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Home›Marginal propensity›Idea farm: high watermarks matter

Idea farm: high watermarks matter

By Faye Younger
April 13, 2022
5
0
  • There are good reasons to doubt the cartography
  • Recent studies suggest 52 week highs are important
  • Lots of idea-generating content

The world of charting – or, to use the brilliant term of its adherents, “technical analysis” – has the characteristics of a pseudo-science.

On the one hand, the idea that you can predict which way a stock will move using only current and historical price data seems absurd. Markets may not always be efficient, but it’s always helpful to think of them as investors’ best estimate of the price they’re willing to pay for risk-adjusted return.

In contrast, when chartists look at a stock chart, they only see the psychology of the market and the formations, trends, and patterns that are likely to repeat themselves.

The problem is that it’s very subjective. Like tea leaves in the bottom of a cup, each technical analyst can draw a very different conclusion from each chart. Fundamental analysis can also produce a variety of viewpoints, but the sources from which it draws – a company’s accounts, forecasts, and relevant economic and market data – are at least defined.

Additionally, while numerous studies have shown that factor investing works, there is no conclusive peer-reviewed evidence to suggest the same from charting.

If there were reliable principles for determining short-term price movements, you can bet the major financial institutions would have spotted them long ago. The fact that most retail investors lose money on day trading platforms strongly suggests that any trading advantage belongs to investment banks, algorithmic traders and hedge funds.

But here’s the catch. If it was all rubbish, then how can some people make a living – and in some cases murder – from day trading?

Of course, the law of probability dictates that certain techniques will work because they are random rather than reliable. Another suggestion is that when used to manage risk, alongside quantitative or fundamental approaches and over longer time horizons, charting might offer marginal benefits. After all, two of its key tenets – betting with the long-term trend and setting high and low bands – are momentum investing by another name.

A recent study by academics from the Universities of San Diego and Sydney suggests that a particular mapping technique may have some weight. In an analysis of all trades on the Finnish stock market between 2000 and 2015, researchers found that liquidity increased and bid-offer spreads narrowed as a stock’s price approached its highest. high level over 52 weeks – a level often considered an important “anchor point”. by chartists.

Investors were also more inclined to sell at the 52-week high, while stock prices proved less sensitive to significant shifts in fundamental and macro news than in normal times. According to the researchers, this could be due to the disposition effect: the propensity of investors to sell stocks that are trading at a profit while retaining those that are trading at a loss.

Does that mean shareholders should seek to outpace the herd and short every spike? As always, it all comes down to timing. Just because liquidity and selling increases with each new high doesn’t mean a stock won’t quickly break through its latest “resistance” level.

For proof, readers need look no further than the 70 stocks in this week’s highs and lows list below. Many have breached their 52-week highs on several occasions in recent months. Others hovered at their one-year highs.

High water marks are important. But anticipating what might mean for a stock tomorrow, while absorbing transaction costs and margin calls, has its limits.

Further reading:

Liquidity and price impact at 52-week high (Della Vedova, Grant & Westerholm)

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