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  1. Home
  2. / Investing

Why Stock Charts Are a More Valuable Tool Than Ever

What I have found is that the real value of charts is as a trade management tool.
By JAMES "REV SHARK" DEPORRE
Nov 16, 2019 | 10:00 AM EST
Stocks quotes in this article: AMRN

In the age of computer algorithms, stock charts are even more important as a tool for enforcing discipline and dealing with random movement.

There has always been a debate among market participants about the value of stock charts and technical analysis. Some of those with a fundamental approach think these tools are a total waste of time since they say nothing about valuation. Some traders care so little about fundamentals that they never even bother to learn the name of the stocks that they trade. They use charts and nothing else to navigate the market. A third group tries to meld fundamentals and technicals into a coherent market approach.

The main disagreement about charts is their value as predictive devices. Technicians claim that certain chart patterns increase the odds of a specific movement. There are many books written about how and why this is supposed to work.

The fundamentalists argue that historic price action doesn't predict future movement and that charts often do not reflect favorable fundamentals or other things that can only be known by research. They also argue that the use of algorithms and ETFs have rendered price movement even more random and unpredictable.

The debate over the predictive value of charts will never end. In my 25 years of trading, my view of the predictive value of charts has decreased. They still are the best guide to what might happen to a stock in the future but they are wrong a great amount of the time and fundamentals can be more important than the chart pattern at times.

What I have found is that the real value of charts is as a trade management tool. Charts are the easiest and best way to design a strategy and to enforce discipline. It doesn't matter whether a chart predicts the future, they will tell you what to do no matter what price action may follow. It often is beneficial to proceed with the belief that the charts will be wrong. That way you can be sure to have a plan to deal with a poor trade.

The benefit of using a stock chart is that they help you find entry points that may be lower risk. The risk is diminished because it is easier to set the levels where you then will exit or buy more without suffering major losses or forgoing gains. It is that discipline that helps to produce superior results.

Recently there have been many bears predicting that the indices were close to a major turning point. They have formulated a thesis and are waiting for the market to acknowledge it. It can be debated whether the charts suggest that a top is about to occur or not but if you use a chart to enforce trading discipline you will be forced to exit and cut losses as the market continues higher. A chart is the best framework to use to assure that your trade thesis doesn't produce huge losses.

In the age of computer algorithms, this sort of trading discipline is even more important. Some market players feel that the price action is less predictable and more random now. Maybe it is, but when trying to deal with random movement it is even more important to have a mechanism that assures that your losses will not grow too big. That is the function that charts serve.

Another benefit of charts in the age of algorithms is that they provide insight into how programs are designed. If you study recent charts you will see a very clear tendency to immediately buy any dip caused by China trade headlines. That can be hugely important strategic information for traders.

As I write this I just added to a position in Amarin (AMRN) which had a favorable FDA decision on Thursday. The chart suggests that there is strong momentum but it could see a sell the news reaction, as many biotechnology names do, or it could be chased higher. I entered pre-market at $21.49 and will now watch the chart and the price action to see if it hits levels where I want to buy or sell. I have no idea how to value this stock but I do know it is going to be very active and that if I use the chart I can develop a framework in which to trade it.

Charts have use as predictive tools for many traders and investors but their real value is as a form of money management and investment disciple.

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At the time of publication, James "Rev Shark" DePorre was Long AMRN.

TAGS: Investing | Markets | Stocks | Technical Analysis | Trading

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