Factor in Trader Memory - dummies

Factor in Trader Memory

In stock markets, a low-probability event (such as a major crash) changes the odds for the next period analysis because traders remember. When you’re performing technical analysis on your securities, you count on traders to remember the last prices and to form their trading plans on those prices. The next price is normally dependent on preceding prices, and most technical analysis programs allow you to project out a trendline (like a linear regression line, for example).

Market panics and crashes on the scale of 1929, 1987, and 2000 are historic events outside the purview of the crowd’s normal trading process. In normal trading, you can assume that a wildly erratic price has a low probability of occurring. But you can’t attach a specific probability statistic to an event of historic proportions — partly because those events are so rare.

One or two really big abnormal prices can sometimes upset the apple cart, and determining which way the crowd will jump is sometimes just a coin toss. Indicators are essentially forecasting tools that depend on past behaviors to predict future behaviors, but they often fail near really big key reversals. Technical analysis is not science, as its inability to capture historic key reversals ahead of time demonstrates. In other words, having the best technical tools on the planet will not save you from a big market crash or other unpredictable anomaly.