When I was in college I took an economics class where the professor put up a chart showing the historical price movement of the Dow Jones Industrial Average.
He then put up another chart that looked almost identical to the first one. Every time the Dow went up the other chart went up as well. Every time the Dow went down the other chart went down. It was remarkable. They were almost identical.
What our professor didn’t tell us, however, was what the other chart was. After an hour of having us all guess, he finally told us. It was a chart of the batting average of the Washington Senators baseball team. Seriously.
The Washington Senators don’t even exist anymore, but by some crazy coincidence the Dow Jones Industrial Average and the batting average of the Washington Senators baseball players moved in lockstep. If you were a “chartist” you might have concluded that if you could figure out how well the baseball team was going to be hitting in the next few days you would be able to predict how the stock market was going to move.
No one would have taken such a correlation seriously, but one could make the argument that “this is what the chart is telling me” (this is a favourite expression that chartists like to use). Be sceptical of this. The batting average of a baseball team is hardly a predictor of how the stock market is going to perform in the future.
Charts show historical data, and for that they can be very useful. They are suspect, however, if you try and use them to predict future stock price movements, and that is where you need to be very careful.
Excerpted with permission of the publisher, Wiley, from “Blue Chip Kids: What Every Child (and Parent) Should Know About Money, Investing, and the Stock Market” by David W. Bianchi. Copyright (c) 2015 by David W. Bianchi. All rights reserved. This book is available at all bookstores and online booksellers.