Monday, November 24, 2014

Review of The Evolution of Technical Analysis: Financial Prediction from Babylonian Tablets to Bloomberg Terminals

I should've read the Amazon reviews of The Evolution of Technical Analysis: Financial Prediction from Babylonian Tablets to Bloomberg Terminals before buying it:

"The other disappointment of the work is that an enormous amount of exposition is devoted to discussing the development of commerce, the discovery of price records, and the supposition that since such records are found, it is natural to assume they were used for technical analysis. However, only the surface is scratched here. Lastly, the authors tend to give undue emphasis to various categories of non-technicians' disdain, ostracism of, disregard for, and general ignorance of technical analysis."
"The author does not have any access to primary sources so there is absolutely nothing new in this book. If you want to write the history of something, you need access to primary sources, eg old newsletters, interviews, subscription statistics."
I agree with those criticisms. The book ex-notes is only 165 pages, so it's pretty thin. There were two interesting sections worth discussing, though. First, in the section about cycles:
"[I]n his 1993 Charles H Dow Award-winning paper, "Charles Dow Looks at the Long Wave" [pdf], Charles Kirkpatrick... observed that from 1700 to 1994, every period that saw both a decline in long-term interest rates and a rise in the stock market has been followed by a major stock market collapse."
Uh oh! That is what has happened over the past couple decades! Here's what the Kirkpatrick paper actually says (this is not quoted in the book even though it is profound):
"The period after interest rates peak is when stock prices rise as an alternative investment. During that period declining interest rates force yield-conscious investors into alternative investments of lesser quality in order to maintain yield. Since stocks are the most risky and least quality investments, they become the final alternative, especially when their price continues to appreciate as a result of increasing cash flow into the stock market. [positive feedback loop] The recent conversion of government-guaranteed CD deposits into stock mutual funds is typical during this period. Unfortunately, it eventually leads to the declining long wave in stock prices."
Note that if this theory is correct, the bond market panic or interest rate increase that bond bears are currently expecting will not happen for years, and then only after a stock market crash.

The second interesting topic alluded to in the book is the development of quantitative trading strategies, which have blurred the lines between technical and quantitative analysis. Technical analysis comes from a time (4-5 decades ago) when things like moving averages were calculated by hand. The significant effort required to calculate and continually update a 50 or 200 day moving average by hand was a barrier to entry, which meant that far fewer people were likely to have access to these signals than today.

There are no evergreen investment strategies that will always work. Having your investment operation in New York, where you got investment information faster, was once an advantage. Having a Bloomberg terminal was once an advantage. Being able to do a fundamental screen of stocks was once an advantage. I foresee a period of a few years where interpretation of Skybox quality satellite photos is going to be an investment advantage, but then it will just become part of the landscape.

By the time an investment approach becomes part of the landscape, the people who were using it have generally gathered assets and are rich, fat, and lazy. The 80 year old fund managers who made it big 50 years ago by being the first people to get copies of filings dropped off at the SEC offices (once a great edge!) are not hungry enough to develop tomorrow's cutting-edge technique. This is why every generation or so there is a New School of investing that displaces the old, like succession in an ecosystem.

Overall, this was only a 2/5 book. Actually, if you were just to reprint the most important technical analysis papers and excerpt the most important books cited in the notes, it would be a great volume that would be better than this book.


CP said...

CP said...