Technical Analysis in Portfolio Management
Performance and Practice
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An Academic Study
Head and Shoulders Above the Rest?
A deep dive into the performance of institutional portfolio managers who use technical analysis, based on a study of over 10,000 portfolios.
By David Smith, Christophe Faugère, and Ying Wang (2013)
Research Overview
This groundbreaking study examines whether institutional portfolio managers who use technical analysis actually outperform their peers. Unlike previous research that tested specific trading rules, this study surveyed over 10,000 institutional managers about their actual use of technical analysis and analyzed their real-world performance outcomes.
The Long-Standing Debate
A persistent divide exists between academic theory and real-world practice.
Academic Skepticism
For decades, academic circles have largely dismissed technical analysis (TA), sometimes comparing it to 'alchemy.' The efficient market hypothesis suggests past price action cannot predict future movements.
Practitioner Reality
Despite academic skepticism, TA remains a core tool for many investors. Surveys show 30-40% of foreign exchange traders find TA important for short-term price forecasting.
The Problem with Traditional Research
Past studies struggled to provide a definitive answer due to several key flaws:
Tested strategies were often too simple and didn't capture the dynamic nature of real-world TA.
It's impossible to test every potential strategy, and practitioners rarely reveal their most profitable methods.
A significant issue is 'data snooping bias,' where strategies appear successful by chance because they are retrofitted to past data.
Ultimately, researchers couldn't 'peer into the black box' of what professional chartists actually do.
A New Approach: Asking the Experts
Instead of testing specific rules, this study took a novel path. It surveyed over 10,000 institutional portfolio managers on their actual use of technical analysis and then analyzed their real-world performance. This method bypasses the "black box" problem by focusing on outcomes, not unobservable strategies.
Who Uses Technical Analysis?
Prevalence, relationships, and how TA fits into the investment puzzle.
Usage Among Managers
~1/3 of funds use TA, with U.S. equity managers being the most common adopters.
Use doesn't vary much by market cap, but 5.9% of All-Cap funds rate it "very important."
Surprisingly, over 85% of U.S. balanced funds deem it unimportant, despite their need for asset allocation timing.
Relationship with Other Strategies
Correlation with TA usage. High correlation with Momentum suggests a focus on trends, while low correlation with Fundamentals indicates a complementary role.
The Performance Advantage
TA provides an edge, but in an "unexpected way."
How Performance Was Measured
Raw Rate of Return (ROR)
The portfolio's total return.
Benchmark-Adjusted Return (BAR)
Returns net of a portfolio's specific benchmark.
Information Ratio
Return from deviating from the benchmark, scaled by deviation.
3-Factor Alpha (Fama-French)
Excess return adjusted for market, size, and value factors.
4-Factor Alpha (Carhart)
3-Factor Alpha plus a momentum factor adjustment.
The Skewness & Kurtosis Edge
The most remarkable finding: TA-managed funds showed significantly elevated skewness (higher chance of large positive returns) and kurtosis (more frequent extreme outcomes). This suggests a strategy geared towards capturing major market moves.
Down-Market Advantage
TA users significantly outperformed during market declines. Those rating TA "very important" beat non-users by an average of 19 basis points per month in negative markets, a statistically significant result.
Volatility & Survival
While performance volatility was higher, it did not lead to a higher failure rate. Survival rates for TA funds were comparable to their peers, suggesting the higher risk was managed effectively.
Cumulative Outperformance Over Time
Value of $1 invested, net of benchmark, comparing technical vs. non-technical portfolios from 1993 to 2012.
Key Insight: Technical analysis portfolios demonstrated superior cumulative performance, particularly during volatile periods and market downturns. The divergence became most pronounced during the 2000-2002 dot-com crash and the 2008-2009 financial crisis.
The Net Benefit: A Clear, Unexpected Advantage
The study concludes that TA has been beneficial for institutional portfolios. The advantage isn't about slightly higher average returns in all conditions, but about creating a unique return profile—characterized by positive skewness and high kurtosis—that offers a distinct edge, particularly in managing risk during market downturns.
Key Advantages of Technical Analysis
- Superior performance during market downturns
- Positive skewness (higher probability of large gains)
- Effective risk management despite higher volatility
- Complementary to fundamental analysis strategies
Important Considerations
- Results based on institutional managers, not individual traders
- Higher volatility requires stronger risk management
- Success may depend on proper implementation and discipline
- Past performance doesn't guarantee future results
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Listen to PodcastEducational Disclaimer
This analysis is for educational purposes only and should not be considered as investment advice. Technical analysis results can vary significantly based on implementation, market conditions, and individual skill. Always conduct your own research and consider consulting with a qualified financial advisor before making investment decisions. Past performance does not guarantee future results.