One of the key assumptions in technical analysis (TA) of the market is that we rely on the belief that history tends to repeat itself. Given the importance of this assumption, it makes sense to understand what this really means.
I was looking at Biocon’s chart on July 13, and I can note a few things panning out. We will call these “things” as factors which are playing out on the chart:
Factor 1 – The stock has been falling for the last 3 consecutive trading sessions
Factor 2 – On July 13, the stock continued to fall, relatively on higher volumes, in the 4th session
Factor 3 – The range in which the stock traded was quite large, in line with the previous 3 sessions.
With these factors panning out in the background, let us assume that on the next trading day (on Monday, July 16) the fall in stock gets arrested to an extent where it recovers all losses incurred on July 13. Further, assume that the stock continues to rally on July 17, as well.
To summarize the stock falls for four days, recovers on the fifth day, and sixth day the stock continues its rally.
Time passes and let’s says after a few months, the same three set of factors are observed for five consecutive trading sessions i.e. four days of continuous fall in the stock followed by a recovery day (to the extent where the fourth day’s loss is completely recovered).
What would you expect for the 6th day?
This is where the assumption – history tends to repeat itself, comes into play.
Technical Analysis tweaks this assumption a bit. When a set of factors that have panned out in the past tends to repeat itself in the future, we expect the same outcome to occur, as was observed in the past.
Therefore, based on this assumption, this time around, we can expect the stock price to go up in the sixth trading session.
This is a key assumption in technical analysis which forms the foundation.
Disclaimer: The author is VP, Educational Services, Zerodha. The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.