Why the Sports Trading Marketplace is the Most Appropriate Context for the Representation of Behavioral Economics Applied Through Technical Analysis Products Via TheWolfLineTM Quant Sports Trading Platform
Technical Analysis is the area of price, volatility and probability market analysis that concerns the quantitative representation of behavioral economics into specific calculated indicators and graphical charts and oscillators. Because the sport speculation markets are based solely on abstract perceptions of value represented by market price with no associated tangible underlying asset (e.g. a share of stock ownership, a plot of real estate, a hard currency, a bushel of wheat, etc.) the interpretation of behavioral economics represented by TheWolfLine™ platform of technical analysis/quantitative analysis is of paramount concern. The closing calculated price/probability/volatility of a sports speculation or relationship is composed of (The Efficient Market Hypothesis + Behavioral Economics + Transaction Cost/Juice/Vig). The subjectivity, and potential "edge", is found in the variable behavioral economics component as the other two components are absolutes.
I wrote the following assessment in 2007, before the financial crisis. This was prior to the genesis of TheWolfLine™ quant sports trading technology so it was in reference to traditional financial market analysis. The second offering is the first page of the first chapter of the 1948 book Technical Analysis of Stock Trends by Robert Edwards and John Magee. I am certain that they would both have been fascinated by the global sports speculation markets of 2017.
Why Technical Analysis?
I often get asked by prospective traders, whether it is in the context of options trading or otherwise, something to the effect of: "What is technical analysis and how can it help me in my trading?" To define technical analysis is quite simple, but in order to explain how it can help a new trader to become more successful is a much more challenging task. As options traders, or prospective options traders, it is the best course of action to first identify a trading opportunity, and then use the most appropriate options strategy that applies all of the Greek variables to the expected outcome of that scenario. In other words, figure out where you feel the underlying asset is going (or not going), how long it will take to get there, and what effects, if any, that movement or stagnation may have on volatility. The optimal way for a trader to ascertain a significant confidence level to put on a trade or speculate on a position depends, not totally, but a great deal on his /her knowledge of technical analysis.
By definition, Technical Analysis is the ability to identify trend continuations, reversals, and consolidations in individual issues, sectors/ETFs, indices, or major averages through the subjective interpretation of objective data which is based on past quantitative performance (that is my personal definition). In contrast, Fundamental Analysis (also my definition) is the study of true economic factors and the effects that these factors will have on future price activity of financial instruments (e.g. interest rates, market share, oil prices, new product pipeline, prospective expenses, industry competition, company management, P/E ratios, etc.). The problem with using fundamental data to "trade" is that once that news is available it either a) is already priced into the value of the underlying, b) will take several quarters to be realized or not realized, and c) can only be predicted by fortune tellers or those who choose to break the law. So the wise alternative, especially if you plan on trading, and realize that "buy and hold" is not the prudent course of action, would certainly be technical analysis as an invaluable skill that must be honed.
Additionally, in our current market environment, fundamental data, both major macroeconomic data reports and information provided by individual companies always has the chance of being revised, distorted, or just plain made up (e.g. Enron, Tyco, Healthsouth, Merck), which would leave the "investor" vulnerable to any adjustments made to this data after the position had been entered in to.
Technical Analysis is basically Chart Reading and it is based on six quantitative variables: 1) price, 2) time, 3) volume, 4) momentum, 5) breadth 6) volatility. These factors can be used to create countless algorithms that can enable the trader, with proper education and experience, to predict potential future activity of the underlying without being a slave to revisions, malfeasance, or brokers personal agenda. Technical Analysis can be used to profit on moves that can be predicted at their inception and have a time frame that ranges from intraday moves to moves that take several years to complete.
Chart reading is also correlated with four non-quantitative factors: 1) past is prologue, 2) humans are creatures of history, 3) psychology drives markets, and 4) technical analysis can be seen as a self fulfilling prophecy. By self fulfilling prophecy I mean that if a technical buying (or selling) opportunity seems apparent, the very nature of a large number of buyers (or sellers) believing it, will drive the markets accordingly. The two key words to be aware of when learning technical analysis are indicator and oscillator. An indicator is a quantity that is derived from a mathematical equation that represents some aspect of the market (e.g. daily volume). An oscillator is a chart that shows movement of data over a certain frame or periods of time (e.g. volume moving average). It is important to be comfortable with these two definitions in order to understand "TA".
In conclusion, knowledge of technical analysis is a skill that is imperative for anyone who plans on successfully trading underlying financial issues or the options on those particular issues in today’s market environment. A firm working grasp on the mechanics of the market allows an individual trader to take a proactive approach to his trades, thus avoiding the tenuous reliability of fundamentals, arbitrary release of upgrades/downgrades by large wire houses, and the subjective whims of their self-serving broker. Technical Analysis is not taught in any business school, but it is surely an invaluable method for anyone who plans to successfully trade or speculate in any financial market.
Edwards and Magee
The Technical Approach to Trading and Investing
Few Human activities have been so exhaustively studied during the past century, from so many angles by so many different sorts of people, as has the buying and selling of corporate securities. The rewards which the stock market holds out to those who read it right are enormous; the penalties it exacts from careless, dozing, or "unlucky" investors are calamitous. No wonder it has attracted some of the world’s most astute accountants, analysts, and researchers, along with a motley crew of eccentrics, mystics, and "hunch players", and a multitude of just ordinary hopeful citizens.
Able brains have sought, and continue constantly to seek, for safe and sure methods of appraising the state and trend of the market, of discovering the right stock to buy and the right time to buy it. This intensive research has not been fruitless – far from it. There are a great many successful investors and speculators (using the word in its true sense, which is without opprobrium) who, by one road or another, have acquired the necessary insight into the forces with which they deal and the judgement, the forethought, and the all-important self-discipline to deal with them profitably.
In the course of years of stock market study, two quite distinctive schools of thought have arisen, two radically different methods of arriving at the answers to the trader’s problem of what and when. In the parlance of "the Street", one of these is commonly referred to as the fundamental or statistical, and the other as the technical. (In recent years a third approach, the cyclical, has made rapid progress and, although still beset by a "lunatic fringe", it promises to contribute a great deal to our understanding of economic trends.)
The stock market fundamentalist depends on statistics. He examines the auditors’ reports, the profit-and-loss statements, the quarterly balance sheets, the dividend records, and policies of the companies whose shares he has under observation. He analyzes sales data, managerial ability, plant capacity, the competition. He turns to bank and treasury reports, production indexes, price statistics, and crop forecasts to gauge the state of business in general, and reads the daily news carefully to arrive at an estimate of future business conditions. Taking all these into account, he evaluates his stock; if it is selling currently below his appraisal, he regards it as a buy.
As a matter of fact, aside from the greenest of newcomers when they first tackle the investment problem, and to whom, in their inexperience, any other point of view is not only irrational but incomprehensible, your pure fundamentalist is a very rare bird. Even those market authorities who pretend to scorn charts and "chartists" utterly are not oblivious to the "action" chronicled by the ticker tape, nor do they conceal their respect for the Dow Theory which, whether they realize it or not, is, in its very essence, purely technical.
Definition of Technical Analysis
The term "technical", in its application to the stock market, has come to have a very special meaning, quite different from its ordinary dictionary definition. It refers to the study of the action of the market itself as opposed to the study of the good in which the market deals. Technical Analysis is the science of recording, usually in graphic form, the actual history of trading (price changes, volume of transactions, etc.) in a certain stock or in "the Averages" and then deducing from that pictured history the probable future trend.
...the technician claims, with complete justification, that the bulk of statistics which the fundamentalists study are past history, already out of date and sterile, because the market is not interested in the past or even the present! It is constantly looking ahead, attempting to discount future developments, weighing and balancing all the estimates and guesses of hundreds of investors who look into the future from different points of view and through the glasses of many different hues. In brief, the going price, as established by the market itself, comprehends all the fundamental information which the statistical analyst can hope to learn (plus some that is perhaps secret from him, known only to a few insiders) and much else besides of equal or even great importance.
All of which, admitting its truth, would be of little significance were it not for the fact, which no one of experience doubts, that prices move in trends and trends tend to continue until something happens to change the supply-demand balance. Such changes are usually detectable in the action of the market itself. Certain patterns or formations, levels or areas, appear on the charts which have a meaning, and can be interpreted in terms of probable future trend development. They are not infallible, it must be noted, but the odds are definitely in their favor. Time after time, as experience has amply proved, they are far more prescient than the best-informed and most shrewd of statisticians.
The technical analyst may go even further in his claims. He may offer to interpret the chart of a stock whose name he does not know, so long as the record of trading is accurate and covers a long enough term to enable him to study its market background and habits. He may suggest the he could trade with profit in a stock knowing only its ticker symbol, completely ignorant of the company, the industry, what it manufactures or sells, or how it is capitalized. Needless to say, such practice is not recommended, but if your market technician is really experienced at his business, he could, in theory, do exactly what he claims.
By K. Gregory Wolfe
Icarus Hegel Analytics, LLC