Can the Past Data Be Used to Predict the Future in Technical Analysis?
Another question often raised concerns the validity of using past price data to predict the future. It is surprising how often critics of the technical approach bring up this point because every known method of forecasting, from weather predicting to fundamental analysis, is based completely on the study of past data. What other kind of data is there to work with?
The field of statistics makes a distinction between descriptive statistics and inductive statistics. Descriptive statistics refers to the graphical presentation of data, such as the price data on a standard bar chart. Inductive statistics refers to generalizations, predictions, or extrapolations that are inferred from that data. Therefore, the price chart itself comes under the heading of the descriptive, while the analysis technicians perform on that price data falls into the realm of the inductive.
As one statistical text puts it, “The first step in forecasting the business or economic future consists, thus, of gathering observations from the past. Chart analysis is just another form of time series analysis, based on a study of the past performance and data, which is exactly what, is done in all forms of time series analysis. The only type of data anyone has to go on is past data. We can only estimate the future by projecting past experiences into that future.
So it seems that the use of past price data to predict the future in technical analysis is grounded in sound statistical concepts. If anyone were to seriously question this aspect of technical forecasting, he or she would have to also question the validity of every other form of forecasting based on historical data, which includes all economic and fundamental analysis.
Basic Concepts of Trend
The concept of trend is absolutely essential to the technical approach to market analysis. All of the tools used in technical analysis software support and resistance levels, price patterns, moving averages, trend lines, etc. have the sole purpose of helping to measure the trend of the market for the purpose of participating in that trend. We often hear such familiar expressions as “always trade in the direction of the trend,” “never buck the trend,” or “the trend is your friend.” So let’s spend a little time to define what a trend is and classify it into a few categories.
In a general sense, the trend is simply the direction of the market, which way it’s moving. But we need a more precise definition with which to work. First of all, markets don’t generally move in a straight line in any direction. Market moves are characterized by a series of zigzags. These zigzags resemble a series of successive waves with fairly obvious peaks and troughs. It is the direction of those peaks and troughs that constitutes market trend. Whether those peaks and troughs are moving up, down, or sideways tell us the trend of the market. An uptrend would be defined as a series of successively higher peaks and troughs; a downtrend is just the opposite, a series of declining peaks and troughs; horizontal peaks and troughs would identify a sideways price trend.
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