All Charts Lie

March 17, 2010

The entire pretense of technical analysis, trend-following, moving averages and charting is based on a lie. It’s time to pull the wool back from the eyes of Wall Street.

Dave Nadig, director of research for IndexUniverse.com, conducted a webinar yesterday on how investors should position their portfolios to cope with a rising rate environment. (A replay will be available on Monday.)

The entire presentation was interesting, but one of the most interesting parts was a throwaway chart Dave delivered halfway through his presentation. It looked like this:

 

Price Return: AGG

 

Dave included the chart because it points toward one of our pet peeves around here. If you go to any finance Web site (Yahoo Finance, Google Finance, etc.), any chart you pull up will be a price return chart. That means it will ignore dividends and interest income.

Dave’s chart laid bare how big a difference it is. If you ignore interest payments, AGG is flat over the past five years. If you enter the world of reality, investors have actually earned about 35 percent in the product.

The same is true of almost any security or fund you chart on the Web. Ignoring the money investors can make cutting coupons when charting securities is an amazing collective delusion.

The most deluded of all are the poor folks who rely on technical analysis and moving averages. I should know: I’ve studied all the books and, way back in the late 1990s, used to write columns about technical opportunities in the market.

The great thing about writing a technical analysis column is that you can always find charts with interesting patterns. For instance, it took me about two minutes to create this chart of AGG, showing the broad-based fixed-income ETF perfectly positioned on the upside.

 

AGG Breakout?

 

As any technical analyst would tell you, this is a bee-uuu-tiful chart. Looking at it, I can feel the old banter start to flow through my fingertips:

AGG has just broken out of a perfect pennant formation and looks poised to challenge its recent highs at $105.80. If it breaks that, the sky’s the limit! Just remember: Set your trailing stops at $104.64, and watch that 50-DMA!!!

It sounds good and looks good, but it’s total nonsense. Because if you incorporate AGG’s interest payments and look at a total return chart, AGG actually looks like the blue line in the chart below. No pennant formation, no breakout, no nothing: The technical analysis is pure fabrication, and completely divorced from investor reality.

 

 

 

TLT vs. 200 MDA

 

Or take moving averages. I actually appreciate moving averages and what they try to accomplish, which is simply to give people a way to measure recent relative performance in an ETF. But the trouble, again, is that the numbers most people use to calculate moving averages are flawed. You see a lot of charts like this one, showing that the iShares Barclays 20+ Year Treasury Bond (NYSEArca: TLT) ETF bumping its head against its 200-day moving average.

See, the chartists say, TLT is completely unable to break its 200-day cap.

 

TLT: Breaking its Cap?

 

But in reality—which is to say, if you include interest income—TLT has been playing hokey-pokey with its 200-day moving average for most of the past month: It goes over, it goes under, it goes over, it goes under.

 

200 DMA?

 

Which 200-day moving average is the real 200-day moving average?

There are a lot of problems with technical analysis, but they start with this: The numbers used to drive the charts are meaningless.

I just checked on Register.com and www.totalreturncharts.com is still available. Will somebody please buy that URL and take charting into the 21st century?

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