is murky at best. To the extent there is one, it most likely derives
from psychology, perhaps in part from the Keynesian idea
of conventionally anticipating the conventional response, or
perhaps from some as yet unarticulated systemic interactions.
"Unarticulated" is the key word here: The quasi-mathematical
jargon of technical analysis seldom hangs together as a coherent
theory. I'll begin my discussion of it with one of its less
plausible manifestations, the so-called Elliott wave theory.
Ralph Nelson Elliott famously believed that the market
moved in waves that enabled investors to predict the behavior
of stocks. Outlining his theory in 1939, Elliott wrote that
stock prices move in cycles based upon the Fibonacci numbers
(1, 2, 3, 5, 8,13, 21, 34, 59, 93,..., each successive number in
the sequence being the sum of the two previous ones). Most
commonly the market rises in five distinct waves and declines
in three distinct waves for obscure psychological or systemic
reasons. Elliott believed as well that these patterns exist at
many levels and that any given wave or cycle is part of a larger
one and contains within it smaller waves and cycles. (To give
Elliott his due, this idea of small waves within larger ones having
the same structure does seem to presage mathematician
Benoit Mandelbrot's more sophisticated notion of a fractal, to
which I'll return later.) Using Fibonacci-inspired rules, the investor
buys on rising waves and sells on falling ones.
The problem arises when these investors try to identify
where on a wave they find themselves. They must also decide
whether the larger or smaller cycle of which the wave is inevitably
a part may temporarily be overriding the signal to
buy or sell. To save the day, complications are introduced into
the theory, so many, in fact, that the theory soon becomes
incapable of being falsified. Such complications and unfalsifiability
are reminiscent of the theory of biorhythmns and
many other pseudosciences. (Biorhythm theory is the idea
that various aspects of one's life follow rigid periodic cycles
that begin at birth and are often connected to the numbers 23
and 28, the periods of some alleged male and female principles,
respectively.) It also brings to mind the ancient Ptolemaic
system of describing the planets' movements, in which more
and more corrections and ad hoc exceptions had to be created
to make the system jibe with observation. Like most other
such schemes, Elliott wave theory founders on the simple
question: Why should anyone expect it to work?
For some, of course, what the theory has going for it is the
mathematical mysticism associated with the Fibonacci numbers,
any two adjacent ones of which are alleged to stand in
an aesthetically appealing relation. Natural examples of Fibonacci
series include whorls on pine cones and pineapples;
the number of leaves, petals, and stems on plants; the numbers
of left and right spirals in a sunflower; the number of
rabbits in succeeding generations; and, insist Elliott enthusiasts,
the waves and cycles in stock prices.
It's always pleasant to align the nitty-gritty activities of the
market with the ethereal purity of mathematics.
Read More : Technical Analysis: Following the Followers
