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Technical Analysis a Drag?

Posted in Individual Investing, Technical Trading

Does technical analysis boost or depress performance for individual investors? In their February 2014 paper entitled “Technical Analysis and Individual Investors”, Arvid Hoffmann and Hersh Shefrin combine actual trading histories and results of a survey to investigate the use of technical analysis by individual investors. The 2006 survey solicits objectives, strategies and traits from a large group of individual clients of an online Dutch discount broker. The survey explicitly asks about use technical analysis and/or fundamental analysis. The authors use actual trading records to measure individual investment performance. Using 5500 survey responses matched to detailed trading histories spanning January 2000 through March 2006, they find that:

  • For the entire sample:
    • 77% are male with average age about 50 years.
    • Average (median) trading experience is 40.2 (39.0) months.
    • Average (median) trades per year is 10.7 (4.7).
    • Average (median) monthly turnover is 23% (10%) for stocks and 9.9% (3.2%) for derivatives.
    • Average (median) monthly net return is -0.2% (0.3%).
  • Those using technical analysis tend to:
    • Have more concentrated portfolios.
    • Drive higher monthly turnover for both stocks (by 6.9%) and derivatives (by 13.1%).
    • Place disproportionate emphasis on speculation to exploit short-term market developments.
    • Exhibit less interest in exploiting price reversals.
    • Assume a higher ratio of idiosyncratic-to-total risk.
    • Engage in more options trading.
  • Based on average net return, users of technical analysis underperform by 0.5% per month due to poor asset selection and by 0.2%  per month due to higher trading frictions.
  • The adverse impact of technical analysis concentrates among investors who trade options frequently. This group underperforms by 1.4% per month due to poor asset selection and by 0.3%  per month due to higher trading frictions. For others, the cost of using technical analysis is small and not statistically significant.
  • Those using technical analysis exhibit excessive optimism and overconfidence. Those who use technical analysis, emphasize speculation and trade option frequently exhibit affinity for lottery-like payouts.

In summary, evidence matching self-reported analysis methods and actual trading generally indicates that individual investor use of technical analysis harms performance.

Cautions regarding findings include:

  • Participating investors may not have a good understanding of technical analysis. However, the broker involved provides a manual explaining the differences between fundamental and technical analysis and requires that clients pass an online test with questions on the difference between fundamental and technical analysis before they can trade.
  • The sample may not be representative of other groups of investors.

See the closely related “Individual Investor Performance by Motive and Method”.

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