indicators is elementary, simple. It's logically sound… but that doesn't matter.
It has been inspired by the real world itself. But that doesn't matter.
Economics doesn't do that.
In economics, there are theories which have long, complicated mathematical proofs. These theories are based on assumptions like normal distribution and rationality of the investors. These assumptions, as everyone knows, breaks the link between theory and reality.
'Statisticians have concentrated their efforts in building more sophisticated models without regard to the ability of such models to more accurately predict real-life data.'
So fundamentals satisfy our intellectual need for complexity at the expense of accuracy, which, sadly, technical analysis doesn't address.
And finally, the last and most important reason in my humble opinion is that technical analysis takes into account irrationality in investor behavior- which as hard as academics try, they won't be able to model -given the current level of technological sophistication at least.
Tony Plummer's book on the psychology of Successful Investing has beautifully explained with logical simplicity how irrational, and in fact, emotional investor behavior can be responsible for much of the movement in the markets.
So what if it can't be modeled into a mathematical equation with our current technological resources? We need to take it into account.
Irrationality is fuzzy… it's messy to deal with. It's not susceptible to measurement or mathematical analysis. Economists, bury their heads in the ground by assuming away all irrationality.
This produces neat theories. And neat theories produce neat predictions which is what the hotshot CEO's, the investors, and in fact the human race wants.
'Legions of empirical psychologists of the heuristics and biases school have shown that the model of rational behavior under uncertainty is not just grossly inaccurate but plain wrong as a description of reality.'
To openly allow Technical Analysis into the realm of academia - would be a tacit acceptance of the fact that all economic theories and complex mathematical models aren't all they're cut out to be.
We cannot expect fundamentalists- the gatekeepers of academia to allow Technical Analysis in and reduce to dust everything that they pride themselves on. It just won't happen.
One last thing I want to talk about is this.
One major point that the highly respected book makes is this: The dependence on the normal distribution is the reason behind the LTCM debacle and it's the reason behind the 2008 catastrophe.
To put it simply: the pioneering, Nobel laureates Merton and Scholes were behind LTCM and their risk measures (based on the normal distribution) led to them being over-exposed. They didn't hedge themselves against the 'fat tail' i.e. low probability high impact events- in their case, the Russian default.
You would think that after de-stabilizing the entire financial system, academics
would go back to the drawing board and figure out what they did wrong.
That never happened.
Even today, students of finance are taught the same theories that caused the 1997 crash and now, the 2008 problem-where the measures of risk used have been proved inadequate time and again.
Here lies the beauty of technical analysis to me: We address fat tails. We take into account Black Swans. We handle uncertainty in a Black Swan efficient way.
Our favorite cliché that the trend is your friend addresses those very 'fat tails' that Dr. Taleb talks about. The normal distribution implies that financial markets do not deviate from the mean. A very high (or low) reading not only has a low probability of occurrence but is also likely to lead to a reversion to the mean.
Trend following techniques under the normal distribution would not make money. Trend following- by definition -means that if the trend is up, the market is likely to continue trending upward- not revert to mean.
It means that extreme values are a part and parcel of market dynamics- the probability distribution of financial market values is leptokurtic- and 'equilibrium' is a lot more elusive than the normal distribution will have us believe.
The maturity and intellectual superiority of technical analysis as a subject of study to conventional finance and economics is represented in this line I read in the Kirkpatrick and Dahlquist textbook:
Technical analysis is used to determine the trend, when it is changing, when it has changed, when to enter positions, when to exit a position and when the analysis is wrong and the position must be closed. It's as simple as that.
Scour as many economics books as you want to, I doubt you will find such honest and truthful acceptance of the fallibility of any discipline to master uncertainty.
Additionally, notice that at no juncture does technical analysis attempt to 'predict' the future. If anything he is only too aware of the possibility of the analysis being wrong. And he is prepared for it. Beforehand.
A reality of the world today- is that uncertainty is unconquerable.
I'd like to end by quoting Dr. Taleb again:
'If you hear a prominent economist using the word equilibrium or normal distribution, do not argue with him; just ignore him or try to put a rat down his shirt.'
If you want a piece of the Pious Hippie magic for your presentation or just for fun… email me!
Do it now.
Well not now now if you're busy now.
But like you could do it whenever.