Technical Indicators and Charting Patterns

Over the years, technical analysts have developed hundreds of technical indicators and detected dozens of chart patterns that they contend help them forecast future price changes. While we cannot describe or even list all of them, we can categorize them based upon the nature of irrationality that we attribute to markets. Consolidating all of the irrationalities that have been attributed to financial markets, we have created five groupings:

• Market participants over react to new information: If this is true - prices rise too much on good news and fall too much on bad news - you would draw on contrarian indicators which would help you to gauge the direction in which the crowd is going and to go against it.

• Market participants are slow learners: In many ways, this is the polar opposite of the first grouping. If investors are slow learners, prices will under react to new information and you would expect price direction to persist and use momentum strategies, which would gauge market direction and move with it.

• Investors change their minds frequently and often irrationally, causing significant shifts in demand and supply, causing prices to move. If you believe that this is the way markets work, you would use technical indicators and charting patterns to detect these shifts.

• There are a group of investors who lead markets, and finding out when and what they are buying and selling can provide a useful leading indicator of future price movements. If this is what you believe about markets, you would track the trading of these leading investors and try to follow them.

• There are external forces that govern up and down movements in markets that override fundamentals and investor preferences. Technical indicators and charting patterns that allow up to see their larger cycles in stock prices can allow us to get ahead of other investors.

Within each, we can consider different technical indicators that we can broadly categorize into three groups - price indicators, which are based upon past price movements, volume indicators, that look at trading volume and sentiment indicators, that use qualitative measures of how bullish or bearish investors feel about stocks.

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