Browsing though my Wealth-Pro program , I ran across some interesting info. This is only part 3 of 5 parts with some editing . ************* Furthermore, technical analysis is objective because it is untainted by personal and external biases. Ron Hoffman of Gnome Capital expresses the consequences that personal biases can have on investment decisions: "At virtually all times there's enough information to support just about any opinion� You filter your opinions through your biases and if they go wrong, then all of your trades go wrong" (qtd. in Schiffres).
By using technical analysis, however, investors can protect themselves from these biases. Since technical analysis does not rely on the opinions of people who may be influenced towards one position, it is objective. Technical analysis is a legitimate tool for investors because, unlike fundamental analysis, it is impartial to the opinions of investors and Wall Street analysts.
Investor Behavior Representation Technical analysis is valuable to investors because it uses charts to represent to the behavior of the investor pool. "[Charts] signify the market's mood. That's because they reflect investors acting in concert, displaying their emotional bias, which in the aggregate yields bullish or bearish movements�".
Elder supports that "chart patterns reveal crowd behavior. Classical technical analysis is applied social psychology" (5). By examining the actions of investors in the market, technical analysis can help predict the direction of stocks. Using charts is a valid method for analyzing stocks because charts represent the attitudes of the market. Understanding the emotional story behind the seemingly random movements of the markets can be very rewarding; technical analysis is beneficial to investors and traders because it encompasses overall market sentiment by using charts to observe the actions of various market forces.
Unchanging Investor Pool While charts may show how the investor pool has reacted to market conditions in the past, technical analysis works because the same emotional biases continue to show up. "Since [the investment] pool doesn't change rapidly, one might expect to see similar chart patterns in the future"
Chart patterns show up repeatedly because they represent the behavior of the investors-behavior that "doesn't change rapidly" (Lott). Because technical analysis uses behavioral finance, the study of how the emotions of investors influence their decision-making processes (and in turn, influence the market itself), technical analysis is successful. The exploitation of charts is one of the aspects of technical analysis that contributes to its legitimacy.
Elliot Wave principle, one of the leading theories of technical analysis, is based on the study of emotional biases in the market. The theory breaks down stock market waves into bearish and bullish waves. "The basic objective of Elliot's rules is to follow and count correctly the development of a five-wave advance�" The principle works because it is established on behavioral finance tenets that are manifested in the stock market. Elliot Wave is good example of how technical analysis is a valid tool because it comprises investor sentiment.