Thursday, October 30, 2008

Behavorial Finance, meet Technical Analysis

What does it mean for stocks to "test the lows" or "test the highs"? Well, most people are delusional cheapskates and Monday morning quarterbacks. As they follow a stock, they privately imagine that they were the geniuses who traded the highs and lows. "Look at the chart -- it's so easy -- you just buy it here and sell it there!" But when it comes time to make a decision, while the stock is making new lows, of say, 13, 12, 11, and 10, these clowns sit on the sidelines, too terrified to buy. However, once it turns around from 10, and goes to say, 11, 12, 13 -- they tell themselves, "gee, I was so close to buying that stock at 10, but I'm not such a fool that I will pay 13"! But once the stock returns to its downward trajectory, these people support the price at the previous low, because they imagine that they would have bought it at the earlier price, and now that it returns to that price, they feel like less of a chump when they pay it. And that, Virginia, is why stocks tend to bounce off their lows and highs.

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