As a rule, I rely more on fundamental analysis than I do technical. I trust economic conditions and actual performance by companies more than lines on a chart. The reason for my lack of reliance on charts is contrary to what some people would have you believe; chart analysis is neither an inexact science nor grounded in logic most of the time. As human beings, we naturally attempt to impose logic on things and search for patterns in the past. It is that urge that is behind the use of previous trades to attempt to predict what will happen in subsequent ones. If you detach yourself from that, however, there is no logical reason that any historical pattern on a chart should tell us anything about the future and, even if it did, there is no way that the tops and bottoms of moves could be accurately predicted based on it.
Unless, of course, enough people thought it could.
Markets are the original crowd sourcing devices. Prices move not directly because of any news or data, but because of people’s reactions to such news or data. If enough people believe that something will make a stock go higher, it will, simply because they will all compete to own it and pay ever higher prices to do so. It stands to reason, therefore, that if people really believe that a previous low or high will prompt buying or selling, it will. That is why simple analysis based on support and resistance levels work in some circumstances but, even then, the numbers are far from exact.
I was first taught to read charts back in the early 80s when computer technology was nowhere near as sophisticated as it is today, and real-time charting was not possible. That meant that we didn’t rely on any complex signals or anything beyond basic, previously formed support and resistance levels. However, with everyone in the market looking at the same things, they became extremely powerful and offered some degree of predictability in the seemingly random movements of price.
In many cases, they still are. Take a look at the annotated 1-Year, 1-day chart for QQQ below, for example.
The most noticeable thing is the 316 low that formed in May of last year, marked in gold, held twice in the drop that came early this year, in both February and March. That is an obvious support level, which is why it was so powerful. Even there, though, it is important to note that neither of the two subsequent attempts at it stopped at exactly 316. The first, on February 24, got only as far as 318.26, while the second got to 317.45 on March 14. That is what often happens with really strong levels: traders basically front run orders that they assume will be at the level, forming support just above the previous low.
As I said, that support is obvious, and it is also simple. There are, however, some less obvious but clearly defined patterns that would catch the attention of most chart analysts. The problem is that they were forming at around the same time and were sending completely contradictory signals. The "W," marked in blue, when looked at alone, is bullish. It represents two failed attempts at a reversal of a big move up. So, the logic goes, having failed to retrace, QQQ should then resume its upward momentum.
However, if you move out a bit, the “obvious” pattern is the double topped, downward sloping "head and shoulders." That is bearish because it represents multiple failed attempts to break higher. So, which should you trust?
The answer is neither.
What actually caused QQQ to drop in January was the perception that a change in Fed policy would weigh heavily on growth-oriented tech companies then just as we were getting over that panic, the invasion of Ukraine by Russia took place. Those things, not lines on the chart, were what was moving markets.
Keep that in mind the next time someone tries to sell you a “system” based on chart analysis, particularly if it sounds impressively complex. No system is stronger than the fundamentals that impact a stock or market, no matter how catchy the name or the number of calculations needed to plot it. Also, understand that the more specific the prediction is based on the chart, the less trustworthy it is.
If, as I heard an analyst say this morning, someone tells you that a break of the February high means a return to the all-time high of 408.71 within a month, ignore it. Is that break of a level going to be more powerful than news from Ukraine or the earnings season that will begin next week? Of course not.
Chart-reading has its uses, but it also has its limitations. Widely followed levels can provide an indication of good entry and exit points, and even some complex patterns can be used in intraday trading. However, if you are a stock investor, there is no shortcut to success. Do your research and trust in that, not lines and squiggles on a chart.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
Read Martin's Bio