Something for the Weekend: Academics Deny TA

I went past a florist yesterday. They had some sort of qualification in floristry which was bragged about in the window. It didn’t seem to include how to tidy up a florist shop. Being a florist though, it’s just flowers unplugged isn’t it? I was never a big fan of unplugged music. It seemed to be your favourite songs with the balls removed. Trading unplugged would be fundamental analysis I suppose. Certainly not TA.

I was at a Gresham College lecture given by Prof Jagjit Chadha last night. He talked about the Efficient Market Hypothesis. The basis of the hypothesis is that, whether overtly or otherwise, all known data is priced into the stock market at any given time and therefore the price is right and it’s impossible to beat the market.  Chadha delivers good lectures. Well considered, logically constructed and delivered with a light-hearted humorous touch, which makes them enjoyable. He’s an academic and very adept at delivering academic viewpoints.

Like most academics however he doesn’t live in the real world, and to be fair, he doesn’t have any real need to. Two things stood out to me at this talk, and as luck would have it I have a transcript to hand so I shall be quoting verbatim.

Firstly, a quote from Nobel Prize winning American economist Robert Lucas Jr. in 2009:

“The main lesson we should take away from the EMH for policymaking purposes is the futility of trying to deal with crises and recessions by finding central bankers and regulators who can identify and puncture bubbles. If these people exist, we will not be able to afford them.”

I’ve been identifying and trading things like this for years. There are two ends of the scale here though. Those who, like George Soros, are so big they literally can’t afford them, but then people like me who don’t (or didn’t) have a big enough platform to impact the markets.

Lucas got his Nobel prize “for having developed and applied the hypothesis of rational expectations, and thereby having transformed macroeconomic analysis and deepened our understanding of economic policy”. This is another facet of the EMH – a fatalistic view on the markets. One where it is not possible to know tomorrow’s price today.

The second quote from the talk is from Chadha himself:

“Indeed when we look at asset prices that follow a random walk, because their next step is taken from as a random draw from a probability density function, we can start to impose shapes on the series that look like patterns. I can assure you, just like clouds in the sky that look like faces or parts of the anatomy, there are no ‘heads and shoulders’ waiting to be completed in asset returns.”

What he is saying there is that TA doesn’t work and cannot work. That’s because he’s denying the basis of those numbers. They represent a barometer of human sentiment. He accepts that human sentiment, investing on the basis of what we think other people might be prepared to pay for an asset, is a valid decision-making tool. But then why deny that patterns will exist? Human behaviour is nothing if not predictable.

This attitude is typical of academics, mainstream financial publications and the investment banking community. Good. I’m very happy about that. The fewer the merrier. What we have here is opportunity. While they’re all in denial we can make hay. It’s like when at 7pm we move into the red route bus lane knowing that the sign says it’s not in force after 7pm, and meanwhile the sheep all stay in the congested lane because they haven’t seen (or haven’t believed) the sign. I’d take people’s licences away under those circumstances. Can’t read simple road signs? Walk or get the bus. Chart patterns can be explained in terms of market participant behaviour. They exist. We use them. Others don’t. They’re in the congested traffic lane; we’re zipping by in the empty out of hours bus lane and mentally flipping the bird.