Recently, two researchers from the Netherlands published a paper that specifically measures the results of trading by investors who rely on technical analysis. In Technical Analysis and Individual Investors, Arvid Hoffmann of Maastricht University and Hersh Shefrin of Santa Clara University analyzed real-world trading records of Dutch investors for the period 2000-2006. These investors were users of technical analysis.
In 2006, the brokerage firm supplying the data administered a survey among all of its clients. The survey included a question asking participants to select which strategies they use as a basis for his/her investment decisions. Technical analysis was one of the selections they could choose. About 32% of these investors stated they used technical analysis exclusively or in conjunction with fundamental analysis. Hoffmann and Shefrin obtained a sample of 5,500 clients and corresponding accounts for which both transaction and survey data are available.
Overall, the results from statistical tests indicate that individual investors who use technical analysis to make investment decisions are disproportionately prone to speculate on short-term stock-market trends, hold more concentrated portfolios, turn over those securities at a higher rate than people who do not use charts, and earn lower returns.
Hoffmann and Shefrin found the investors using technical analysis had lower performance, on average, approximately 50 basis points (0.5%) per month in raw returns from portfolio selection decisions and 20 basis points (0.2%) from additional transaction costs. Adding these together, the marginal cost in investor returns due to technical trading was 70 basis points per month — approximately 8.4% per year.
I admit to looking at a chart or two over my career. I’ll even admit to believing at one time that the strategy works. Technical analysis is a compelling idea that tends to consume us because it comes across like finding a treasure map that leads to a chest full of gold. Even Warren Buffett admits to spending years trying to master the technique.
Yet, for all the promises that technical analysis brings, studying charts has actually detracted from the bottom line. Buffett reportedly joked about this dilemma with an audience at Vanderbilt University in 2005, “I realized that technical analysis didn’t work when I turned the chart upside down and didn’t get a different answer.”