It can be fascinating, yet horribly frustrating, to realize that stock prices are not a mathematical function. If stock spices behaved as a mathematical function, there would be only one outcome for a given set of conditions. For example, if a stock price fell to the 200-day simple moving average, and always moved higher immediately afterward; the bounce higher would be a function of the simple moving average.
Output is, in reality not a function of input for stock prices. Stock prices are always stochastic no matter how deterministic their appearance.
While it is true that there are times that stock prices tend to behave as a function of certain technical indicators, there are also times when those technical indicators fail miserably. No technical indicator works 100% of the time. If it did, there would be no need for human involvement in the stock market; computers could handle every trade with 100% efficiency.
In fact, it is quite possible that 100% efficiency would eventually lead to one huge stalemate, in which no computer could gain an edge over another, and all trading would cease as if in the middle of an un-winnable chess game. Thus, the fact that trading has not yet reached such a stalemate justifies the conclusion that the stock market is not yet 100% efficient. As such, human interaction still plays a role, and it will continue to play a role as long as prices remain stochastic and not deterministic.
The emotional aspect of human interaction is important; greed and fear still have a measurable and noticeable effect on stock prices. After all, the effect of human emotions is why indicators such as the S&P 500 Volatility Index (the VIX) are ubiquitous these days. The effect of emotion, as big as it is, is sometimes overshadowed by the effect of price manipulation.
This post was published at ZenTrader on November 9, 2014.
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