“The only technical analysis book you will ever need” by Brian Hale

Overall, a comprehensive book on technical analysis describing trend, momentum, volume, and volatility indicators. Of particular interest were “candlesticks”, combining the trading range with gain/loss, which origin dates back to the 18th century Japan, developed by Munehisa Homma who would have accumulated a wealth equivalent of $10bn by trading rice. Also chart patterns including the classic “double top/bottom”, “head & shoulders” (not the shampoo!), “wedges”, “flags”, “cup with handles” are among the classic patterns which traders should be familiar with. The book concludes with two useful chapters on “trading edge” and “risks and rewards” to have a clear investment horizon and better risk management.

Markets are not efficient as there is no efficient relationship between risks and returns across assets and time periods. They are influenced by emotional bias in the shorter term, overreacting to headline news or noise, while they generally tend to converge towards fundamentals in the longer term (beware, pricing can sometimes become a self-fulfilling prophecy like with distressed debt). Too many investors consider the purchase price as their key reference, despite its arbitrary nature for a market stand point, being unwilling to sell below, or happily selling as soon as the price has recovered from an initial loss, or increasingly eager to sell to crystalise gains after a strong rally. This is the typical “holding losses too long” and “cutting winners too early”. Candlesticks and chart patterns can allow traders to assess support levels, resistances, trends, and potential inflection points. It would have been a useful addition in this book to statistically test these bullish and bearish formations with key financial assets (S&P500 and/or $10ys yield) over a significant period to back up their significance.

Among the indicators, I am unconvinced to say the least by moving averages. Having tested (see previous post) the famous 200/50 days moving averages alongside a variety of longer/shorter moving average combinations, the long/short signals provided by the intersection of the two moving averages dramatically underperform the S&P500 over the past 10 years, as trend indicators tend to perform very poorly with volatility, missing market crashes and V-shape recoveries.

Otherwise, Bollinger bands (typically 20-periods rolling average volatility bands) appear the most useful when assessing likely return distribution for mean reverting assets, alongside volume indicators which provide information regarding the strength of a trend or risks of a potential reversal.

Yes, technical analysis can appear backward-looking or “tea leaves reading”. Nonetheless, it provides useful short-term information regarding the market psychology which is, as long as we remain human beings, reference dependant. Maybe a future entirely governed by Artificial Intelligence will make it completely obsolete? The development of trading models seems to have already affected its effectiveness. A good addition to your financial library. Fabrice Pellous, CFA