What Is Not Seen

The last couple of weeks I’ve been reading books about technical analysis and trading. Technical analysis, some times ridiculed by academics for the lack of rigour, is at best regarded as a pseudo science. Although, this method of analysis is widely used by practitioners in the financial world its usefulness is often highly questioned. At the moment I am reading Thomas J. Dorsey book about Point & Figure Charting. This method is one of many tools available for the individual investor interested technical analysis or trading.

Economics in general and Austrian economics in particular properly deal with fundamental causal relationships. When it comes to the content of these relationships or economic laws, theory does not say very much. Instead, this area is what economists call entrepreneurial activity or entrepreneurship. This is the heart of the economic process, where business men offer their different services to each other and consumers in exchange for money, resulting in the formation of market prices.

As mainstream economics primarily deal with economic equilibrium, entrepreneurship does not even enters the picture. Fortunately this process – which allocates capital and adjusts prices according to supply and demand – is thoroughly analysed by the Austrian school of economics.

But still when it comes to the content of entrepreneurship, e g the currant real life relationship between supply and demand Austrian economics does not provide the complete picture. Knowledge of the inner workings of the business cycle and the fact that e g, a price ceiling for product X will raise prices, ceteris paribus, is necessary. But in real life the ceteris paribus assumption does not hold (everything is not equal). Prices can very well move in a counter intuitive fashion. The only thing that we can know is that prices tend to move according to fundamental factors over time. So for the business man or the private investor interesting in trying out the stock market, Austrian analysis and other qualitative assessments is not sufficient, especially not in the short term, where prices move along investors’ sentiment.

It doesn’t matter if you are looking at the price of fish or the price of a stock ABC, both are determined by supply and demand every minute every day. The only different feature is that the prices of stocks tend to change more frequent than the price of fish.

On Wall Street there are an old saying that: “the market can stay irrational longer than you can stay solvent”. If you would enter an investment solely based on the ceteris paribus assumption, the odds that you would loose money is to big to be ignored. So the million dollar question then becomes how you take a logical and rational approach to overcome this problem. Since investing is entrepreneurship and no one knows what will happen tomorrow, there is no closed formula to how one would do this successfully.

Because of the entrepreneurial element of this problem the concept of truth and falsehood does not enter, as in economic propositions. In technical analysis or in investing, concepts like, consistency and accuracy are more suitable for evaluating any particular method.

Thomas Dorsey’s idea about both consistency and accuracy is found in the method of Point and Figure charting. Based in the fundamental truth of supply and demand, first formulated by Charles Dow, P&F charting aims to give the accurate picture of this supply and demand relationship. Simply put, if demand for stock ABC is in control over supply, prices will rise. On the other hand if supply of stock ABC is in control over demand, prices will fall. Based solely on this fact, P&F charting then offers a hint for investors of whether prices will tend to fall, or if they will tend to rise in the future.

Compared to many other analytical tools P&F charting reduces volatility in price movements. Because of this, one can more easily discern important price changes from unimportant noise.

Point and Figure Charting by Thomas J. Dorsey is a valuable tool and a good friend to lean on when you are evaluating the often times erratic market.

According to famous investor Jim Rogers: “Everyone who’s involved in financial markets must understand Point and Figures charting in order to get the full picture, whatever your view of technical analysis”

For more information of Point & Figure charting visit www.DorseyWright.com

Welcome to my weblog

In his essay “What is seen and what is not seen” the 19th century economist, Frédéric Bastiat remarked

In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

Often the subsequent effects, following the cause and emidiate effect are misinterpreted or simply forgotten in the following discourse. As the title says, this web log will try to shed some light on the often overlooked effects of economic affairs, or as Bastiat would have called them; the unseen.

Henry Hazlitt, the great popularizer of Bastiat put it beutifully when he spoke about the art of economics, as it

…consists in looking not merely at the immidiate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

From this perspective, this web log deals with topics I find interesting and important, taken from the rich plethora of past and present economic events.