Friday, June 6, 2008

Big Picture Chart Patterns

Does the title read a bit confusing ? I am referring to multi month chart patterns which give pricce targets widely different from current price levels. Are these patterns and their target implications, relaible ?
My answer would be, not really. Chart patterns will often have measuring implications that set a target for a possible price move. In a head and shoulder pattern, you can measure the distance between the neckline and the head, then subtract this distance from the breakdown point, and thus arrive at a downside price target. This method works for traders, giving an indication of where prices may go to. But, what happens when a chart pattern like the head and shoulder develops on a monthly chart, giving targets that are far away from current price levels ? Should such targets be considered at all ? I would avoid using these targets. Now, a chart pattern forecasts what may happen in the near future. Once the forecast moves beyond the near term, then the pattern loses its forecasting ability since no one can say predict the future with any certainty.
Vikas Sharma, in his blog ( http://surakshit.blogspot.com/2008/06/how-low-can-markets-
stoop.html ) refers to a head and shoulder in the Nifty which gives a downside target of 2600. He emailed me asking for my opinion on this pattern. The Nifty is currently trading at 4635. Now this is a target far away into the future. I do not think that chart patterns have this kind of forecasting ability. Therefore, beyond the near term, stay away from price forecasts made by big picture chart patterns.