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Technical Analysis and Efficient Market Hypothesis

Efficient Market Hypothesis is one of the most debated theories in the world of business
due to its contradictory nature. This theory that has attracted many theorists, some of whom
argue in its support and others argue against it. There are three variants of the theory which are
weak, semi-strong and strong EMH. Weak EMH states that all prices of the stocks in question are
a reflection of the past information. Semi-strong EMH claims that the prices are a reflection of
the past information, but they can change to reflect information that did not exist before. Finally,
Strong EMH claims that prices reflect new information and at times hidden information. Since it
was first coined by Eugene Fama, there have been a number of debates in regard. Similarly, there
has been a lot of literature by various authors and researchers regarding how Efficient Market
Hypothesis and Technical analysis influence the decisions of investors. Different ideas of various
theorists are to be addressed while at the same time focusing on the various techniques that are
used for analyzing market dynamics.
Changes in the prices of assets are highly dependent on the information that is available
in the market as well as he changes in discount rates. There are investors who attempt to find
loopholes in the market so that they can make higher profits. It is possible to find a loophole in
the market, but this only occurs with extensive technical analysis, which helps the investor to
acquire a lot of information that maybe others have not been able to acquire, but which is
available in the market. When people accept the EMH, it means that their rational behavior does
not have any significant effect on the markets. People should apply rationality in finding any
information that is likely to help them gain an advantage in the market. These theorists argue
against the EMH theory. However, Adam Smith and John Keyenes have been in support of
EMH. They believed in irrational behavior as being significant on the markets.
Investors would attempt to buy stocks at an undervalued price or sell them at an
overvalued price in order to make abnormally high profits. However, the fact that stocks are
always dependent on the information available in the market and that they will always trade at
their fair prices makes it difficult for investors to beat the market. According to the efficient
market hypothesis, the prices of stocks are a reflection of the information that is available in the
market and the discount rates at given times. No stock is too expensive or too cheap. In practice,
in case a stock becomes too cheap, its demand will increase. When the demand becomes too
high, the marketers will tend to increase the prices and the demand lowers again. They will lower
the price as well. This makes the prices to stay at a relatively same level. No major changes can
occur. In such cases, the law of demand, which states that as the demand goes up, the price of a
commodity goes up, and as the demand decreases, the price also decreases.
There are people who have often claimed that they have beaten the market by correctly
anticipating certain news that end up producing significant changes in prices. These are news that
were unforeseen by most of the other investors. Among investors who have often beaten the
EMH are Warren Buffett, William Ruane and Walter Schloss. There are also some companies
that have highly succeeded by having information that helps them make the right investment
decisions. For instance, a company like Microsoft has on many occasions been seen to have
beaten the market to make big profits. However, the company does not violate the EMH theory.
Its share prices are predictable through the historical patterns. When the price of stocks is
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decreasing, investors are either selling their stock before the prices go too low or they are
avoiding buying more stocks. The demand of stocks goes down, causing a resistance. While the
stock price is on the rise, the demand increases. Investors buy more stocks and hence they are
supporting the trend. Trend lines are indicators of stock price movements. These factors help
investors to make decisions in that they are able to know the trend of prices and hence, predict
which stocks are profitable to invest in.
The confusion between EMH and the technical analysis has been explained by a number
of theorists. These are the theorists who criticized Eugene Famas EMH theory. For instance,
Robert Shiller developed the Price Earnings Ratio predictor that can be used by investors to
predict the costs of stocks over a long period of time. This proposition was later affirmed by
Burton Malkiel who stated that EMH had a consistent correlation the interest rates. This is the
loophole that has been used by investors such as Warren Buffet to make huge profits. Basically, it
is possible to find a loophole in the market, but this only occurs with extensive technical
analysis, which helps the investor to acquire a lot of information that maybe others have not been
able to acquire, but which is available in the market.
Being able to predict this kind of trend for any stocks can lead to an investor making high
profits. This is the trick that most investors who have been able to make high profits apply. These
investors are able to carry out perfect market analysis of the stock prices and then make the right
decision regarding when to buy and when to sell stocks. From the graphs given, an investor who
buys stocks in January and sells in April is likely to make high profits. If the investor sells the
stocks in September or October, the profitability will be lower. Therefore, it is usually not about
which stocks one buys. It is about the ability to predict price movements. This is made possible
by observing past prices and using moving averages to predict their future behavior.
The analysis of how the securities behave may take two approaches. These are technical
analysis or the fundamental analysis. On the fundamental analysis, the investor is interested in
the behavior of a company. It is from this behavior that they can estimate the value of the
companys stocks and then make their investment decisions. Normally, when a company is
performing well financially, there are high chances that its value will be high and so will be the
value of its stocks. An investor will in turn be more likely to invest in such a company since the
value of its stock is likely to increase. The behavior of a company has a major influence on the
manner with which the investors make their decisions. As a matter of fact, the first impression
any investor will get is about the company behavior, even before they carry out any other form of
analysis. However, there are cases where the behavior of a company is not always a reflection of
its value. It is for this reason that the technical analysis is employed. This analysis only focuses
on the movement of prices in the market and in most cases it is accurate or nearly accurate.
The head and shoulder technique is arguably the most reliable form of technical analysis
in predicting the market trends. It is a representation of a natural point of origin for any empirical
research and hence it forms the basis of all predictions. In other words, the final prediction will
always be influenced by this technique regardless of the technique that the researcher uses. This
technique may not always give a true reflection of the future market prices of a given stock. As it
has been mentioned earlier, there are situations when the market may be unpredictable due to
unforeseen events. In such cases, the head and shoulder technique cannot give and accurate value
of the stock process. Different investors value stock differently. This means that the value that
one investor assigns to a certain stock is different from the value that another investor will
assign. Therefore, even with the head to shoulder technique, it is still not easy to predict the
market movements and hence it is difficult to take advantage of the markets. Investors worry a
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lot about the instabilities in the internal and external environment of firms and their impacts on
stock prices. Thus, technical analysis becomes imperative in gathering as much information as
possible to make meaningful predictions.
Conclusion
The analysis indicates that market trends can be predicted; however, the prediction is not
always accurate. The fact that information about stocks is available to all market participants in
equal measure means that no investor is able to beat the market. Technical analysis is important
as it helps investors to increase their chances of making profits. Investors not only show interest
in the behavior of firms in the stock market, but mostly importantly into the operational
competencies of these firms. This makes the head and shoulder technique a far-reaching
approach as far as the probability of making gains through investment in the stock is concerned.