Why the Chart Will Tell You the Truth

Most people lose money in the stock market.

I’m sure you’ve seen the figure that gets bandied about.

It goes that roughly 90% lose.

My guess is that it’s a little higher than that.

But let’s go with that figure.

Why is it that most lose money?

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Why do most traders lose money?

There’s a multitude of reasons.

The first thing to realise is that it’s not easy trading markets.

If it were easy, there wouldn’t be any street sweepers.

You have to spend a little time in markets. Gain an understanding of how they really work.

Spend some time in the market.

See what works and what doesn’t.

That then gives you a bit of a base to develop a system.

Keep in mind, no system you develop will create winners all the time.

So big part of being successful in markets is how you manage risk.

Think position sizing and stop losses.

That’s what keeps you in the game.

It’s always about what stock to buy.

But little thought is given to the downside. Manage risk.

Another cause for losses is not trading with the trend.

And you can sort of follow this by looking at short selling.

Short sold positions are required to be reported to ASIC.

And ASIC makes those short positions available to the public.

Trading related websites will often sort them for you. You can easily find a list of the 10 to 30 most shorted stocks on the ASX.

Now here’s the thing to note.

Often stocks on those lists are trending up.

In other words, the share price is already going the wrong way for the short sellers.

They’re trading against the trend.

Why you have to must look at the charts

Stocks trend for a reason.

I’ve found that markets will often move before information becomes public knowledge.

Those who know something, very often act on what they know.

I’m not suggesting anything illegal.

It’s just that somehow the news gets out.

It could be a supplier who notices accounts are being paid late. It could be idle conversation on the golf course about a potential new contract, that might totally rerate a company. Whatever it is, somehow the news just gets out.

And that inside buying and selling must show up on a chart.

This is why you must look at charts and trade the trend. The market is often ahead of the news.

Often you’ll read in fundamental analysis, some analyst saying a stock is overvalued.

But that high share price may already be factoring in the potential new contract. Or, the big new mineral find which would totally rerate the company.

That’s the upside, but it works just the same to the downside.

If a stock is going lower on the chart, there is often a reason.  You only get to hear the bad news months later.

Those who go by fundamentals will often say their method is based on facts. Unlike the voodoo of the charts.

The balance sheet simply shows the facts.

But that’s not always true. Be aware that in some cases, not everything makes it to the profit and loss statement.

Sometimes the fundamentals do lie. But, as you’ll see, the chart never does.

Here’s a chart of Enron:


Enron stock prices from 2000 to 2002

Source: EWM Interactive

[Click to open in a new window]

Enron was one of the largest corporate frauds in history. Executives disguised the firm’s finances and continued to issue numbers showing growth. 

The chart never lies

See how the chart was telling you the truth. And all the while the profit and loss statements were telling lies.

When Enron finally declared bankruptcy, over 4,000 employees lost their jobs and many their life savings.

Investors lost billions.

As the share price was sinking, the company told workers the company was solid and to buy more stock.

And all the way down, the analysts rated the stock a buy.

In 2001, and right up to bankruptcy in December that year, analysts rated Enron a buy, some even calling it a strong buy!

Even experienced, successful fund managers continued to buy the stock as it went lower.

Right to the end, the lower it went, the more they bought.

It’s not the first time fund managers and analysts have been wrong about a stock.

And it won’t be the last.

Why were they buying?

Because the stock was cheap at those values.

This is a prime example of why you never want to be looking for cheap stocks.

Prosecution trials took place in 2006, and here’s a just one brief comment that sticks out for me.

In examination, it came up that former vice president Sherron Watkins (who was never charged with insider trading) sold almost $50,000 worth of shares in 2001. By the end of that year those shares were worthless.

When prosecutors asked her if her stock sales were proper, she replied, ‘no, I had more information than the marketplace did’.

So she did.

And this is why the chart will never lie to you.

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Because when someone knows something and there’s money blowing in the breeze, they act.

If you learn nothing else from this affair…

When you read what the analysts say about the company, bring up the chart.

What’s the trend?

If you want to buy a beaten down and unloved stock cheaply. Well that’s your choice.

But at least you now know what can and does happen, with that strategy.

It’s not a style of investing I subscribe to.

Terence Duffy,

Chartist, Phil Anderson’s Time Trader


Markets & Money is unlike any other finance newsletter. Our mission is to look at the world of investments and finance in a sceptical and contrarian way. Our editorial team looks beyond the headlines and obvious explanations to bring you what we think is really moving the market. More importantly, we’re trying to show you where the next big opportunities and where the big risks are that you might not be aware of. In Markets & Money you’ll read about the state of the Australian housing market, the future of the commodity boom, China’s rise to an economic superpower, the fate of the US dollar, and of course a whole lot more.


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