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 THE COMMON THREADS IN TECHNICAL ANALYSIS
 

   This is a translation of the former paper published by André Gosselin on the OrientationFinance.com web site on June 22 2005 ( Read the original paper in French here).

 

   * Extract written by André Gosselin published in his book "Investir ŕ l’aide de l’analyse technique".

   The technical analysis strategies, whereas they are numerous and diversified, are mainly based on the four following proposals, as stated by Edwards and Magee, authors of Technical Analysis of Stock Trends, by far the technical analysis book the most read in the world.

   We find in the four following proposals the essence of what I call the common doctrine of the technical analysis, which is the oldest and the most widely shared by the technicians:

   1. The value of a security in the market depends on supply and demand.
   2. Supply and demand are controlled by several factors, some rational and some irrational ones.
   3. The market is very efficient and fast to incorporate, in the price of the securities, all the rational (profits' annoucements) and irrational factors (rumors, panics, etc.) who influence the investors.
   4. The prices of the stocks evolve according to trends which appear as well in the very short term as in the very long term.

   Supply and demand

   The first proposal does not have anything very revolutionary or eccentric. Almost all the investors, technicians or not, accept the idea that the price of stocks is determined, among other factors, by the balance between supply and demand. The question is to know which weight to give to this factor in his theory or his market concept.

   The fans of the fundamental analysis and of the strategies based on the value or the growth of the companies consider that there are factors more significant than the investors' supply and demand to judge valuation of a stock. The technicians estimate that it is the main factor to be taken into account if your objective is to obtain the maximum return from your investments. In any case, it is the most accessible and practical factor for the investment decision.

   What is the supply and demand, when these two phenomena are considered in the financial markets context? The supply is all the investment decisions which derive from a pessimistic fundamental analysis of a given stock and from its value; on the contrary, the demand is made of all the investment decisions which derive from an optimistic fundamental analysis of a given stock and from its value. All things considered, the technical analysis is the equivalent of what is called, in economic science, macroeconomics, because the analyst is interested first and above all in the aggregate supply and aggregate demand, i.e. in the offer of all the investors together and in the demand of all the investors together.

   The rational and the irrational

   The second proposal of the common doctrine of the technical analysis evokes the idea that the markets are controlled by individuals who use sometimes their intelligence, and sometimes their emotions and feelings. Sometimes, the markets seem to evolve roundly and the investors appear to be guided only by the cold calculation and the pure intelligence; sometimes, the markets look a sport game, or even a gambling game, where all the moves are allowed and where the low instincts dominate. In this last case, it is like attending a race against the clock, in a zone where a weather alert has been announced, with the demonstrations of panic, the anxiety, the rescue attempts and the "deaths" that includes.

   In short, the financial markets demonstrate the best intelligence and the worst instincts of the mankind. The technical analysis fans consider that the market is 10% logic and 90% psychological. The fundamental analysis fans affirm on the contrary that the market is 90% logic and 10% psychological.

   The markets efficiency

   The third proposal, as you may have noticed, is a pretty direct charge against the claims of the fundamental analysis. Several followers of the technical analysis, as I said, do not hesitate to refer to the scientific authority to fustigate the fundamental analysis.

   Stan Weinstein for example, the author of a well-known book about technical analysis and the editor of a very popular financial letter, write this:

   "You will never be able to beat the market with constancy by reading today fundamental news in the newspapers and by acting on the faith of this information. It is a passport for failure, a small amount of mortal poison that the beginner administers himself without realizing it [... ] It is not either while following the economic and financial news that you will turn your investments into winning bets. In a society saturated with computers and instantaneous information, the financial markets react to the last developments well before you are informed about it in the press."

   It is like to read an academic convinced by the theory of the efficient markets or a researcher buying the conclusions of one of the many studies showing the uselessness of public information, accessible to all, at least in an investment strategy which aims at beating the market.

   To some extent, Weinstein is not wrong. However, the technicians are proven wrong, when they forget to mention at all one of the works of the economists on one of the rules of the technical analysis. They get out of this dead end by affirming, like Weinstein, that the technical analysis is more about art than science. Their position is to say that you can make a fortune with the Stock Exchange by being right only half of the time, or even once out of three times, considering that you let the profits run and that you cut your losses quickly. The position of the scientist is to say that a method which does not work more than once out of two times is not valid.

   Thus, the two sides have different criteria to judge a method: the scientist will say that it is valid if it succeeds at least more than once out of two, the technical analyst will say that it is not necessary that a method succeeds more than once out of two and that it is acceptable and useful as long as it brings back enough money to who follows it.

   The prices trend

   The fourth proposal of the technical analysis common doctrines is the most significant. As Martin Pring, author of Technical Analysis Explained, explains, the objective of the technical analysis is to determine the changes or the reversals in the stock prices, thanks in particular to indicators and simple mathematical ratios on the state and the economic situation of the markets. The markets evolve in trends, in a given direction, either upwards, or downwards; sometimes flat, as if the market has taken a pause and that the investors have entered in a phase of indecisiveness.

   These intermediate periods have their importance for certain technicians, because, as soon as the market takes a clearer direction, with upwards or downwards, it is possible to take position in order to take the train on time. It is all about the art, the difficult one, of the technical analysis.



Technical Analysis of Stock Trends


Edwards, Robert D.; Magee, John; Bassetti, W.h.c.

Special Price
US$ 59.82
in our bookstore



Technical Analysis Explained


Pring, Martin J.

Special Price
US$ 29.57
in our bookstore


   André Gosselin

 
 
 
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