The Zurich Axioms By Max Gunther
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Beware the Chartist’s Illusion
Representing numbers by lines on graph paper can be useful or dangerous. It is useful when it helps you visualize something with greater clarity than you could achieve with numbers alone. It is dangerous when it makes the thing represented look more solid and portentous than it really is.
The Chartist’s Illusion is often a graphic extension of the Historian’s Trap. This is best illustrated by the chartists of Wall Street. These are people with their own jargon, which hardly anybody else can understand; their own magazines and newsletters, which ditto; and their own starkly visualized illusion of order. They believe that the future price of a stock – or a currency, a precious metal, or anything else for which frequent market-price data are published – can be ascertained by charting price movement of the past.
The chartist begins by fastening his attention on a certain investment medium, let’s say a stock, Hoo Boy Computer. He goes back through months or years of records showing the up and downs in Hoo Boy’s trading price, and he translates these numbers into points and lines on graph paper. He studies the resulting patterns. He looks particularly for jiggles and wiggles that occurred just before Hoo Boy stock began a significant price rise or a sharp drop. He believes these patterns will repeat themselves. The next time he sees a similar set of jiggles and wiggles, he will conclude that a new price rise or drop is on the way and will take the appropriate speculative action.
When thigs don’t work out as he expects – which, as often as not, they don’t – he will humbly blame himself. The problem, he insists, is that he hasn’t been astute enough. He knows the market can be predicted by charting, if only he can figure out what patterns to look for.
He can’t make himself believe the simplest of all possible explanations: that the stock market has no patterns. It almost never repeats itself and never does so in a reliably predictable way. Making charts of stock prices is like making charts of ocean froth. You’ll see pattern once, and then it will be gone. Only by blind chance will you ever see it again. If you do see it again it will have no significance, for it predicts nothing.
Another element of the Chartist’s illusion springs from the peculiar way in which a solid black line, boldly drawn on grid paper, can make a bunch of uninteresting and essentially disorderly numbers look like a Major Trend. The hucksters and con artists of the world have been aware of this power of the chart for centuries. Mutual fund salespeople use it all the time. The value of a fund’s units may have been creeping up o slowly that the haven’t even kept pace with inflation, but by squeezing years close together on a chart page, and perhaps by bridging over some bad years they would prefer not to discuss, the trust’s promoters can produce a honey of a chart for their sales brochure. You look at that soaring black line and say, “Wow!”
The danger is not just that you can be conned by others, but that you can hoodwink yourself. You look at a chart depicting the value of the lira against the dollar in recent years, for instance. The line slopes upward. You think, “Wow! Maybe I ought to climb aboard!”
But wait. Don’t be mesmerized by the line alone. Look at the numbers it is supposed to represent. Maybe it depicts only the lira’s yearly highs. Another chart showing he yearly low might have a downward slope. In other words, the lira-dollar relationship has been marked by increasingly wide swings. The calm, steady change implied by that upward-sloping line is an illusion. The truth is that the relationship is one of increasing disorder.
In such ways do people allow themselves to be deluded by chart. A chart line always has a comfortingly orderly look, even when what it depicts is chaos.
Life never happens in a straight line. Any adult knows this. But we can too easily be hypnotized into forgetting it when contemplating a chart.
You look at a chart portraying the earnings of Hey Wow Electronics Corporation. The chart, especially prepared for Hey Wow’s annual report, depicts unmitigated glory in four delicious colors. That upward sloping line, so thick, so solid, so thoroughly established, looks as though it will never quit. Nothing can break it. It can be bent, but only slightly. It looks as though it will go up and up forever!
But don’t you bet on it.