Technical Analysis Critique

I bet you cannot distinguish a stock chart from a chart of randomness. I also bet that your understanding of support and resistance is demonstrably wrong. You know what? I bet you have almost no idea how to use technical analysis correctly, period! Good morning, and time for a healthy debate. As my citation authority, I could pull from the annals of game theory, statistics, or the infamous government study about 90% of traders losing money. But I won't. Instead, I will defer to Adam Grimes of SMB Capital. You see, Grimes has been quietly working on a blog series about randomness. His thesis is that most traders would trade a randomly-generated chart in the exact same way that they would trade a real stock chart. Ahem. How about that for getting your attention? In his five-part (to date) series, Grimes is questioning the validity of an entire industry based on technical analysis. Millions of dollars are spent every year by traders looking to improve their analysis of "trends," "support," "resistance," or a variety of other stock chart indicators. The vast majority of these traders will never maintain profitability, and yet an endless supply of new traders continue to buy analytical products and pay for this education because of hope that they might become one of the fortunate few. The problem is, they probably won't. Although the technical analysis industry is more than obliged to meet this demand, of course, and so continues to sell workshop after seminar after book after software package to hungry traders looking to perfect the art of technical analysis. My goodness, if Grimes' critique gained popularity and this industry collapsed… well, let's not get too far ahead of ourselves. Despite the prestige of his firm, Grimes' critique of technical analysis has gone relatively unnoticed in the trading community. Benzinga would like to help solve that problem by giving credit where credit is due. So, here we go: a quick summary, with plenty left "for further reading." In part 1, random thoughts (or, rather, thoughts about randomness), Grimes introduces the concept of randomness and its consequences for traders. It has serious consequences, as you might have imagined by now- consequences that just might make you think twice about that 50-day moving average on your computer screen. Anyway, although he begins to formulate some of his critiques of technical analysis, he leaves this post open-ended. Thankfully, he continues in part 2, another look at randomness. Here, Grimes outlines his core argument: I challenge readers to distinguish between a random chart and a stock chart. He also places his bet, and he bets that you can't. He leaves readers with a quiz of several charts for testing their own abilities. Grimes lets readers complete the quiz and returns, winning his bet, in part 3, Randomness: the answer key. In the teacher's edition of the series, Grimes provides the surprising answers to the quiz, along with some take-aways up to this point. Based on popular demand, Grimes continues the series in part 4, http://www.smbtraining.com/blog/volatility-clustering-one-way-that-markets-are-not-random, demonstrating an unusual way in which a stock chart should not look like a randomly-generated chart. Just before Grimes spills the beans on a legitimate trading method that could actually beat the markets, he stops just in time for the cliffhanger. Finally, in the recently-published part 5, Randomness revisited: random levels, Grimes applies the lessons of the previous posts to a real-world setting, showing that most traders' use of support and resistance is, well, worthless. Benzinga certainly hopes there comes a part 6, and 7, and many more, but the time has come to increase awareness about this series now. Benzinga hopes that all traders who question the fundamental nature of the markets will find answers to their questions, rather than sales pitches for seminars or software packages. Therefore, we highlight this blog series as an opportunity to engage with a critical thinker who obviously has considered the true definition of a "high-probability trade." Grimes is able to take traders away from the endless reminders about self-discipline and performance-targeting and, instead, ask them to consider what they are doing altogether. What is technical analysis? What are support and resistance? Are price and volume really enough information on which to base a high-probability trading decision? As the webpage comments show, the series leaves its reader wanting more. Perhaps that was Grimes' goal. In the minds of readers after every post is a lingering question, "What does this mean for _______ trading method?" This is an extraordinary question to be asking in the trading industry. If you, or anyone you know, uses technical analysis to trade stocks, then you might consider joining the discussion on Grimes' blog. And let Benzinga know if you find some ways to trade stock charts differently than you would trade computer-generated charts, because we bet you will have a little bit more trouble after hearing what Grimes has to say. Disclaimer: Benzinga has no affiliation with Adam Grimes or SMB Capital in any way whatsoever. This article was written to solely increase critical awareness of technical analysis and securities markets. The views and opinions expressed by SMB Capital do not necessarily reflect those of Benzinga.