The Psychology of Technical Analysis: Ch. 2- 5

The Psychology of Technical Analysis: Profiting From Crowd Behavior and the Dynamics of Price

Evolution is the unfolding of order and complexity in the process of learning.

Aren’t investors supposed to behave rationally at all times? What is the reason behind seemingly intelligent and rational individuals caving in to heard-instinct? The simple truth is that membership of a crowd causes people to behave differently from the way that they would in isolation.

In fact, herd-instinct is hardwired into our brains. Our brain stem (the innermost part of the brain) that is primarily concerned with instinctive behaviour, developed over 250 million years ago, compared to our neo-cortex (which allows us to be aware of the thought process itself and to anticipate the future/recreate the past) that developed only during the last 50 million years or so. The operation of the neo-cortex is all too easily suppressed by the emergence of a crowd mentality. As the crowd comes into being, the brain stem and the limbic system hold sway.

Membership of a crowd involves the abrogation of personal responsibility to some degree. A crowd tends to behave in a non-rational way and forces its members to do the same. For most people, some form of crowd pressure provides a major motivating force in their social, economic and political activities.

So in essence, a crowd is a self-organized entity defined by a common purpose. Once a crowd is formed, it will react to new pieces of information from the environment. Feedback loops are created and leaders emerge. The feedback loops create stable fluctuations (limit cycles) in the relationship between the crowd and the environment. These limit cycles are subjected to shocks and the crowd readjusts to deal with unfamiliar events. Understanding limit cycles and the readjustment process is key to understanding and predicting the the overall behaviour of the crowd.

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