Based on information found in Market Logic by Fosback
The chartist believes that changes in volume and price performance are predictive in and of itself of future performance of a stock; and thus those who correctly apply their methods will out perform those who rely upon fundamental alone. However, in and of itself a chart has no force; the observed signs can have many causes. It is not like looking to clouds to predict the weather. The chart is not connected to a modus operandi; i.e., a chart is not a force producing the effect upon pricing, but rather the result of something else. And giving the causal complexity of price movement, charting is a waste of time. It is always, always better to look at that something else, to look directly at the causes.
A. There is a weak exception as per modus operandi; it is for those who read them and act upon them. It, if there are enough chartists relying upon the same type of chart, then it is a self-fulfilling prophecy. However the small percentage with the same method of charting; and even so grouped, they lack long-term consistent action. Chartists even when subscribing to the same approach react differently; intuition plays a large role. Thus one doesnt need to read charts to figure out how the chartists will react.
B. It is better to look to these causes directly then to look to their effect shown in the charts; for example, to look to the news effecting a swing in volume then to the chart. By relying upon the chart, the chartists might read falsely the significance of what they take to be a buy or sell sign in their charts.
C. Consider, for example The Volume Breakout Signal. A buy signal is sent when the bar chart pattern exhibits an extended downward or sideways price trend on low or declining trading volume and then a sudden upward price spurt with a concomitant large increase in volume. This is taken by the chartist to be extremely bullish.
D. How relying upon Volume breakout signal can lead to the wrong position. The spurt producing a buy signal might be the result of (1) favorable fed monetary news, or (2) a large block purchase. The favorable news could be followed the following week by unfavorable fed policy the following week. Or buy a down turn of sales in the companys industry. The chartist would, just using his rules, still be long. Moreover, the negative monetary news next week might not produce a large flurry of activity in the stock market, thus no sell signal. As for (2), the large-block purchase of the companys shares will not effect, for example, the bear market and the continuing downward spiral of all stocks.
E. It is always better to have a an accurate understanding of the causes of the causes of price swings; the chartist doesnt. There are two defects. (1) To rely in part on charts entails that a sometimes a misleading sign is incorporated into the analysis process with sometimes unfortunate and avoidable results. (2) Each cause should be weighed accordingly. The distortion produced by charting entails their mental vector-analysis is skewed incorrectly. The more heavily the charts are relied upon, the greater is the distortion of the vector analysis. For these reasons the chartist is more likely to err then the astute investor.
G. Chartist have two general replies: 1), that they apply fundamentals (economic and industry information about the company) and also consider the national economic conditions; and 2) that charting is an art, one with an assortment of rules, rules which may not be easily quantified and thus defy accurate computer based testing. They then claim superior results for those who have mastered the art; the critic has not so mastered the art.
1). The criticism is not of the right things done, but the superfluous charting: what of value does the charts bring to the table? i.e., what is the intrinsic worth of charts? Fosback, Zweig and others hold that superior results are obtained by fundamentals, sentiment indicators, and economic indictors alone; viz., without charting. The lack of a modus operandi is fundamental, charts lack a fundamental link to the phenomena they are supposed to predict. Adding a chart to fundamental analysis is like adding wings to a horse, both are useless consumption of energy.
2). Most advance explanations of charting confirm, give the assortment of rules (see Gaping Gaps, Fosback, for a brief account of such complexity), it doesnt follow that such brings to the table anything more than the sun, moon, and planet charts does for understanding human behavior. The convincing examples of application are either shopping for paradigms which are drawn with the use of hindsight (215).* The failure to state a mechanically applicable set of rules, one amenable to computer analysis supports the analogy with astrology.
F. It is better to learn and attend to the causes of the charts, then the charts themselves. The stock market is a sufficiently complex phenomena. The sincerely held beliefs of the astrologers of stocks doesnt entail that they have something of value to add to ones understanding of the stock market. The explanation of everything is an explanation of nothing (215). Buying a stock because you like its chart pattern, or buying a stock because you like its balance sheet are both exercises in ego--one is granting himself superior ability to see that which is desirable, be it a chart or a financial statement.... There is an old adage on the Street that says, There are no rich chartists (218). Any success in the market he may realize as a direct result of that usage can only be ascribed to random performance or blind luck (219) or it may simply be hype.
G. Do not miscomprehend the message, however. Stock prices do move in trends and future price behavior can frequently be predicted with greater than random accuracy. Successful prediction simply requires the use of sophisticated techniques than drawing lines on charts (219). Fosback uses jointly econometric modeling of fundamentals about a traded corporation, modeling of financial indexes, and of sentiments of investors.
STOCK MARKET LOGIC, Norman G. Fosback, The Institute for Econometric Research, 1986.
I. Chartist will produce with hind-sight chart that show that they can predict market movement. It is like astrologers producing analysis of their clients. A test was done in the late 90s of a number of noted astrologers in France who were asked to produce an analysis given a particular birth date. The date was that of a quizzling, Nazi support who was responsible for the death of hundreds of French men and women. Faith does not make the charts of an astrologer a psychological tool, nor that of charts of technical analysis a market guide (JK).