Behavioral finance FAQ / Glossary (Technical)

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Dates of related message(s) in the
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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, trend, representativeness
+ bfdef3

Found any market forecasts
within 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   investing 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 hint on
the market behave and what will drive its future prices.

The assumptions are that:

Even if markets are supposed to move at random , their

future sticks , or at least depends, 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 (and decrypt):

Not only the effect of public information on prices,

But also what is behind the scene and contribute also to
    market price moves.

For example:

* 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 evolution pattern (a geometric image 
    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, what road they will follow.

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
images/pi-graph.gif graphs / charts. 

Some call it 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, secret weapon stuff!.

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
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.

But it is also said to contribute to investor herding, and thus 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
gains "momentum".

Here some stickiness is at play.

Or proceeds from weak signals about investor
   behavior
or economic evolution: information cascades,

investor sentiment, anchoring on past prices...

Or are due to private information.

They would detect hidden events that even the most
nosey, imaginative and anticipative financial analyst
would not suspect, or to which it would attribute a too
low probability to be worth entering in its scenarios.


Another thing (is it good or bad?) is that TA 

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 persists or reverts,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)
sometimes verging 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 decisions
, as:

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 already outdated
    phenomena    .

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 if there is in parallel a robust behavioral 
          
explanationto a TA phenomenon, it could be used as a 
          
confirmation or an alert signal.

For example:

A "trend" on a chart might signal, as said above, a

of underrreaction - adjustment - overreaction process,

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 market evolutions could be predicted.

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, in 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 think
    
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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This page last update: 08/08/15  

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