Technical Analysis, or the method of stock buying that has been known in previous decades as chart reading, holds no sway for the consummate capitalist.  Technical analysts must engage in active trading (hyperactive buying and selling) in order to follow the daily gyrations of the market.  Technical analysis revolves around the idea that past action of the market tends to predict future action.  Prior market price movement of an individual stock is charted (or graphed) and then studied for discernible patterns.  Much hay is made of the charts that result from past market price undulations (trend lines, double tops, resistance points, etc.).  The problem, of course, is that a chart may be made of any series of changes over time.  The presence of patterns in the market price of a given stock is unquestioned; however, the presence of patterns that consistently provide empirical data that can be acted upon in a consistently profitable manner is an entirely different question.  Warren Buffett, among the most successful capitalists in history, has said that he engaged in technical analysis prior to studying under Benjamin Graham; however, technical analysis is now more than 55 years in Buffett's past.¹

 Benjamin Graham, the father of modern securities analysis and mentor to Warren Buffett, took issue with the logic of technical analysis in his monumental classic, Security Analysis (1934).  Professor Graham likened technical analysis to that of studying the records of winning horses at the track.  The prior records of horses could be charted and studied; and some people would make money on certain horses, some of the time.  However, he noted that horse racing charts could not provide valuable information on a consistent basis, so as to make horse betting a consistently profitable endeavor (Security Analysis, p. 610).

Even more damning, Graham wryly noted parallels between technical analysis and gambling.  He opined that technical analysis gained tremendous influence in Wall Street by stressing an alluring idea: losses must be cut short and winnings encouraged.  This strategy not only encourages, but by its nature, requires active trading.  Professor Graham pointed out that the "cut losses short and run up winnings" strategy was typically employed at the roulette table by professional gamblers; and many, if not most of them, ran into trouble because the aggregate of small losses exceeded the total of any large, "run up" profits.  Additionally, the total heavy trading transaction costs (buy/sell commissions, fees, taxes, etc.) greatly handicapped the professional gambler's strategy when used in the stock market (Security Analysis, pp 610-613).

The single greatest point of departure between technical analysts and Graham's security analysis was that Graham insisted upon a very wide margin of safety in his analysis of a security's value.  That is, unlike the technical analyst, Graham's security analyst will not recommend a stock or other security unless it can be acquired at a very significant discount to its intrinsic value.


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Notes:
[1] http://www.fool.com/investing/value/avoid-the-mistake-that-cost-buffett-8-years-of-bet.aspx

Michael's Comments:
Great article! So if I understand you right, those who use technical analysis cannot determine a margin of safety because by analyzing the price alone and by never analyzing the business behind it they can never know whether the business is strong enough to have that margin of safety? Thanks!

JL Eaton (author)'s Comments:
Michael,   You pretty much got the gist of the article.  Technical analysis leaves people in a lurch: if they are wrong, the full brunt of being wrong slams them.  Alternatively, the Buffett-Graham-Munger approach  (the Capitalist approach) overcomes this problem by refusing to buy unless the market price is significantly below an appraised market value.  In essence, the Capitalist insists upon an  insurance policy each time a company is added to the portfolio.  No insurance, no purchase.