Patterns are generated by market participants and their reaction towards previously traded patterns, the gut to implement newer strategies. Traders react upon the actions of ancestral trades and benefit when similar patterns occurs in the future. Today standard patterns like, hanging man, Head and shoulders, were once a highly repetitive chart patterns, perhaps they will cease to exist when more traders act on the pattern. Patterns are the reflection of trader’s psychological decisions.
If a pattern is found, people tend to act accordingly and tend to profit until the pattern evolves. Evolution in patterns happened when existing patterns were insufficient to predict the movements, indicators helped trace whether the price goes up or down at a variable time intervals.
Imagine a stock market existed in the 13th century, the pattern here is repeated often and traders were confused on daily movements. This is a less volatile market. Research after research yearly charts were drawn which came up this way. The strategy is simple, Buy at the bottom (35), sell or short in the levels of 65. The strategy used is fairly transparent, a trader with basic math skills would know this is a sinusoidal wave. After months of implementing the pattern starts to differ from sine and clings to a different function. At a point of infinite executions, charts tend to move randomly, makes predictability difficult. The rise of Technical Analysis.
After a significant time of trading based on the chart, the chart changes to some other pattern and newer implementations are needed to profit from the new patterns formed.
When an investor or a trader acting on an earnings call, the forecast, which in a very least way helps in profiting, makes a market efficient. Earnings miss consensus estimates and the major group reacts (sell) because the earnings don’t hit the analyst call. This is completely erroneous, People forecast with high uncertainty and believe that the crunched number is the standard and act upon to profit, when the real earnings, that the business produces hasn’t hit the call, the price decreases. The earnings aren’t appreciated, that’s why stock prices rise even when the earnings are below the estimates or no QoQ, YoY growth.
More people trying to predict the market, market is in opposition to older strategies and getting more efficient. The market is a blank paper with invisible interpretations, participants who try to predict markets are simply feeding the market with information on How many ways you can crack me down?. The main rule of profiting is not letting the opponent know your weakness and the strategy used on them.
The January effect is an anomaly of this kind
Shorter the time frame harder it is to predict prices and hence returns.
A point is reached where stock market players have to be dynamic in adapting to newer patterns, which pushes the market to randomness and randomness helps statistical data to be more meaningful and refined. Randomness is the quality, a stock exchange should have inorder to prevent predictability in both short and long term. The market should not be predictable. Market participants should lose money when they are on the wrong side of the trade and make money when they are right.
During the long haul, some stocks move up and some down, no participant should be able to predict what will be the direction the charts head to.