Looking Before You Leap
Getting technical. One of the big lessons of the bull market is that many individual investors aren't thrilled about number crunching (not that many Internet stocks had any actual numbers). One alluring alternative is to employ technical analysis, or "chart-reading," which involves tracking a stock's price and trading-volume patterns as a way of predicting future performance. Loads of investing Web sites are devoted to supposedly predictive patterns such as "head and shoulder," "pennants," and "descending triangles."
Does any of this really work? Most academics would just shake their heads (and probably mutter something about "voodoo" or "tea leaves"). Since efficient markets theory holds that a stock's current price already incorporates all information about the stock, there's presumably nothing to be learned by examining past prices. Still, most brokerages employ a few technical analysts. "I think technical analysis can help you spot turns in the market," says Davidson Lowdon, president of BarChart.com. "I think people who had the tenacity to stay with their [technical analysis] systems would have seen the last turn [in 2000]. But it is no panacea, and you can go wrong with it."
There is a smattering of academic research that seems to lend some credence to the method, but the brainiacs behind it are hesitant to advise its use. "There is more to it than the standard academic answer--which is that there is nothing to it," says Blake LeBaron, an international finance professor at Brandeis University. Moving averages, for instance, tend to indicate that there is some momentum for a stock in a particular direction. So it might be one factor in an investment decision. But "I would caution the average investor that these things are difficult to implement and require a good deal of discipline," says LeBaron.
Professionals, for instance, can constantly test and retest their strategies and tweak as needed. The average investor who doesn't want to take the time to read a company report would seem unlikely to do that. Even so, he could fall prey to all sorts of statistical traps. Apply enough trading schemes to 100 years of stock data, and you will surely find some patterns that seem to bring huge returns, yet they may not have the power to predict future returns. It's like a famous 1997 study by money manager David Leinweber, who found that variances in butter production in Bangladesh seemed to predict the direction of the S&P 500. With enough computing power at your fingertips, you can always find a chart pattern that will predict the past. But the future? Don't bet on it.
advertisement
