A Case For Technical Analysis

Charts Oust Ben Graham in John Hancock Technical Fund
By Elizabeth Stanton

Aug. 21 (Bloomberg) -- John Hancock Funds is betting its money-management clients are ready for Bollinger bands, Moving Average Convergence/Divergence and the Relative Strength Index.

The John Hancock Technical Opportunities Fund, started this month by the Boston-based unit of Canada’s Manulife Financial Corp., is the second in the U.S. to rely solely on stock charts for investment decisions, according to data compiled by Bloomberg. It’s among the 10 most-popular of John Hancock’s 54 funds, attracting about $1 million a day, said Keith Hartstein, the company’s president and chief executive officer.

Technical analysis, ridiculed as “alchemy” by Burton Malkiel in his 1973 book “A Random Walk Down Wall Street,” is attracting investors after techniques based on profits and valuations failed during the worst year for stocks since the Great Depression. Elliott Wave International’s Robert Prechter and Ralph Acampora of Altaira Wealth Management SA, who use charts, warned investors to avoid equities in 2007 as strategists at the biggest Wall Street firms forecast gains.

“At the core of technical analysis is the study of supply and demand, but also the risk-control aspect of it, which a lot of other disciplines don’t necessarily use,” said Frank Teixeira of Wellington Management, which runs the John Hancock fund. “That’s why technical analysis is having a little bit more of a rebirth.”

Teixeira gets it. The real beauty of technical analysis is not its superior ability to predict stock market moves. Technicals trump fundamentals for the short-term trader looking to identify momentum-based trades. But, for the long-term investor earnings drive stock prices and there is no substitute for a thorough fundamental analysis of the underlying company.

Yet, technical analysis contains a very important regimen often overlooked by investors: sell rules. It is easy to find thousands of books teaching investors how to buy, what to buy and when to buy but there are far fewer books teaching investors the other necessary component: when to sell. With the buy-and-hold philosophy so ingrained in our stock market teachings, many investors just held last year losing half their wealth.

Technical analysis is based on a risk-to-reward discipline that must be adhered to strictly for success. Technicians continually preach the necessity of accepting small losses in order to avoid fatal situations. So while the technician finds himself stopped out of winning trades quite often, he also has the unencumbered flexibility to take short positions should the momentum shift. It is likely that he will not make as much on the rally but he will compensate for that by also profiting in the decline as he shorts falling stocks. On the other hand, the fundamentalist will likely gain more in the rally because he does not sell any pull-in prematurely but he will also find himself holding the bag when prices collapse as they did in the 2008 bear market.

So what's better? Forget exclusivity and use a combination of the two. For too long, technical analysis has been ignored as heresy because academics plug the so-called patterns into a computer and cannot find a reliable output. Forget all the line drawing and recognize the strength of technical analysis. Its strengths lie in its flexibility and money management discipline. Fundamentals can identify great companies but only technicals will tell you to run for the exits when the books lack the expected transparency and there is actually billions in loses coming. Sometimes stocks fall for reasons we do not fully understand. Fannie Mae and Freddie Mac were quasi-government companies and AIG was the largest insurer in the world. All three went from enormous profits to bankrupt in a year. Opaque accounting fooled the long fundamental analysts but the technician was able to jump on the short wave. The financial mess last year should teach investors the need for price movement-based stop-out rules. Technicals can offer these rules and more; its rebirth is expected and welcomed.



(This is not a recommendation to buy the John Hancock Technical Opportunities Fund. With a 5% front load and a 2.05% expense ratio, the fund's manager, Frank Teixeira, certainly has his work cut out for him.)