Technical Analysis and its Controversy among Nepalese Investors

Tue, Dec 25, 2018 7:23 AM on Economy, Recommended, Stock Market,
Technical...

Technical analysis has recently gained popularity among Nepalese investors, be it in a positive way or in a negative way. These days you can hardly find investors, who have not heard about technical analysis, however, the opposite was true 5 years back. In Nepal, commodity traders are known to be the early adopters of the technical analysis discipline. I personally know a handful of commodity traders implementing technical analysis a decade ago when it was still unknown to stock investors. The sophisticated charting platforms provided by the commodity exchanges may have contributed to the interest towards chart analysis among the commodity traders. However, it is heard that early stock market guru Jeevan Basnet used to plot the stock prices manually on the paper to analyze the price actions. In the recent years, various companies started to cater charting services to the general public and the technical analysis began to gain popularity among everyday traders. Some believed TA helped them to make their trading/investing decisions while others thought it as a complete absurd way of looking at the market.

Why Hatred towards Technical Analysis?

The root cause for hatred towards technical analysis (and technical analysts) lies in the way investors perceive the stock market. By definition, individual investors and general public are considered as uninformed and unsophisticated investors, they lack proper research and resources and most of the time they are assumed to be in the wrong direction of the market. However it does not mean that individual investors cannot be in the right direction, smart ones can. In Nepal, criticism of TA is heard mostly from individual investors rather than from institutional levels. General public are looking for certainty in the market while it does not exist at all. Either a fundamental analysis or technical analysis, both of these have to deal with uncertainties. In reality, both methods are on the same page on this regard. The common misconception I see among Nepalese investors about TA is that they think TA can predict market prices. Yes, you read that right. However, TA cannot predict prices; TA can just tell you what is likely to happen over the other. Although chart patterns and Elliott wave theory can give you price forecasts, they are quite subjective in nature. Modern technical analysis is concerned with defining objective rules that are programmable. Trading is the game of probability and you do those actions which have higher probabilities of occurring. Market practitioners and researches have demonstrated that market does not follow random walk and market is not fully efficient all the time. In other words, you can exploit the trend of the market and make money out of it. When an experienced TA gives opinion on the market, he/she talks about the most probable outcome and warns you where to exit your position when you are wrong. But market takes the analyst’s opinion as a sure shot prediction and the worst is they are ignorant to stop loss mentioned by the analyst. Moreover, they even conclude that TA is useless.

Besides, there are so many “so called TAs” in the market. Some take TA classes for few weeks and begins posting TA analysis claiming 100% certainty which is unlikely to happen.  

Problem arises when investors expect 100% accuracy out of any analysis (fundamental or technical). Uncertainty is the fundamental feature of the market and how can one think of any method that will precisely forecast the future.  Since public expects TA to be perfectly accurate all the time, it is the sole reason why they are disappointed with it very soon.

TA Does Not Work in Nepali Market (Myth)

This is the most absurd statement one can make regarding TA in Nepali stock market. It is absurd because the logic that backs up this argument is baseless. One of the hilarious logics is- it does not work because only few people use TAs. If so many people had to use it to work, then imagine how TA must have begun? Do you think large number of people gathered and created an imaginary line and promised to follow it to manipulate the market? No, stock market does not work like that. If majority of the investors use the same strategy it will be useless because everyone tries to be ahead of the game. Many technical indicators that were profitable in 70s in the western market are now useless because majority of the people use it. Having more people using same technique means that technique will be less effective, opposite of what most of us think.

Another premise investors have to support their conclusion is, our stock market is sentiment and news driven; so, fundamental, technical, in fact nothing works here. If one says so then one must be assuming either we have a highly efficient market or very inefficient market. As per Efficient Market Hypothesis (EMH), in a strong form of efficient market, no amount of public (fundamental and technical) and private information (insider) can help you to earn above benchmark return. The subject of behavioral finance has already demonstrated that a perfectly efficient market does not exist at all, efficient and inefficient markets rather coexist. Even the best stocks from most developed economies have crashed regardless of the company’s breathtaking fundamentals. So, when no stock market is perfectly efficient at all times how can you expect Nepse to be so efficient? If inefficiencies exist in the market, it is possible for FA and TA to make money from the market.

Or do you think that Nepalese stock market is very inefficient? If it is so inefficient then why NABIL which has EPS of 52 trades around 900 and CBL with EPS of 6 trades around 170? It means that our market may not be as efficient as in developed economies but it isn’t really inefficient either. Even if the uninformed investors drive the price away from its fair value, the informed investors bring it to the normal value. However, it may take a bit time to come to the fair value in market like ours. This rather means if you discover any mispricing of stocks, it’s a very good opportunity for you. Moreover, TA and FA can exploit the mispricing caused by overreaction and under reaction of the crowd and can take advantage of it. Inefficient market is a gift not a bane.

Another logic investors use to argue against TA is that TAs are bullish when the market is up and they are bearish when the market is down. This is called trend following. Based on the time period the trend persists, the market trend can be classified into- primary, secondary, and minor trends. Primary trends are secular bull and bear markets, secondary trend lasts for months, and minor trends lasts for few days. So, when a technician is bullish and bearish overnight it means that they are looking at the minor trends. Minor trends are subject to erratic price movements and they change overnight. Shorter the time frame, more random is the price movement. So when you ask any chartist for market opinion you should also let them know which degree of trend you are asking. If you are asking about weekly trend, obviously the trend may keep shifting over weeks. When you talk about trend, understanding time frame is crucial. Changing opinion with changing market conditions is better than sticking to same view hoping that market will come back to your level. It is not a stupid thing to listen and follow the market.

Criticizing TA without statistical evidence is useless

If someone really thinks TA is useless, one should back test and forward test the technical indicators and patterns and prove it. Any technical indicator can be considered useless if it does not generate consistent results and profitability. Cursing TA without actually understanding it and testing it in the market data makes the argument very weak. In fact it was found that even a 20-day simple moving average could largely outperform the buy and hold strategy in Nepalese stocks. Next time when you say TA is useless, please tell me which indicator did you test and what results you got. Testing is easier in quantifiable (objective) TA techniques, subjective analysis like chart patterns, trend lines, support and resistance, etc. are hard to test in computer using algorithms.

TA in Global Investment Space

Based on extensive research carried out by Lo and Hasanhodzic (2010), prices were recorded with the intention to predict in ancient Babylonia in the first millennium B.C. These prices were found in the diaries of traders and astronomers who were trying to correlate astrology with commodity prices. During fifth and sixth centuries, price charts similar to those used today were developed in China, Europe, and Japan. Chinese were inclined to cyclicality of prices, Europeans loved astrology, and Japanese invented candlestick chart which we use today. Establishment of commodity exchange in Western Europe (1561) and Japan (1654) opened doors to the development of charts. By 1830s, various chart vendors started selling published charts on stock and commodity. Invention of the ticker and ticker tape changed technical analysis and charting completely. After Thomas Edition invented Edision Telegraph Printer to print messages from a telegraph, Edward A. Calahan invented ticker tape.  By early 1900s, Charles Dow and other pioneers contributed largely to the TA discipline.

A small group of sell-side analysts on Wall Street started a not-for-profit association in 1973, it is now called “CMT Association”. CMT stands for chartered market technician. CMT association initiated a certification program by developing and administering exams in the late 1980’s. Currently more than 4500 technicians in over 85 countries have taken CMT certification. In 2005, the Financial Regulatory Authority (FINRA) and U.S. Securities and Exchange Commission (SEC) accepted CMT Level 1 and 2 as an alternative to Series 86 examination, which is a basic requirement for an equity research analyst. Morgan Stanley, Wells Fargo, Bank of America, Charles Schwab, Fidelity, Bloomberg, Barclays, Credit Suisse, etc., are some of the top employers of CMT charter holders. Today we can see professionals with both CFA and CMT designation and they admit that TA helped their decision making process. Popular one is- “CFA helped me to get the job and CMT helped me to keep the job.”

There Is No Single Right Method

Whether fundamental or technical the ultimate goal of the investor/trader is to make money. There is no rule of thumb in investing. Traders and investors should focus on what works for them not on what does not.  Investors/traders should build the habit of studying good books rather than looking for investment tips on social networking sites. Moreover, TAs don’t manipulate the market because they cannot, instead money and inside information can manipulate the market. Big boys don’t spend time on Facebook and they don’t care what people are posting, so Facebook posts does not move market, money does. And for those people, who do not believe in TA, it is okay you do not have to believe it, focus on what you believe in. But before criticizing the discipline, study about it in-depth so that you can give valid opinions against it. Try to find scientific and statistical evidences defying the TA, not some cheap irrational arguments.

No investment philosophy is without drawbacks and limitations. If one method worked so well, there would be no need to search for another method, but still today people are looking for innovative ways to trade in the market. To sum up, before judging TA based on some analysis on Facebook and three lines of definition on Investopedia, please do some study and feel free to let me know on what point you disagree. Happy Investing!

 

Arun Krishna Lama

mrarunlama@gmail.com

Technical Analyst (Passed CMT Level I, waiting for Level II result)

Global IME Capital Limited