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Technical and Human Analysis

May 7, 2009

The FT Alphaville Blog put up a post earlier this week about Bloomberg being critical (see article) of technical analysis and its ability to make money using techniques such as "Bollinger Bands". In summary Bloomberg have backtested some of the most common technical analysis strategies over recent years and found the majority of them have lost money.

This took me back a few years to a conversation with a derivatives trader in Hong Kong who having come from a mathematical background was a natural believer in "efficient markets" in that all information known about an asset was reflected in its current market price (and hence that drawing some lines on a chart would not tell you anything that the market had not already factored into the price of the asset).

On one occaision, the trader was phoned by a broker who asked him if he had "seen that the Hang Seng had just broken its resistance point". Initially having dismissed the broker's call as rubbish, then upon reflection he knew the broker was going to be calling many of the major players in the market and that many would listen to the broker and act upon it. Thinking about it further, the trader decided to go along with the broker's trading idea simply because others would and it would become a self-fulfilling opportunity. Sure enough, the Hang Seng did rise that day as the broker had predicted and the trader made some (reasonable) money from the trade.

So whilst technical analysis has its failings, human behaviour ("herd instinct" or the ubiquitous "Mr Market") cannot be ignored. Given the underlying human causes to the current crisis, the more work that can be done on better modelling of human behaviour is all to the good in my view.