Does technical analysis of the stock and commodity markets
have any validity, or is it the financial equivalent of reading tea leaves?
Technical analysis encompasses a wide variety of methods, so a workable
definition might be any method that uses historical prices and volume to
predict future ones. Of course, the efficient market hypothesis denies that is
possible. The alternative to technical analysis is fundamental analysis, which
looks at earnings, dividends, management, sales growth, etc. to predict prices.
Technical analysts
search charts for patterns such as head-and-shoulders, hammers, shooting stars,
flags, pennants, double tops or bottoms, cups-and-handles, and many others.
They employ multiple moving averages, relative strength indices, Bollinger
Bands, Dow Theory and many other methods of analyzing price pattern and volume
of trading.
A few financial economists have tried to assess the validity
of technical analysis methods with mixed results. Economists typically ridicule
technical analysis, but a late great Austrian economist, Ludwig Lachmann, who
championed the importance of the stock market more than any economist, provided
support for technical analysis in his concept of the “elasticity of
expectations.” He applied the concept to all kinds of prices, not just to the
stock market, but it fits the stock market exceptionally well.
