A:

This has been a topic of much controversy since the invention of technical analysis, and it remains a very heated debate. A self-fulfilling prophecy is an event that is caused only by the preceding prediction or expectation that it was going to occur.

On the one hand, the tools used in technical analysis - such as support and resistance, trendlines, major daily moving averages and other types of indicators - do seem to have predictive qualities. Often the price of an asset does move in the direction foretold by these indicators.

However, those who see technical analysis as a self-fulfilling prophecy argue that these indicators are "right" only because extremely large numbers of people base trading decisions on these same indicators, thereby using the same information to take their positions, and, in turn, pushing the price in the predicted direction. Others argue that technical indicators can predict future price movements because the basic tenets of technical analysis, on which the design of these indicators is based, are valid and provide real insight into the market and the intrinsic forces that move it.

However, both sides of the debate may be right to some extent. It is true that common signals generated by technical analysis can be self fulfilling and push the price of a security higher or lower, reinforcing the strength of the signal. That said, it's likely this may last only for a short time. Because the goals of participating investors and traders are different and there are hundreds of indicators informing these market players- not to mention fundamental forces that drive prices - it becomes nearly impossible for technical analysis to be self fulfilling in the long run.

For example, many technical traders will place a stop-loss order below the 200-day moving average of a certain company. If a large number of traders have done so and the stock reaches this price, there will be a large number of sell orders, which will push the stock down, confirming the movement traders anticipated. Then, other traders will see the price decrease and also sell their positions, reinforcing the strength of the trend. This short-term selling pressure can be considered self-fulfilling, but it will have little bearing on where the asset's price will be weeks or months from now. In sum, if enough people use the same signals, they could cause the movement foretold by the signal, but over the long run this sole group of traders cannot drive price.

To learn more about technical analysis see the tutorial The Basics Of Technical Analysis and Analyzing Chart Patterns.

RELATED FAQS

  1. How reliable is the Fibonacci retracement in predicting stock behavior?

    Learn why the reliability of the Fibonacci retracement indicator is debatable, and how the indicator is used to identify ...
  2. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Discover how the fixed charge coverage ratio is useful to investors and analysts, and when it suggests that a company should ...
  3. How can a company execute a tax-free spin-off?

    Understand the two most commonly used methods, distribution and share exchange offer, that companies use to do a tax-free ...
  4. How are American Depository Receipts (ADRs) priced?

    Understand what American depositary receipts are and how they work, including how the price of ADRs is determined by the ...
RELATED TERMS
  1. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...
  2. Fintech

    Fintech is a portmanteau of financial technology that describes ...
  3. Indicator

    Indicators are statistics used to measure current conditions ...
  4. Intraday Momentum Index (IMI)

    A technical indicator that combines aspects of candlestick analysis ...
  5. Appraised Equity Capital

    The excess of the market value of an asset over its book value. ...
  6. Asset Valuation Review (AVR)

    A process that establishes an estimate of the value of a failed ...

You May Also Like

Related Articles
  1. Charts & Patterns

    How reliable is the Fibonacci retracement ...

  2. Charts & Patterns

    Avoid The Perfection Trap In Trading

  3. Professionals

    DCF Vs. Comparables: Which One To Use

  4. Chart Advisor

    Four Great Stocks for Day Traders

  5. Chart Advisor

    Looking To The Mega Caps For Strength

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!