Technical analysis in order to take a greater account of psychology

For its part, technical analysis comes from a simple financial theory: at a T period of time, a stock price precisely reflects all information available on this stock, all its history. This is due to the fact that time is considered as continuous, as any variation of the price determines a new level, which constitutes a new basis for further variations. It is thus possible to use prices evolution, on different levels, to try to determine further likely evolutions.



Still, this identification of variations directions and extents is not self-understanding. Indeed, it becomes quickly obvious that psychological effects (such as threshold effects or the behavior of individuals compared to that of institutional investors) can actually be just as important as pure technical reflections. Thus, opposite opinions can happen on the basis of still similar information. This is even on this very principle that stock prices are determined, as they reproduce a market consensus between buyers and sellers.

Thus, technical analysis does not aim, by itself, at determining precise reasons for stocks variations but rather at measuring their evolution and, if possible, at determining their future likely behavior.


This approach thus enables to take a greater account of the psychology of operators.

Indeed, up and down markets moves are almost always following trends, in short or longer terms. These trends are based on the investors’ approach to the stocks, either pessimistic (bear) or optimistic (bull). The optimism situation is characterized by stock prices always higher even though the fundamentals do not at all justify this rise. Ratios are thus increasing, which can lead analysts to sell the stocks.

Still, this is often on such up trends that individuals slowly convince themselves that it may be wise to buy, just as the rise potential is significantly diminished. This observation is an example of the 'sheep like' effect of the markets, and thus the interest of belonging to the first beneficiaries of movements.