Introduction to the Art and Science of Technical Analysis
participants, one can always observe the uncanny accuracy with which price
tests and reacts at a psychologically significant barriers or prices. It is hard to
believe that price action is the result of random acts of buying and selling by
market participants where the participants are totally unencumbered by cost,
biases, psychology, or emotion.■ (^) The strong form of the Efficient Market Hypothesis (EMH) argues that since
the markets discount all information, price would have already adjusted to
the new information and any attempt to profit from such information would
be futile. This would render the technical analysis of price action pointless,
with the only form of market participation being passive investment. But such
efficiency would require that all market participants react instantaneously
to all new information in a rational manner. This in itself presents an insur-
mountable challenge to EMH. The truth is that no system comprising dispa-
rate parts in physical reality reacts instantaneously with perfect coordination.
Hence it is fairly safe to assume that although absolute market efficiency is
not attainable, the market does continually adjust to new information, but at
a much lower and less‐efficient rate of data discounting. Therefore, technical
analysis remains a valid form of market investigation until the markets attain
a state of absolute and perfect efficiency.
■ (^) Another argument against technical analysis is the idea of the Self‐Fulfilling
Prophecy (SFP). Proponents of the concept contend that prices react to tech-
nical signals not because the signals themselves are important or significant,
but rather because of the concerted effort of market participants acting on
those signals that make it work. This may in fact be advantageous to the
market participants. The trick is in knowing which technical signals would
be supported by a large concerted action. The logical answer would be to
select only the most significantly clear and obvious technical signals and
triggers. Of course, one can further argue that such signals, if they appear
to be reliable indicators of support and resistance, would begin to attract an
increasing number of traders as time passes. This would eventually lead to
traders vying with each other for the best and most cost‐effective fills. What
seems initially like the concerted action of all market participants now turns
into competition with each other. Getting late fills would be costly as well as
reduce or wipe out any potential for profit. This naturally results in traders
attempting to preempt each other for the best fills. Traders start vying for
progressively earlier entries as price approaches the targeted entry levels,
leading finally to entries that are too distant from the original entry levels,
increasing risk and reducing any potential profits. This disruptive feedback
cycle eventually erodes the reliability of the signals, as price fails to react at
the expected technical levels. Price finally begins to react reliably again at the
expected technical levels as traders stop preempting each other and aban-
don or disregard the strategy that produced the signals. The process repeats.
Therefore, SFP may result in technical signals evolving in a kind of six‐stage
duty cycle, where the effects of SFP may be advantageous and desirable to
traders in the early stages but eventually result in forcing traders into unten-
able positions. See Figure 1.8.