Technical Analysis officially died on April 21st, 1982, the day stock index futures first appeared on the Chicago Mercantile Exchange.
Ever since, the stock market’s behavior has become more volatile in the short term due to the tremendous leverage that traders can use to their advantage (or demise).
In this post, let's explore the hotly debated question, does technical analysis work?
Stock Index Futures Changed Everything About Technical Analysis
You should start paying attention to the S&P 500 futures market because it's what really controls the broader stock market.
It's "the tail that wags the dog" so to say...or maybe more like Captain Smith at the helm of the Titanic.
So why did technical analysis die that day?
(Personally, I don’t think it was ever alive)
It was the leverage provided by these new stock index futures - it changed everything.
The markets instantly became more volatile.
I'll demonstrate why you should never trust technical analysis again with a common occurrence we've all faced.
Stop limit orders...
They Got My Stop Again!
Have you ever bailed on a stock because it broke support - or moved your entire portfolio into cash because the S&P 500 broke support?
(This is one of the tenets of technical analysis "theory").
You can raise your hand, nothing to be ashamed of; we've all done it.
Some analysts (or your advisor) put the fear of God in you that the market was going to continue lower....
"There will be hell to pay! With a lot more downside to follow!"
At face value that makes perfect sense, but I never put much stock in face value, so I actually did some analysis of my own.
As it turns out, buying a support break in the S&P 500 has actually been profitable 74% of the time for the last 40 years!
How's that for a kick in the pants?
You've probably turned on the financial boob tube and seen highly paid “technical analysts” finger-painting all-over charts, yelling “The market is falling apart!”
Check it out for yourself; here's a famous example right after the Brexit vote in 2016:
Don't Sell the "Support Break" - Buy It!
Clear as day, no sooner had support been broken - when BAM! The S&P 500 shot higher - way higher!
So, here's a quick trading tip if you want to take it... Buy the S&P 500 when it closes at a new 20-day low and sell it when it hits a 5-day closing high.
It's counter-intuitive, right?
It goes against popular wisdom, which is to sell your losers and ride your winners. But you can't argue with the facts.
And if the "technical analysts" had looked deeper into the data, like I did, they would have discovered that from 1920 to 1982, whenever the stock market broke support, the right move was for you to absolutely get out of Dodge!
But that stopped being true in 1982 - the year index futures were created and sold to investors.
If the "pros" on TV, newsletters, and the internet ever did their homework they would realize that "technical analysis" had gone the way of the dinosaurs.
"Technical Analysis" Tested Back to 1920:
The Program That Proves Technical Analysis Is Garbage:
/* BUY SIGNAL */ If Marketposition = 0 And Close <= lowest(close, Buy_Periods) Then Begin Buy ("BUY") contractsToTrade contracts next bar on open; sharesTraded = contractsToTrade; End; /* SELL SIGNAL */ If Marketposition = 1 And Close >= Highest(close, Sell_Periods) Then Begin Sell ("SELL") sharesTraded contracts next bar on open; End;
Stocks Are Now Mean Reverting
The fundamental character of the stock market changed that day in 1982 and technical analysis became as useless as a wooden frying pan.
The S&P 500 had transitioned from a trending market to a mean-reverting market.
(Also called "reversion to the extreme")
Investopedia has a decent definition of mean reversion here.
And by understanding this one fundamental principle alone, you can really clean up.
Take a look at this super simple swing trading system built on mean reversion.
You Need a Paradigm Shift, Not Technical Analysis
So, if you feel like the stock market is rigged, you’re not alone.
But that doesn’t mean you can’t beat it.
You’ve just been following the wrong advice from the wrong people, listening to “pros” that got their ideas from theories that died decades ago.
Take this to heart; you really need a paradigm shift, a new way of thinking.
The old way was fooled by randomness, called "Pareidolia" (i.e., looking for patterns on stock charts is the same as looking for shapes in the clouds).
I've written before about how pareidolia will drive your trading account to zero.
The old way didn’t have the benefit of using computers to do the heavy lifting.
But now we do.
If you’re listening to someone that can’t prove what they say is true with a computer, it’s time to toss them to the curb.
My mission is to expose you to the world of TESTED analysis and debunk the non-scientific quackery of "technical analysis".