This is not an accurate view of tehcnical analysis. Unfortunately, many technicians work from this viewpoint. Technical analysis is really not about predicting the future price of the stock. It is about assessing probabilities and inclinations of the stocks future movement based on what is occuring in the present time, which also involves what had lead up to the present time. This relationship between the present and future is not necissarily as directly related as A + B = C. This is where experience is helpful. For there may be what appears to be conflicting indications that have to be appropriately weighed in order to arrive at a decision. So the past does not need to directly relate with the present and future, even though there usually is a connection here.
For instance, it is possible for a stock to just sit there not doing much of anything for a good part of its past. But a time can come where there can be seen evidence of accumulation which seperates it from its past. Because accumulation can lead to price appreciation of the stock in the form of a trend. This price action when it comes alive can attract other players,which will be revealed also be their "footprints" in the price action of the stock. This price action will form a type of basing pattern. If the demand for the stock increases as the result of this accumulation, the price of the stock will end up breaking out of this basing pattern into a trend that will last for a period of time. Through furthe application of TA, the technician can get an idea when the trend is slowing down and the goes into a consolidation patter (original purchasers are taking their profits). If the demand for the stock is not there during this distribution phase, the stock can end up moving into a correction which can retrace part of its previous uptrend.
Applying this to a specific situation, suppose two companies were in merger talks that are suppose to be "secret". As soon as a deal is struck, some insider lets this news tidbit slip to an "outsider". That outsider calls their stock broker and starts purchasing shares in an agressive way. After all, it is just a matter of time before everyone find out about this deal. Meanwhile, other people are told about this "opportunity", like those hair dressers in that "Barbarians at the Gates" movie that was on television. This causes unusual activity on the stock's price. This unusual activity attracts others who make it their business to follow stock which encourages them to start moving their money into this stock. The technician sees on his chart that something is up and then is eventually able to determine that strong accumulation is being made of this stock. So when enough interest grows in the stock to support the likelihood of higher stock prices, the price of the stock will indicate this by breaking out of its basing pattern and starting a trend. This "rings" many technician's "bells" where they start moving into the stock.
So as you see, technican analysis need not have anything to do with "cycles" and other predictive tehcniques that are derived from the stock's past. And TA is more of an art of tracking stock then of predicting where it will be tomarrow. In some ways it is like following a puppy dog around a house. After a while, you end up being able to get an idea of where the dog will go next by seeing what attracts it at a give moment, and also part of this is understanding its behavior patterns that can render what it is next inclined to do predictable to an extent. Sometimes you are 1/2 of a step ahead of the dog, other times 1/2 of a step behind, and there are times when you may not have a clue where the dog wil go next.
This does not mean that TA does not work for the long term. By being able to help the tehcnician assess the probabilities, the technician can follow the stock until it looks like the stock is showing signs that a correction is likely. Once the stock's price action confirms in some fashion this prognosis, then the technician can respond by exiting the stock. Those who are watching the stock without having TA as a tool may see the stock taking a momentary pause. After all, the price went up this far, why should it not go further, right? Wrong! The stock then can start the retrace of its previous uptrend. The signs were there, so the technician is already out of the stock. Those who are still on this "train" are thinking: "the stock will turn around any time now". After the stock moves down further, they start thinking: "I cannot take this loss. I will have to wait fot the stock to move back up here". And so forth. Also, markets themselves have "patterns" as money moves from sector to sector in response to the changing economy and the business cycle.
What can happen after the stock has been in a downtrend for a period of time is that it can stop its downtrend, "regroup" by basing once again, and then start an uptrend. If this were to happen lets say after a few months have went by, guess what will happen if this stock were to reach the price where it started its original downtrend? By that time, there are many traders that became investors who are still holding onto the stock and are ready to sell at break even. They begin to sell when the stock comes back to them in price. This creates what technicians refer to as a resistance level. Here is where some technicians can choose to reenter the stock when the price action is showing the likelihood that the stock will continue its recent uptrend. This is where those traders who became investors are more than willing to give their shares over to that technician who actually sees another profit opportunity. So goes the stock market: traders chasing after their vision of success which turn into memories of missed opportunities and losses.
Bob Graham |
