The Trader’s Edge

If you would be a real seeker after truth, it is necessary that at least once in your life you doubt, as far as possible, all things.

—René Descartes

There is something fascinating and mesmerizing about price movements in actively traded markets; academics, researchers, traders, and analysts are drawn to study markets, perhaps captivated as much by the patterns in the market as by the promise of financial gain. Many people believe that price changes are random and unpredictable; if this were true, the only logical course of action would be to avoid trading and to invest in index funds. This is, in fact, what a significant number of financial advisers recommend their clients do. On the other hand, there are analysts and traders who believe that they have some edge over the market, that there is some predictability in prices. This camp divides into two groups that historically have been diametrically opposed: those who make decisions based on fundamental factors and those who rely on technical factors. Fundamental analysts and traders make decisions based on their assessment of value, through an analysis of a number of factors such as financial statements, economic conditions, and an understanding of supply/demand factors. Technical traders and analysts make decisions based on information contained in past price changes themselves.

Our work here concerns the latter approach. Few traders make decisions in a vacuum; technical traders may consider fundamental ...

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