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When to Use and When to Ignore Technical Analysis (accounting)

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By Dillon Norris

 Let me first say that I do not now engage in technical analysis; nor, have I ever engaged in technical analysis. I do not believe doing so would be a productive use of my time.

Having said that, I do not claim technical analysis has no predictive value. In fact, I suspect it does have some predictive value. The Efficient Market Hypothesis is flawed. It is based upon the (unwritten) premise that data determines market prices. As Graham so clearly put it in “Security Analysis”:

“…the influence of what we call analytical factors over the market price is both partial and indirect - partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and indirect, because it acts through the intermediary of people’s sentiments and decisions. In other words, the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.”

I’ve seen a lot of people cite this quote, without bothering to notice what’s really being said. Graham had a very broad mind, much broader than say someone like Buffett. That’s both a blessing and a curse. At several points in Security Analysis (and to a lesser extent in his other works), Graham can not help but explore an interesting topic more deeply than is strictly necessary for his primary purpose. In this case, Graham could have said what many have since interpreted him as saying: in the short run, stock prices often get out of whack; in the long run, they are governed by the intrinsic value of the underlying business. Of course, Graham didn’t say that. Instead he chose to describe the stock market in a way that should have been of great interest to economists as well as investors.

Data affects prices indirectly. The market is a lot like a fun house mirror. The resulting reflection is caused in part by the original data, but that does not mean the reflection is an accurate representation of the original data. To take this metaphor a step further, the Efficient Market Hypothesis is based on the idea that the original image acts on the mirror to create the reflection. It does not recognize the unpleasant truth that one can interpret the same process in a very different way. One could say it is the mirror that acts on the original image to create the reflection. In fact, that is often how we interpret the process. We say an object is reflected in a mirror. We rarely use the active “an object reflects in a mirror”.

For some reason, when we talk about the market we like to use inappropriate metaphors. We talk about wealth being destroyed when prices fall. Yet, no one talks of wealth being destroyed when the price of some product falls. When the market rises, we talk about buyers, as if there wasn’t a seller on the other side of the trade. Above all else, we talk about “the market” not as a mere aggregation of trades, but as some sort of object all its own.

The Efficient Market Hypothesis does not recognize the true importance of interpretation. Saying that data (publicly available information) acts on market prices omits the key step. After all, the same data is available to every blackjack player. Casinos just don’t like the way a card counter interprets that data.

The Efficient Market Hypothesis is not the only argument against technical analysis. There is also empirical evidence that questions the utility of technical analysis. However, empirical evidence alone is not sufficient to prove technical analysis has no predictive power. If most knuckleball pitchers had limited success, the knuckleball might be an inherently ineffective pitch, or there might be a better way to throw it. The same is true of technical analysis.

The adjective “random” is a very strange word. Although it is rarely the definition given, the most appropriate definition for random would have to be “having no discernible pattern”. The word discernible can not be omitted. If it is, we will take too high a view of science and statistics. There’s a great introduction to economics written by Carl Menger which begins:

“All things are subject to the law of cause and effect. This great principle knows no exception, and we would search in vain in the realm of experience for an example to the contrary. Human progress has no tendency to cast it in doubt, but rather the effect of confirming it and of always further widening knowledge of the scope of its validity.”

All things are subject to the law of cause and effect; therefore, nothing is truly random. A caused event must have a pattern - though that pattern needn’t be discernible. Even if one argued there is such a thing as an uncaused event, who would argue that stock price movements are uncaused? We know that they are caused by buying and selling. Stock prices are the effects of purposeful human actions. Several sciences study the causes of purposeful human action; so, it would be hard to argue any human action is uncaused. Furthermore, each of our own internal mental experiences suggests that our purposeful actions have very definite causes. We also know that the actions of some market participants are based in part on price movements. Many investors will admit as much. They may be lying. But, there is plenty of evidence to suggest they aren’t.

If the actions of investors cause price movements, and past price movements are a partial cause of the actions of investors, then past price movements must partially cause future price movements.

Technical analysis is logically valid. Not only is it possible that some form of technical analysis might have predictive power; I would argue it necessarily follows from the above assumptions that some form of technical analysis must have predictive power.

So, why don’t I use technical analysis? I believe fundamental analysis is a far more powerful too. In fact, I believe fundamental analysis is so much more powerful that one ought not to spend any time on technical analysis that could instead be spent on fundamental analysis. I also believe there is more than enough fundamental analysis to keep an investor occupied; so, he shouldn’t devote any time to technical analysis. Personally, I feel I am much better suited to fundamental analysis than I am to technical analysis. Of course, there is no reason why this argument should hold any weight with you. I also believe there is sufficient empirical evidence to support the idea that fundamental analysis is a far more powerful tool than technical analysis.

Even though I believe there must be some form of technical analysis that does have predictive power, the mental model of investing which I have constructed does not allow for such a form of technical analysis. In other words: logically, there must be an effective form of technical analysis, but practically, I pretend there isn’t.

Why? Because I believe that’s the most useful model. One should adopt the most useful model not the most honest model. I’m willing to pretend technical analysis does not work, even though I know some form of it must work.

Really, this isn’t all that strange. In science, I’m willing to pretend there are random events, even though I know there must not be random events. In math, I’m willing to pretend zero is a number, even though I know it must not be a number. A model with random events is useful. In most circumstances, a refusal to allow for random events would be harmful rather than helpful. The model with random events is simpler and more workable. The situation is much the same with zero. It isn’t a number. To include zero as a number, you would have to put aside the principles of arithmetic. So, we don’t do that. In school, you were taught that zero is a number, but that there are certain things you must never do with zero. You accepted that, because it was a simple, workable model.

I propose you do much the same in the case of technical analysis. You should recognize the logical validity of technical analysis, but create a mental model of investing in which technical analysis has no utility whatsoever.

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The Real Effects of Inflation

By Dillon Norris

 In a series of speeches designed to defend his record, Alan Greenspan, until recently an icon of both the new economy and stock exchange effervescence, reiterated the orthodoxy of central banking everywhere. His job, he repeated disingenuously, was confined to taming prices and ensuring monetary stability. He could not and, indeed, would not second guess the market. He consistently sidestepped the thorny issues of just how destabilizing to the economy the bursting of asset bubbles is and how his policies may have contributed to the froth.

Greenspan and his ilk seem to be fighting yesteryear’s war against a long-slain monster. The obsession with price stability led to policy excesses and disinflation gave way to deflation - arguably an economic ill far more pernicious than inflation. Deflation coupled with negative savings and monstrous debt burdens can lead to prolonged periods of zero or negative growth. Moreover, in the zealous crusade waged globally against fiscal and monetary expansion - the merits and benefits of inflation have often been overlooked.

As economists are wont to point out time and again, inflation is not the inevitable outcome of growth. It merely reflects the output gap between actual and potential GDP. As long as the gap is negative - i.e., whilst the economy is drowning in spare capacity - inflation lies dormant. The gap widens if growth is anemic and below the economy’s potential. Thus, growth can actually be accompanied by deflation.

Indeed, it is arguable whether inflation was subdued - in America as elsewhere - by the farsighted policies of central bankers. A better explanation might be overcapacity - both domestic and global - wrought by decades of inflation which distorted investment decisions. Excess capacity coupled with increasing competition, globalization, privatization, and deregulation - led to ferocious price wars and to consistently declining prices.

Quoted by “The Economist”, Dresdner Kleinwort Wasserstein noted that America’s industry is already in the throes of deflation. The implicit price deflator of the non-financial business sector has been -0.6 percent in the year to the end of the second quarter of 2002. Germany faces the same predicament. As oil prices surge, their inflationary shock will give way to a deflationary and recessionary aftershock.

Depending on one’s point of view, this is a self-reinforcing virtuous - or vicious cycle. Consumers learn to expect lower prices - i.e., inflationary expectations fall and, with them, inflation itself. The intervention of central banks only hastened the process and now it threatens to render benign structural disinflation - malignantly deflationary.

Should the USA reflate its way out of either an impending double dip recession or deflationary anodyne growth?

It is universally accepted that inflation leads to the misallocation of economic resources by distorting the price signal. Confronted with a general rise in prices, people get confused. They are not sure whether to attribute the surging prices to a real spurt in demand, to speculation, inflation, or what. They often make the wrong decisions.

They postpone investments - or over-invest and embark on preemptive buying sprees. As Erica Groshen and Mark Schweitzer have demonstrated in an NBER working paper titled “Identifying inflation’s grease and sand effects in the labour market”, employers - unable to predict tomorrow’s wages - hire less.

Still, the late preeminent economist James Tobin went as far as calling inflation “the grease on the wheels of the economy”. What rate of inflation is desirable? The answer is: it depends on whom you ask. The European Central Bank maintains an annual target of 2 percent. Other central banks - the Bank of England, for instance - proffer an “inflation band” of between 1.5 and 2.5 percent. The Fed has been known to tolerate inflation rates of 3-4 percent.

These disparities among essentially similar economies reflect pervasive disagreements over what is being quantified by the rate of inflation and when and how it should be managed.

The sin committed by most central banks is their lack of symmetry. They signal visceral aversion to inflation - but ignore the risk of deflation altogether. As inflation subsides, disinflation seamlessly fades into deflation. People - accustomed to the deflationary bias of central banks - expect prices to continue to fall. They defer consumption. This leads to inextricable and all-pervasive recessions.

Inflation rates - as measured by price indices - fail to capture important economic realities. As the Boskin commission revealed in 1996, some products are transformed by innovative technology even as their prices decline or remain stable. Such upheavals are not encapsulated by the rigid categories of the questionnaires used by bureaus of statistics the world over to compile price data. Cellular phones, for instance, were not part of the consumption basket underlying the CPI in America as late as 1998. The consumer price index in the USA may be overstated by one percentage point year in and year out, was the startling conclusion in the commission’s report.

Current inflation measures neglect to take into account whole classes of prices - for instance, tradable securities. Wages - the price of labor - are left out. The price of money - interest rates - is excluded. Even if these were to be included, the way inflation is defined and measured today, they would have been grossly misrepresented.

Consider a deflationary environment in which stagnant wages and zero interest rates can still have a - negative or positive - inflationary effect. In real terms, in deflation, both wages and interest rates increase relentlessly even if they stay put. Yet it is hard to incorporate this “downward stickiness” in present-day inflation measures.

The methodology of computing inflation obscures many of the “quantum effects” in the borderline between inflation and deflation. Thus, as pointed out by George Akerloff, William Dickens, and George Perry in “The Macroeconomics of Low Inflation” (Brookings Papers on Economic Activity, 1996), inflation allows employers to cut real wages.

Workers may agree to a 2 percent pay rise in an economy with 3 percent inflation. They are unlikely to accept a pay cut even when inflation is zero or less. This is called the “money illusion”. Admittedly, it is less pronounced when compensation is linked to performance. Thus, according to “The Economist”, Japanese wages - with a backdrop of rampant deflation - shrank 5.6 percent in the year to July as company bonuses were brutally slashed.

Economists in a November 2000 conference organized by the ECB argued that a continent-wide inflation rate of 0-2 percent would increase structural unemployment in Europe’s arthritic labour markets by a staggering 2-4 percentage points. Akerloff-Dickens-Perry concurred in the aforementioned paper. At zero inflation, unemployment in America would go up, in the long run, by 2.6 percentage points. This adverse effect can, of course, be offset by productivity gains, as has been the case in the USA throughout the 1990’s.

The new consensus is that the price for a substantial decrease in unemployment need not be a sizable rise in inflation. The level of employment at which inflation does not accelerate - the non-accelerating inflation rate of unemployment or NAIRU - is susceptible to government policies.

Vanishingly low inflation - bordering on deflation - also results in a “liquidity trap”. The nominal interest rate cannot go below zero. But what matters are real - inflation adjusted - interest rates. If inflation is naught or less - the authorities are unable to stimulate the economy by reducing interest rates below the level of inflation.

This has been the case in Japan in the last few years and is now emerging as a problem in the USA. The Fed - having cut rates 11 times in the past 14 months and unless it is willing to expand the money supply aggressively - may be at the end of its monetary tether. The Bank of Japan has recently resorted to unvarnished and assertive monetary expansion in line with what Paul Krugman calls “credible promise to be irresponsible”.

This may have led to the sharp devaluation of the yen in recent months. Inflation is exported through the domestic currency’s depreciation and the lower prices of export goods and services. Inflation thus indirectly enhances exports and helps close yawning gaps in the current account. The USA with its unsustainable trade deficit and resurgent budget deficit could use some of this medicine.

But the upshots of inflation are fiscal, not merely monetary. In countries devoid of inflation accounting, nominal gains are fully taxed - though they reflect the rise in the general price level rather than any growth in income. Even where inflation accounting is introduced, inflationary profits are taxed.

Thus inflation increases the state’s revenues while eroding the real value of its debts, obligations, and expenditures denominated in local currency. Inflation acts as a tax and is fiscally corrective - but without the recessionary and deflationary effects of a “real” tax.

The outcomes of inflation, ironically, resemble the economic recipe of the “Washington consensus” propagated by the likes of the rabidly anti-inflationary IMF. As a long term policy, inflation is unsustainable and would lead to cataclysmic effects. But, in the short run, as a “shock absorber” and “automatic stabilizer”, low inflation may be a valuable counter-cyclical instrument.

Inflation also improves the lot of corporate - and individual - borrowers by increasing their earnings and marginally eroding the value of their debts (and savings). It constitutes a disincentive to save and an incentive to borrow, to consume, and, alas, to speculate. “The Economist” called it “a splendid way to transfer wealth from savers to borrowers.”

The connection between inflation and asset bubbles is unclear. On the one hand, some of the greatest fizz in history occurred during periods of disinflation. One is reminded of the global boom in technology shares and real estate in the 1990’s. On the other hand, soaring inflation forces people to resort to hedges such as gold and realty, inflating their prices in the process. Inflation - coupled with low or negative interest rates - also tends to exacerbate perilous imbalances by encouraging excess borrowing, for instance.

Still, the absolute level of inflation may be less important than its volatility. Inflation targeting - the latest fad among central bankers - aims to curb inflationary expectations by implementing a consistent and credible anti-inflationary as well as anti-deflationary policy administered by a trusted and impartial institution, the central bank.

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Being a Successful Insurance Agent

By Dillon Norris

 The successful insurance agent always stays informed on how he or she can improve themselves both personally and professionally. In these days of fast paced lifestyles and the quickly disappearing face-to-face communication styles of doing business, the professional has to adapt. First, your personal good health is an important component to the success of your business. Second, I’ll present some proven business and customer satisfaction strategies that will guarantee you a thriving business and continued success for the future.

Taking care of your personal health is very often overlooked. The daily life of the professional is fraught with burnout and responsibilities. Many of us juggle on a daily basis the demands of family, parenting and other essential duties. Even the regular duties of getting the dog to the vet, grocery shopping and paying the bills, to name a few, can become dreaded tasks. Eventually, we’re going to get burned out and possibly ill. There are strategies to keeping a healthy mind and body.

Start having a social life outside of work. Just like your daily “to-do” lists at work, start planning a social “to-do” list. In other words, don’t forget to have some fun. Listen to your favorite music for a few minutes each day. Take in a concert or musical affair. Go out to dinner occasionally.

Exercise. Start going to the gym or fitness club. A healthy physical body will give the hard working professional the energy needed to be both highly productive and active socially. Go for a short walk in your neighborhood. Get some fresh air and breath.

Manage your time wisely. Poor time management can be costly. Missing appointments or being late NEVER looks good. The client’s time is just as valuable as yours.

Aside from these tips to stay healthy physically, don’t forget your mental health. Be sure to take regular breaks away from your desk, the phone, the laptop or anything else keeping you chained to your desk.

So, you might ask, what does this mean for me? Many studies have shown that productivity levels significantly decrease for the professional that doesn’t take time for fun, a social life, rest and exercise. If you become both physically and mentally weary, your customers are going to notice.

Many professionals are keenly aware of the saying “presentation is everything”. When you present yourself to a potential client, be it on the phone or in person, it is important to be at your best. I don’t know about you but I would definitely re-think associating with any professional that was unkempt in appearance or tired and sluggish in communications with me. It is very difficult to convince your potential clients to accept your advice to stay healthy when you appear physically ill yourself. Be a role model of what you’re trying to sell. Now that you have some vital information to help you stay personally healthy, let’s examine some strategies to keep your business thriving and profitable.

Continuing Education

Many professional associations offer continuing education workshops, seminars or classes. If you are not a member of a group or organization in your field, then look into classes at an institution of higher learning. It is imperative that you keep up to date on the latest news or information regarding the type of insurance you provide. Don’t forget-classes in human psychology can go a long way in providing you an advantage to understanding your customers better.

Network! Network! Network! Experienced agents know that aligning themselves with a company that will appreciate their skills is a must. Building a customer base with a reliable and strong company that can bring the clients to you is valuable. Your reputation as an experienced, reliant and self-assured insurance agent will guarantee a successful business and many good leads for clients.

The Psychology Of It All

Building a relationship with your customer(s) is integral to your success as an insurance professional. People want quality service. They rely on you to guide them into making the best decisions around their insurance coverage needs. If they don’t trust that you know what you are doing (remember the continuing education and how you present yourself?), they will not buy anything you have to offer. How can we gain their trust?

First and foremost, if you have been informed of a potential client looking for insurance, contact them immediately. As mentioned earlier, people want quality service. A quickly returned phone call sets a good first impression. This action alone tells your customer you care about their needs and are interested in their inquiry.

Next, follow through with what you promised in a timely manner. For example, if you stated you would get back to them in 48 hours on a matter, then return your call within that time.

Be sure you are giving them the appropriate and best advice you can. Obviously, I can’t stress the “educational” component enough in this article. None of us knows the answer to everything and it is acceptable to say I don’t know to a client’s question. Let them know that you will find the answer.

A healthy, informed and experienced insurance agent that is genuinely attentive to their client’s best interests and communicates that effectively will have a successful business.

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Friday, April 30th, 2010 at 3:45 am and is filed under business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.