Charting the value of technical analysis

The analysis of price action through technical, rather than fundamental, examination has been with us for several hundred years.

The 18th century Japanese rice trader, Homma Munehisa, began tracking prices of rice using his system of candlesticks. As he developed records he noticed repeated patterns. He then began trading the rice markets and, as history suggests, he became a very rich man.

Here, Ron William, founder and principal market strategist of RW Advisory, looks at some of the viewpoints of modern day technical analysis. These include Dow theory, efficient market hypothesis (EMH), crowd psychology, the cycle of emotions, multi cycle trends, self-fulfilling prophesies and more.

He discusses the value of technical analysis during different market phases and event-driven responses but at all times he says that underpinning this remains the core tenets of Dow theory, initiated by Charles Dow. In 1882 Dow and his business partner Edward Jones began the Dow Jones index of stocks, and it was from this that Charles Dow established the theory that retains its place as a cornerstone of modern day technical analysis.

Dow Theory is broken down into five basic tenets, these being:

  1. The averages discount everything
  2. Markets have three trends
  3. Major trends have three phases
  4. The averages must confirm each other’s moves
  5. Volume must confirm the trend

With his deep understanding of modern day technical analysis, Ron William puts current market performance into perspective and explains the idea that crowd psychology, or human emotions, drive markets. Meanwhile, the individual ‘may be rational’, but pit them against the crowd and rational behaviour can turn crazy, as evidenced in the run up to the financial crisis of 2007-2008.  

Set against this is the idea, Ron explains, that nothing lasts forever and we should be ready to set a different strategy. This, he says, is highlighted in the book ‘A random walk down Wall Street’ by Burton G Malkiel, in which the EMH was discussed. Ron says that EMH was popularised in the later 1960s through to the early 1980s, during which the market suffered from the oil price shock.

Ron ends the discussion by reminding us that an holistic approach needs to be taken to market analysis, in that no one idea can prevail, instead suggesting that one has to engage with all the ‘ideas that work’.

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