the hAnDbook of teChnICAl AnAlysIsstudies the dispersion, central tendencies, skewness, volatility, regression analysis,
hypothesis testing, correlation, covariance, and so on. Sentiment analysis is con-
cerned with the psychology of market participants, which includes their emotions
and level of optimism or pessimism in the markets. It studies professional and
public opinion via polls and questionnaires, trading and investment decisions via
flow of funds in the markets, as well as the positions taken by large institutions
and hedgers. Finally, behavioral analysis studies the way market participants react
to news, profit and losses, the actions of other market participants, and with their
own psychological and emotional biases, preferences, and expectations.
Mean reverting versus non–Mean reverting approach
The type of technical studies employed also depends on the approach taken by
traders and analysts with respect to their personal preferences and biases regard-
ing the action of price in the markets. Basically, traders either adopt a contrarian
or a momentum‐seeking type approach. Being more contrarian in their approach
implies that they do not usually expect the price to traverse large distances. In fact
they are constantly on the lookout for impending reversals in the markets. In es-
sence, they expect price to be more mean reverting, returning to an average price
or balance between supply and demand. Those that adopt the mean‐reverting ap-
proach prefer to employ technical studies that help pinpoint levels of overbought
and oversold activity, which includes divergence analysis, regression analysis,
moving average bands, and Bollinger bands. They prefer to trade consolidations
rather than trend action. They normally buy at support and short at resistance.
Limit entry orders are their preferred mode of order entry. Conversely, being more
momentum seeking in their approach implies that they usually expect the price to
traverse large distances and for trends to continue to remain intact. They are con-
stantly on the lookout for continuation type breakouts in the markets. In short,
fIgure 1.6 The Four Branches of Technical Analysis.