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Technical Analysis: Self Fulfilling Prophecy

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October 20, 2008 – Comments (2)

In a paper written in 1989 three economists (Murphy, Schleifer, and Vishny) argued that the investments that companies made to industrialize in the 19th century were each in and of themselves unprofitable because markets did not exist at that time that could purchase goods made on such a large scale.

 However, because business owners had a false perception of the future size of the market they each made the decision to industrialize.  The businesses did not turn out to be unprofitable because each factory provided  a wage premium to its workers creating a larger market for the other factories/companies.

Therefore even though an individual company industrializing would be unprofitable, the industrialization of many companies at the same time proved to be profitable for all of them.

 

Technical Analysis can be profitable for the very same reason.  If enough people believe something to be true and then take actions based upon that belief then it becomes true.

If enough investors believe that there is support at a price level then they take actions based upon that belief which causes that support to exist.

If enough investors believe that a stock is breaking out of a trading range and then their actions will cause it to break out of that trading range.

People do not use technical analysis because it works, technical analysis works because people use it.

2 Comments – Post Your Own

#1) On October 20, 2008 at 4:23 AM, jester112358 (28.83) wrote:

Exactly right!  Correlation is not causation.  Very important to remember.

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#2) On October 20, 2008 at 12:47 PM, Ph1sh55 (28.49) wrote:

As I like to say: technical analysis works, until it doesn't.

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