John J. Murphy in the first chapter of his book "TECHNICAL ANALYSIS OF FINANCIAL MARKETS" says that concerns regarding fundamental analysis being a self-fulfilling prophecy are seldomly raised, as opposed to technical analysis which receives criticism in the form of getting labelled as a self-fulfilling prophecy. So is the fundamental analysis, at-least in a few ways, a self-fulfilling prophecy?
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1$\begingroup$ Market efficiency suggests that either methodology isn't particularly useful and there seems to be consensus (among academics) that the US stock market is pretty informationally efficient. $\endgroup$– AlexCommented Mar 14, 2021 at 16:49
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1$\begingroup$ @Alex what if the market is only efficient because of people doing technical analysis? Market efficiency is an outcome, not an axiom. $\endgroup$– Criticizing Israel not allowedCommented Mar 15, 2021 at 12:11
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$\begingroup$ @1muflon1 I've marked this as "nonexpert" since books are generally not peer-reviewed. I don't think this meets the standard in any other criteria. $\endgroup$– jmbejaraCommented Mar 15, 2021 at 20:36
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$\begingroup$ @jmbejara ok I wont fight you on this in this case but I think textbooks/handbooks should generally count as academic literature. I don't know enough about this author, and the question is entry level, but I think it would be mistake to apply the label to lets say Q based on Woodford Insterest and Prices. I definitely do not want to discourage use of the tag but also lets not be too overzealous either. $\endgroup$– 1muflon1 ♦Commented Mar 15, 2021 at 20:45
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$\begingroup$ @1muflon1 The benefit of using Woodford's book is that either the question will be about a mathematically precise economic/econometric model or the text of the book will be, itself, referencing a peer-reviewed article. Makes it easy to transform a Q from his book into one that meets the criteria. (E.g., can provide a citation to the underlying peer-reviewed article referenced in the textbook.) $\endgroup$– jmbejaraCommented Mar 15, 2021 at 21:04
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2 Answers
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If a sufficient fraction of market participants follow technical analysis it can work as self-fulfilling prophecy. If some pattern occurs that technical analysis interprets as signalling an imminent drop in prices these people will sell, which will cause the prices to actually drop.
As is obvious from the above argument, whether an interpretation of the data can become a self-fulfilling prophecy, depends not on the nature of the the interpretation, but on whether a sufficient amount of market participants are prepared to act upon it. For example if fundamental analysis shows that a firm is likely to go bankrupt other firms become hesitant to trade with it because if it fails without settling its bills with them they will have to take the losses. This in turn makes it harder for the threatened firm to survive.
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By fundamental analysis I assume you mean, e.g., if a firm's earnings increase a lot (i.e. much more than expected) then the stock price will increase. I wouldn't call this a self-fulfilling prophecy because the increased earnings were not 'prophesized."
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$\begingroup$ Thank you for taking the time to answer my query. Fundamental analysis is the one that says that the stock price should increase based on the observation that a firm's earnings have increased. Thus, people following fundamental analysis invest in the stock of this firm, thereby actually causing the price-increase, as predicted by the fundamental analysis. This is definitionally known as the self-fulfilling prophecy, and technical analysis suffers from a similar problem. I would like to humbly ask you to elaborate your point. Thanks in advance!! $\endgroup$ Commented Mar 14, 2021 at 18:45
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$\begingroup$ I agree with your second sentence (increased earnings $\to$ increased stock price). But I disagree with the third sentence. After the earnings increase, the stock price will increase instantly (or maybe after one share has been traded); you don't need lots of people investing in the stock. $\endgroup$– DanielCommented Mar 17, 2021 at 2:31