The FTSE 100 has reached a tricky point for technical analysts, those diviners of patterns and turning points in share price charts.
The trend is the friend of the technical analysts and, since UK shares turned the corner from a low of 3287 on March 12 2003, they have had a pretty clear market run to work with. The FTSE 100 has rallied 60 per cent from the 2003 trough. But after reaching a near four-year high of 5,377.48 on August 8, there has been a 2.3 per cent slide back. For technical analysts and, of course, for UK investors, the critical question is whether this is just a slight dip or a genuine turning point.
Does it matter what technical analysts think? Many would argue no. There is a strong school of thought that the techies rank with astrologers in terms of credibility and predictive powers. The perception is not helped by the arcane methods employed by some techies to discern patterns that are described in language – such as black crows or three white soldiers – that would not be out of place in a Harry Potter novel.
The theory of technical analysis is as far away from the fundamental valuation of a company’s earnings, dividend payout and prospects as a spread-betting day trader is from Warren Buffett. The technical analysts largely ignore fundamental factors to focus on the charts. For some, this preoccupation is based on the hypothesis of efficient markets – that share valuations reflect all known price-sensitive factors. So to study anything else but the charts would be considered a waste of time.
Other technical analysts base their work on the belief that patterns develop in markets due to investor psychology or the ebb and flow of trading momentum. The case of the chartists has been bolstered by the increasing use of technical analysis by hedge funds.
Critics point out that the case for the efficient markets hypothesis has suffered recently, particularly in the dotcom bubble. They add that models of the technical analysts are too rigid to reflect the dynamics of a market guided by innumerable hidden hands.
It is a highly emotional debate. The academic evidence is mixed. One study by Carol Osler of the Federal Reserve Bank of New York found
that one popular technique of equity chart analysis was unprofitable. However, another study by Ms Osler found technical analysis to be “quite successful” in foreign exchange markets. That latter study may reflect the heavy reliance on technicals in a market where it is notoriously difficult to make forecasts on fundamental factors. The Osler study cited statistics that some 25 to 30 per cent of forex traders base their trades on technical signals and that some 90 per cent used technical analysis as a primary or secondary information source.
Personally, I am an agnostic in the debate. If the charts throw up something interesting, why not listen? This is what some of the techies are saying now. Stephen Pope at Cantor Fitzgerald says the broad upward trend in the market since 2003 is still largely intact. He says the 5-day moving average of the FTSE 100 yesterday at midsession of 5285 was below the 21-day average of 5315. This was a sign of weakness but not yet a signal of a major turnround. Mr Pope adds that the 50-day moving average 5238 is still well above the 200-day average of 4977.
Sanjay Jadeja of Finspreads is more bearish. “For the near term, I expect the FTSE, which has already reached our initial target of 5,378, to decline into support levels of 5,079 and lower at 4,887,” he says. “A breach of the 5,000 psychological level may prompt selling activity, but I view this as a prospective buy area which may take the FTSE to our ultimate price target of 5,549 before a major decline takes place commencing early next year.” Mr Jadeja says the key price level of 4,773 must hold to support this view, otherwise the FTSE will experience further declines rapidly towards 4,607.
Jeremy du Plessis, head of technical analysis at Updata, says the FTSE is trading between a support level of about 5000 and a resistance level of 5,300.
He says it is too early to know whether the market has peaked in this bull run or whether it is resting before another advance to the 6,000 level. A break above 5,400 will confirm the continuation of the bull trend. “You only know when you have been at the top when you have been there and retraced from it,” he says. It would be hard to argue with that.
Be alerted on Personal Finance