Why technical 'analysis' is garbage (explained by a quant developer)

Summary

In this video, Coding Jesus critiques technical analysis, arguing it's fundamentally flawed and largely ineffective for predicting future price movements. Drawing on his experience as a high-frequency trading software engineer, he explains that prices are random and cannot be accurately forecasted by past data. He highlights the simplicity of technical analysis, its appeal to human pattern recognition, and the misleading reports from brokerage firms. He emphasizes that empirical studies show popular patterns, like head and shoulders, fail to yield profitable signals. Ultimately, he encourages viewers to focus on more substantive analyses rather than relying solely on price charts.

Takeaways

• 🚫 Technical analysis is deemed ineffective by the speaker, who argues that it is based on flawed beliefs about price predictability.
• 📈 Prices are considered random in the short and medium term, making future price movements unpredictable.
• 🦖 Many traders are attracted to technical analysis because it simplifies the trading process, appealing to their desire for minimal effort.
• 🧠 Humans are naturally wired to recognize patterns, which leads to the misconception that identifying patterns on charts can guarantee profits.
• 🔄 Different traders can interpret the same chart in completely opposite ways, highlighting the subjective nature of technical analysis.
• 💰 Brokerage firms issue technical analysis reports not to validate the method but to attract more trading activity on their platforms.
• 📚 Empirical studies show that popular patterns, like the head and shoulders, do not reliably predict future price movements.
• 📉 Retail investors often focus on short-term trading, neglecting the fact that profitable strategies usually involve long-term investments.
• 🧩 Technical analysis may lead to stress and dissatisfaction for traders who rely on it, as it fails to provide consistent success.
• ⚠️ The speaker encourages viewers to question the validity of technical analysis and consider the underlying economic principles that influence prices.

Q & A

What is technical analysis according to Coding Jesus?

Technical analysis is the belief that future price movements can be predicted based on current and previous price movements, often using charts and indicators like MACD and volume.

Why does Coding Jesus believe prices are random?

He argues that prices are random in the short and medium term, citing concepts from 'A Random Walk Down Wall Street' and stochastic processes like Brownian motion.

What appeal does technical analysis have for traders?

Technical analysis is appealing because it simplifies trading, suggesting that one can achieve wealth by simply analyzing price charts without deep market understanding.

How does Coding Jesus describe the psychology of traders who rely on technical analysis?

He suggests that traders focusing solely on technical indicators may be processing information ineffectively, often leading to stress and poor trading outcomes.

What is the flaw in the pattern recognition aspect of technical analysis?

Coding Jesus explains that different traders can interpret the same chart in completely opposite ways, which shows that pattern recognition is subjective and unreliable.

What role do brokerage firms play in the perception of technical analysis?

Brokerage firms issue technical analysis reports primarily to generate trading volume and fees, not necessarily to provide accurate or beneficial advice to traders.

What empirical evidence does Coding Jesus reference to support his views?

He refers to studies indicating that certain patterns, like the head and shoulders pattern, do not yield reliable trading signals in the long run.

What is the significance of understanding price as a valuation of future cash flows?

Coding Jesus emphasizes that a price is a subjective valuation based on expected future cash flows, which contrasts with the notion that past prices can predict future ones.

How does he suggest traders should approach the market instead of using technical analysis?

He advocates for a deeper understanding of market fundamentals and long-term trends rather than focusing on short-term price movements or patterns.

What does Coding Jesus imply about the effectiveness of technical analysis among retail investors?

He implies that retail investors often fail to make consistent profits using technical analysis due to its inherent flaws and reliance on subjective interpretations.