Fundamental Thoughts Regarding Technical Analysis T/A
by Rob Kirby, Kirby Analytics. May 23, 2005
Why do chartists chart and what is technical analysis?
Technical analysis is the examination of past price movements to forecast future price movements. Technical analysts are sometimes referred to as chartists because they rely almost exclusively on charts for their analysis.
Man's propensity to look for answers to the big questions; Are we alone? Is there life after death? What does the future hold? Man's curiosity and the quest for answers to these and other questions have no doubt led to great advances in math and science. From a cultural and standard of living angle we've seemingly made plenty of progress – that is, if you happen to live in the right part of the right country under the right set of circumstances. But still, the big questions remain unanswered – to the best of my knowledge.
Some claim that they use technical analysis to get an "edge" on other investors. Some claim to have superior systems. Some advocates of T/A even claim to have systems that are infallible. But then again, once reality sets in, there's always this:
"...[technical analysis] looks for peaks, bottoms, trends, patterns, and other factors affecting a stock's price movement and then making a buy/sell decision based on those factors. It is a technique many people attempt, though very few are truly successful."
From where I sit, the chances of success using any system based on utilizing data only requires discipline, probably over and above all other traits. Funny thing, though, the most disciplined folks where personal health is concerned tend to live longest too – I'd be willing to bet – without even looking at a chart.
What stands out in my mind, that you're not likely to see written in many books, is that there exists a couple of underlying assumptions upon which the science of T/A is built. You will not see these assumptions articulated very often since they sound too logical and are, well, assumed. I would contend that the first of these assumptions is that investors are assumed to be rational. The second of these assumptions [which I believe follows logically from the first] is that people engage in economic activity for profit. I would argue that should either of these underlying assumptions be violated, T/A becomes highly unreliable and a massive invitation for impropriety on the part of ill doers.
Interestingly, I would now like to use technical analysis, and the work of one of the craft's most experienced practitioners, to try and make this case – explaining how this works:
Table 1 Compliments G. M. Bolser http://www.interventionalanalysis.com
What this graph charts is standard deviation - using a proprietary measure derived by statistician/mathematician, Mike Bolser, called the Preemptive Selling COMEX Gold. In Bolser's words,
"...preemptive selling is a fraud detection algorithm, measures very aggressive COMEX gold market selling when compared to the London gold market (LBMA). Table 1 displays the percentage of days per month in which the COMEX gold price falls 300% more than the London gold price. The probability of changing macroeconomics being the cause for such extreme New York price drops is highly diminished because the two markets trade the same commodity on the same day. Preemptive selling should not be confused with price volatility or rate of change, which are measures of rapid price fluctuation. In addition, preemptive selling is a measure of relative activity between two markets. It does not measure the volume of comparative selling, only its effect as measured by gold market prices."
Not that Mr. Bolser's words need improving, but in plain layman's speak, Bolser has devised a lie detector – using scientific and mathematical analysis. It was created to help resolve the question of whether or not the world price of gold is "rigged" by Central Banks – even though the CB's insist that it is not. The CB's would have a lot more credibility if they could pass the lie detector exam on this issue. The reality is this: they fail miserably.
A fuller explanation as to the machinations of exactly what is occurring in the standard deviation spikes in the graph above in Bolser's words,
"The numbered spikes are correlations to other gold-related events as follows: (1) Federal Reserve assumes two board seats at Bank for International Settlements; (2) steadily rising gold price threatens to pierce $400; (3) important change downward in the long-term gold price; (4) failure of Long-Term Capital Management, reportedly involved in the gold carry trade; (5) Washington Agreement provokes sharp rise in gold prices; and (6) Canadian Imperial Bank of Commerce works to resolve Ashanti hedge book failure."
The selling of gold depicted and outlined in the graph above does not happen by accident. Standard deviation moves of 4.22 sandwiched in amongst other standard deviation moves of well in excess of 3 - always skewed to the sell side – are absolutely and categorically contrived man made events. This type of selling has categorically been executed without the seller's attempting to maximize their returns on the sale of their gold. Where I come from, it is safe to assume that the underlying assumptions that make technical analysis of the gold market relevant – have indeed been violated. At the end of the day, I highly question the effectiveness of technical analysis to give us the true picture regarding the health or underlying sentiment in the gold bullion or shares market since it is clear for all to see that the price of gold has been managed or rigged in this fashion for years. Remember folks, technical analysis in a free market is a lot like a sharp tool. In a rigged market, its effectiveness is blunted and strict adherence could hurt you.
Where I sit, prudence dictates that all investors should have some exposure to gold and precious metals in light of this manipulation. Remember folks, maintaining an artificially suppressed price for any commodity requires the sale of that commodity in its physical form. Pundits at GATA have long held that the World's Central Banks are fast approaching the time when their stocks of bullion will be exhausted. If you haven't already got some exposure to precious metals, I fundamentally feel you better get some.
I have written about this same topic before, highlighting Mr. Bolser's work in an essay called, To GSE or Not to GSE?, that you can find here. I find his work important enough that I also fundamentally feel it should be revisited from time to time.
In overseas equity markets, Japan's Nikkei Index finished the day up 121 to 11.158. North American Indexes closed broadly higher with the DOW up 51.65 to 10,523, the NASDAQ up 10.23 to 2,056 and S & P up 4.58 to 1,193.
Bonds did better with the benchmark 10 yr. ending the day at 4.07% while the 5 yr. closed at 3.82%.
Precious metals finished the day mixed with COMEX gold futures closing down 1.00 at 416.80 and silver unchanged at 6.96. The XAU Index closed up 1.23 at 81.96 with the HUI up 5.38 to 177.14. NYMEX crude oil futures finished the day up .51 to 49.16 per barrel.
The US dollar Index closed modestly lower, down .28 at 86.39. The YEN finished the day at 107.65, the EURO at .7951, the GBP at .5470, the CAD at 1.2584 and the RUBLE at 28.04.
On the docket for tomorrow, May 24 at 10:00 a.m., we'll be watching for the release of April existing home sales, expected to be 6.90M vs. a prior 6.89M. Then at 2:00 pm. the Fed is expected to release its FOMC minutes from its May 3rd meeting.
That's the day that was – good night to all – have a great evening and have a pleasant tomorrow.
© 2005 Rob Kirby