Voodoo Finance
During my Fall 2005 Semester at Hopkins, I took Database Systems with professor David Yarowsky. The course included a final project, which I did with Raymond Buse. Our aim: to build a simulator capable of investigating the performance of technical analysis tools over a long period of time.
Technical Analysis is the study of the price movement for a security in order to extrapolate a dependable trend that could theoretically predict a future price and allow the investor, or as Benjamin Graham would correct, speculator, to act upon this prediction. It is sometimes referred to as chart reading or voodoo finance and contrasts with fundamental analysis, which is the in-depth study of the security, such as the profitability of the underlying company in the case of an equity.
Needless to say, this practice is often the anathema of seasoned investors. To understand why we decided to quantify how a trader would perform if the decision making process relied exclusively on the output of these algorithms. As control data we had two non technical strategies, BuyAndHold and InsiderTrading. The first is self explanatory; the second relies on an oracle of perfect information that knows the exact stock movement of the following day for a particular stock, and performs a transaction only if it will be profitable the next day.
Our results showed that starting with only $10,000, you could buy Microsoft in less than 10 years regardless of when you started to invest using perfect information, however, there’s no stock on the Dow Jones when you would be able to consistently beat the market in the long run using any technical analysis and that in fact, BuyAndHold would beat the other strategies. The results for this study will appear sometime soon on this website.
Given how versatile this simulator is, another interesting study would be to compare Dollar Cost Averaging versus Lump Sum investments; perhaps this will also be done soon, and if so, the results will be posted on this site.