The section Traditional Analysis Methods covered the basics of the technical and fundamental analysis of stock markets and concluded that the hardest task with regard to stock market trading is the ability to analyze the market’s trends and, accordingly, to predict the factors and how they will affect the market.
We can assume that the development and improvement of these methods of analysis are the foremost priority for the future as well. However, we are lately seeing the emergence of alternative methods of market analysis, especially methods based on the Chaos theory, where chaos is essentially the highest demonstration of Order in Nature. The Chaos theory is one the most popular approaches to market study.
To assess the efficiency of these or other methods of analysis, it would be beneficial to go through a brief historical review.
It was at the turn of XIX and XX centuries that the first price charts were produced in the United States. Among those involved were Charles Dow, the author of the famous theory on the securities market, was William Hamilton, who replaced Dow as the editor of the Wall Street Journal. Dow didn’t write any books during his life, but left some editorial articles. Hamilton on the other hand laid out the principles of Dow’s theory in his book The Securities Market Barometer. Robert Rea, the author of an informational bulletin, finalized Dow’s work in his book The Dow Theory published in 1932, where the philosophical basis for the creative analysis was first laid out based on these three postulates:
- Market accounts for everything
- Price movements are subject to trends
- History repeats itself
The 1930s were the golden years for charts. Many creative people had a lot of time on their hands following the 1929 collapse. Shabacker, Rea, Elliot, Vikoff, Gunn and others, published their studies during those times. In 1948, Edwards and Magi published The Technical Analysis of Market Trends. They popularized such notions as triangular, square box, "head and shoulders" and other chart figures as well as levels of support and resistance to trend lines. Other chart favorites also applied these principles to commodity markets.
While a technical analysis primarily studies the market’s performance, the subject matter of a fundamental analysis is the economic powers of demand and supply which cause price volatility. The fundamental approach analyzes all factors which in one way or another affect a product’s price. It serves to determine the internal or real cost of a product. The fundamental analysis allows determining the real cost and shows how much this or that product really costs. If the real price is lower than the market price, the product should be sold since one can get more money for the product then it really costs. If the real price is higher than the market price, it should be bought because it is cheaper than it really costs. This is based primarily on the laws of demand and supply.
Both of these approaches for forecasting a market’s performance try to solve one and the same problem, namely: to determine in what direction the prices will move. But they approach this issue from different directions. While the fundamental analyst tries to understand the reason for the market’s movement, the technical analyst is only interested in the actual movement. The only thing that the analyst needs to know is that such a movement or market performance really takes place, while the reasons for it are trivial. The fundamental analyst will try to understand why it happened.
Since the times of Edwards and Magi, the markets have changed considerably. While in 1940’s the number of stocks traded daily at the New York Stock Exchange represented but a few hundred, in 1990’s this number often exceeds a million. The balance of powers in the securities market shifted towards “the bulls”. Early chart specialists write that the market’s ups pass very quickly and drastically while the market’s downs last longer. This was true in their deflation era, but since 1950’s the opposite is also true. Now downs pass very quickly while the ups take a lot more time.
These changes took place because of the incredible progress in the fields of scientific and technical research and of the implementation of their results in all spheres, including economics, finance and stock markets: the development of personal computers provided technical analysts with tools that allowed them to operate with large volumes of information, develop various charts for different markets and analyze them in depth. The computer handles the data processing which provides the analyst with more time for evaluations and decision-making processes. The computer provided access to a greater number of indicators for analyzing the markets and the possibility of considering a greater number of market situations. The so-called trade mechanical systems – computer market analysis software with automatic decision making for deals – are developed and implemented by technical analysts. Thanks to the evolution of telecommunications and, in particular, the wide integration and accessibility of the Internet, the stock market’s environment is changing ever faster: we are seeing an enormous growth of the market’s volumes and of its participants, and the markets are being globalized – they are world-wide, and it is very important to note the psychological changes occurring amongst the so called “market crowd” and caused by the drastic growth of both its quantitative and qualitative content (meaning its average social and economic status).
In response to all of these changes and to the rather modest results by its participants, of fundamental and technical analysts armed with supercomputers and the latest systems of analysis and telecommunications, more and more traders are searching for new principles and approaches to trading. And we believe that the leading and perhaps even revolutionary approach is based on the Chaos theory, denying postulates and the philosophy of the “traditional” technical analysis.