To those who follow them, they are simply the most reliable and trustworthy form of trading analysis. To their detractors, they represent nothing more than pretty patterns that tell the trader little if anything about market trends and the future behaviour of assets.
They are, of course, charts, a branch of what is known as technical analysis. Charts take the seemingly-random movement of any price or set of prices – shares, commodities, currencies, indices – and seek underlying patterns from which future movements may be predicted.
The novice trader may find aspects of “chartism” baffling, not least because some of the language is replete with “secondary support levels” and “tertiary turning points”. So let’s start with some relatively straightforward features.
A $4 trillion trading factor
That there are “technical aspects” to market trading activity is accepted by all schools of thought, including the fundamental analysts, those who focus on earnings, profits and underlying performance and tend to be dismissive of chartists. The most basic of these technical aspects is supply and demand.
One of the most dramatic technical factors at play in recent years has been the “quantitative easing” (QE) undertaken by central banks, in which new money is conjured out of thin air and used to buy securities, mostly government bonds. QE, intended to pump cash into the economy in the wake of the financial crisis, has the effect of artificially inflating the demand for bonds, pushing up the price and reducing the yields with which they reward investors, who are now paying more for the same dividend income.
In the US alone, QE amounted to $4 trillion at its peak.
If supply and demand are uncontroversial technical factors, the notion of trading ranges is a little more contentious. That an asset has, in the jargon, “found support” over a period of time at a lower price band and “met resistance” at a higher price point is understandably significant to a chartist, but those who prefer to make trading decisions based on fundamental factors would, in the words of the “wealth warnings” mandatory on financial products in many jurisdictions, say that past performance is no guarantee of future outcomes.
Real people using real money
A fundamental trader would note that any number of factors – a takeover bid for a company, a supply shock for a commodity, a market crash (or boom) for an index – can, and do, push prices sharply up or down. Indeed, such a trader may uncharitably point out that, when this happens, the chartists are in the habit of remarking that the asset in question has “broken out of its trading range” and busy themselves drawing up a fresh trading pattern that, in turn, will one day be superseded.
Charts, they may say, show the price history of an asset, and from this can be deduced its current trajectory, up or down, the momentum behind that trajectory and, the object of the whole exercise, where it is likely to go next and when it is likely to get there.
Indeed, to a chartist, the fact that a price can break out of a range, thus signalling the end of a chart pattern within that range, far from representing the failure of chart analysis is proof of its success. Whether the price breaks out on the upside or downside, the fact it has exited the trading range is a strong indication of the future direction of that price. Yes, a new trading range will then be established, but that is rather the point.
Picking out the trend
From all this, you may gather that the debate can become a little acrimonious at times.
Even if you are sceptical about the usefulness of charts, you need to have some idea of what will prompt trading behaviour in others. It is possible, although highly improbable, that just about every trader in the market is a chart sceptic, but all still consult charts in the belief that others will act on them and each trader needs to be prepared.
In reality, there will always be genuine, “conviction” chart-based traders, for the simple reason that plenty of traders believe in charts and have done so for more than a century in markets on both sides of the Atlantic, and beyond. Asset trading forms trends, say the chartists, and the charts can detect those trends if used properly.
Too often, fundamental analysts seem to believe asset prices are always responding to external forces, such as a profit warning or takeover bid, and ought to be inert in the absence of such factors. The fact that they rarely are is a flaw in the fundamentalists’ argument, say the chartists.
But chartists are quite distinct from momentum traders, who simply trade in line with the current trend, or traders who seek to discern market sentiment and capitalise on it.
To sum up, charts are useful as an indicator of current and future trends, and can tell you what others in the market may well be looking at. Used in conjunction with more fundamental analysis, they can form the basis of a successful trading strategy.