Book Review: The Heretics of Finance – Conversations with Leading Practitioners of Technical Analysis

05 Apr 2009

Special to AllAboutAlpha.com by: James Burron, CAIA, ICICI Wealth Management Inc.

Ever heard of Peter Lynch, Warren Buffett or Benjamin Graham?  Sure.  But how about Robert Farrell, Alan Shaw or Stan Weinstein?  Chances are many investors have heard of most or all of members of the first group and none of the second.  What’s the difference?  Lynch, Buffett and Graham are fundamental (research) investors; Farrell, Shaw and Weinstein are technical adherents.

The striking part of reading The Heretics of Finance (Andrew Lo & Jasmina Hasanhodzic, Bloomberg Press, 2009) was that upon opening it up to the table of contents, I could only find one interviewee I recognized (Laszlo Birinyi Jr., if you were wondering – and only because he was often on Wall Street Week). This made me think: was I missing out on something, or was technical analysis really just a rather obscure investment style more akin to astrology?

I tried to keep an open mind as I readied myself for talk of head & shoulders (not the shampoo), double and triple tops, pennants (whatever those are) and breakouts.  I’ll admit to being a somewhat of a skeptic of technical analysis.  But as I read Heretics, I gained an appreciation for what drives these highly intelligent – if not quirky – individuals.

Heretics of Finance has two sections. The first includes the answers to a series of questions posed to 13 technical analysis practitioners. They are not all investors, as many of them author newsletters that alert subscribers of trends and patterns of the day.

The questions were actually posed back in 2003/2004, so it was quite interesting to view the answers in the context of today’s financial markets.  For example, Robert Pretcher has recently been pounding away at the Elliott Wave Theory saying we have more downside than up right now.  Yet several of the experts interviewed in Heretics said there is a fundamental problem with the Elliott Wave Theory: it misses reversals.

Each practitioner describes what got them into technical analysis in the first place.  The common thread: they say simply weren’t getting the answers they needed from fundamental analysis.

Apart from that common genesis, each of the practitioners approaches technical analysis in a strikingly different way. Some manage money; some do not. Most start early in the morning; but some stay late. Some preach Elliott Wave; some don’t see it working very well at all.  Some look at economic indicators; and some are purely price-driven. It just goes to prove that there is more than one way to skin a cat, or to read a market.

The second part of Heretics covers questions that many of us might want ask a technician.  For example, the what is role of luck in technical analysis; the effect of astrology on technical analysis (and the resulting perception of technical analysis); the need for a formal education in technical analysis; and what are the most – and least – reliable indicators. Some questions elicited common answers from the interviewees, while others elicited responses that seem diametrically opposed.

It all makes for very interesting reading. But does it make you money? That was my question when I started Heretics and after completing the book, I’m still not really certain. Of course there are technical analysts who make a lot of money in the markets; there are technical analysts who make a lot of money publishing newsletters; and there are newsletter subscribers that make a lot of money applying the content contained within them.  But not surprisingly, it’s difficult to distill specific trading lessons from the anecdotes presented in Heretics.

I’m reminded of an idea initially proposed by author Nassim Nicholas Taleb.  He said that the very existence of someone like Warren Buffett should come as no surprise to anyone.  After all, we’d expect that given the millions of investors in the world, at least one of them is bound to beat the odds and make a few tens of billions of dollars.

By extension, one could argue that the success of Renaissance Technologies (James Simons’ quant-based fund management company; quoted in Heretics) Man AHL, Winton Capital and Aspect Capital was the outcome of simple probabilities. If success had not fallen on these firms, it would necessarily fall on some other technical-trading operation.

in other words, for every 1,000 traders there might be just one big winner (and many losers).  Yet oddly, we never hear of the losers. Since there are so many managers out there, it makes sense that a few just might make tremendous (almost unbelievable) returns over the years.

So the question on my mind when I completed this enlightening compilation was: Is this technical analysis skill or luck? I still don’t really know.

However, after reading the book, I am definitely more in touch with the nuances of technical analysis and the fact that it seems to work well in certain markets.  There is no disputing the track record of certain technical traders and if it can help you (or your money manager) earn a few more basis points then I’m all for it.

Heretics of Finance may not change the way readers see the markets, but it just might change the way we see those who read the markets.

– J. Burron, April, 2009

The opinions expressed in this guest posting are those of the author and not necessarily those of AllAboutAlpha.com, ICICI Wealth Management Inc. or its affiliates. Any third party information has been taken from sources thought to be reliable but there can be no assurance that such information will be accurate or remain constant. This review is provided for information purposes only.

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3 Comments

  1. valerie
    April 8, 2009 at 9:07 am

    Doesn’t it strike you that financial analysts are always wrong? That all of them (OK, 99%) forecasted nothing about the current crisis? Nothing about the 2000 dot com bubble, then collapse?
    Why do you doubt about technical analysis, and do not even have doubts about the proven failures of fundamental analysis when it comes to forecasting prices?
    Valerie


  2. siin
    October 1, 2009 at 8:13 am

    Doesn’t it strike you that financial analysts are always wrong? That all of them (OK, 99%) forecasted nothing about the current crisis? Nothing about the 2000 dot com bubble, then collapse?
    Why do you doubt about technical analysis, and do not even have doubts about the proven failures of fundamental analysis when it comes to forecasting prices?
    Valerie


  3. Denise Shull
    October 2, 2009 at 4:30 pm

    Part of the problem here is that there is an infinite number of technical analysis variables and the quality among them varies by great degrees.

    On the other hand, if you look at the ones that most purely represent what other investors/traders have done and the ones that most of the people can see (moving averages for example), you will find that indeed they tell you something about what many other investors/traders are very likely to do in the future.

    The saying “the market has a memory” is very clearly seen on a chart.


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