Is Technical Analysis a Self Fulfilling Prophecy?

Technical analysis critics have long argued that modern technical analysis is a self-fulfilling prophecy, where the prices respond only to technical trends because traders believe they will. Thus, it is the self-fulfilling prophecy that moves the market in response to their own trendlines, oscillators, or moving averages.

This charge, however, is easily dispelled with historical evidence and the success of many of the most popular technical indicators. Many technical analysis tools worked long before they were published.

The History of Technical Analysis

While the first look into technical analysis may have happened in the mid-1600s, the study didn't become more widespread until the 1930s when a number of analysts began studying market action and very basic chart patterns. Of the earliest published discoveries was Ralph Elliot's Elliot Wave Theory based on market price action.

In the midst of today's algorithm heavy trading systems, Elliot Waves appear to be quite primal. In fact, most traders, whether they have years of experience or very little experience, have probably heard of Elliot Waves before. However, just because the knowledge of technical analysis patterns exist doesn't mean the patterns are self-fulfilling.

It wasn't until the 1970s that technical analysis became a very serious study. New developments in algorithms, mathematics, and electronic number crunching with new computers and electronic trading really started to push the ball forward. It was during this time that technical analysis boomed in popularity. New research and indicators were published from some of the best minds on Wall Street.

Fast Forward

Fast forward to today, and traders know so much about market theory that we're now questioning what we understand about technical analysis -- and whether our understanding of technical analysis is what makes it work.

Real back testing of technical analysis indicators does help paint the picture technical analysis is not a self-fulfilling prophecy. Instead, technical analysis helps us understand the mind of the market with hard data surrounding each buy and sell -- not the other way around.

Moving averages, for example, work because at certain prices, more or less of the market is in the money or out of the money. The relative strength index, a very common oscillator, reflected accurate buy and sell signals in the Dow as many as 70 years before it was first published! The candlestick pattern evening doji star accurately pinpoints market reversals because in the process of forming the three main bars (an up bar, a island doji, and a down bar equal or greater than the length of the first bar), the price action takes out all immediate support lines holding up the current price.

The list goes on and on, but if you were to study any technical indicator used commonly today, you would find that before the indicator became popular enough to move the market, the market moved with the indicator. Technical analysis detractors have existed for a long time, but soon enough, long term profitable technical analysts will have existed for just as long!
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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