Fisher Investments UK Reviews Technical Analysis

In Fisher Investments UK’s reviews of financial commentary, charts can be useful tools for visualizing and presenting market data. Beyond this, however, we have found charts’ role in equity market analysis is limited – their shapes reveal nothing about future direction. For this reason, we think a chart-reliant method known as technical analysis may be counterproductive, and investors can benefit by understanding what we see as its shortcomings.

Technical analysis uses chart patterns to predict future price moves. Imagine an equity chart: as an equity’s price moves up and down, from left to right, the resulting line can form myriad shapes, from letters (e.g., a W) to household objects (e.g., a cup’s handle). Based on Fisher Investments UK’s reviews of technical analysis adherents’ arguments, investors can theoretically use these shapes as part of their decision to buy, sell or hold since they supposedly indicate where the equity price goes next.

To see how this would work in practice, consider the head-and-shoulders chart pattern, which is a series of three peaks that (as the name suggests) resemble a human head and shoulders: a small peak on the left, a larger peak in the middle and another small peak on the right. We have seen adherents claim that if equity prices move below the pattern’s neckline – that is, the line created by connecting the low points between each of the three peaks – they will move even lower soon. Hence, this particular formation is a supposed signal to sell, which investors can use to sidestep an impending decline. Fisher Investments UK’s reviews of popular market analysis have found this logic underlies most technical analysis, as the purported evidence is past chart patterns producing what appear to be similar results.

We think this and other technical analysis methods have some drawbacks, however, as Fisher Investments UK’s reviews of the data have found false signals. Consider two chart patterns that receive a lot of attention in financial publications we monitor: the death cross and the golden cross. The death cross is a supposedly bearish pattern that forms when the line depicting an equity or equity index’s 50-day moving average (which reflects the average price level over the 50 days preceding every point) crosses beneath the line depicting its 200-day moving average. Technical analysis adherents view the death cross as a sell signal. A golden cross is an inverse – a supposedly bullish buy signal.

But we think recent history highlights the ineffectiveness of acting on either formation. In 2020, America’s S&P 500 experienced both patterns, each of which received hype in financial publications we follow. On 30 March 2020, the S&P 500 formed a death cross.[i] A hypothetical American investor acting on the death cross would have interpreted this as a bearish sell signal – but exiting after the shape formed and not returning to the market would have meant missing the S&P 500’s 44.9% subsequent return in US dollars through that year-end.[ii] What if this same hypothetical investor waited to buy equities until 10 July 2020 – when the S&P 500 presented a golden cross?[iii] Though this investor would have participated in a stretch during which the S&P 500 returned 18.9% in US dollars through year-end, waiting would have also meant not owning equities whilst the S&P 500 rose 43.2% from 23 March’s low through 10 July – a costly miss, in Fisher Investments UK’s view.[iv] We have found similar false signals in Europe. The Euro Stoxx 50 experienced a death cross on 30 May 2012.[v] Yet a theoretical investor who sold then and didn’t return to the market for the rest of the year would have subsequently missed out on a period in which the index rose 15.7% (in euros).[vi] These are just a few examples we have seen. And, yes, sometimes patterns succeed – enough times for technical analysis adherents to claim their approach works – but these are by coincidence, in our view.

Fisher Investments UK thinks technical analysis’s key flaw is its backward-looking nature – relying on equities’ past wiggles to predict future moves. We have found equities look forward, weighing probabilities and economic and political developments affecting corporate profits over the next 3 – 30 months. It doesn’t matter what happened in the past, in our view – equities will have digested that information and already moved on. Furthermore, our research shows equities aren’t serially correlated – that is, past price movements don’t influence future moves. Said another way: at any given point, equities are just as likely to rise the next day as they are likely to fall.

This isn’t to say history is useless in equity analysis. The past can inform analysis of economic cycles, sector behaviors under various political and economic conditions and investor sentiment amidst prior ups and downs. Whilst Fisher Investments UK doesn’t think history repeats exactly, it can provide a framework for what is probable – helping investors set expectations accordingly. However, we think using chart patterns for insight into future market direction is ineffectual – at best. At worst, acting on technical analysis may cause investors to miss out on equities’ big long-term returns, or endure the worst of a decline and then miss the rebound.