The Fallacy of Chartism
November 8th 2006 11:55
Chartism, or technical analysis, is about predicting share price behavior, and more specifically, determining investment and divestment decisions by analyzing historic share price figures.
Chartism typically assembles a chart based on past figures for the prices of a company or an entire market, and then draws certain lines that represent an interpretation of the data. These lines could be “resistance” and “support” or “moving average”, etc.
The moving average, particularly, allows the chartist to know when a particular price has moved above the moving average line, and it’s probably time to buy, and when a particular price has moved below the moving average line, and it’s probably time to sell. There's a whole lot more into chartism or technical analysis.
All this is very interesting and, who knows, maybe useful to a certain degree.
What I cannot accept is the assumption that technical analysis makes prior to anything. And that is that the market is efficient and rational and that all available information in it has been factored into the price.
The fact is that the market often behaves irrationally.
One example of this is Aristocrat Leisure, the Australian poker machine manufacturer, that in the first half of 2003 fell to ridiculous lows after losing a contract and then, six months later, recovered, far surpassing its original high.
The price for this company at the time it fell was far too low for its value and that is in contrast with the belief that the market processes all available information rationally.
From this must result that trying to interpret price charts, which assume prices are rationally set, is the same as trying to read the mind of a foul.
On the other hand, chartism makes another mistaken assumption: that, in a frame of cause and effect, past price is a “cause” of future price, which is completely wrong.
The cause for future price is in the economic performance of the company, in the case of shares, and the market in the long run reflects that fundamental value by pricing the company accordingly. To me this is common sense.
Finally, I see something else in technical analysis: that the need to detect the trends of the market means a need to validate one's decisions on the actions of the market.
If the trend is up—they should know what they're doing so let's jump in and buy; if the trend is down—follow them, jump and sell. To me this is herd mentality and, thankfully, I do not suffer from it.
In conclusion, I see chartism or technical analysis as a major fallacy of our time as investors.
Chartism typically assembles a chart based on past figures for the prices of a company or an entire market, and then draws certain lines that represent an interpretation of the data. These lines could be “resistance” and “support” or “moving average”, etc.
The moving average, particularly, allows the chartist to know when a particular price has moved above the moving average line, and it’s probably time to buy, and when a particular price has moved below the moving average line, and it’s probably time to sell. There's a whole lot more into chartism or technical analysis.
All this is very interesting and, who knows, maybe useful to a certain degree.
What I cannot accept is the assumption that technical analysis makes prior to anything. And that is that the market is efficient and rational and that all available information in it has been factored into the price.
The fact is that the market often behaves irrationally.
One example of this is Aristocrat Leisure, the Australian poker machine manufacturer, that in the first half of 2003 fell to ridiculous lows after losing a contract and then, six months later, recovered, far surpassing its original high.
The price for this company at the time it fell was far too low for its value and that is in contrast with the belief that the market processes all available information rationally.
From this must result that trying to interpret price charts, which assume prices are rationally set, is the same as trying to read the mind of a foul.
On the other hand, chartism makes another mistaken assumption: that, in a frame of cause and effect, past price is a “cause” of future price, which is completely wrong.
The cause for future price is in the economic performance of the company, in the case of shares, and the market in the long run reflects that fundamental value by pricing the company accordingly. To me this is common sense.
Finally, I see something else in technical analysis: that the need to detect the trends of the market means a need to validate one's decisions on the actions of the market.
If the trend is up—they should know what they're doing so let's jump in and buy; if the trend is down—follow them, jump and sell. To me this is herd mentality and, thankfully, I do not suffer from it.
In conclusion, I see chartism or technical analysis as a major fallacy of our time as investors.
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Comment by Benjamin
Benkaiser.NET Investment Portal
It depends on charting of past return peformance and its a very technical one. Forget about fundamentals, save for the generic economic and industrial performance.
Comment by Anonymous