Timing Dragons

Although, logically, I’ve always felt that the idea of investing by charts should be something on the map between “Dragons” and “Free Lunches” I’ve never been so sure of this as to be outright skeptical. And I know a few smart people who insist that they are at least helpful in timing investing decisions.

Of course, the idea of “timing” anything in investment is fairly ludicrous anyway, but some recent research suggests the whole charting concept does actually help in prediction. Unfortunately what it predicts is a bunch of irrational self-fulfilling behaviour.

Logic

Logically chart based investing can’t work. The argument can be run one of two ways. Firstly, let’s assume that charts do provide valuable investing information, ignoring all those tricky questions about what this information might be. Well, charts are freely available so if there is some informational advantage associated with them you’d expect more and more people to pick up on this and, inevitably, it becomes a crowded trade.

The second point is that, in a market dominated by hugely well funded corporations the idea that they’ll have missed something as obvious as chart based signalling is too ludicrous to be even worth considering. If such signals exist the gigantic computing engines of the securities industry will be trading them to death within nanoseconds of their birth.

Weather

And yet, and yet … There’s a faint chance that there might actually be some people who can discern information in charts that even supercomputers can’t extract. The human brain is an amazing pattern recognition engine that, as yet, not even the best IT can outperform (see: Google Charts You Can Trust and Technical Analysis on Display).

For example, weather forecasting has improved out of all recognition in the past thirty years. It may not feel like it when you’re caught in a freak sunny spell in London in the middle of August, but the gradual introduction of supercomputers and better and better algorithms have significantly improved performance. Yet weather forecasts are still finally analysed by human beings because despite all of the improvements in the technology a good pattern recognizing human can improve the final forecast accuracy for rainfall by about 25% (well, according to Nate Silver in The Signal and the Noise). Which is pretty amazing, to be honest.