Mick Weinstein The Week's Best Stock Blogs

Do you get excited about a 'cup and handle' - or only when it's holding your steaming morning joe?

While the market continues to flounder, an interesting and constructive debate erupted this week between two of the financial blogosphere's brightest stars. The topic: technical analysis of stock charts.

It began when Felix Salmon, who writes the outstanding 'Market Movers' blog for Portfolio.com, found the inimitable Jim Cramer urging his CNBC "Mad Money" viewers on June 13th to "buy, buy, buy!" stocks based on a certain reading on a technical tool called the "S&P 500 oscillator." Cramer encouraged his minions to purchase financials, tech and homebuilders in particular - a call that, ahem, didn't turn out so well over the past couple of weeks. The Great Booyah himself backtracked on it just a few days later.

Salmon took both Cramer and his "oscillator" to task: "Whenever you hear words like ‘overbought' or ‘oversold' or ‘momentum' or ‘support' or ‘resistance,' it means that whatever you're hearing is garbage. But it also means that the person you're listening to has no idea what's about to happen, and is therefore resorting to the financial equivalent of astrology."

Salmon then brought fund manager Barry Ritholtz - author of the popular Big Picture blog - into the fray: "[S]tock traders don't know anything," said Salmon. "It's not just Cramer, is the point. They all do it: even much smarter and much more analytical traders like Barry Ritholtz do it... [resorting] to ‘technical analysis,' which is the art of drawing lines on charts and extrapolating from them what the market is going to do next... If you don't have any bright ideas about which way the market is going...the smart and sensible route is to say ‘I don't have any bright ideas about which way the market is going.' The dumb route is to get out your charts and start making predictions on the strength of technical analysis."

Ritholtz - who, besides managing money, is CEO of a company that provides stock-indicator software based on technical and fundamental factors - responded: "I cannot put aside the fact that Cramer is not, and has never been, any sort of technician... [yet] we do not dismiss medicine because accountants cannot do open heart surgery, so it seems odd to use a bad call of Cramer's -- a self-admitted non-technician -- as proof that technicals are worthless."

"Technicals are not magic," continued Ritholtz. "They are not a way to forecast the future, nor are they a guarantee of future profits... Technicals can be, however, far less squishy than fundamentals. There is as much art as science in the application of TA. That some people are lousy technicians proves only that it requires skill... I posit that charts and data provide tremendous insight, if used appropriately... the bottom line is that TA is merely a tool, albeit one used more skillfully by some than others."

Salmon replied with a call for results: "[W]ho are the investors who consistently underperform the market? Do they happen to be exactly or even mostly the same as the group of people who don't use technical analysis? It seems improbable, to say the least, especially given the fact that celebrated investors like Warren Buffett and Peter Lynch loudly and frequently declare that they think technical analysis is bullshit."

"Insofar as technical analysis is any better than pure guesswork or astrology," Salmon continued, "I think it works as a way of gauging market sentiment and psychology. But here's the problem: everything in technical analysis seems to work backwards. No one ever seems to start from first principles and make predictions of what would happen to price-and-volume charts when sentiment does this or does that... As any quant fund will tell you, those kind of models work until they don't. Meanwhile, the technical-analysis crew seems to think that they're dealing with immutable, permanent, semi-scientific probabilistic laws. In the markets, there's no such thing."

A Question of Personality and Time Horizon?

For Bill Luby, an investor and blogger who focuses on market volatility, the Salmon-Ritholtz debate revolves around a matter that "each investor has to struggle with, usually a number of times over the course of his or her investing lifetime...I find it hard to believe that the high court of investment strategy will ever rule in favor of one approach at the expense of the other... Part of the reason investors gravitate to one approach or the other is that it fits their personality and provides a certain level of comfort."

"To my thinking, the most important determinant of whether to focus on fundamentals or technical analysis is one's investment time horizon," says Luby. "[T]he shorter the time horizon, the more important technical analysis becomes. Find me a day trader, for instance, that invests primarily based on fundamental factors. On the flip side, find me a chartist who is looking at monthly charts covering more than a decade who does not think it is important to be educated on some of the relevant fundamentals that are driving the long-term price action."

Dr. Declan Fallon at the Zignalsblog weighed in on the debate: "It is wrong to assume all technical analysis is based on chart watching... Technical analysis is not financial astrology, but is a tool to study the psychology of human participants in a collective marketplace.... only by studying past behavior can we gauge what current participants may (or may not) do in the market. Technical analysis is a science and an art. If it was a pure science, then quants would rule the day."

Fallon advocates combined use of technicals and fundamentals: "Many technicians avoid using fundamentals, but doing so is like looking at the market with one eye. Fundamentals provide a whole new set of tools which marry perfectly with technicals."

The value of technical analysis a longstanding debate among investors and professional market participants - and it won't be resolved anytime soon. But, as in any debate, clarifying the underlying principles is helpful. What are your thoughts on the value of technical analysis? Have your say in comments below.