Lesley Beath, Morningstar .

When the technical analyst talks about chart patterns, or price formations (terms such as head and shoulders, tops and bottoms, rising wedges, double bottoms, triangles and key reversals to name just a few), they are often met with a roll of the eyes by the staunch fundamental analyst.

But there is nothing extraordinary about these chart formations. They simply reflect human behavior -- fear, greed and indecision. They are a representation of the prevailing mood of the market and can indicate whether a stock is in an accumulation or distribution phase.

Some patterns work well at times and not at others. Like anything, they are used in conjunction with numerous other factors.

Trend lines and support and resistance levels are also merely a representation of market sentiment. Breaks occur when the equilibrium of supply and demand changes--simple as that.

The analysis of price charts has always been open to a lot of subjectivity. This led, many years ago, to the development of indicators, be they volume or momentum-inspired. This was an attempt to change technical analysis, or charting as it was then known, from an art to a science. But there is still a lot of subjectivity.

Momentum indicators can be useful at times, but at other times they give little guidance. It is how you interpret them that matters. A very naive approach, for example, is to look at oversold and overbought levels as buying or selling opportunities.

But that is not the case. For a start you have to know the difference between momentum indicators that work in a trending market and those that work in a ranging market.

There are dozens of momentum indicators out there but tend to stick with the old RSI (relative strength index) and the stochastic. They need to be analyzed correctly if they are to be of any use. They have support and resistance levels of their own and breaks of those can often occur before a break in the price.

The psychology component of "market analysis" goes beyond chart formations and support and resistance levels--it also includes such aspects as the general market mood, cover stories and consumer sentiment.

A lot of technical analysts use the Elliot Wave in their analysis of the market and do find, that the psychology associated with the different "waves" is reliable. Even the cycles and seasonality patterns simply relate to the behavioral patterns of humans. There are two major explanations for the existence of cycles in markets.

The first is fundamental--the operation of the laws of supply and demand does not happen smoothly and instantaneously. There are time lags between observing a situation and reacting to it.

Moreover, such reaction is often an overreaction, driving the market from one imbalance to an opposite imbalance. This leads to the development of cyclic swings in activity and prices.

From a psychological aspect, markets are driven by fear and greed. There is a considerable body of literature describing how this leads to rotating periods of boom and recession in markets.

Yet another aspect as far as psychology is concerned is the investor or analyst's natural bias.

Just as the same fundamental data can be interpreted in a number of ways, so too can the technical’s. It is not uncommon to see one analyst put forward a positive outlook on a stock, at the same time as another presents a negative view. Same data, different interpretation.

This is common--an individual can often depend on what they expect to see. The investor or analyst who is bullish will "see" bullish technical patterns, and ignore, or play down, any evidence that might contradict his views.

At times we can get too wedded to a particular view and fail to see a change emerging. This is easy to do and we will all be guilty of this at some time.

To get around this, invert the price charts of individual indices or stocks and then apply momentum indicators, or look for price patterns, on this inverted data. This might sound strange it does help in the analysis.

In the analysis of financial markets, it is a constant battle to see both sides of the equation. By inverting the charts we are forced to look at the opposing side of the story. This is not a common part of technical analysis, but it serves well over the years.

Sometimes, approaching things from a different angle helps to clarify the issue.

Remember that when analyzing the markets it is imperative that we are always questioning our view. We can never be complacent. It is at the time we are most confident in our view that we are most likely to be wrong.

The more we agonize over our view, the more we sweat, the more likely we are to be rewarded.

When thinking about the psychology of financial markets be reminded of the passage from Ecclesiastes:

"The thing that hath been, it is that which shall be; and that which is done is that which shall be done; and there is no new thing under the sun."

As they say, times can change and events can change but the one thing that doesn't change is the human reaction to those events.

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