Capitalistic Musings | Page 7

information - and a lot to do with mass psychology. How else
can we account for the crash of October 1987? This goes to the heart of
the undecided debate between technical and fundamental analysts.
As Robert Shiller has demonstrated in his tomes "Market Volatility"
and "Irrational Exuberance", the volatility of stock prices exceeds the
predictions yielded by any efficient market hypothesis, or by
discounted streams of future dividends, or earnings. Yet, this finding is
hotly disputed.
Some scholarly studies of researchers such as Stephen LeRoy and
Richard Porter offer support - other, no less weighty, scholarship by the
likes of Eugene Fama, Kenneth French, James Poterba, Allan Kleidon,
and William Schwert negate it - mainly by attacking Shiller's
underlying assumptions and simplifications. Everyone - opponents and
proponents alike - admit that stock returns do change with time, though
for different reasons.
Volatility is a form of market inefficiency. It is a reaction to incomplete
information (i.e., uncertainty). Excessive volatility is irrational. The
confluence of mass greed, mass fears, and mass disagreement as to the
preferred mode of reaction to public and private information - yields
price fluctuations.
Changes in volatility - as manifested in options and futures premiums -
are good predictors of shifts in sentiment and the inception of new
trends. Some traders are contrarians. When the VIX or the NASDAQ
Volatility indices are high - signifying an oversold market - they buy
and when the indices are low, they sell.
Chaikin's Volatility Indicator, a popular timing tool, seems to couple
market tops with increased indecisiveness and nervousness, i.e., with
enhanced volatility. Market bottoms - boring, cyclical, affairs - usually

suppress volatility. Interestingly, Chaikin himself disputes this
interpretation. He believes that volatility increases near the bottom,
reflecting panic selling - and decreases near the top, when investors are
in full accord as to market direction.
But most market players follow the trend. They sell when the VIX is
high and, thus, portends a declining market. A bullish consensus is
indicated by low volatility. Thus, low VIX readings signal the time to
buy. Whether this is more than superstition or a mere gut reaction
remains to be seen.
It is the work of theoreticians of finance. Alas, they are consumed by
mutual rubbishing and dogmatic thinking. The few that wander out of
the ivory tower and actually bother to ask economic players what they
think and do - and why - are much derided. It is a dismal scene, devoid
of volatile creativity.
The Friendly Trend
By: Dr. Sam Vaknin
Also published by United Press International (UPI)
The authors of a paper published by NBER on March 2000 and titled
"The Foundations of Technical Analysis" - Andrew Lo, Harry
Mamaysky, and Jiang Wang - claim that:
"Technical analysis, also known as 'charting', has been part of financial
practice for many decades, but this discipline has not received the same
level of academic scrutiny and acceptance as more traditional
approaches such as fundamental analysis.
One of the main obstacles is the highly subjective nature of technical
analysis - the presence of geometric shapes in historical price charts is
often in the eyes of the beholder. In this paper we offer a systematic
and automatic approach to technical pattern recognition ... and apply
the method to a large number of US stocks from 1962 to 1996..."
And the conclusion:
" ... Over the 31-year sample period, several technical indicators do
provide incremental information and may have some practical value."
These hopeful inferences are supported by the work of other scholars,
such as Paul Weller of the Finance Department of the university of
Iowa. While he admits the limitations of technical analysis - it is
a-theoretic and data intensive, pattern over-fitting can be a problem, its
rules are often difficult to interpret, and the statistical testing is

cumbersome - he insists that "trading rules are picking up patterns in
the data not accounted for by standard statistical models" and that the
excess returns thus generated are not simply a risk premium.
Technical analysts have flourished and waned in line with the stock
exchange bubble. They and their multi-colored charts regularly graced
CNBC, the CNN and other market-driving channels. "The Economist"
found that many successful fund managers have regularly resorted to
technical analysis - including George Soros' Quantum Hedge fund and
Fidelity's Magellan. Technical analysis may experience a revival now
that corporate accounts - the fundament of fundamental analysis - have
been rendered moot by seemingly inexhaustible scandals.
The field is the progeny of Charles Dow of Dow Jones fame and the
founder of the "Wall Street Journal". He devised a method to discern
cyclical patterns in share prices. Other sages - such as Elliott - put forth
complex "wave theories". Technical analysts now regularly employ
dozens of geometric configurations in their divinations.
Technical analysis