PostHeaderIcon Why using technical analysis in stock market investing does not work – Part 3

Last time in “Why using technical analysis in stock market investing does not work – Part 1” I discussed the first two reasons why technical analysis does not work and that is because of its nature and because its tools are flawed.

Why using technical analysis in stock market investing does not work – Part 2” discussed reason number 3 and that is using technical analysis in stock market investing does not work because a lot of credible long term studies reveal that it does not work. Getting Offset Mortgages to invest in the stock market while using technical analysis will certainly give you more problems as it will over-leverage your portfolio and as pointed out.

We continue with the last part of this series with reasons number 4 and 5.

Reason #4 – Using technical analysis in stock market investing does not work because it based on a wrong premise

The premise of technical analysis is that you can maximize profit by buying low and selling high. This is achieved going in and out of the market within a short period of time. Technicians think this is possible since you can predict where most the stock price will be headed by using charts. This makes technical analysis very tempting to use. The reasoning seems to be based on logic that is why it has attracted lots of people. If you can buy stocks today for $10.00 and tomorrow it becomes $100.00 why not do it? After all buying low and selling high is the name of the stock market game. The fluctuation of stock prices is based on supply and demand which in turn is based on market sentiment about individual stocks so it is logical to conclude that the charts should reflect where the stock price is headed.

It may sound logical but it isn’t effective because as discussed technical analysis does not work because of its nature. Market sentiment is just so unpredictable and cannot be confined to a chart. The premise that you can maximize profit by going in and out of the market within a short period of time using technical analysis is severely flawed. Investors end up loosing more instead. According to the Wall Street Journal Europe “Whether technical analysis is really useful … is a matter of some dispute on Wall Street. Some investors believe that it is impossible to forecast the market’s ups and downs. Academic studies have shown that when most people, professionals and amateurs alike, try to move money in and out of stocks to beat market fluctuations, they tend to wind up with losses.”

Another reason why the premise is wrong and people using pure technical analysis end up loosing more is because of the transaction fees and taxes. By moving in and out of the market rapidly you get slapped with lots of transaction fees and taxes such that your expected net gain becomes much smaller. This is what Warren Buffet calls as the “4th law of motion.” He writes “Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, ‘I can calculate the movement of the stars, but not the madness of men.’ If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”

Reason #5 – Using technical analysis in stock market investing does not work because the real stock market experts who made billions in the stock market says it does not work.

The real stock market gurus who made billions in stocks and had consistent market returns for a long period of time has revealed their disdain for technical analysis.

Famed value investor Peter Lynch who has grown Fidelity’s Magellan fund from a mere $18 million in assets in 1977 to $14 billion in assets in 1990 (An average of averaged a 29.2% return) has this to say about reading charts “Charts are great for predicting the past.”

It is said that the world’s greatest stock market investor, Warren Buffett spent years learning technical analysis during the early part of his career This proved to be a futile effort and an expensive mistake. What was his conclusion on technical analysis and reading charts? Well he has this to say “I realized that technical analysis didn’t work when I turned the chart upside down and didn’t get a different answer.” He added “”If past history was all there was to the game, the richest people would be librarians.” Warren Buffett then decided to turn to what Benjamin Graham taught – Value Investing. This proved to work wonders for him.

Famous investors who were very consistent in getting high rates of returns for a long period time such as John Templeton, Shelby Davis, Philip Fisher, David Dreman, John Neff and many others all succeeded in the stock market by being value investors and relying heavily only on fundamental analysis.

In conclusion technical analysis does not work; those who insist that it does are only deluding themselves. To become an intelligent investor, there’s no other way but to approach stock market investing from a business perspective. To invest in stocks from a business perspective you have to know the business inside out and do a diligent study of its financial statements. An intelligent investor is a good businessman. As Warren Buffett puts it “I am a better investor because I am a businessman, and a better businessman because I am an investor.”

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11 Responses to “Why using technical analysis in stock market investing does not work – Part 3”

  • Anon says:

    Zdiaz,

    Tae ka kahit delete mo pa.

  • zigfred says:

    Anon: hahahah Ingit ka lang kasi pure technical analyst ka and then ipit ka sa stocks mo 🙂

  • francis says:

    i agree. I know the basic of technical analysis but still prefer basing my decision on price actions in trading stocks. Its too laborious to do such technical analysis but the reward is not that high.
    nice blog

  • zigfred says:

    Francis: Thanks for dropping by !

  • footballer says:

    Zigfred,

    i thought you ended the blog already because i didnt
    see a new post since november. hopefully you can write
    more articles.

    i also checked out the link to batangas today but
    there were no new articles there as well.

    incidentally, my impression is it would be hard to
    apply phil town’s rule no. 1 here because of the lack
    of websites like msn and yahoo covering local stocks,
    how do you manage?

    thanks.

  • zigfred says:

    Footballer: Sorry for that. Just got so busy and caught up with other things. But I intend to write additional articles for this blog again as well as for Batangas Today. I will be unloading some of my responsibilities come June this year to focus more on blogging and portfolio management and of course to spend more time with my family 🙂

    Yes, its hard, but fortunately most companies already have websites wherein you can download the annual reports. Still, its hard to get 10 years of data. I’ve managed to get 5 and some 10 years for some company though.

  • don doc jb says:

    Zigfred,

    Keep up the good works of sharing the bit of your knowledge to a newbie like me.

    More Power!

    and to you ANON, what do you contibute to the society ???

    I dont think meron kaya you are the one you describe _ _ _ right anon?

  • zigfred says:

    Thanks don doc jb 🙂

  • erialc says:

    hi zig,
    am a newbie here just recently tried the Stock market with zero knowledge, thnks i got accross ur blog..
    im learning here.. hope to read more on your post..

    thanks & GB!
    erialc

  • zigfred says:

    erialc: You are more than welcome

  • zigfred says:

    eiralc: You are most welcome !

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D’ Intelligent investor is one of the first few updated value investing blogs in Asia and probably the only updated value investing blog in the Philippines where you can learn stock market investing through intelligent investing that makes business sense. The stock market investing strategies are very different from what most stock market players advocate. The strategies featured here are mainly value investing principles more specifically inclined with what are perceived to be Warren Buffett’s style of investing. Other value investing strategies by great value investors such as Benjamin Graham, Peter Lynch, John Boggle among others are also featured.