It’s amazing how many people, including financial professionals, do not take chart reading seriously. The most common argument against is that charts are merely a reflection of past action and cannot predict the future. Another common misconception is that a chartist can look at a chart at ANY point in time and accurately predict what the stock is going to do the next day, week, or month. And if they can’t, or their prediction turns out to be wrong – aha! – they don’t know anything!

Most opponents or skeptics of chart reading are NOT chart readers. How can you argue against something without any knowledge of it? To successfully argue a point in economics you have to study it first, right? But I have yet to meet a chartist who is against chart reading.

Charts reflect what people do, not what they say. Since human nature never changes, charts are patterns of human behavior as it pertains to stock trading, and behavioral patterns repeat themselves under similar circumstances. So the predictive value of chart reading is in recognizing past patterns and knowing what to expect next. In other words, if a stock does A, it is reasonable to assume that it will do B because that’s what it has done in the past.

Charts do not tell you what WILL happen, just what is LIKELY to happen. It is not an exact science. Furthermore, some patterns are more reliable than others. Successful speculators can use this information to decide on the size of their commitment and optimal entry/exit strategies.

Another benefit of chart reading is that they can save you from a major disaster. Stocks precede the economic cycle by 3-6 months by anticipating, or discounting, future events. Furthermore, a stock’s CHART precedes the STORY. In other words, it’s the stock’s MOVE that propagates the story, not the other way around. People who buy on the story and all known facts, when the stock commands Strong Buy ratings from a dozen of Wall Street analysts, invariably buy too late, often at the top.

Analysts maintain Strong Buy ratings on declining stocks for a number of reasons:

(a) It’s outright manipulation: by touting a stock to small retail investors they help their big institutional clients to unload a position;

(b) They are not chart readers and have no clue whether a stock is in an uptrend or a downtrend;

(c) Many are value-oriented, thinking that if a stock was a Strong Buy at $30, it is a Steal at $20.

(Too bad a Steal is not an official Wall Street term above Strong Buy!)

I recently read Dan Reingold’s “Confessions of a Wall Street Analyst: A True Story of Inside Information and Corruption in the Stock Market.” While it is a must read for anybody who intends to use analysts’ ratings to build wealth, the truly amazing thing is that the entire book does not contain the words “chart” or “technical analysis” even when describing the time when the most respected analysts maintained their Strong Buys on MCI in a free fall.

Before a chart pattern can be recognized and acted on, it has to be completed. It means that the day-to-day fluctuations may seem random, or at least much less predictable, until a stock reaches a critical point where the preponderance of evidence is that it is highly likely to act in a certain way. Chart readers call these critical points pivots, and the stock action around them breakouts. Those are the strong buy and sell signals successful speculators look for. As in any form of professional gambling, they are simply situations with as many variables in your favor as possible that maximize the chances of a gain and minimize the chances of a loss.

Slav Fedorov is a full time stock trader and founder and managing member of TradingZoom, LLC – a provider of proprietary trading data that swing traders can put to work right away.
http://www.tradingzoom.com/

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