Charts can be a great way to illustrate trends in markets or the economy. But some chart readers—technical analysts—take it too far, in Fisher Investments’ view. They try to predict future market direction and trends based on past price movement and chart patterns. We believe such tactics are more likely to lead investors astray than improve returns. In our view, technical analysis has a fatal flaw: It looks only at past market movement, while markets are forward-looking and care solely about the future.
Technical analysts attempt to find patterns in charts of stocks (individual companies or the broader market), bonds, commodities, currencies, indexes and even cryptocurrencies nowadays, on the presumption these patterns show what will come next. There are a huge array of different technical indicators. Among them, two key concepts are support and resistance. On a chart, support is where analysts expect buyers to step in and prop up prices after a drop—very often because the stock has fallen to that price before and then rebounded. Resistance is the opposite, a point where technical analysts expect rampant selling to drive prices lower after a rally. When a stock breaks through either of these levels, chartists expect it to continue in that direction.
Chartists sometimes watch moving averages to spot areas of support and resistance. A moving average is simply the average price over a set period of time, which theoretically illustrates a broad trend. A lot of popular technical indicators, including the Death Cross (and its bullish brother, the Golden Cross) and the Hindenburg Omen, are based on this concept.
The 200-day moving average is among the more popular indicators chartists consider longer term. When a security’s price crosses this average, many presume a shift in trend is afoot. Still others compare trends in short-term averages, like the 50-day moving average, to the 200-day moving average. When the short-term trend crosses the long, many analysts consider it a telling change.
Technical indicators seem to “work” often enough to help keep their reputation. But false signals abound, very often flashing during or even just after short-term spats of volatility or corrections (sharp, sentiment-driven declines of -10% to -20% that typically reverse fast). The risk: Moving to the sidelines after a correction or volatility often means missing the recovery—and can risk missing the gains beyond it.
Consider the S&P 500 and its 200-day moving average. In the past five years, the index has fallen below its 200-day average a dozen times, a supposedly bearish indicator. [i] One time—on February 27, 2020—it did signal a bear market forming. [ii] But the rest? While a few came amid a correction, they weren’t indicating broader trouble. Acting on them could have been exceedingly costly. (Exhibit 1) For example, the last time the S&P 500 fell below its 200-day average was late June 2020. A month later, it was up 6.9%. [iii] Two months? 15.6%. By year end, it was up 24.8% from the date of that “bearish” signal.
Exhibit 1: 200-Day Moving Averages Aren’t Predictive
Comparing short-term moving averages to long-term moving averages also gives you little of use. Take the allegedly uber-bearish Death Cross (when the 50-day moving average drops below the 200-day) and its supposedly bullish counterpart, the Golden Cross (when the 50-day rises above the 200-day). There are countless examples in data ranging back to 1928 of these signals misfiring or firing too late. Consider last year’s bear market once again. The S&P 500 flashed a Death Cross on March 30, 2020—one week after the bear market bottomed. Meanwhile, a Golden Cross didn’t appear until July 6, 2020. By that time, the S&P 500 was up a massive 42.1% from its low. (Exhibit 2)
If you need stock-like returns to reach your financial goals, heeding the Death and Golden Crosses last year would have been a disastrous error.
Exhibit 2: Shorter-Term Averages Aren’t Predictive, Either
In our view, the reason technical analysis doesn’t work is that it is backward-looking. Past market movement tells you exactly nothing about what lies ahead. Markets are not “serially correlated”— yesterday’s movement has no bearing on today’s or tomorrow’s. Furthermore, consider: If these signals delivered consistent results, everyone would use them, they would get priced in and they likely wouldn’t work anymore.
In Fisher Investments’ view, ditching the charts is wise. Instead, look forward, and consider fundamentals like expected economic growth trends or political developments. History, in terms of how fundamentals like economic trends, politics and sentiment have impacted stocks in the past, can help inform the range of possibilities you may expect. Then, since markets pre-price widely known information, assess what markets currently reflect and how those expectations line up with the conditions you expect. Does the consensus view match the fundamentals you expect? If not, will reality likely surprise positively or negatively? That should yield much more insight into market direction than a pattern on a chart .
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
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