September 16, 2021

Is Technical Analysis a Self Fulfilling Prophecy?

Is Technical Analysis a Self Fulfilling Prophecy?

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A self-fulfilling prophecy is a process where an original expectation creates the conditions of its own reality. With a self-fulfilling prophecy expectations and behaviors about a future event cause the result that confirm the original prediction.

Some speculate that the reason that price support levels and price resistance levels have meaning is because people believe they do so they buy dips to support and sell into resistance. Technical analysis can be seen as a self-fulfilling prophecy because indicators have meaning only because a large amount of traders make trading decisions on the most popular indicators. When a larger number of traders are using similar information for entry and exit decisions that can move the price in the expected direction.

Support and resistance in price only has meaning if enough buyers are waiting to purchase in that price zone. A breakout in price can cause momentum traders and trend traders to buy the breakout leading to even higher prices. Many times old resistance becomes new support because a pullback to the breakout area gives traders that missed it a second chance to get in at the same price. Technical analysis in many cases can be a leading indicator as the signal comes first then the traders follow it. 

The art and science of technical analysis is to study the patterns in market price data on charts to identify trends and quantify the potential location of past buyers and sellers to trade in the path of least resistance in the future. 

Stop losses and trailing stops set at key technical levels can feed on itself and cause a price to move lower. A price moving under the 200-day moving average can set off stop losses that causes price to go lower and trigger more stop losses set at different prices under that level leading to a cascading effect. The same can happen at a key proft target or resistance where sellers lock in profit and a trend ends. 

Is technical analysis a self fulfilling prophecy? Yes and no. Yes, if enough people believe in the meaning of a price level or indicator signal they will take the action that fulfills the prediction of the movement. Technical analysis is a popularity contest and only the most watched, seen, and believed in levels can affect price movement. For any technical analysis signal or reading to become so popular that it begins to influence price action, it would have to be well known and acted upon. Also no, sometimes technical analysis is no match for the fear or greed in the market with people just wanting in or out of a position regardless of any charts pattern. In the past four years technical analysis has been no match for one Trump tweet. Technical analysis is best used to create good risk/reward ratios in the present at entry and not to predict an unknowable future. 

Is Technical Analysis a Self Fulfilling Prophecy?

Chart courtesy of StockCharts.com