Technical analysts identify these boundaries and trace
breakthroughs and their outcomes in terms of prices.
Technical analysis may be nothing more than a self-fulfilling prophecy,
though. The more devotees it has, the stronger it affects the shares or
markets it analyses. Investors move in herds and are inclined to seek
patterns in the often bewildering marketplace. As opposed to the
assumptions underlying the classic theory of portfolio analysis -
investors do remember past prices. They hesitate before they cross
certain numerical thresholds.
But this herd mentality is also the Achilles heel of technical
analysis. If everyone were to follow its guidance - it would have been
rendered useless. If everyone were to buy and sell at the same time -
based on the same technical advice - price advantages would have been
arbitraged away instantaneously. Technical analysis is about
privileged information to the privileged few - though not too few, lest
prices are not swayed.
Studies cited in Edwin Elton and Martin Gruber's "Modern Portfolio
Theory and Investment Analysis" and elsewhere show that a filter model
- trading with technical analysis - is preferable to a "buy and hold"
strategy but inferior to trading at random.
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