Charts look ominous, but can we trust them?

Written by John Osbon on February 1, 2012

My son Max is a superstar in the making at Bloomberg, and therefore has access to the latest market intelligence 24/7. When I got a note from him last week about a potential market disaster looming on the horizon, it gave me a chill.

His note included a chart of SPY, the goliath S&P 500 ETF. Captured in the daily market data was an alarming pattern that materializes only once every 20 years or so. That’s right, a dreaded black swan, darker and more menacing than any thundercloud you’ve ever seen.

 

Have you ever seen anything so scary?

Welcome to technical analysis, the alleged art and so-called science of predicting the future direction of prices based on previous market data, especially price and volume. Most often seen with stocks, technical analysis (TA) can be applied to bonds, gold, oil, even real estate.

The premise of TA is that history repeats itself, so that patterns seen in the past can be predictive of future price moves. Chart readers often draw circles, trend lines and fancy arrows to identify head-and-shoulders formations, double bottoms, pennants, wedges and even something called the cup-and-handle. I guess if you look closely enough you can always see a pattern of some kind.

Even a doomsday-worthy black swan.

A priceless price chart

I don’t know who drew the black swan chart originally.  It’s been bouncing around the internet for a couple years. I expect that whoever is responsible for its creation shares my meager regard for TA. In my view, the future movement of prices just can’t be reliably predicted – not by dissecting balance sheets, not by tracking economic indicators, and not by drawing 200-day moving average trend lines on a graph.

Yes, historical trends and patterns do repeat themselves. Except when they don’t. Trying to decide which will happen basically comes down a coin flip. And if you’re making investment decisions based on coin flips, you can probably skip the charts altogether.

May all your swans be white today.

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