What about Inflation?

Now with all this talk about long range charts, you may have been wondering whether inflation will upset your analysis, and whether you should try and account for it and make adjustments. After all, the rate of inflation must be reflected in the price of the security over the long term. This is an interesting point that leads to some discussion amongst analysts. On the whole, the answer seems to be that you do not have to make any allowance for inflation over the years that you are viewing, and there are several reasons for this.

First and foremost, the markets have already included inflation in their prices. If the dollar falls in value, which is the same as inflation, then everything else goes up in price when it is quoted in dollars. If the dollar rose in value, then prices should drop.

If you look at the historic prices of commodities, you will see that they rose rapidly in the 1970s, and fell in the 1980s and 1990s. This reflects the way inflation occurred in those years. It wouldn’t have made sense to adjust the rising prices in the 1970s for the inflation, as that was what the markets were doing. The information you got would be of no use when deciding what and when to trade.

One of the basic tenets of technical analysis is that market action, in this case price action, discounts everything. If we follow this, inflation is only another factor that is discounted along with other price influences, so we should not single it out for special treatment. All markets adjust themselves as needed, allowing for inflation, changing market conditions, varying foreign exchange rates, and every other price influence.

One final note about adjusting for inflation. In the next module, you will learn about support and resistance, which are levels which prices have some hesitation passing through. When there is no adjustment for inflation, you will observe that even some historic values of these from previous years retain their validity, and can be used in your analysis and assessment of the stocks.

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