Burton Malkiel is an economics professor at Princeton University and in his book, “A Random Walk Down Wall Street“, he strongly criticized the chartists (or known as the technical analysts who look at charts to make investment decisions).
Past results cannot predict future prices (hence you cannot time the market)
“The results (from back testing of technical rules) reveal that past movements in stock prices cannot be used reliably to foretell future movements.”
Hence, he stated that it is futile for technical analysts to observe and time the market.
It is even more dangerous to time the market as “Prof. Seybun of the University of Michigan found that 95% of the significant market gains over the thirty-year period from the mid-1960s through the mid-1990s came on 90 days of the roughly 7500 trading days.” This means that a chartist only has slightly more than 1% of a chance to enjoy the large gains during that period. Malkiel sees the risk of missing out these large gains inherent in the chartist way of investing; while such risk is not bore by a buy-and-hold investor.
Momentum in stock market = Fooled by randomness
Malkiel believes that the perceived “momentum” in the stock market can actually be as random as a series of coin tossing results. Using a simple experiment – Starting with a hypothetical value of a stock, toss a fair coin to determine the price movement of the stock. By adding half a point for every head and subtracting half a point for each tail, one is able to replicate a real stock chart showing a typical stock profile. (You can try it!)
He mentioned, “Sometimes one gets positive price changes for several days in a row; but sometimes when flipping a fair coin you also get a long string of “head” in a row…” “What are often called “persistent patterns” in the stock market occur no more frequently than the runs of luck in the fortunes of any gambler playing a game of chance.”
A high cost game
As he was not a believer of the strongest form of efficient market, he acknowledged the slight presence of momentum in the market. However, he felt that chartists’ frequent entries and exits in the market incurs profit wiping results:
“While the market does exhibit some momentum from time to time, it does not occur dependably and there is not enough persistence in stock prices to overwhelm the substantial transactions costs involved in undertaking trend-following strategies.”
He added, “after paying transactions costs, the method does not do better than a buy-and-hold strategy…”
If you are one investor that practises technical analysis, you may like to defend your method! Show us the numbers!
You may also like:
- A Random Walk Down Wall Street by Burton Malkiel
- Fooled By Randomness by Nassim Taleb
- Why investing in mutual funds or unit trusts may not be a good idea?
- Why share prices fluctuate?
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