Regarding the correctness of Technical Analysis

trilateral · #1 22nd July 2005, 01:09 AM

Hi,

This is trilateral. I am fairly new to the stock markets... hardly an year. Technical analysis has fascinated me a lot and in this regard, I would like to post a question to the Technical Analysis Gurus we have among us.

Suppose a trading opportunity exists and lets say one particular indicator has already revealed this opportunity. Now people who are actively following this indicator would certainly try to take advantage of the situation. Imagine the case of a much popular indicator, say MACD which is tracked by quite a lot of analysts. If this indicator gives of a signal, one can be fairly certain that this opportunity is going to be exploited by the masses in general. In such a case wouldn't this indicator become the reason for its own success as time progresses

To make myself more clear - Lets say MACD gives a buy signal on a certain scrip. People who are monitoring this scrip, would be interested in entering it and the increase in demand due to this results in price increase which in turn triggers the indicator to move further into positive territory.

Cycle of price changes
(1). Price Increases --> Indicator Gives buy signal --> Price increases again --> Indicator Gives buy signal ...

This loop continues till some external factor(a natural calamity/poor rainfall etc) or a strong fundamental factor (quarterly results below expectations) causes the price to fall abruptly. In this case,
the loop becomes modified as follows
(2). Price Decreases --> Indicator Gives sell signal --> Price Decreases again --> Indicator Gives sell signal... and the loop continues from step(1)

Please don't get me wrong... I'm not saying that technical analysis is wrong. My intention is only to to reinforce my belief (and perhaps the belief of any novice reading this post) in this technique, by questioning it and proving it correct

Regards
Trilateral

Traderji · #2 22nd July 2005, 09:59 AM

What you are trying to say is Technical Analysis Principles are Self-Fulfilling!

Some claim that because the price patterns and indicators of technical analysis are widely disseminated throughout the investment community and that traders are so familiar with them, technicians act on them together unknowingly. These bursts of buying and selling appear to give credence to the predictive claims of the patterns and indicators when no such predictive quality exists.

Chartists counter that if it were the case that they were acting in concert with each other, the same signals that told them all to buy would tell them all to sell. I.e., none of them would make any money trading. Since this is not the case, they claim, technical analysis principles are not self-fulfilling.

Chartists also point out that pattern recognition and reading technical indicators is somewhat subjective so it would be impossible for their entire community to act as one.

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