Given all the recent controversy about financial forecasting and predictions about the economy; here is an extract from Chapter Six of my book Financial Speculation.
“One inch forward lies darkness” Japanese Proverb
None of us know the future, but of course in financial markets little else is talked about. Will the latest economic figures be good? Is it true the central bank will intervene overnight? What are the chances of a take-over bid? Why is the market lower, when we expect good news next week? What will happen next? This insatiable demand for prognostication has led to a huge industry of analysts, commentators, pundits, experts and alike. In every financial market there is a veritable travelling circus of performers that seek to persuade us that they can guess, surmise and predict absolutely anything and everything – in return for a modest fee.
Much of what is said and written about in financial markets is often dreadful rubbish, but that of course doesn’t matter. As we all know, the truth doesn’t count in finance, it’s what everybody else believes that is important. As a result there are tons of amusing and bizarre stories about how rumours and misunderstandings some times grip markets. Efficient Market types usually label such behaviour as ‘noise’ and that over time random and ill-judged market moves are soon corrected. Certainly much of the ‘noise’ is created by market commentators themselves, who feed the never ending demand for information, opinion and that ultimate Grail – What will happen next? Once again we can see that the rise of cheap global communication has been a major component in this activity. The sheer omnipotence of computers, e-mail, 24 hour business television etc., has caused avalanches of comment, analysis and opinion to rain down on the marketplace. The market is full of information – but of course knowledge is much more rarely seen.
It is against this background that the financial soothsayers operate. Theirs is a business with almost infinite demand, and a client base that is usually very forgiving of their often poor predictive records. There are many different groups to choose from, they have differing methods and techniques, and frequently approach their work with almost religious fervour. Often however, the only thing that truly unites them is their barely concealed hostility towards one another. Again for the sake of good order and to try and maintain some sanity when discussing these would-be financial Merlins, let’s just remind ourselves; none of us know the future.
Chartists – Selling Maps of the Future
Charts have been around for ages – certainly since the days of Charles Dow, the American journalist and publisher who in the late 19th century, was a co-founder of the Dow Jones Index and created The Wall Street Journal. Dow recorded closing prices of thirty major industrial stocks, created the world’s first stock index and then plotted various line graphs of industry sectors, and then over a period of time created a predictive idea called Dow Theory. From this point on the chartists were in business with a vengeance. Bar charts, point and figure charts, market timing cycles, percentage moves, swing charts; a whole plethora of inventive ideas appeared, all long before the computer. In the Orient the Japanese can lay claim to their own system, Candlestick Charts; that have a history going back to the 17th Century rice market; they have also dreamt up the Kagi, Ichimoku (a particularly bizarre format) and Renko charting systems.
If one thinks about it, charts are a curious investment tool; they can only perfectly map the past. Unlike naval charts or say road maps they record a journey that cannot be revisited. Of course a stock can trade at a previous price again, but the time frame will have changed, and the precise price action is nearly always different. So financial charts cannot be used in the same way as road maps, perhaps in a way they are more like a diary of the past events that faithfully records where a share price, or commodity has been; but in truth can give no definitive answer as to the future. You cannot use a stock chart to plan your future investment journey in the same way as you might use a road map to plan a touring holiday of France, though of course many market players seem to adopt this approach. Many chartists would bridle at such a notion; this is to misrepresent their craft, their skill they claim is in the interpretation of these past moves and postulating likely scenarios going forward. In one sense they do have history on their side; financial markets do seem to repeat the same cycles and the same general patterns of events, certainly at a macro level. But the key is can charts do the same on the micro level?
Nowadays of course charting is big business, and has exploded in popularity with the advent of the personal computer. Every cheap and cheerful internet broking system offers free charts, and charting tools. Of course some market participants had been hand drawing charts long before computers, but only a dedicated band of players could be bothered to do all the donkey work. As a result most of the data that was plotted was daily information; usually the open, high low and closing prices for the stock, index, commodity, or currency that was being charted. Occasionally trading volumes were also included, and amongst futures traders the open interest data was also plotted. Now of course computing power and graphics allows almost limitless time slicing. Some people create one minute bar charts, or perhaps divide the day up into unusual time periods, all as a way to try and reveal the coming the moves in the market. Charts have also developed into technical analysis, which seeks to create and analyse essentially secondary or derivative information about the market price. This can range from simple moving averages, through a whole gamut of mathematical indicators, to some of the latest ideas involving fractals, artificial intelligence and chaos theory. In fact some have extended the art (could it be called a science?) to make predictions about time in the markets as well as prices. Not content with predicting the Y axis on the graph, many claim to know when on the X axis things will happen. This seems to be prediction on a heroic scale; and of course the punters lap it up. Imagine knowing where the price will move to, and when!