Question

In Working’s experiment, he found that commodity traders could tell the difference between graphs of commodity price changes and graphs of changes in the sequence of random numbers.

According to statistics professor Maurice Kendall,

"Investors can, perhaps, make money on the Stock Exchange, but not, apparently, by watching price movements and coming in on what looks like a good thing…"

In the face of two strong statements supporting randomness over observable patterns, does this make you reconsider your position on Dow Theory and on the value of stock price patterns in general? If so, how? If not, why not? Be sure to state your position.

What is a head and shoulders top? What do traders believe will happen next?

What are “noise traders” and how do they factor into investors’ efforts to beat the market?

Do you believe that stock priced follow observable trends or are random?

Would you trade purely on technical analysis? Why or why not ?

Answer 1

According to Dow theory, one should buy the stock once the market has made a sizable advance (10%) since this advance is likely to continue. Similarly one should sell on a general decline, as this means that the market probably is entering a "bearish" period. It appears, however, that prices of individual stocks do not move independently. There is a strong tendency for prices to move in unison, either up or down.

Dow Theory helps investors identify facts, not make assumptions or forecast. It can be dangerous when investors and traders begin to assume. Predicting the market is a difficult, if not impossible, game. Hamilton readily admitted that Dow Theory was not infallible. While Dow Theory may be able to form the foundation for analysis, it is meant as a starting point for investors and traders to develop analysis guidelines that they are comfortable with and understand. They believed that success in the markets required serious study and analysis that would be fraught with successes and failures. Success is a great thing, but don't get too smug about it. Failures, while painful, should be looked upon as learning experiences. Technical analysis is an art form and the eye grows keener with practice. Study both successes and failures with an eye to the future.

A head and shoulders pattern predicts a bullish-to-bearish trend reversal In technical analysis. The head and shoulders pattern is one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end. After a long bullish trend, the price rises to a peak and subsequently declines.The price rises again to form a second high substantially above the initial peak and declines again.The price rises a third time, but only to the level of the first peak, before declining once more.The first and third peaks are shoulders, and the second peak forms the head. The line connecting the first and second troughs is called the neckline.

once price declines a second time and reaches a point below the initial peak, it is clear that bears are gaining ground. Bulls try one more time to push price upward but succeed only in hitting the lesser high reached the initial peak. This failure to surpass the highest high signals the bulls' defeat and bears take over, driving the price downward and completing the reversal.

Noise traders are those who trade on the basis of hype, biases or unconventional theories without any quality analysis. Noise trading represents a type of anti-information that makes it difficult to interpret price fluctuations. It can also represent an opportunity as noise traders may drive irrational prices in an otherwise efficient market.

For example, A stock initially goes up after an extremely negative press release because investors read the title but not the content and assume it's good news. A small cap stock rises because its ticker symbol is confused with a large-cap stock.

It’s possible to earn handsome profit from the trade done purely based on technical analysis. Here, technical analysis means the decision taken on the basis of security’s past price, volume & Open Interest. Technical analysis supports the following concept
“The trend is a friend” i.e. Price moves in trend, it may be Bullish, Bearish or sideways.
“History repeats itself” which help to predict investor major reversal and important levels and also helps in interpreting future on the basis of the past price moment.
Last, but not least, it also believes in the concept of “Market discount everything” which reflects all publicly-available information in itself in their price action.

Technical analysis is the game of probability where chances of odd in favor of winning a trade are higher than losing. Normally 85% of traders lose their money due to greedy emotions. Discipline plays a vital role in technical analysis & if you trade with the proper risk & reward ratio, you will be always in a profitable situation. You should cut losses when you realize on the basis of technical analysis that your position is against them and also book profit time to time which helps to maintain a profitable portfolio. Capital market Diversification also plays an important role to earn by using Technical analysis.

Please keep in mind that technical analysis doesn’t mean only using different indicators such as Bollinger Band, MACD, RSI etc. It is purely based on pattern formation &breakouts, as well as resistance and support levels, most importantly your observation & time-frames. Indicators only support your right decision. The technical analysis really works when you keep below-mentioned points in your mind:

Follow the Trend

• Pattern formation and breakout
• Timeframe plays an important role. Your time frame helps to decide the movement in the Stock market.
• Major support and Resistance
• Supported 2-3 indicators, not more than that.
• Observation
• If you missed the boat then don’t enter again from the same level. Just wait for another chance.

But sometimes when you follow all the above-mentioned points, still you fail to earn money from the market. It happens because technical analysis is giving the sound result, but have a chance of retracement also. Each and every pattern have a 30% chance of failure where you can’t understand the exact reason for their not giving results as expected. Every analyst has a different view on same price pattern. Some believe more in breakouts where some belief in reversals. Thus, this is an art as well as science, where your practice and experience gives you a better level of understanding the technical analysis.