``We can chart our future clearly and wisely only when we know the path which has led to the present." - Adlai E. Stevenson
Now we know that no trend moves in a linear fashion.
Yet we cannot be heavily reliant on chart actions to determine the “overbought or oversold” conditions from which to base our positions.
In any major trend (bear or bull cycles), overstretched markets or securities can last for an extended period.
Besides, chart actions greatly depend on patterns from past performances in the probabilistic assumption of a recurrence. The operating word is here probability.
But charting does NOT incorporate the prospective stimulus-response and action-reaction by the public to the ever fast evolving highly fluid environment nor does charting impute exactly similar conditionalities from which decisions had been shaped. This is despite some successful repetition of patterns.
For instance can charting say to what degree the markets will react to a sustained QE? The answer is NO.
And it is from such dimensions that I accurately debunked earlier claims by perma bears of the supposed repetition of the Great Depression, through the alleged similarities in the unfolding of chart patterns[1].
For most of the perma bears, whom have been influenced by some form of (political or economic or cultural) bias rather than sound analysis, they can characterized by the frequent use of post hoc fallacy and data mining to support their desired outcome.
This is why I also correctly disproved earlier notions of chart based bearish patterns which ALL failed to pan out.
I earlier wrote[2],
``They never seem to run out of materials to throw in, after the earlier “death cross” and the ERCI leading indicator, whose effects remain to be seen, now they point to the Hindenburg Omen as a reason to take flight.”
Now that the actions have been reversed and that all former bearish patterns have evaporated, chartists have been talking about the bullish “Golden cross”. Duh!
Yet even if one looks at the charts, the synchronous breakouts in global markets imply a tailwind effect or “momentum” in favour of continuity going forward. As charts have yet to signify distribution or exhaustion.
Also the assumption that charts impute all the necessary information is similar to the flawed premises of the Efficient Market Hypothesis (EMH) which ignores the role of the individual entrepreneurial activities that generate variable outcomes and the erroneous implication that all participants have the same homogenous ‘rational’ expectations[3].
And in learning from the recently departed Benoit Mandlebroit, the father of fractal geometry, on why not to trust charts, Mr. Mandlebroit wrote[4],
``And in the fun-house mirror of logic of markets, the chartists can at times be correct...But this is a confidence trick: Everybody knows that everyone else knows about the support points, so they place their bets accordingly. It beggars belief that vast sums can change hands on the basis of financial astrology. It may work at times, but it is not a foundation on which to build a global risk-management system.” (bold emphasis mine)
In other words, Mr. Mandlebroit shares the analysis disputing the homogeneity of rational expectations incorporated in charting, such that everyone employing the same pattern recognition techniques would render charting to be impractical and an undependable tool for investment or trade.
For me, chart patterns have higher probability of repetitions only when it treads on major trends.
Yet I find more value in identifying the stages of the trend or the cycle, where charts only serve as supplemental role or a guidepost for entry and exit points rather than for main reasons to anchor on a major investment or trading decision.
Hence, given the current market actions and fundamental based developments brought about by QE 2.0, I am unlikely to recommend any position that would fight the major trend.
Remember, QE 2.0 represents uncharted waters in modern central banking, unless we’d include Zimbabwe Gideon Gono’s approach as part of this.
So why use traditional or conventional tools to engage in something unprecedented?
[1] See Seeing Patterns Where None Exist, February 17, 2010
[2] See The Importance of Peripheral Vision, August 23, 2010
[3] Shostak Frank, In Defense of Fundamental Analysis: A Critique of the Efficient Market Hypothesis
[4] Mandlebroit, Benoit B and Hudson Richard, The (Mis) Behaviour of Markets, Profile Books p .8
