Behavioral finance FAQ / Glossary (Technical)
This is a separate page of the T-U section of the Glossary
Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed, i: incidental
TA / Technical analysis
00/10i,11d - 01/1i,2d,4i,5i,8i,9i,10i - 02/5i,7i,8d -
03/2d,2i,6i,7d,8i,11i - 04/3i,7d - 05/1i - 06/3d
- 08/12i + see price memory, representativeness,
trend + bfdef3
Found any market forecasts in Picasso or Pollock paintings lately?
TA/ Technical analysis is a way to use financial market price data to try to:
Detect patterns in price evolutions,
Draw investment guidance
from those patterns.
The hypothesis behind TA
Can the recent price moves tell the secret of the next ones?
TA uses the hypothesis that past prices - and particularly
the recent price moves - can give an idea of how
the market behave and what will drive future price evolutions.
The assumptions are that:
Even if markets are supposed to move at random ,
their future sticks in some degree to their past moves.
The observed price evolutions reflect the current market forces.
They might reveal what the main buyers and sellers were doing / are doing / are ready
to do next.
TA is therefore supposed to detect:
Not only the effect of public information on prices,
But also what is behind the scene and contribute also to market price moves.
* Private (insiders) information
* Investor sentiments...
How is TA done?
Lines and pictures on the screen? Or figures on the blackboard?
There are several "schools" of TA, as seen below.
The techniques they use have in common a two step process:
1) To spot, usually on a chart,
a trend (see that word) ,
or another typical price pattern (some geometric figure, if chartism is used, see below)
2) To compare those market "fingerprints" to a set of models, built on empirical experience,
that could give some idea on what prices will do next.
As an example, many of those models are supposed to judge
if the spotted trend is on the way to persist or to break.
The main "school" of TA: Chartism
TA relies mostly on Chartism, by using various forms of graphs / charts.
This is called sometimes the "chart craze" or "chart invasion"
Chartists "join the dots" in order to see if visual patterns appear and
give signals about future price evolutions.
The patterns that are usually looked for are not boudoir wallpaper flowers
but abstract geometrical shapes such as channels, support or resistance
clusters, triangles, diamonds.
Well, figurative painting is not fully neglected either, for example with the
famed head and shoulders pattern.
Technicalists have many other graphic configurations in their bags, some
of them quite elaborate and, among them, some quite confidential.
Other "schools" of TA: using numbers
Some "technicalists" use simple calculations
(i.e. "200 days average", "relative strength analysis" ...),
Others go further and apply "stochastic" methods used in quantitative analysis
(see that phrase).
But how repetitive are the phenomena found in those quantitative models?
Others even fringes on the esoteric / numerology
(Gann, Elliott, Fibonacci methods).
The debate: is TA useful?
Scientific police clues? Or wishful voodoo?
TA is quite popular, in the general public as well as among market professionals.
It is also said to contribute to investor herding, and therefore to pervert market evolutions.
Is there some rationale in using it, or is it a modern superstition?
A) Elements in favor of TA
A glimpse of what is behind the scene?
One justification for TA, although evidences of its relevancy are
flimsy, is that it might detect "hidden forces" , which:
Either match what we could deduce from public information
and behavioral finance combined.
For example a process of price underreaction - adjustment - overreaction
to information might appear and show that a price trend is activated
and is gaining "momentum".
Here some stickiness is at play.
Or proceeds from weak signals about investor behavior or
Information cascades, investor sentiment, anchoring on past prices...
Or are due to private information.
They are about hidden events that even the most nosey, imaginative and
anticipative financial analyst would not suspect or anticipate, or would
attribute a too low probability to be worth entering in its scenarios.
Another thing (is it good or bad?) is that technical analysis itself
plays a part in market trends.
We have here a kind of self-fulfilling prophecy. TA incites traders to wait for a
rise or fall, as a signal that the previous trend is persisting or reverting, before they
start to buy or sell.
TA specialists reply that methods diverge from one analyst to another. This would
exclude a common rush to the entrance or the exit. But even so, some widely
popular TA approaches weigh on the market.
B) Elements against TA
The picture might be misleading.
This search of patterns can be labeled as representativeness (see
that word) that sometimes verge on optical illusions,
except maybe for the most salient patterns (prolonged trends...).
Thus, the result of TA-driven decisions might differ only marginally from random
Except for some clear trends or clusters, the graphs are often
intertwined and unclear.
Beware or optical illusions! Even if they could interest your shrink, like a
Rorschach test ;-)
They also can be belated and show phenomena that are already
As seen above, there are different "schools" of TA.
Which one to choose?
Technical analysis usually doesn't explain the "why" of the signals.
It appears as a black box containing an indeterminate mix of fundamental and
behavioral factors, if not a belief in some universal laws.
This obscurity about the real causes of the phenomena can lead to wrong
conclusions and actions.
The corollary is that when there is a robust behavioral explanation to a
TA phenomenon, it could be used as a confirmation or an alert signal.
A "trend" on a chart might signal, as said above, a process of
underrreaction - adjustment - overreaction,
A price cluster might show an anchoring on some past price phase
and be interpreted as a "support" or "resistance".
C) The broader picture
Bridging art and technique: the investment cocktail.
The idea behind TA is that it could be possible to predict market evolutions.
This assumption is also shared to some extent by fundamental analysis and behavioral
analysis,albeit with different approaches.
This idea obviously opposes the Efficient Market Hypothesis, or at least its strong
form (see "efficient"), and the RWH (see "random"),
Well, what is right, between all the analysis methods
(fundamental, quantitative, technical, behavioral)?
More generally, is investment an art, and for some aspects a philosophy,
more than a technique? Or at least a combination that bridges several approaches?
One problem is overconfidence, the fact that most of us thinks to be superior
technicians or artists.
A lucky thing maybe: if that illusion was not at play, markets would be boring and
inactive, and the economy comatose because of lack of risk taking and investment.
D) In conclusion
Technical analysis seems to confirm some behavioral finance
approaches, and to give some results.
But it is often deceptive. "Handle with care" .
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