the scientific method and technical analysis

1. The Scientific Method and
Technical Analysis

2. The Scientific
Method and
Technical Analysis
•Possibilities & Challenges of
applying the scientific method to
Technical Analysis
•Three form of EMH
• Null Hypothesis
• Five Stages of Hypothetico
Deductive Method

3. The Most Important Knowledge of All: A Method to Get More
• Informal observation and intuitive inference are especially prone to
failure when phenomena are complex or highly random.
• Financial market behavior displays both.
• Historically, TA has not been practiced in a scientific manner
• Now most successful hedge funds are using strategies that could be
called scientific TA.

4. The Legacy of Greek Science: A Mixed Blessing
• The Greeks were the first to make an effort at being scientific, though
their legacy proved to be a mixed blessing.
• The formal reasoning procedures he developed remain a pillar of
today's scientific method.
• Aristotle empirical approach based on inductive logic—observation
followed by generalization. Its invention was his most significant
contribution to science.
• Aristotelian legacy would prove to be an obstruction to scientific
progress

5. The Birth of the Scientific Revolution
• seventeenth century, science has progressed a great deal and has
discovered many truths, and it has conferred many benefits
• The doctrines of the Roman Church and the dogma of Greek science
were taken as literal truths
• Artillerymen observed that projectiles hurled by catapults and shot
from cannons did not fly in conformity with Aristotle's theory of
motion
• The notion of testing the validity of a theory by comparing its
predictions with subsequent observations is fundamental to the
modern scientific method. This was an early step in that direction.

6. The Birth of the Scientific Revolution

7. Faith in Objective Reality and Objective Observations
• Science makes a fundamental assumption about the nature of reality;
there is an objective reality that exists outside and independent of those
who observe it, and this reality is the source of the observer's sensory
impressions.
• The principle says simpler is better. Thus, when judging which of several
theories is most likely to be true, when all theories are equally good at
fitting a set of observed facts, the principle of simplicity urges us to accept
the simplest theory.
• The principle of simplicity, also known as Ockham's Razor
• Elliott wave pattern that assumes waves embedded within waves, golden
ratios, Fibonacci sequences, and a host of other complexities, the random
walk is the preferred explanation.

8. Scientific Knowledge Is Objective
• Scientific knowledge is, therefore, public in the sense that it can be
shared with and verified by as many people as possible. This
promotes maximum possible agreement among independent
observers.
• Scientific knowledge is empirical or observation based. In this way it
differs from mathematical and logical propositions that are derived
from and consistent with a set of axioms but need not refer to the
external world or be confirmed by observation.

9. Scientific Knowledge Is Quantitative
• “Wherever mankind has been able to measure things, which means
transform or reduce them to numbers, it has indeed made great
progress in understanding them and controlling them. Where human
beings have failed to find a way to measure, they have been much less
successful, which partly explains the failure of psychology, economics,
and literary criticism to acquire the status of science.”
• Quantification is the best way to ensure the objectivity of knowledge
and to maximize its ability to be shared with and tested by all
qualified practitioners.

10. The Purpose of Science: Explanation and Prediction
• The goal of science is the discovery of rules that predict new
observations and theories that explain previous observations.
• Explanatory theories go further than predictive rules by telling us why
it is that B tends to follow A, rather than simply telling us that it does
• Laws also differ with respect to their predictive power. Those that
depict the most consistent relationships are the most valuable. All
other things being equal, a TA rule that is successful 52 percent of the
time is less valuable than one that works 70 percent of the time.

11. Role of Logic in Science
• Consistency : The most fundamental principle of formal logic is the rule of
consistency .
• Consistency is expressed in to laws :
- Law of the Excluded Middle
- Law of Non contradiction.
• Propositions and Arguments
• Proposition : a declarative statement that is either true or false sometimes
referred to as a claim.
• Argument : a group of propositions, one of which is referred to as the
conclusion, which is claimed to follow logically from the other
propositions, called premises.

12. Role of Logic in Science
• Conditional Syllogism : If A is true then B
is also true. (If A then B). It appears
through a major premise, a minor
premise and a conclusion.
• An example of a conditional syllogism is as follows:
• I fit is a dog, then it has four legs.
• It is a dog(affirms the truth of the antecedent).
• Therefore, it has four legs (affirms the truth of the
consequent).
• Valid Forms of the Conditional Syllogism
- They assume all dogs possess four legs.
• Invalid Form of the Conditional Syllogism
- Creature has four legs certainly does not compel the
conclusion that the creature is a dog. It may be a dog.

13. Role of Logic in Science
• Inductive Logic : Induction is the logic of discovery. It aims to reveal
new knowledge about the world by reaching beyond the knowledge
contained in the premises of an inductive argument
• It proceeds from a premise that enumerates the evidence contained
in a set of observations, and then draws a general conclusion that
pertains to all similar observations outside the enumerated set.
• Premise: Over the past 20 years there have been 1,000 instances in
which TA rule X gave a buy signal and in 700 of those instances the
market moved higher over the next 10 days.
• Conclusion: In the future, when rule X gives a buy signal, there is a
0.7 probability that the market will be higher at the end of 10 days.

14. The Philosophy of Science

15. Bacon's
Enthusiasm
Descartes's Doubt
Hume's Critique of
Induction
William Whewell:
The Role of
Hypothesis
Karl Popper:
Falsification and
Bringing Deduction
Back into Science
The End Result:
The Hypothetico-
Deductive Method

16. 5 Stages of Technical
Analysis

17. Stages
• Observation : A possible pattern or relationship is noticed in a set of
prior observations
• Hypothesis: Based on a mysterious mixture of insight, prior knowledge,
and inductive generalization, it is hypothesized that the pattern is not an
artifact of the particular set of observations but one that should be found
in any similar set of observations.
• Prediction: A prediction is deduced from the hypothesis and embodied in
a conditional proposition. The prediction tells us what should be
observed in a new set of observations if the hypothesis is indeed true.
• For example: If the hypothesis is true, then X should be observed if
operation O is performed. The set of outcomes defined by X makes clear
which future observations would confirm the prediction.

18. Stages
• Verification : New observations are made in accordance with the
operations specified and compared to the predictions. In some
sciences the operation is a controlled experiment. In other sciences it
is an observational study.
• Conclusion : An inference about the truth or falsity of the hypothesis
is made based on the degree to which the observations conform to
the prediction. This stage involves statistical inference methods such
as confidence intervals and hypothesis tests.