We are all chartists now. Chartists (or “technicians” in the US), study the movements of markets, rather than the underlying fundamentals of securities, when predicting price moves. Their methods can sound like voodoo, but at times of high confusion, charts offer the only way to navigate. Only once the markets find a new level, can fundamentals reassert themselves.
Trading chatter is now almost exclusively about technical patterns. And they suggest more turbulence is to come. The yen has breached its “trend line support” (a straight line formed by joining up its strongest points) that had lasted for 10 months. This implies, even with the decline, that it could rise further. Its decline earlier this week also owed something to chartist psychology. Once the yen had approached, but failed to break, the milestone of Y115 to the dollar, traders felt the momentum was done for a while and bought the dollar.
In stocks, the charts show that corrections during a bull market follow a “two-wave” pattern. After a first downdraft, there is a recovery, or relief rally (charmingly known as a “dead cat bounce” in London), followed by a second or “capitulation” down draft. This pattern was seen in March and then April of 2005, and again in May and then June of last year.
Another popular tool of chartists is the moving average – an average of an index over the past 30, 50 or 200 days. If a price drops below a moving average, this can be an indication that the market has lost confidence. Last Tuesday’s huge afternoon sell-off in New York came in large part because the main indices fell through their 50-day moving averages, for the first time since last July.
Whether charts really have predictive power is for the moment not the question. Enough people act on the assumption that they do to ensure that they have an effect. In the long run, fundamentals matter – economies tend to grow, and stocks grow with them. In the long run, we need not worry too much about the charts. But traders go along with Keynes: in the long run we are all dead.
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