Reasoning Consistent with Technical Analysis

 Reasoning Consistent with Technical Analysis

To start, I want to clarify that neither currently nor in the past have I participated in technical analysis. Doing that does not seem like it would be a good use of my time.

But I am not arguing that technical analysis is useless as a forecasting tool. Actually, I think it might be somewhat predictive. Disproved is the Efficient Market Hypothesis. The (unspoken) assumption is that market prices are determined by data. In "Security Analysis," Graham made it crystal clear:

"...what we refer to as analytical factors have an indirect and partial impact on the market price. It's partial because it often competes with purely speculative factors, which have an opposite effect, and it's indirect because it acts via the intermediary of people's emotions and choices. To rephrase, the market is not a tool that precisely and impersonally records the worth of each item based on its individual attributes, like a weighing machine. Instead, we could compare the market to a voting machine, wherein millions of people cast ballots that reflect a mix of rational and emotional decision-making.

A lot of people quote this without looking at the context, in my opinion. In comparison to, instance, Buffett, Graham possessed a far more expansive intellect. There are advantages and disadvantages to that. Graham inadvertently delves more deeply into an intriguing subject than is technically required for his main aim on multiple occasions in Security Analysis (and to a lesser degree in his other writings). Here, Graham could have said what many have taken him to mean: stock prices are subject to short-term fluctuations, but the underlying company's intrinsic value determines their long-term trajectory. Graham, of all people, did not say that. The stock market, on the other hand, was characterized in a way that would have piqued the interest of both investors and economists.

Prices are indirectly impacted by data. In many ways, the market is like to a fun house mirror. While the original data does have a role in producing the resultant reflection, it does not guarantee that the reflection faithfully portrays the original data. Building on this analogy even further, the Efficient Market Hypothesis postulates that the initial image has an influence on the mirror, causing it to produce the reflection. It ignores the uncomfortable reality that different people can arrive at different conclusions from the same process. One could argue that the mirror is responsible for producing the reflection by manipulating the original image. Actually, that's how we usually understand it. In a mirror, we say that something is reflected. In everyday speech, the active voice is hardly employed.

We have a strange penchant for using cliches and oversimplified metaphors when discussing the market. We discuss how falling prices can wipe out riches. But nobody ever mentions how wealth is wiped out if a product's price drops. Every time the market goes up, we hear about buyers—as if the seller weren't involved. We refer to "the market" as an entity in and of itself, rather than as an aggregate of transactions.

When it comes to interpretation, the Efficient Market Hypothesis completely misses the mark. The crucial phase is left out when one states that data, which is publicly available information, influences market pricing. Ultimately, all blackjack players have access to the same data. Casinos just dislike the data interpretation methods employed by card counters.

Technical analysis has its detractors, and they aren't limited to the Efficient Market Hypothesis. Additionally, there is data that casts doubt on technical analysis' usefulness. Nonetheless, it would be a stretch to say that technical analysis lacks predictive power based on empirical evidence alone. If the majority of knuckleball pitchers were unsuccessful, it could be because the knuckleball is fundamentally unproductive or that there is an improved technique to throw it. Technical analysis is no different.

"Random" is an incredibly peculiar adjective. Having no obvious pattern is the most suitable definition of random, however it is seldom used. There must be the term "discernible" in the sentence. If that's the case, we risk elevating science and statistics to an unhealthy level. Carl Menger wrote a fantastic introduction to economics, and it starts with:

The rule of cause and effect applies to everything. We could go all over the world for an example that contradicts this wonderful idea, but there isn't one. Human development does not undermine it but rather has the effect of reinforcing it and continuously expanding our understanding of its breadth of validity.

Nothing happens at random because everything is governed by the rule of cause and effect. An identifiable pattern is not necessary for an event to be considered caused. Who would contend that changes in stock prices are uncaused, even if one were to argue for the existence of such an event? We have the knowledge that they are a result of trade. The stock market is a reflection of the intentional behavior of individuals. It would be difficult to claim that any human conduct is uncaused, given that numerous sciences investigate the reasons for intentional human behavior. Additionally, our individual subjective perceptions of reality point to the existence of distinct reasons for our deliberate acts. In addition, we are aware that price swings influence the behavior of some market players. Yeah, a lot of investors will tell you that. Possible deceit on their part. However, there is a mountain of proof that contradicts this.

Past price movements must partially cause future price movements if investors' actions cause price movements and past price fluctuations partially cause investors' actions.

Logically, technical analysis makes sense. Given the preceding assumptions, it is not only plausible that technical analysis might have predictive potential, but it is, in my opinion, an inevitable consequence.

Technical analysis isn't something I do, so why not? Fundamental analysis is, in my opinion, even more potent. To the contrary, I think one should forego any time spent on technical analysis in favor of fundamental analysis because the latter is so much more effective. Additionally, I think an investor doesn't need to spend time on technical research because there is plenty of fundamental analysis to do. To be honest, I think basic analysis is where my strengths lie, rather than technical analysis, which is where my weaknesses lie. Naturally, this argument does not have any merit in your eyes. Furthermore, I think there's enough data to back up the claim that fundamental analysis is a much more effective strategy than technical analysis.

I have built a mental model of investing that does not permit any kind of technical analysis with predictive potential, even though I think there must be one. To rephrase: I act as though there isn't a viable method of technical analysis, even though I know there must be one.

Why? This is due to my conviction that it is the best model. Not the most truthful model, but the most practical one should be adopted. Technical analysis, in some form, must be effective, but I'm prepared to pretend it isn't.

Actually, I don't find this very unusual. I am prepared to act as though random events actually occur in scientific contexts, despite my knowledge that this is obviously not the case. For the sake of argument, I will pretend that zero is a number in mathematics even though I am well aware that it is not. An event-based paradigm can be helpful. Refusing to acknowledge the possibility of chance occurrences would usually do more harm than good. It is easier and more practical to use the model with random events. With 0, things are pretty much the same. A number it is not. You would have to disregard mathematical rules in order to incorporate 0 as a number. For that reason, we abstain from that. Zero is a number, but there are several things you should never do with it, according to what you learned in school. It was a straightforward and practical model, so you went with it.

Regarding technical analysis, I suggest you follow a similar procedure. Though you should acknowledge technical analysis's rationale, you should imagine an investment paradigm in which technical analysis serves no purpose.

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