Sources of Wealth by Plos Andrea

Author:Plos, Andrea [Plos, Andrea]
Language: afr
Format: epub
Published: 2013-07-31T18:30:00+00:00

The pros and cons of charting

There is an advantage to charting, which is that investors who see a rising trend may jump on the bandwagon and push stock prices higher thanks to new demand. This has the consequence of confirming the chartist’s predictions about the existence of a rising trend, which becomes a self-fulfilling prophecy.

However, there are disadvantages to this method too. In the first instance, the chartist makes a recommendation to buy or sell based on a trend that has already been established. By the time he acts on this information, it may be too late and another trend may have begun. Another downside is that once a technique has been proven to be successful, more and more people use it. As a result, its usefulness declines as the element of exclusive knowledge vanishes.

Finally, we should question whether the “trends” we are seeing are actually trends at all. Even random occurrences can look like trends when plotted on a graph. For example, imagine flipping a coin which lands on heads five times in a row. There seems to be a pattern of success for heads, but in reality the chances of getting heads are still 50/50. The pattern is just an illusion.

Ultimately, the stock market is random. Trends may be seen to establish themselves, but overall, in the long run, the market will correct itself to maintain some sort of equilibrium. In general, what goes up must come down, and vice versa. If the market as a whole is demonstrating a sharp upward trend, that trend must and will be reversed at some point.

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