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

(sohrab1953) #1
the hAnDbook of teChnICAl AnAlysIs

Ironically, most equity valuation modeling and standard economic statistical
indicators are based on past or historical information as well. How else are we
able to make an intelligent assessment of future outcome without reference to
past data? It is human nature to try to infer, extrapolate, generalize, and predict
potentially probable future outcomes.
The reason for the popularity of classical price and chart patterns lies in the fact
that they are essentially visual in nature. Human beings have an innate tendency for
pattern recognition and as such there is a natural inclination to gravitate toward such
forms of analysis. The reliability of pattern analysis tends to improve as more market
participants start to employ such patterns in their day‐to‐day trading and forecasting.
Unfortunately, there are some challenges to the reliability of using past action
as a forecasting tool, some of which are:



  1. The preempting effect will slowly erode the reliability of historical patterns as
    traders start to outbid or outsell each other in anticipation of the approaching
    technical trigger levels. Preempting is a direct result of the self‐fulfilling prophecy.

  2. The effect of widespread program trading will affect the reliability of histori-
    cal pattern trading as programs are able to trade in ways not easily replicated
    by manual or human trading.

  3. The ever‐changing influx of new participants into the markets will slowly af-
    fect the reliability of chart and price patterns unfolding in the expected manner.
    Although human psychology remains largely predictable over the longer‐term
    horizon, short‐term patterns are sometimes impacted by new participants who
    have a slightly different approach than the usual participants in that market.


the Market tends to Move in trends


Lastly, from the definitions given of technical analysis, it is generally accepted
that the market has a tendency to move in trends. This explains the popularity of
trend‐based methodologies. Of course, it is not hard to understand the basis for
the popularity of trend trading, since trend action affords market participants the
greatest profit over the shortest possible duration in the markets.
But if we analyze this statement more closely, we understand that the term
trend is inconclusive. What is actually is a trend? When is a trend a trend and
when does it cease to be one? There have been many attempts to define what a
trend is objectively. Successively higher or lower peaks and troughs is one widely
accepted method, and is by far the preferred mode of identifying a trend. But then
this begs the next question, which is: what constitutes a peak or a trough? Signifi-
cant containment of price below or above a trendline or sloping moving average
may also be deemed a valid way of defining a trend. We shall delve into the specif-
ics of defining trends, consolidations, and other formations in Chapter 5.
Although trend following is popular, there are some challenges to using it,
some of which are:


■ (^) Inefficient trade sizing in volatile markets
■ (^) Inefficient profit capture during trends

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