Why Might Charting Fail to Work

Why Might Charting Fail to Work?

It is easier for me to present the logical arguments against charting. First, it should be noted that the chartist buys in only after price trends have been established, and sells only after they have been broken. Since sharp reversals in the market may occur quite suddenly, the chartist will miss the boat. By the time an uptrend is signaled it may already have taken place. Second, such techniques must ultimately be self-defeating. As more and more people use it, the value of any technique depreciates. No buy or sell signal can be worthwhile if everyone tries to act on it simultaneously.

Moreover, traders will tend to anticipate technical signals. If they see a price about to break through a resistance area, they will tend to buy before, not after, it breaks through. If it ever was profitable to use such charting techniques, it will now be possible only for those who anticipate the signals it is doubtful that any profitable technical trading rules can be developed.

Charting may fail to work. Photo by Elena

Perhaps the most telling argument against technical methods comes from the logical implications of profit-maximizing behavior on the part of investors. Suppose, for example, that Universal Polymers is selling at around 20 when Sam, the chief research chemist, discovers a new production technique that promises to double the company's earnings and stock price. Now Sam is convinced that the price of Universal will hit 40 when the news of his discovery comes out. Since any purchases below 40 will provide a swift profit, he may well buy up all the stock he can until the price hits 40, a process that could take no longer than a few minutes.

Even if Sam doesn't have enough money to drive up the price himself, surely his friends and the financial institutions do have the funds to move the price so rapidly that no chartist could get into the act before the whole play is gone. The point is that the market may well be a most efficient mechanism. If some people know that the price will go to 40 tomorrow, it will go to 40 today. Of course if Sam makes a public announcement of his discovery as the law requires, the argument holds with even greater force. Prices may adjust so quickly to new information as to make the whole process of technical analysis a futile exercise.

Illustration: Megan Jorgensen