Saturday, June 5, 2010

Contrarian Investment Strategies - The Next Generation: Chapter 2

The founder and Chairman of Dreman Value Management (est. 1977) shares his views on how investors can beat the market with this book (written in 1998). In reference to the efficient market hypothesis (EMH), Dreman writes "Nobody beats the market, they say. Except for those of us who do." More on this book is available here. One of his earlier books (from 1982) has already been summarized here.

In this chapter, Dreman takes the reader through the history of technical analysis. Technicians try to determine the future prices of stocks by looking at charts of past prices. They look at items like moving averages and head-and-shoulders patterns to help gauge future prices. They care not if profit explodes or if a plant implodes, as they believe they can determine future prices from past prices only.

Many early technicians used astrology to guide their decisions, and some made some correct calls and ended up well-followed. Eventually, however, every famous technician has run into a bad streak. (One such example is the famous Joseph Granville, who made a few correct calls in a row and became so well followed that it is believed he single-handedly moved markets.) Today's technician uses the immense power of computers to help detect the patterns for which they are looking.

Technical analysis has survived despite the evidence that suggests its use is of no help. As early as 1900, a French PhD Student (using commodity and bond price/volume data) concluded that past prices could not predict future prices. Since 1960, many academics have come to the same conclusion across a number of different asset classes and markets, with no exception. It is from this work that the idea of the Efficient Market Hypothesis came to be.

Dreman concludes by instructing the reader not to use market-timing or technical analysis, as they will only cost you money.

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