Its All About Patterns 07-03-2018
Technical analysis is all about patterns. Candlesticks, one of the most widely used form of charting is all about patterns. Bar charts create patterns and lots of them. Point and figure charts create their own patterns. As though candle patterns were not enough, they invented variants and called theem Renko, Kagi and Three Line break to create even more patterns. Fibonacci relations create yet another pattern while line studies are also symmetry of some sort, creating patterns. Divergences are patterns as are Reversals. Overbought and oversold are patterns too. Elliot wave is a pattern and so is the Square of nine or other geometric technics of WD Gann.
So, when you study TA, you are essentially studying patterns. Now, these are patterns of human behaviour because prices print as a result of human interaction based on their thinking. Since human behaviour tends to repeat thru time, it is postulated that the technical patterns will be successful in reading human behaviour. This is not just a theory. It goes back into the study of human nature where it has been shown (particularly by Nobel prize winners Daniel Kahnman and Amos Tversky) that finding patterns even in random data is a common predilection of human beings. Humans have a phenomenal ability to detect and interpret simple patterns. That’s what helped our ancestors survive the hazardous primeval world, enabling them to evade predators, ﬁnd food and shelter, and eventually to plant crops in the right place at the right time of year. Today, our skill at seeking and completing patterns helps us navigate many of the basic challenges of daily life.
The markets are full of, seemingly, random data. But our incorrigible fondness for finding patterns leads us to believe that markets have patterns. So people sift through mountains of stock market data to ﬁnd “predictable patterns” that might enable them to beat the market.
The problem does not lie there. There are repetitive behaviors and if one finds them and sticks to that pattern, some reasonable success can be enjoyed. Rats and pigeons, in laboratory conditions, are quite capable of sticking to a pattern once they find it. They go by the simple fact that if they stick to one pattern, then it means a reward of some sort. But human beings are different. As soon as they find a pattern, they immediately move to forecasting what the NEXT instance of the pattern will be! They cannot, somehow, remain content following the pattern, as pigeons and rats do. And, while rodents and birds usually learn quite quickly how to maximize their score, people often perform worse the longer they try to ﬁgure it out. The more time they spend working at it, the more convinced many people become that they have ﬁnally discovered the trick to predicting the “pattern” of these purely random occurrences. In a profound evolutionary paradox, it’s precisely our higher intelligence that leads us to score lower on this kind of task than rats and pigeons do.
This function is driven by our left brain as shown in experiments on epileptic patients done by Prof George Walford of Dartmouth University. They determined that there is an ‘ interpreting center’ within the brain and that it is present somewhere in the left brain area. Rats and pigeons and most other animals are more right brain oriented and hence suffer less from this malady. But the interpreter in our brain, makes us feel that we can figure out patterns even when there isnt one! Unfortunately, this behaviour leads us to jump to conclusions and it is uncontrollable, unconscious and automatic!
The way to tackle this problem is therefore to create legible patterns! Then, you are enabling a natural and powerful part of your personality to work for you! While fundamental analysis has far too many variables in it to form consistent coherent patterns, technical analysis has just two variable i.e. price and volumes. The many tools within technical analysis exist only to group price and volume into coherent patterns to enable our brain to read it swiftly and create a more logical ( and probably more correct) conclusion.
So it makes immense sense for people to learn technical analysis. This will then help them harness the natural abilities and strength of the brain (the ‘interpreter’) and make better conclusions. Since these interpretations occur unconsciously and automatically, with the aid of technical analysis, you can truly become an Intuitive Trader!