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Ask Clem: Is Warren Buffett right to laugh at chartists?

by LLB Reporter
7th Feb 12 6:23 pm

Clem Chambers, founder of ADFVN.com and one of the City’s most well-known characters, answers your questions

Question for Clem:

“Are chartists frauds? Some investors I know don’t look at the fundamentals of companies at all, they simply look at the pretty patterns the share price makes over the very short term. They apply Fibonacci ratios and squint their eyes to see Ws, Ms, pennants, flags and diamonds to guess how a stock will move.

“Wouldn’t surprise me if they saw a picture of Jesus in their Bollinger bands. Surely this approach is no more credible than examining animal entrails to tell the future. Warren Buffett mocks them.

“So help me! Are they crackers?”

Clem answers:

The short answer to this question is no, yes and maybe.

Charts contain information and the question is: can that information inform a viewer of insights that help them make an investment decision?

Theoretically the answer is no.

The past does not influence the future. Every tick is random from any previous tick and is not influenced by it; there is no trend.

As a platform for using charts this is a good starting point. That doesn’t mean you shouldn’t use charts to help you make investment decisions. Here is why, and using Mr Buffett as an example. He will buy a stock he likes when it has a sudden fall, as per Tesco in the UK recently.

In effect he is buying on a share price fall, that information is just what is held in a chart. As an investor you are much more likely to see that fall in a stock chart as by any other tool, especially if it just recently happened and you missed it on the day.

That is a simple example of how charts are useful.

Likewise, if you want to know what has happened to a stock over the years a chart is a great tool. You can follow the news the stock has released over time and trace the effect in the chart. This can be a good method of getting a feeling for when a stock is cheap or otherwise. For example when a long fall has ended and the share trades sideways for a fair amount of time, a chart indicates the “falling knife period maybe over.”

This is the kind of information the math geniuses in investment banks and their computers can’t calculate for, and it is those guys that will defeat any mechanical way of using charts to make money.

If you set up your MACD and your moving averages and hope they will give you buying signals that will win, you will be disappointed. These schemes do not work. If they did then people who read stock charts, like the hero of my financial thrillers The Armageddon Trade, The Twain Maxim and Kusanagi, would become amazingly rich like he does and they do not.

This is because any mechanical system that can be found would be pre-empted by traders and their computers, until the system would be destroyed. That is why the market makes few mistakes, because an army of bright people is trying to capture that kind of profitable quirk, and in the process beat it out of the system.

It is hard to look at a stock chart and imagine that it is totally random and it isn’t. However it is very random, not totally random. The randomness can come and go, for example during a ‘flash crash’ or some such other rare event. If you can see a non-random moment in a chart you can make money from it, if you can move fast enough, which you probably can’t.

Also, if there was something to find in a chart and only you know it then you could make good money from that. But in my experience you can’t hold a unique technique for long and it will slowly but surely be found out by others and fade away.

For any chart technique to work it has to be nearly unique to you – the more people use it the more its profitability will decay. This means old systems are pointless and you will have to find your own.

This is extremely difficult and if you find opportunities you will discover all kinds of practical problems implementing them, which will be probably the reason they are there – no one can actually do anything about them for technical reasons. They can be found, but it’s the trading equivalent of finding a new species of critter.

So in conclusion,

No:

Charts don’t work for 99 per cent of what your read about as useful T/A techniques, be it support and resistance, trends, MACD, fibs, moving average cross overs, Bollinger bands etc. They may have worked once but not anymore. (You can back test them till you die of boredom if you don’t believe me.)

Yes:

Charts are very useful because they are a summary of the price history of a company and can help you understand their history and how they relate to the stock’s news history.

Maybe:

You can find your own profitable chart insights because if there is any inefficiency in the market you should be able to see them in a chart when inefficiencies come and go. Don’t expect to find any useful signals in the established literature, these signal will be long dead.

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