This has to be one of the more hilarious things that smart people say all the time: “The problem with technical analysis is that it only looks at information from the past”. This, to me, is a classic case of non-conscious human mimicry. Some of that research in this area of psychology is fascinating to me as humans tend to mirror the behavior patterns of others. In this example, it’s clearly just people repeating something that they once heard, and not something they’ve actually thought through. I mean, come on. The problem with technical analysis is that it only looks at information from the past? As opposed to what? Information from the future?

As a market technician, both as a hobby and a profession, I obviously laugh at this sort of thing, especially when it comes from someone smart. It’s clear they haven’t even thought through this and just spit out something they’ve heard before because they are stuck in their fundamental non-price behavior-analyzing ways. Of course technical analysis only looks at information from the past. So does any other form of market analysis. If we had information from the future, trust me we would use it. So would fundamental analysts. Go ask them.

I’ll let John Murphy take it away:

….the validity of using past data to predict the future. It is surprising how often critics of the technical approach bring up this point because every known method of forecasting, from weather predicting to fundamental analysis, is based completely on the study of past data. What other kind of data is there to work with?

The field of statistics makes a distinction between descriptive statistics and inductive statistics. Descriptive statistics refers to the graphical presentation of data, such as the price data on a standard bar chart. Inductive statistics refers to generalizations, predictions, or extrapolations that are inferred from that data. Therefore, the price chart itself comes under the heading of the descriptive, while the analysis technicians perform on that price data falls into the realm of the inductive.

As one statistical text puts it, ‘The first step in forecasting the business or economic future consists, thus, of gathering observations from the past.’ (Freund and Williams) Chart analysis is just another form of time series analysis, based on a study of the past, which is exactly what is done in all forms of time series analysis. The only type of data anyone has to go on is past data. We can only estimate the future by projecting past experiences into that future.

So it seems that the use of past price data to predict the future in technical analysis is grounded in sound statistical concepts. If anyone were to seriously question this aspect of technical forecasting, he or she would have to also question the validity of every other form of forecasting based on historical data, which includes all economic and fundamental analysis

I really like the things Murphy mentions in this quote. It’s difficult for me to put it any better. It’s funny, back in 2012 I gave a presentation at Harvard University. It was the first time I ever spoke at any college. Since then I’ve also spoken at Duke, University of Chicago, NYU and Hong Kong Baptist University among others. I wasn’t even 30 years old at the time, but I took advantage of the invite and took the train to Cambridge. I went up there ready to tell a bunch of academics that analyzing price behavior is the best way to approach the market in order to both profit and manage risk responsibly. As soon as I opened my mouth, I don’t even think I was through my first slide yet, a heckler from the back yells, “Come On, Technical Analysis Only Looks At The Past!”. Without even skipping a beat, I yelled back in front of the entire room, “As opposed to what? Information from the future? Do you have a time machine?”.

It was one of those instances where you don’t think before you speak. You could feel the cringe in everyone’s stomachs. I felt so bad and tried to make a joke out of it so I started quoting Back to the Future movies. It was awkward. Thankfully from there my presentation went great and I think everyone got to learn about my approach to the market. It also gave me a chance to get up in front of a bunch of smart people and present confidently about a topic that I know well. This experience helped me later on when I had to do TV appearances multiple times a week for 5-6 years and present in front of intelligent market participants at conferences all over the world.

We want to learn from the past, not be afraid of it. As traders and investors, we are historians by definition. I wish I knew this much American History when I was in high school and struggling through History exams that I didn’t care enough about at the time. It’s amazing how the same patterns happen over and over again. This isn’t only true for price patterns, but is especially true for human behavior patterns. Later in this Educational Series we discuss sentiment and how when we get to bullish or bearish extremes, the snap backs tend to be violent. We see this over and over and over again in the stock market, in forex, in bonds and even soybean futures. It’s amazing how often history repeats itself. We just have to pay attention and be aware of it.