Drawing Lines On Charts Is Not A Strategy

Maybe one of the biggest wastes in finance is using a Bloomberg terminal to draw a few lines on a chart. But we see it done many times each day. There are some explanations why so many do this. Do they have a strategy?

Drawing lines on charts and looking at a few indicators is not a strategy. People did that in the early days of technical analysis when computers and the first charting programs were made available. Soon the quantitatively oriented realized that drawing lines and looking at indicators plotted on charts was not any specific strategy but a way of describing what had already happened.

But why so many, even well-known fund managers, do it? Here are two possible explanations.

  1. There are those who are indeed naive and think visual charting has value
  2. Some use it as a way of communicating with the public that can be easily alienated by more advanced analysis

The well-known ones who use this visual analysis method to communicate their market views are the drive behind the availability cascade bias that compels more to use such analysis. I get so surprised when I see in Twitter someone who is supposed to be an accomplished market professional pointing to some trendline or trivial chart pattern. Many may see that as an endorsement of the method and not as a public relations vehicle. The naive think this method works.

Some see triangles in the S&P 500 chart above; others see support at the 200-day moving average, etc. All these can change depending on news.

Price leads fundamentals” Wall Street Adage.

Some people confuse the notion that price moves first in anticipation and fundamentals follow with price forecasting fundamentals. Price action is the result of collective actions to forecast the markets. But these forecasts can be wrong on the average when fundamental information becomes available. The danger of assigning too much value in memes is that context varies constantly because markets are non-linear stochastic dynamical systems. There are no immutable truths, only probability and in many cases it is unknown or impossible to calculate.

The variation in volatility is evident from the above S&P 500 chart. The 21-day standard deviation of returns spiked to about 2% late 2015 and then collapsed near 0.2% in October of last year, or a drop of an order of magnitude. Does anyone in the right state of mind and with sufficient skin-in-the-game think that simple indicators are reliable at elevated volatility levels?

Most visual charting techniques are remnants of the 1980s as already noted. They were the first step of traders in getting familiar with price action. The major difference with the 1970s, 1980s and partly the 1990s was that daily returns exhibited very high serial correlation at 1-lag. The chart below shows the 1-lag, 252-day correlation of daily returns of the S&P 500 since 1960.

Ignore this chart at your own peril. The major market regime change occurred before the 1998 Ruble crisis with a switch of high positive serial correlation on the average to negative serial correlation. This regime change was the main cause of failure of the visual techniques developed in mid 20th century. The failure was inevitable and reflexive in nature: the market could not provide profits to all those who started using these trivial visual methods after charting programs became available and reorganized in an adaptive sense to defend itself. The result was ruin for visual traders with the profits going to the pockets of market makers and early algos who faded those trivial signals.

Therefore, using these failed visual methods in the era of algos and machine learning is curious to say the least and the two explanations offered above may partly explain it. Market traders need specific strategies and even that is not a ticket to success. Do you have a strategy? Instead of showing charts with random lines that reflect either confirmation bias or even confusion, it is better to point to the strategy returns. Many are doing this in social media already but the majority still think that a trendline or a head and shoulders pattern have some significance. Especially curious is the phenomenon of some that claim to be quants and suddenly make references to some triangle or trendline. Some do it as argued before to keep connected with the public that understands only this type of trivial analysis.

Markets are becoming more sophisticated and maybe in ten years there will be no chartists or very few around. Market trading will take place via black boxes. The few chartists will be the remaining targets of the predator algos.

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