AMSTERDAM Technical analysis, the study of price charts to predict future market moves, depresses investment returns for private investors as it leads to overconfidence, high trading costs and undiversified portfolios, a Dutch-American study shows.
Maastricht University financial economist Arvid Hoffmann and Santa Clara University's behavioral finance specialist Hersh Shefrin found in a study of 5,500 users of a Dutch online discount brokerage that the investment returns of small investors using charts were 0.6 percent per month or about 7 percentage points per year lower than those who do not.
"It is not that there is anything wrong with technical analysis in itself, but we found that it leads to investor overconfidence and very busy trading, which pushes up costs," Hoffmann told Reuters on Tuesday.
He added that private investors using the technique often have highly concentrated portfolios, making big bets on just a few stocks, which increases risk and weighs on overall returns. They also tend to use more options.
For the study, which took in data from 2000 through 2006, the researchers had access to the investors' trading data, as well as a survey about their investment techniques. The study - which is available on the Social Science Research Network - does not reveal which online brokerage's data were used.
"We find that individual investors who use technical analysis and trade options frequently make poor portfolio decisions, resulting in dramatically lower returns than other investors," the study said.
While technical analysis tries to spot investment opportunities by looking at trends and patterns on historical price charts, fundamental analysis - also called value investing - looks at company accounts and the company's business.
Pioneered by Benjamin Graham and David Dodd in the 1930s and made popular by investment gurus like Warren Buffett, fundamental analysis is more popular among professional investors, although many combine both techniques - using fundamentals to decide which stocks to buy and technicals to decide when.
While fundamental analysis tends to focus on equity investments, technical analysis - such as establishing support and resistance levels beyond which further moves can be expected in the same direction - is also widely used in currency, fixed income, commodities and precious metals trading.
Hoffmann said his study shows that technical analysis enthusiasts are more likely to be men. While 77 percent of the investors in the study were male, of those investors who used technical analysis exclusively 85 percent were male.
"Behavioral science research shows that men, compared to women, tend to be more overly confident in their own analysis and ability," Hoffmann said.
(Editing by David Holmes)