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Far From Random: Using Investor Behavior and Trend Analysis to Forecast Market Movement by Richard Lehman

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Chapter 10. Introduction to Trend Channel Analysis

Although it is always perilous to assume that the future will be like the past, it is at least instructive to find out what the past was like.

William F. Sharpe, Nobel Laureate

Behavior is a rather amorphous and unquantifiable variable for any single individual, let alone millions of market participants. Consequently, knowing that human behavior affects the markets is somewhat useless without having a way of interpreting or measuring it at the market level. So, the question before us is how do we actually accomplish that?

The answer lies in technical market analysis and charting. Knowing that investors are strongly prone to exhibit common heuristics and biases in their thinking—and that their judgments and actions are affected by a plethora of unconscious efforts, such as herding, anchoring, and overconfidence—there is good reason to accept that what price charts communicate is the "signature" on the market that is imposed by the participants. More simply, if the charts depict the action of the market and market action reflects the aggregate behavior of the participants, then participant behavior is reflected in the charts, and our challenge is to interpret it.

Price charts provide a plethora of visual cues and can be analyzed in numerous ways. Although prices change continually, the way they change over time (e.g., the market's cyclical ebb and flow, the angles and degrees of ascent and descent, and the subsequent patterns formed) ...

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