The study of price behaviour in the markets has growing importance as over time volatility in the markets is increasing giving more opportunities for profitable trades. With this advantage comes higher risk and that is why the study of Behavioural Finance and Technical Analysis should be critical. Methodology combined from these two aspects may help investors make faster more efficient trading decisions than following the older models like the Efficient Market Hypothesis (EMH).
For years, historically, academics have searched for inefficiencies in the financial markets ultimately searching for arbitrage profits. Over time various sophisticated statistical tests have been conducted with results suggesting that market price movement is purely random and the best way to make a profit in the market is to use a ‘buy and hold’ strategy.
In this blog Technical Analysis and the psychology behind it will be introduced in order to try and identify patterns within the price movement that can be used to make better informed investment decisions. Investors, fund managers and private investors have believed the idea that the market digests information efficiently into the price and that it is not possible to forecast future prices based on past information.
Why I’m writing this blog and what you will get from it?
This blog will look into methods that contradict the idea that market prices move randomly suggests they can be forecasted by past behaviour. The study of the Efficient Market vs Technical Analysis is important because literature on the Efficient Market Hypothesis (EMH) does suggest it to be correct. Proven through such tests as variance ratio or runs tests.
This assumption is undermining the more recent literature of Technical Analysis and Behavioural Finance which is used by many fund managers today.
The failure of mathematical models such as the Gaussian Copula Function, an asset pricing model which eventually lost the markets trillions of dollars, should make way for the newer approaches and methodology behind Technical Analysis.
Despite this, Investment decisions are still largely based on the macroeconomic or fundamental factors highlighted by the main stream Media and supported by the older approaches of ‘random walk theory’ and EMH. The technical or behavioural side of Investment is largely neglected. The neglect by the Media, firms, and individual investors alike of newer approaches to Finance could be costing them countless amounts of money that doesn’t have to be lost.
Technical Analysis Will Prevail
So in summary this blog will cover two main aims. The main aim is to apply Technical Analysis methods to continuous data and contrast it with that of the Efficient Market Hypothesis and ‘random walk’ theory, which may be seen as outdated and no longer the most efficient method of making trading decisions.
This aim is not to prove that Technical Analysis is an exact science and the methods work every time. It is to question if prices do in fact follow a ‘random walk’ pattern. The second main aim is to question how the Media delivers information to the public in that they blame clear technical/psychological price reversals on almost irrelevant macroeconomic factors. The importance of the understanding of these approaches is critical for private investors who use the Media as a base for a lot of their investment decisions. If mainstream Media was to show how the market prices can be forecasted it could help save investors’ from missed profitable opportunities or even save them from substantial losses. These two main aims will be broken down into five objectives tailored to achieving my aims.