CNBC decides to throw a scare our way:
The Dow Jones Industrial Average is repeating a pattern that appeared just before markets fell during the Great Depression, Daryl Guppy, CEO at Guppytraders.com, told CNBC Monday.
“Those who don’t remember history are doomed to repeat it…there was a head and shoulders pattern that developed before the Depression in 1929, then with the recovery in 1930 we had another head and shoulders pattern that preceded a fall in the market, and in the current Dow situation we see an exact repeat of that environment,” Guppy said.
The Dow retreated 457.33 points, or 4.5 percent last week, to close at 9,686 Friday. Guppy said a Dow fall below 9,800 confirmed the head and shoulders pattern.
Bullshit.
Repeat after me: Charting doesn't work. Charts tell us nothing. Why? Because charting doesn't work.
Charting does NOT work, because securities markets are weak form efficient. The weak form of the Efficient Capital Market Hypothesis posits that all information concerning historical prices is fully reflected in the current price. Put another way, the weak form predicts that price changes in securities are random. Randomness does not mean that the stock market is like throwing darts at a dart board. Stock prices go up on good news and down on bad news. If a company announces a major oil find, all other things being equal, the stock price will go up. Randomness simply means that stock price movements are serially independent: future changes in price are independent of past changes. In other words, investors cannot profit by using past prices to predict future prices. Consistently, empirical studies have demonstrated that securities prices move randomly and, moreover, have shown that charting is not a long term profitable trading strategy. For an accessible defense of this proposition see Burton Malkiel's Random Walk Down Wall Street.
Even younger and less developed stock markets than the US capital market have been shown to be weak form efficient. See, e.g., The United Arab Emirates. So why should we expect charting to work in our markets?
To be sure, a few studies claim to have found one or more weak form inefficiencies in the US stock market, but even they are forced to concede concede that "with real transaction costs no significant abnormal return can be obtained from investment strategies that take advantage of this effect."
A comprehensive study of the question by Amsterdam economist Gerwin Griffioen concludes that: "for the U.S., Japanese and most Western European stock market indices the recursive out-of-sample forecasting procedure does not show to be profitable, after implementing little transaction costs. Moreover, for sufficiently high transaction costs it is found, by estimating CAPMs, that technical trading shows no statistically significant risk-corrected out-of-sample forecasting power for almost all of the stock market indices."
In sum, no matter what you call it, charting doesn't work. Stock movements are serially independent. Any resemblance between charts of 1932 and today is purely coincidental and tells us NOTHING.
If we're about to go into a Great Depression 2.0, it'll be because of lousy government policies by Obama and the Congressional Democrats. Not because some technical elf's chart looks like a shampoo brand.
