Stocks & Commodities V. 1:4 (89-89): The Evolving State of Technical Analysis

The Evolving State of Technical Analysis

Leafing through a back issue of "Success Farming" magazine the other day, I was quite surprised to run

across a fairly sophisticated article on the technical analysis of some of the meat and grain futures. The purpose of the article was apparently to educate and to provide a method of calculating hedging levels for some of its subscribers. In fact, some of the Midwestern farmers I know, use words like "Elliot wave or 50% retracement" just as easily as they use "heifer or grain combine." At first, it sounded somewhat strange to me, hearing all this technical jargon used so naturally. I always thought that farmers generally perceived the futures market more in terms of a fundamental rather than technical perspective. It emphasized to me just how pervasive the use of technical analysis of price activity has become in the 1980's.

This widespread use of technical analysis relative to 10 or 20 years ago, seems to be a natural product of the convergence of several factors. I once read a very interesting article that classified Americans as the "engineers" of the world. Although we are not the only "engineers" around as evidenced by the tremendous technological advances arising out of Japan and Western Europe, the fact still remains that we have engineered a great portion of the major technological advances of the 20th century.

This engineering and mathematical quality of the American people has spawned a whole generation that relates quite readily to the world in terms of numbers and statistics. The President himself effectively uses charts and statistics in his speeches to the American people, my neighbor's 12 year old writes his own programs for the Apple computer, and any viewer of a baseball game on television is inundated with a constant flow of numbers and statistics of the players and teams that are on the field. We are a society that feels very comfortable with numbers.

The major factor is this "Age of Information'' we seem to be in the midst of. Never before in history has there been such an overcapacity in the ability to communicate and process information. The widespread introduction of the hand-held portable calculator in the early 70's and the availability of relatively low cost microprocessors has introduced people to the mechanical processing of information. The parallel development and distribution of software has also caused a leap over the potential stumbling block of not understanding computer programming.

"User friendliness" is a common adjective used to gauge the relative simplicity of use of a specific computer product by a person not skilled in computer programming.

This mathematical proclivity of the American people combined with the current overcapacity in the ability to process information and the ready availability of affordable microprocessors and concordant software, has far reaching implications.

This trend has already asserted itself in the investment markets in the rapid development of sophisticated technical trading systems. The whole area of developing investment systems based on the study of derivatives of price (moving averages, oscillators, etc.) was due, initially, to the ability of market participants to use the hand-held calculator to sidestep long tedious calculation previously done by hand. The availability of the microprocessor is further fueling this development.

Another important factor in the development and use of technical systems is the more efficient ability of

Article Text 1Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 1:4 (89-89): The Evolving State of Technical Analysis

the markets to discount fundamental changes in supply and demand. Information is processed and communicated so rapidly that the markets react instantly to fundamental changes. The swings are so great that a fundamental approach, used exclusively, can be disastrous. Also, the volatile nature of the worid's financial situation further enhances risk. When prices were at much lower levels prior to 1970, a 10% correction could have been tolerable to some investors using a fundamental approach, but with prices at such high levels relative to the past, a 10% correction is no longer tolerable in most cases. As an example, a grain like soybeans traded around $2.50 in the late 60's and a 10% correction in price would mean a drop of about 25¢. Now a 10% correction of recent high levels would mean more like 75¢ to $l.00. Therefore, the greater efficiency of the markets, relative high price levels and volatile financial circumstances combine to make the current markets too dangerous to approach solely on a fundamental level.

In summary, the apparent ability and willingness of the American people to adapt to the use of mechanical devices for processing information combined with the inherent volatility of today's markets should continue to fuel the popularity of technical analysis well into the 21st century.

Article Text 2Copyright (c) Technical Analysis Inc.