Editor’s note: This article was first published in September 2014; its discussion of high-frequency trading and its reference to Pescanova, whose shares were suspended in 2013, reflect that context.
Burton Gordon Malkiel is an economist and author, president of the American Finance Association in 1978 and author of A Random Walk Down Wall Street. According to Forbes, only half a dozen good investing books have been written in the last 50 years, and this one is on that list.
Burton says plainly that most of the traders he knows can often be seen with holes in their shoes and frayed shirt collars. He says that he personally has never met a single successful trader, but he has seen the state many unsuccessful ones end up in.
Burton’s theory, and part of the main message of his book, is that the past history of share prices (which is what we study with technical analysis) cannot be used to predict a share’s future performance in any meaningful way.
Burton maintains that any investor who has put money into a low-cost index fund will have made more money than any individual trader.
Technical analysis vs fundamental analysis
Benjamin Graham himself used to say that investors and speculators alike have a gambler inside them, and that there’s nothing you can do about it except know it’s there and try to keep it under control.
Fundamental analysis studies the company’s business and industry to determine the value of the company we are going to invest in, working out whether we are buying its shares expensive or cheap, with a long-term view. Technical analysis (used by traders), on the other hand, is used only to try to predict where a share price will go based on what it did in the past.
Burton sees just one problem with technical analysis. The problem, quite simply, is that it doesn’t work, unless you belong to the small, select club that makes it work by moving large amounts of money.
Everyone dreams of achieving what others have supposedly achieved with short-term speculation (trading), but no individual trader beats the strategy of “buying and holding shares for the long term” once transaction costs and losing trades are taken into account.
For Burton, making trade after trade by looking at a chart and a supposed scenario in which a stock breaks through or bounces off a line makes trading no different from a casino game, which is also based on probability and randomness. And just as in casinos, there are winning streaks and losing streaks, but all players have one thing in common: in the long run, every single one of them loses money. Everyone except the casino. The luckiest ones get lower returns than someone who invests in an index fund.
(Read: How Warren Buffett analyses shares before investing)
For Burton, trading is very profitable, and one of the easiest ways for brokers to make large sums of money at the expense of people who leave their money behind in commissions. Commissions are the most profitable business for brokerage firms, which don’t make a living by being good traders but feed off the trades of bad traders.
Analysing charts and trading will leave you walking around with holes in your shoes, but you’ll help the brokers buy themselves a yacht.
Burton also says that in currency and commodity trading, technical analysis can become a kind of fundamental analysis, because these assets can’t really be analysed any other way: they are assets that are essentially only good for speculation.
Trading can be fun, and often comforting, but it has no real value for the investor, even though it is the brokers’ main business.
And honestly, after knowing traders for a long time, I haven’t met anyone either who day trades and makes money consistently. In fact, all the traders I know who do make money get most of their income from selling courses, selling magic methods and selling books.
Does this mean technical analysis is useless?
I wouldn’t say that either. Technical analysis gives us very valuable information about where a stock has been and the resistance or support levels traders may play with, so it is very useful for choosing an entry point in trend trading or in a long-term investment. But I agree that analysing companies’ fundamentals will always be a better idea for knowing whether we are buying something attractive, and not just a trend on a chart that sometimes represents a company it makes no sense to invest in. And we mustn’t forget market manipulation either.
My short or long track record in investing has shown me that market manipulation is a reality, and since high-frequency trading machines increased their presence and trading volume, manipulation has become more than evident. That manipulation can wipe out traders’ stop losses, but it doesn’t affect the long-term investor who bought on the fundamentals.
For example, technical analysis indicated that Pescanova (a Spanish seafood company) was at a good technical buying point shortly before its shares were suspended from trading.
Remember these words: not even God knows what the price of a good or bad company will do in the next 5 minutes or hours, but in the long run, the bad company will fall and the good one will rise.
As for miracle tricks for making money on the stock market every day, all you need to know is that, logically, any technical trick that works stops working the moment everyone knows about it.
Further reading
- 19 secrets of investing
- 6 life lessons I learned trading millions of dollars
- 5 books every investor should read
- Jesse Livermore: the greatest speculator of all time
Featured image: W. Bulach, CC BY-SA 4.0, via Wikimedia Commons.
