Read with caution (03/12/2013)
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Adrian
:
Hi Roger, perhaps we will agree to disagree on support/resistance, but I’d like to make some final clarifications from my side, and thanks for the interesting dialogue.
1) SOURCE: WIKIPEDIA – [ In a paper published in the Journal of Finance, Dr. Andrew W. Lo, director MIT Laboratory for Financial Engineering, working with Harry Mamaysky and Jiang Wang found that “Technical analysis, also known as “charting,” has been a part of financial practice for many decades, but this discipline has not received the same level of academic scrutiny and acceptance as more traditional approaches such as fundamental analysis. One of the main obstacles is the highly subjective nature of technical analysis – the presence of geometric shapes in historical price charts is often in the eyes of the beholder. In this paper, we propose a systematic and automatic approach to technical pattern recognition using nonparametric kernel regression, and apply this method to a large number of U.S. stocks from 1962 to 1996 to evaluate the effectiveness of technical analysis. By comparing the unconditional empirical distribution of daily stock returns to the conditional distribution – conditioned on specific technical indicators such as head-and-shoulders or double-bottoms – we find that over the 31-year sample period, several technical indicators do provide incremental information and may have some practical value. ]
2) I’m not suggesting any “conspiracy”. As per 1) above and my earlier comment, for whatever reasons it seems academia has not focused very much on TA. The private individuals/entities who use TA usually have no desire/obligation to educate others or substantiate their beliefs/methods. Obviously if profit-driven and they believe they have found an edge they will keep it confidential. Equally if they lost money they won’t be inclined to advertise that either.
3) There is a big difference in perspective, trader vs investor. For a trader, a pattern with 55% success might be considered useful. They are looking for any small advantage, coupled with good risk control and position size, to generate profits. Similar to a casino or insurance company. For a long-term investor, a pattern that only works 55% of the time might be of little interest, barely better than heads/tails.
4) Some markets are much more technically oriented than others, e.g forex/commodities vs equities.
5) General perception of TA/charting is not helped by get-rich-quick/day trading spruikers, 24 hour media cycle trying to explain every little price move, and more exotic methods such as Elliott Waves. All of these can easily invite criticism, comparison with astrology etc.
6) For me personally: Support/resistance is a useful tool for fine-tuning the execution of trades (timing, price level). Clearly this will only be a small part of a broader investment strategy that includes fundamentals, risk control, etc. I don’t have (or require) statistical proof of the support/resistance concepts, and I haven’t seen any compelling statistical disproof either. I do accept that they won’t “work” for everyone.
Adrian
:
Thanks for the reply. Good to hear you’re open minded re: TA but I’m still personally surprised you don’t buy the support/ resistance concepts as these are foundational building blocks of TA. There is some logic underpinning these concepts which I believe follows common sense and also has elements of market psychology. Statistical evidence is hard to find in the public domain. Academia not very focused on this and the ones who are don’t tend to stay in academia. It does exist in private. Certainly hedge funds, investment banks etc have studied the technical patterns and historical probabilities on performance and profit targets, but they don’t share. TA is as much art as science so it’s difficult to even find consensus definitions, which would be a precursor to the statistics you seek. I guess one might have similar difficulties to find real statistical evidence that value investing works, apart from pointing to Buffett, but is he the exception or the rule.
Roger Montgomery
:
Foundational building blocks they might be, successful and profitable they might not be. Plenty of scholarly work globally showing correlations between price and various combinations of fundamental company performance data. If, as you suggest there is some conspiracy keeping the charting signals”secret’, one wonders why if academics can find successful fundamental ratios for constructing portfolios (now often referred to as smart beta) and are willing to publish the results openly and widely (which they do and have been for decades), why they aren’t willing to do the same with technical indicators if found to be successful? Sounds like a bit of an old wives tale or urban myth to me and a neat conspiracy theory for explaining why the stats aren’t published.
Adrian
:
Just to add, I thought your earlier insight on 19 Nov, banking on gains, was a very good example of weaving fundamentals and technicals when you pointed out CBA has hit resistance when price reaches 25-30% premium to intrinsic value, and this could be a sell or profit taking signal. I think this highlights how technicals can complement value investing to help quantify price levels and timing.
Roger Montgomery
:
Indeed Adrian, especially if you have a robust method for both.
Adrian
:
I’ve been following your website for some weeks now and am generally impressed, but I must disagree with some aspects of this video. Technicals are useful to many traders, in fact they are almost indispensable nowadays. Majority use a combination of fundamental and technical, some are technical only but very few fundamental only. Please note I’m referring to traders as opposed to investors. But even for longer term investors, technicals are useful to identify price levels for entry/exit. More tactical than strategic, but still a useful tool to be aware of. Especially the basic concepts like support, resistance and trendlines. I do concede some exotic theories such as Elliott wave might well be nonsense. I also agree regarding the financial press who can easily butcher technicals in their need to try and explain every little price movement, a lot of which is noise. However it would be more credible to judge the utility of technicals based on real practitioners rather than journalists. Even if you don’t buy in to technicals at all, is it really wise to dismiss them outright when so many market participants are using them?
Roger Montgomery
:
Hi Adrian,
I would like to be convinced of their merit Adrian. But please understand I am not dismissing all forms of TA. Its just the ‘support’ and ‘resistance’. Can you find any real statistical analysis supporting their robustness? When you speak of traders, I worked at BT during the early 90’s one of the world’s best. Richard Farleigh headed the prop desk at BT and he said that charting was at best a clumsy way of identifying trends.
Kelvin Ng
:
Thanks Roger, yes Richard Farleigh was a legend in trading. In his book “Taming the lion : 100 secret strategies for investing” its clear he does not have much time for chartists and calls them astrologers. At the same time he says identifying and following trends was a core part of his philosophy. But he does not disclose how he himself identified trends. If not by charting, what tools did he use?
I am just trying to learn here and it would be much appreciated if you could share some pointers with us.
Many thanks.
Kelvin
Roger Montgomery
:
I know what some of the ideas that were used and can offer you some suggestions to investigate when we next catch up.
Kelvin Ng
:
Thank you very much Roger.
Andrew Legget
:
I think technical analysis (although i still need to learn a bit more about it) could be useful in some ways and can aid a value investor but this might not be the traditional use of it. The scenario where you see a stock as being a better buy at $2 than $1 does not make a lot of sense.
I also agree with the warning about taking what you read with a grain of salt. A good investor needs to have a healthy dose of skepticism to try and remoove themselves from the noise which a lot of articles tend to be. I am currently reading “the signal and the noise” and the author and also encourages this skepticism and raises the observation that sometimes there is an incentive for people to make outlandish predictions rather than necessarily accurate ones as getting attention drawn to them is more valuable than being seen with the crowd. However there is also the case that this outlandish prediction might be the best one to pay attention too as it has new information.
Either way, question everything, you will learn more and get a lot closer to correct outcome.
Roger Montgomery
:
Great suggestions Andrew…
zoran arnautovic
:
Technical Analysis
If it doesn’t go “down” it will go “up” or it might go “sideways”.
How clever is that?
Cheers
carlos.cobelas.1
:
Roger, whilst you have the skills needed to analyse the fundamentals of a company’s 100 page accounting report, many of us do not, but can use charts successfully to generate profits. Technical analysis is merely a tool, not the holy grail. The trouble with only using fundamental analysis is that often mere mortals like me are not privy to changes occurring in the fundamentals until it is too late, whereas insiders and people in the right industries do. I have been caught out too many times by companies with what appear to be good fundamentals, only to watch the share price fall by 30% or more, and by the time the bad news gets to my ears it is too late, and the price takes forever, if ever, to recover. That is why I, and many others, use BOTH fundamentals and technicals in our buying and selling decisions. Please do not ridicule or lambast people who do.
Roger Montgomery
:
Hi Carlos,
If you don’t have the skills to do one thing, is the only answer to go and do something else, especially when that other thing is ineffective for so many? Most mere mortals lose money trying their hand at charting. I have met a few people who have explained they have an effective trading system however and wouldn’t it be potentially more effective if applied for example to higher quality companies for the buy signals, and poor quality companies for the sell signals?
Carlos
:
Roger, whilst you have the skills to perform detailed fundamental analysis of a company’s 100 page accounting report, many of us do not but can successfully follow the charts for useful profits. Technical analysis is merely a tool, not the holy grail, and can be used successfully for profit particularly with momentum trading. The trouble with fundamentals is that they can change without mere mortals like me knowing about it, whereas the insiders or people in the industries get the sniff so to speak. Too often I have been caught out by companies with seemingly good fundamentals only to watch the share price fall by 30% and take forever, if ever, to recover. So that is why I use BOTH fundamental and technical analysis in my buying and selling decisions. Please don’t ridicule or lambast people who do.
Roger Montgomery
:
Hi Carlos,
You might note that I am particularly focusing my comments on the idea of support and resistance levels having any effectiveness. Please show me some stats that demonstrate that support and resistance levels are reliable…
I believe there are a few people that have developed trading systems that might incorporate some technical trading signals and I am not lambasting them. It’s the comments in the press about support and resistance and important “psychological” levels like “5000” that has me beat…
Roger Montgomery
:
Smart Investor (http://www.afrsmartinvestor.com.au) has expanded on some of my thoughts in this video…
You might be interested in entering the debate too:
Is technical analysis rubbish?
Published 04 December 2013 11:15James Frost
It’s all a load of rubbish, says fund manager Roger Montgomery of technical analysis.
Respected fund manager Roger Montgomery has delivered a spectacular take down of technical analysis describing it as ‘rubbish’ in video released earlier this week.
Montgomery, a strict value investor, says that the notion of support and resistance levels are absolute nonsense and that charting simply contributes to the noise that distracts investors.
“There is little scientific evidence, there’s little quantitative evidence and there’s little statistical evidence to show that they have any meaning whatsoever,” he says in the video.
Using the example of a property auction, he says it makes no sense to pass on buying a house at $250,000 – choosing to jump in only when it reaches $300,000 in the hope that it will pass through $400,000 next year.
While the analogy isn’t perfect (properties are not fungible – the vast difference in the quantum of homes auctions to shares traded) it does raise a number of interesting questions about some forms of technical analysis.
Fairmont Equities managing director Michael Gable, however, is a firm believer in the system’s value. He says it can be used to understand whether movements in price are significant and can be helpful in identifying buying opportunities.
“It’s also very helpful in the early spotting of major reversals in shares,” he says. “It tells me what the market is doing as it is often safer to swim with the tide than against it.”
Gable is, of course, a regular contributor to Smart Investor , and is also a director of the Australian Technical Analysts Association.
Readers who have followed his technical analysis and recent recommendations across the likes of Qantas, Woolworths and CSR would be comfortably in the black.
The great offence that some take to the idea that technical analysis can be used to any effect at all can be traced back more than half a century to the godfather of value investing, Benjamin Graham.
Graham was the author of two seminal investment texts for the value investing crowd. The books, Security Analysis in 1939 and The Intelligent Investor in 1949, would later inspire the world’s greatest investor, Warren Buffett.
In his 1949 book, Graham doubts that technical analysis is much good for anything, noting that most of it was based on momentum, and as such was unlikely to make money over the long term.
“This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success in Wall Street” he says.
“In our own stockmarket experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus “following the market”.
While there are various strands of technical analysis which attract a lot of criticism, including the Elliot Wave Theory, other aspects hold considerably more weight.
For example, there is little question that momentum and the weight of money can affect share prices in the short term. To be aware of this fact seems like a sensible place for investors or traders looking to eke out incremental gains to start.
This short term approach to investing is the more likely source of tension between the two camps. While the technical analysts look to exploit factors like momentum the value investors are happy for prices to over and undershoot.
Because for the value investor in search of intrinsic value, time is on their side. Value investors believe that over the long term the truly great companies will reveal themselves. And they don’t mind waiting.
As Warren Buffett himself once said, “our favourite holding period is forever.”
For those of us with slightly shorter investment horizons, it would seem foolish to disregard indicators that can act as reliable predictors of share price movements, even if it is only over the short term.
tim mann
:
Roger, by name as he deserves to be ridiculed for the constant stream of drivel he continually spouts.
I enjoyed your discussion about the nonsense surrounding technical analysis, as discussed by the AFR. I wish you mentioned
All the best,
Tim
Roger Montgomery
:
Thanks Tim. I agree but no need to name and shame. Thank you for the encouraging words.