This was something I was thinking about over Memorial Day weekend. While most people would have preferred to be drinking beer and watching the Indy 500 I was cracking open my new copy of Hedge Fund Market Wizards, the latest book in a series that is a must-read for anyone who has an interest in being serious about this business.
The sermon at church on Sunday touched on the past influencing the present and like most subjects, I couldn’t help but related this thought to trading. Many market pundits, traders, money managers, what have you, are either completely for or completely against the use of technical analysis. The big cop-out for the ‘against’ crowd is often the idea that using a chart when trading is just trying to predict the future. This is far from the true purpose of plotting price action and how it is meant to be used as.
The stock market is more than just a market of stocks, it’s a market of people, of people’s emotions and their beliefs. The stock market, or individual stocks could care less that you bought or sold them. Stock certificates have no emotion and couldn’t tell you who the last person to own them was or how good of a trader they were. It just doesn’t work like that. However, people do remember past experiences. For example, they remember that once XYZ hit $35 a few weeks ago that it wasn’t able to break passed it and so they don’t expect XYZ to break $35 this week due to that previous level of resistance. Humans seek out patterns, we love repetition. Fraud discussed the act of repeating an action often due to a traumatic event as ‘repetition compulsion.’ Fraud gave an example of a child throwing a favorite toy out of his crib, and then once the child is upset and is given the toy back, he throws it out of his crib again. Traders act the same way, and this causes technical analysis to be that much more effective.
Technicians do not look for past price action to identically repeat itself, although it can help provide a path for future price movement. Those that have studied technical analysis know that the past influences the future. Because we truly are a market of humans who seek comfort in repetition and patterns, technical analysis can work. It is not a perfect science, it’s often called an art form.
Disclaimer: Everything in this post is meant for educational and entertainment purposes only. Do not construe anything written in this post or blog as a recommendation, advice, or an offer to buy or sell any securities. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.