TECHNICAL analysis, the study of price charts to predict future market moves, depresses investment returns for private investors because it leads to overconfidence, high trading costs and undiversified portfolios, a Dutch-American study shows.
Maastricht University financial economist Arvid Hoffmann and behavioural finance specialist Hersh Shefrin from Santa Clara University in the US found in a study of 5,500 users of a Dutch online discount brokerage that the investment returns of small investors using charts were 0.6% a month, or about seven percentage points a year lower than those not using them.
“It is not that there is anything wrong with technical analysis in itself, but we found that it leads to investor overconfidence and very busy trading, which pushes up costs,” said Mr Hoffmann.
Private investors using the technique often had highly concentrated portfolios, he said, making big bets on just a few stocks, which increased risk and weighed on overall returns.
They also tended to use more options.
For the study, which took in data from 2000 to 2006, the researchers had access to the investors’ trading data as well as a survey about their investment techniques.
The study does not reveal which online brokerage’s data were used.
“We find that individual investors who use technical analysis and trade options frequently make poor portfolio decisions, resulting in dramatically lower returns than other investors,” the researchers said.
Whereas technical analysis tries to spot investment opportunities by looking at trends and patterns on historical price charts, fundamental analysis — also called value investing — looks at company accounts and the company’s business.
Pioneered by Benjamin Graham and David Dodd in the 1930s and made popular by investment gurus such as Warren Buffett, fundamental analysis is more popular among professional investors, although many combine both techniques — using fundamentals to decide which stocks to buy and technicals to decide when.
Technical analysis — such as establishing support and resistance levels beyond which further moves can be expected in the same direction — is widely used in currency, fixed income, commodities and precious metals trading.
Mr Hoffmann said his study showed that technical analysis enthusiasts were more likely to be men.
“Behavioural science research shows that men, compared to women, tend to be more overly confident in their own analysis and ability,” said Mr Hoffmann.
• This article was first published in Sunday Times: Business Times