Tuesday, March 28, 2017

Unmasking the Voodoo of Chart Reading

Did I just call chart reading - and technical analysis - voodoo? Me, a Chartered Market Technician with the letters CMT on my business card? Me, a technical analyst who writes a column called "Getting Technical" for the past 16 years?

Well, the way everyone uses it does seem to be voodoo. And even more so when one of us gets on TV and starts talking about indicators. Even my eyes glaze over when they chatter on about RSI and moving averages did this or that so you should buy (or sell).

I'll forgive the former NFL coach who was hired to sell a technical analysis trading course and called one of them the 200 moving day average. Come on, TA nerds, you get it?

Recently, I needed to justify my analysis to a media outlet that does zero technical analysis and more likely thinks it is garbage. I basically said that you don't buy because two lines crossed. Rather, the two lines crossing is the market telling us conditions have changed and now the odds have shifted in favor of being long.

It's not the lines crossing that means buy. It is the other way around. The market is trying to tell is it is OK to give it a go so the lines crossed. Think of it as the spirit's manifestation on the screen.

We've all seen stories about the market about to tank because the S&P 500 just formed a black or death cross on its chart. Within days, the index is higher than it was at the time of the cross so the hate mail starts to flow. But let's look at it the other way and it will make perfect sense.

First of all, the death cross occurs when the trend has already changed. That is the only way the math works, by the way, because the pattern is defined as the 50-day moving average crossing below the 200-day moving average. That cannot happen when prices are rising.

Anyway, in practice we often see the market bounce right as the cross happens. Why? Because typically it has been falling for a while already. Again, is has to be falling otherwise the short-term average cannot drop under the long-term average.

OK, Einsteins, I know we can make the math work with price spikes and outliers but roll with me here.

So, the market may be a bit oversold and it bounces. But overall the cross appeared because most likely something is wrong. Short of real voodoo telling us what's what that is all we can hope from charts. They do not tell us what will happen. They are meant to give us clues as to what to do.

Rinse, repeat.

Charts do not forecast the future. They suggest that it is time to take an action.

You don't sell when the market is overbought. It may still be going up and will get more overbought. But you pay attention because if the market does start to succumb to supply, the indicator - whatever told you it was overbought - will back down by a certain amount.

And as we have to say with any indicator, none work in a vacuum. We need several to really understand what the market is telling us. Plus, we have to understand that it is only telling us its condition, not what it is going to do. That part is up to us.

Charts are tools, not your momma. You have to make the decision for yourself and at no time will you (or should you) think you have certainty. You are playing the odds. And all you can do is control what you do - buy, sell or hold.

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