Technical analysis is all about patterns. Candlesticks, one of the most widely used forms of charting, is all about patterns. Bar charts create patterns and lots of them. Point and figure charts create their own patterns. As though candle patterns were not enough, they invented variants and called them Renko, Kagi and Three Line break to create even more patterns.
Fibonacci relations create yet another pattern, while line studies also show symmetry of some sorts, creating patterns. Divergences are patterns as are reversals. Overbought and oversold conditions are patterns too. Elliot Wave is a pattern and so is the Square of Nine or other geometric technics of WD Gann.
So, when you study technical analysis, you are essentially studying patterns. Now, these are patterns of human behaviour, because prices are the result of human interaction based on their thinking. Since human behaviour tends to repeat through time, it is postulated that the technical patterns will be successful in reading human behaviour. This is not just a theory. It goes back to the study of human nature where it has been shown (particularly by Nobel Prize winners Daniel Kahnman and Amos Tversky) that finding patterns even in random data is a common predilection of human beings.
Humans have a phenomenal ability to detect and interpret simple patterns. That’s what helped our ancestors survive the hazardous primeval world, enabling them to evade predators, find food and shelter, and eventually plant crops in the right place at the right time of year. Today, our skill at seeking and completing patterns helps us navigate many of the basic challenges of daily life.
Patterns are everywhere in our lives. Our daily behaviour follows a set pattern. We adapt a certain behaviour to a certain environment. Any variance from that is immediately identified by others as a change in pattern. The police work on this aspect a great deal -- they are always looking for a shift in the pattern of behaviour shown by suspects and use that to detect and solve crimes. Medical science uses patterns in their studies- whether it is Sonography or a cardiogram or an XRay or Histopathology. There are fixed patterns in all of them and variances are caught because the basic pattern is identified and studied deeply.
Technology is all about patterns and today’s hot topic of machine language learning involves the same. Computers recognise existing patterns and over repetitive study of the same are able to model new behaviours and expectations very effectively. The list is actually endless!
Pattern recognition occurs when you receive information from the environment and your brain saves this into the short-term memory. Recognizing patterns allow us to predict and expect what is coming. This could be a pattern in numbers, objects, symbols, music and more. Because the brain is wired to recognise patterns, everyone has the potential to be pattern smart, but, in different ways. People who are numbers smart, for example, can predict from a series of numbers what the next one will be. Those who can recognize a species of bird from its flight pattern are nature smart.
Pattern recognition was key to the survival of our Neanderthal ancestors, allowing them to identify poisonous plants, distinguish predators from prey, and interpret celestial events. Today, pattern recognition plays new, but just as important roles in diagnosing diseases, inspiring new ways to safeguard data, and discovering new planets.
The markets are full of, seemingly, random data. But our incorrigible fondness for finding patterns leads us to believe that markets have patterns. So people sift through mountains of stock market data to find “predictable patterns” that might enable them to beat the market.
The problem does not lie there. There are repetitive behaviours and if one finds them and sticks to that pattern, some reasonable success can be enjoyed. Rats and pigeons, in laboratory conditions, are quite capable of sticking to a pattern once they find it. They go by the simple fact that if they stick to one pattern, then it means a reward of some sort. But human beings are different. As soon as they find a pattern, they immediately move to forecasting what the NEXT instance of the pattern will be! They cannot, somehow, remain content following the pattern, as pigeons and rats do. And, while rodents and birds usually learn quite quickly how to maximize their score, people often perform worse the longer they try to figure it out. The more time they spend working on it, the more convinced many of them become that they have finally discovered the trick to predicting the “pattern” of these purely random occurrences. In a profound evolutionary paradox, it’s precisely our higher intelligence that leads us to score lower on this kind of task than rats and pigeons do.
This function is driven by our left brain as shown in experiments on epileptic patients done by Prof George Walford of Dartmouth University. They determined that there is an ‘interpreting center’ within the brain and that it is present somewhere in the left brain area. Rats and pigeons and most other animals are more right brain oriented and hence suffer less from this malady. But the interpreter in our brain, makes us feel that we can figure out patterns even when there isn't one!
Unfortunately, this behaviour leads us to jump to conclusions and it is uncontrollable, unconscious and automatic!
The way to tackle this problem is, therefore, to create legible patterns! Then, you are enabling a natural and powerful part of your personality to work for you! While fundamental analysis have far too many variables in it to form consistent coherent patterns, technical analysis has just two variables i.e. price and volumes. The many tools within technical analysis exist only to group price and volume into coherent patterns to enable our brain to read it swiftly and create a more logical (and probably more correct) conclusion.
That it why it makes immense sense for people to learn technical analysis. This will then you harness the natural abilities and strength of the brain (the ‘interpreter’) and help you arrive at better conclusions. Since these interpretations occur unconsciously and automatically, with the aid of technical analysis, you can truly become an Intuitive Trader!
The best thing we have going for us is our intelligence, especially pattern recognition, is getting sharpened over eons of evolution. Pattern recognition, according to IQ test designers, is a key determinant of a person’s potential to think logically, verbally, numerically and spatially. Compared with all mental abilities, pattern recognition is said to have the highest correlation with the so-called general intelligence factor. The ability to spot existing or emerging patterns is one of the most, if not the most, critical skills in decision making, though we’re mostly unaware that we do it all the time.
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