The Rational Expectations Hypothesis is based on three interlinked assumptions:
- Individuals do not behave irrationally
- Individuals learn from their mistakes
- Individuals arrive at their decisions independently of one another
However, REH fails in the real world. Natural forces encourage people to herd together as groups. Groups behave as single organisms that respond in predictable ways to new information, have their own emotional cycles and follow a definable path of growth and decay. This is the rationale for technical analysis.
Technical analysis assumes that prices reflect the entirety of investors’ expectations of the fundamentals (both economic and company specific). Financial markets will always be trying to anticipate the future and hence market prices precede changes in fundamental conditions. And most importantly, each price movement is mathematically related to preceding price movements.
Read the review of the first few chapters here.