Chart of the Day – Anchoring Expectations

by Enis July 9, 2012 7:43 pm • Commentary

Would you rather buy this chart?



Or this chart?



Almost anyone who has never traded before would rather buy the first chart and sell the second chart.

Whenever I started training a novice trader, I would first show them a batch of charts.  I’d ask them to label each chart as a Buy or a Sell.  Nothing else.  Just buy or sell.  The large majority of the time, they would label the charts that were near their lows on the chart as a buy, and the charts that were near their highs on the chart as a sell.  It’s human psychology to look at a chart and immediately assume that the boundaries on the chart are the boundaries of the asset’s future price.  So you want to buy close to the lower boundary and sell close to the upper boundary.  That’s why it’s so hard to buy strength or sell weakness.

In fact, the 2 charts above are of the same asset.  The first chart is a weekly chart of the EUR/USD exchange rate over the last 5 years.  The second chart is a monthly chart of the EUR/USD exchange rate over the last 37 years (maybe you recognized it from my Euro since 1975 CotD post).  I saw someone post the 5 year chart as a justification that the Euro was near a “long-term” low, and should be bought.  It all depends on your definition of “long-term” though.  I bet if I showed him the 37 year chart, he might change his tune.

Charts anchor your expectations.  They create artificial boundaries.  And they affect your trading as a result.  People looking at the same asset on different time frames or with different axes can come to completely opposing conclusions.

Charts can educate.

Charts can enlighten.

But charts can also deceive.

Most importantly for traders, don’t let a chart’s mere construction affect your interpretation.  Try to look at asset prices on different time frames, priced in different currencies, and compared to different benchmarks.  You don’t want others to anchor your expectations just because of how they constructed the chart.

As for the Euro, I’m still short.  The 1.18-1.20 area should act as near-term support, but I intend to remain short for a long time to come, no matter where others might place “long-term” support.