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Charting

Many people use charting, or 'technical analysis', to help them make decisions about timing. The idea behind charting seems to be that whilst it is impossible to know all the fundamentals behind a stock, all relevant information is revealed in its price movement. Of course this is a very dangerous assumption, as share price manipulation is common on the Australian stock market, especially in the speculative sectors. A stock could also be rising or falling due to general market or sector sentiment, which is not always soundly based and can quickly change.

My own attempt at a humorous summary of the basic philosophy behind charting is that

A trend will continue until it doesn't.

So, you simply buy when the trend is up, ride the trend until it stops and then sell at a profit. Very simple in theory, not so simple in practice. There are a number of problems with using only charting as a basis for timing decisions. Here are a few that can occur in practice.

1. By the time the chart unequivocally suggests a buy, most of the run may have already occurred.

2. By the time the chart unequivocally suggests a sell, it may be difficult to do so because of illiquidity.

3. Many charts are choppy and would entail frequent buying and selling, but this creates significant transaction costs.

4. Charts are open to interpretation and sometimes even experienced chartists cannot agree, except in hindsight.

Add this to the fact that charting has to be learned and this inevitably entails a cost, and you will realise that technical analysis is not the magic wand that some sellers of charting seminars, software programs and books would have you believe.

If someone claims that it is easy to make money through charting then, as suggested earlier, politely ask to see their tax returns for the years they made their big killing from it. There is a famous quote that goes,

'I've never yet met a rich chartist'.

A bit harsh, but like the mining company definition, possibly containing a hint of truth.

It is worth mentioning at this point that not all chartists are the same. There are followers of Elliot Wave theory, Fibbonaci sequences and so forth. They all have one thing in common though, a belief that certain patterns occur and recur for some often hidden reason and that it doesn't matter why something happens in the market, as long as you know that it is happening or will happen.

As I have made clear, I am a little skeptical of the chances of doing well in the sharemarket using only charting, but there are those who swear by it. Charting can however no doubt, be a useful tool in your arsenal and at least a rudimentary knowledge is worthwhile if only because there are so many chartists and it's good to know what they're likely to do.

The futures markets too, may be a different kettle of Plankton and appear to lend themselves much better to technical analyses. The whole argument about exactly what sort of chaotic system the sharemarket represents and whether any kind of mathematical or charting based predictive technique can ever be reliable is a very interesting one.

NEXT ... Volume traps

 


 

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