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Charting – Can it Predict the Future?
by Colin Nicholson

... often inexperienced investors, who are trying to learn the craft of investing, complain that even after quite extensive study of charting and technical analysis, they cannot get to the point where they can tell what is going to happen i.e. predict the future. They want to know how much longer will it take to reach that point? ... some people never find the answers to questions like this for the simple reason that they are asking the wrong questions.


... The correct questions we should ask of technical analysis are not about prediction, but about analysing a situation in order to better understand it and plan what action to take. Analysis questions will include: What is the condition of the market? What is the balance of supply and demand? Is there any evidence of a change in the balance? What are all the things that might happen, no matter how unlikely?

Charting and technical analysis is no more or less reliable than any other method in predicting the future – abysmal. The very real value of charting and technical analysis lies in being able to see what buyers and sellers are doing. We cannot see this with fundamental analysis, because it studies value. Charting and technical analysis studies price. Price is determined by the interaction of buyers and sellers. If buyers are stronger, prices rise. If sellers are stronger, prices fall.

So, what we should be looking for from charting and technical analysis is to assess how the past led to the present situation. This assessment is then the basis for developing a strategy that is appropriate for the present conditions. That means to take advantage of opportunities and to manage risks.

Thinking only in terms of prediction is ... doomed to failure and frustration. Successful investors graduate from that level to one where they learn to read the situation and develop investment strategy. In doing that, there are some basic guidelines:

1. Start with the long term and analyse down to the short term. This is a very powerful idea, even for short term traders. Trends exist in multiple time frames. Longer term trends have a powerful influence on shorter term trends within them. The key idea is that if you trade any time frame in the direction of the higher time frames, you have more chance of being in a strong trend. Short term trends that are counter to longer term trends tend to be much weaker.

2. Start your analysis of the chart in any time frame with the facts. You should first establish what information is on the chart that is not an opinion or a judgement, but a fact. Is there a trend? What direction is it in? Where are support and resistance levels in relation to the present price? And so on. In other words, you describe what you can see that is factual.

3. Then move into analysis. Analysis is when you reason from the facts to a conclusion about the balance of buyers and sellers and whether there is evidence of a change in that balance. It also involves assessing the level of risk. Is it high or low? From those assessments, you should form a view as to where any opportunities are that you might take advantage of and where there are risks that you need to manage.

4. Finally, move into developing strategies for taking advantage of the opportunities and protecting yourself from the possible risks. Are the opportunities good enough to chase? Is the risk worth taking? How much risk should you assume? What sorts of risk should you assume and what types of risk should you minimise?

This is the proper use of technical analysis. You have probably already got enough knowledge to do this. All you have to do is to start asking the correct questions.

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