Can Technical Analysis be predictive of future market action?

John Murphy, respected author of the textbook “Technical Analysis of the Financial Markets” defined Technical Analysis as “the study of market action, primarily with charts, for the purpose of forecasting future price trends”.The first of the three premises on which he considers technical analysis depends is the statement that “Market Action Discounts Everything“.  He expresses a commonly held view of the first tenet of Dow Theory, that all known information about a security is factored into the share-price. This implies that fundamental and economic considerations, separate from the share-price, are irrelevant. The two other premises according to Murphy  are:

  •  markets move in trends,
  • history tends to repeat itself.

Hence it is only necessary to study past price action to be able to forecast future price movement.

This is a controversial view not accepted by the larger market participants such as institutional fund managers and brokers who see little need for technical analysis in their decision-making.

It implies the primacy of technical analysis over other disciplines and is therefore alienating. A common retort is to allege that technical analysis has more to do with astrology and clairvoyance than science, and is just not a reliable predictive tool.

This view is also not an exact statement of Dow Theory, or of Dow’s own beliefs, since he never himself enunciated the Dow Theory. The three tenets as expressed by his successor as editor of the Wall Street Journal, William Hamilton are as follows:

  1. The averages discount everything
  2. The averages consist of three price movements, the primary trend, secondary reactions, and daily fluctuations
  3. Both averages must confirm.

His goal in studying the averages was to differentiate between bull and bear market sentiment, to decide when it was wiser to invest on the long or the short side of the market.

Dow himself held strong views on the importance of both fundamental and economic considerations.

But the observations he made during his working life were on the movement of the rail-road and the transport averages, not of individual stock-prices. Please see earlier posts of the topic of Dow Theory in Technically Speaking.

 
The larger “wheeler dealers” may have the clout to influence the markets themselves, but even they cannot foretell how the market will  play out when their strategies interact with other participants.  Any serious observer of, and investor in the markets, needs to be aware of technical analysis considerations.

 
The word adumbration, rather than prediction, is more apt to describe the forecasting role of technical analysis. The word comes from Latin words  “ad” meaning to, and umbra, shadow, and thus means to foreshadow, or represent in outline.  It connotes a vague indication of events to come. In art it means shading,  a faint sketch, an outline, or a brief representation. In heraldry it is a shadow or outline of a figure. Figuratively it is a rough or symbolic representation of something.

 
Technical analysis at best can provide just an outline of the possible turn of events to come, based on reasoning as to future circumstances, and knowledge of human behaviour. It seeks to evaluate the statistical likelihood of the possible outcomes. It does not, or should not, depend on inside information, or clairvoyance, in any way.

 
Adumbrations or Predictions are not recommendations, or tips in any way. They are simply a view as to where the share-price will go, and when. They often need to be modified as market events unfold. They are just another tool to use in making intelligent informed decisions.

 

Always do your own research, make your own decisions, and do not blame others.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: