The Handbook of Technical Analysis + Test Bank_ The Practitioner\'s Comprehensive Guide to Technical Analysis ( PDFDrive )

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Introduction to the Art and Science of Technical Analysis


Technical analysis is based on the assumption that people will continue to
make the same mistakes they have made in the past.
Martin Pring, Technical Analysis Explained, 4th Edition
(McGraw‐Hill, 2002)

This definition by Pring stresses and underscores the point that there is a real
reason and explanation as to why past price patterns tend to repeat. The tendency
of price to repeat past patterns is mainly attributed to market participants repeat-
ing the same behavior. Although it is not impossible with sufficient and continuous
conscious effort and strength of will, human beings rarely change their basic behav-
ior, temperament, and deep‐rooted biases, especially in relation to their emotional
response to fear, greed, hope, anger, and regret when participating in the markets.
The following statement about technical analysis explains its effectiveness in
timing early entries and exits.

Market price tends to lead the known fundamentals.... Market price acts
as a leading indicator of the fundamentals.
John Murphy, Technical Analysis of the Financial Markets
(NYIF, 1999)

This definition by Murphy highlights a very important assumption in techni-
cal analysis, which is that price is a reflection of all known information acted
upon in the markets. It is the sum of all market participants’ trading and invest-
ment actions and decisions, including current and future expectations of market
action. It also reflects the overall psychology, biases, and beliefs of all market
participants. Therefore, the technical analysts believe that the charts tell the whole
story and that everything that can or is expected to impact price has already been
discounted. This assumption forms the very basis of technical analysis, and with-
out it, technical analysis would be rendered completely pointless.

fundamental versus technically based Market timing
Before proceeding any further, it is best to briefly explain the meaning of a few
commonly used terms in trading and technical analysis:

■ (^) To go long means to buy to open a new position
■ (^) To liquidate means to sell to close a position previously held
■ (^) To go short means to sell to open a new position
■ (^) To cover means to buy to close a position previously shorted
Both fundamental and technically based market timing aim to satisfy the same
basic principle of buying low and selling high. There are four basic scenarios
where this may occur:



  1. Long at a low price and liquidate at a higher price

  2. Long at a relatively high price and liquidate at an even higher price

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