Better known as Fibonacci, Leonardo produced the sequence formed by adding consecutive number components of a given series - 1,1,2,3,5,8,13 and so on. Numbers in this series crop up frequently in nature and the relationship between components tends towards 1.618, a figure known as the golden rule in architecture and design.
Believers in Fibonacci numbers are part of the school known as technical analysis, or Chartism, which believes the future movement of asset prices can be divined from past data. But there is bad news for the numerologists.
Experience suggests that chartists defend their territory with an almost religious zeal. But their arguments are often anecdotal: “If technical analysis doesn’t work, how come so-and-so is a multi-millionaire?”Furthermore, the recommendations of technical analysts can be so hedged about with qualifications that they can validate almost any market
outcome.
If the efficient market theory is correct, technical analysis should not work at all; the prevailing market price should reflect all information, including past price movements. However, academic fashion has moved in favor of behavioral finance, which suggests that investors may not be completely rational and that their psychological biases could cause prices to deviate from their“correct” level. Technical analysts also make the perfectly fair
argument that those who analyze markets on the basis of fundamentals such as economic statistics or corporate profits are no more successful.
Besides, technical analysis tends to increase trading activity, creating extra costs. Hedge funds may be able to rise above these costs; small investors will not. As illusionists often proclaim, don’t try this at home.
Now answer the following questions:
(a) "Technical analysis is the search for recurring and predictable patterns in stock prices. It is based on the premise that prices only gradually close in on intrinsic value. As fundamentals shift, astute traders can exploit the adjustment to a new equilibrium." Critically explain this statement using an example