Don't Believe Every Chart You See on the Internet (Including This One)

You're about to see three charts. Try to figure out what they all have in common.

Here's the first chart, which has been making the rounds in the financial world lately. It shows an ominous similarity between the Dow Jones Industrial Average (INDEX: ^DJI) in 1929 and the Dow today:

Here's another look at the same chart, but this time we'll look at both time periods in relation to how much the Dow actually grew in percentage terms:


Source: St. Louis Fed and author's calculations.

And here's our third chart:


Source: St. Louis Fed.

What do these three charts have in common? They should all be completely meaningless to rational investors, because none of them show two variables that are actually related to each other. Sure, the first chart seems compelling at first glance, because humans are visual creatures. Look at that scary chart! Doesn't the Dow look like it's doing the same thing it did in 1929? Sure it does, if you mangle your variables badly enough. But as has already been pointed out multiple times, the Dow really isn't following 1929's pattern -- you can see what's really happening over similar time frames on the second graph, which shows a far more modest gain in today's Dow than the wild surge that preceded the worst crash in history in 1929.

It's easy to find patterns where none exist, especially if you set out to force a pattern to fit your thesis in the first place. There's even a psychological term for this search for patterns: apophenia, which was originally used to characterize psychotic or schizophrenic delusions. Gamblers often experience an apophany -- the opposite of an epiphany, since you think you really get it but really don't -- when they believe that an unlucky run must end for the sake of balancing some cosmic scale. Traders who rely on "chart patterns" are always eager to share their apophanies with you on blogs or social media, because there really are a million different ways to make a squiggly line look like it's going to squiggle the way you want tomorrow.

There are a million different ways to make a bunch of numbers say what you want them to as well, if you're clever enough with the construction of your chart. Zach Weiner, creator of the Saturday Morning Breakfast Cereal webcomic, has a strip that perfectly captures the problem afflicting much of the news media today: "According to the fundamental law of media graph construction, any two things that look correlated on a graph are causally related in real life." That's what the third chart is in this article. It means absolutely nothing, but I fiddled with the Y-axes until both of the lines followed the same path.

Do 1929 and 2014 look similar? Sure, on one particular graph, if you tweak the variables long enough. Is there a direct relationship between 1929 and 2014 when it comes to market movements? No. It doesn't matter if you're talking about stocks, commodities, demographics, or just two random sets of data that happen to be paired up on the same chart -- the Internet is full of articles that claim to find patterns in data where none exist.

You don't even need two different sets of data to manipulate your audience into freaking out. Just look at these two charts:

Dow Jones Industrial Average Chart

Dow Jones Industrial Average data by YCharts.

Dow Jones Industrial Average Chart

Dow Jones Industrial Average data by YCharts.

The first graph shows how terrible the Crash of 1929 was for everyone who lived through it. The second graph shows just how negligible that crash was on the Dow's longer-term history. Neither of these graphs will help you become a better investor, unless you look at both of them and realize that there's not much point in freaking out about market drops if you plan to stay in for the long haul, and that there's no reason to go hunting for meaning in data that doesn't actually drive market moves today.

Numbers might not lie, but charts can and often do -- or at the very least they can tell an incomplete story. That's not to say that charts have no value, but you'll often have to do a little bit of legwork to separate what matters from what's meaningless. Or you can take everything at face value, until you wind up believing that your investments will rise along with the population of monkeys in Madagascar.

Turn your knowledge into power
Want to figure out how to profit on analysis like this? The key is to learn how to turn broad-based insights into portfolio gold by taking your first steps as an investor. Those who wait on the sidelines are missing out on huge gains and putting their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you what you need to get started, and even give you access to some stocks to buy first. Click here to get your copy today -- it's absolutely free.


Read/Post Comments (1) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 12, 2014, at 10:18 PM, usedtobelieve wrote:

    Alex--usually when someone wants to prove or disprove something they provide facts to support their position. From what you wrote it appears that your "facts" are "because I said so"--all I have to do is change the variable to what I want to disprove it". What would provide real value would be to show correlations between the 2 graphs--U.S. debt then vs now, unemployment then vs now, underemployment then vs now. Set out trying to prove that one has a direct correlation to the other--if you can't because the facts don't support it then it isn't true. That is much more valuable than "because I said so".

Add your comment.

DocumentId: 2836355, ~/Articles/ArticleHandler.aspx, 4/21/2014 6:23:39 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement