2. Technical Analysis To non-believers,technical analysis
cansound like a lot offocus-pocus! 3. Introduction Technical
analysis is the attempt to forecaststock prices on the basis of
market-derived data. Technicians (also known as quantitative
analystsor chartists) usually look at price, volume
andpsychological indicators over time. They are looking for trends
and patterns in thedata that indicate future price movements. 4.
Important view points Price Time Volume Pure supply and demand
analysis for common stocks Strong market when volume goes up Weak
market when volume goes down Breadth Looks at number of stock
prices that go up (advances)versus number of stock prices that go
down (declines) Strong market when advances outnumber declines Weak
market when declines outnumber advances 5. Underlying Assumptions
of TechnicalAnalysis The market discounts everything.Price moves in
trends. History tends to repeat itself The market and/or an
individual stock acts like abarometer rather than thermometer. The
market value of any good or service isdetermined solely by the
interaction of supply anddemand. Supply and demand are governed by
numerousfactors, both rational and irrational. 6. Advantages of
Technical Analysis Unlike fundamental analysis, technical
analysisis not heavily dependent on financial accountingstatements
Problems with accounting statements: Lack information needed by
security analysts GAAP allows firms to select reporting procedures,
resultingin difficulty comparing statements between firms Many
psychological and other non-quantifiable factors donot show up in
financial statements 7. Advantages of Technical Analysis
Fundamental analyst must process newinformation and quickly
determine a newintrinsic value, but technical analyst merely hasto
recognize a movement to a new equilibrium. Technicians trade when a
move to a newequilibrium is underway but a fundamentalanalyst finds
undervalued securities that may notadjust to correct prices as
quickly. 8. Challenges to Technical Analysis Challenges to
technical trading rules Rules that worked in the past may not be
repeated Patterns may become self-fulfilling prophecies. A
successful rule will gain followers and become lesssuccessful.
Rules all require subjective judgment. 9. Typical Stock Market
CycleStockPrice 10. Typical Stock Market CycleStockPriceDeclining
Peak TrendChannelFlat Trend Channel Sell PointRising Trend
ChannelDeclining Buy Point TrendBuy PointChannelTroughTrough 11.
Content Charting Stocks Line charts Bar Charts and Japanese
Candlestick Charts Point and Figure Charts Major Chart Patterns
Price-based Indicators Volume-based Indicators Dow Theory 12.
Charting the Market Chartists use line chart, bar charts,
candlestick,or point and figure charts to look for patternswhich
may indicate future price movements. They also analyze volume and
otherpsychological indicators (breadth, % of bulls vs% of bears,
put/call ratio, etc.). Strict chartists dont care about
fundamentals atall. 13. Drawing Bar (OHLC) Charts andJapanese
candlestick chart Each bar is composed of 4elements: Open High High
High Low Close Open Close Note that the candlestick bodyis empty
(white) on up days,and filled (some color) on OpenClosedown
daysLowLow Standard JapaneseStandard Japanese Bar ChartCandlestick
Bar ChartCandlestick 14. Line chart and bar chart 15. Examples of
Charts: Bar Charts 16. Japanese Candlesticks Japanese Candlestick
chart with open, high, low, close 17. Different Kinds of Formation
ofCandlesticks Long Candlesticks Long wicks Short Candlesticks
Wicks 18. Patterns of Candlestick Charts The Spinning Top Doji
Candlestick Pattern The Bullish and Bearish Engulfing Patterns The
Hammer and The Hanging Man CandlestickPattern Morning and Evening
Star Pattern 19. Drawing Point & Figure Charts Point &
Figure charts areindependent of time. An X represents an up move.
An O represents a downmove. The Box Size is the number ofpoints
needed to make an X orO. X The Reversal is the priceXchange needed
to recognize a X X O X X Ochange in direction. XO O Typically,
P&F charts use a 1- XO O Xpoint box and a 3-pointreversal. 20.
Point & Figure Charts 21. Basic Technical Tools Trend Lines
Moving Averages Price Patterns Indicators 22. Trend Lines There are
three basickinds of trends: An Up trend where pricesare generally
increasing. A Down trend whereprices are generallydecreasing. A
Trading Range. 23. Support & Resistance Support and resistance
linesindicate likely ends of trends. Resistance results from
theBreakoutinability to surpass priorhighs. Support results from
theinability to break below toprior lows. What was support
becomesresistance, and vice-versa.Support Resistance 24. Support
and resistance95BALLARPUR INDS (104.900, 109.500, 104.500, 107.750,
+3.45000) 959090858580807575707065656060555550504545404035
Support35Nov Dec2001 Mar Apr May Jun JulAugSep Oct NovDec 2002Mar
Apr May Jun Jul Aug Sep OctNov Dec 2003 Mar Apr May Jun Jul Aug Sep
Oct Nov Dec 2004 Feb RELIANCE CAPITAL (594.000, 673.800, 594.000,
670.300,
+77.7500)85858080757570Resistance7065656060555550504545404035353030AugSepOct
Nov Dec2002Feb Mar AprMay JunJulAugSep Oct Nov Dec2003 Feb Mar Apr
May Jun Jul AugSep Oct 25. Simple Moving Averages A moving average
is simplythe average price (usually theclosing price) over the last
N MSFT Daily Prices with 10-day MA 9/23/93 to 9/21/94periods. 60 55
They are used to smooth outfluctuations of less than N 50periods.
Price 45 This chart shows MSFT with 40a 10-day moving average.
35Note how the moving average301 21 41 6181 101 121141 161 181 201
221 241shows much less volatility Datethan the daily stock price.
26. Price Patterns Technicians look for many patterns in
thehistorical time series of prices. These patterns are reputed to
provideinformation regarding the size and timing ofsubsequent price
moves. But dont forget that the EMH says thesepatterns are
illusions, and have no real meaning.In fact, they can be seen in a
randomly generatedprice series. 27. Some Popular Chart Formations
28. Head and Shoulders H&S Top This formation is
Headcharacterized by twosmall peaks on eitherLeft Shoulder Right
Shoulderside of a larger peak. This is a reversal pattern,
Necklinemeaning that it signifiesH&S Bottoma change in the
trend.NecklineLeft Shoulder Right ShoulderHead 29. Head &
Shoulders ExampleSell Signal Minimum Target Price Based on
measurement rule 30. Double Tops and BottomsDouble Top These
formations aresimilar to the H&Sformations, but there isno
head. These are reversal Targetpatterns with the same
Targetmeasuring implicationsas the H&S. Double Bottom 31.
Double Bottom Example 32. Triangles Triangles arecontinuation
formations. Three flavors: Ascending Ascending Descending
Symmetrical Symmetrical Typically, triangles Symmetricalshould
break out abouthalf to three-quarters ofDescendingthe way through
theformation. 33. Rounded Tops & Bottoms Rounding formations
are Roundingcharacterized by a slow Bottomreversal of
trend.Rounding Top 34. Rounded Bottom Chart Example 35. Broadening
Formations These formations are likereverse triangles.Broadening
Bottoms These formations usuallysignal a reversal of
thetrend.Broadening Tops 36. Technical Indicators There are,
literally, hundreds of technical indicators usedto generate buy and
sell signals. We will look at just a few that I use: Moving Average
Convergence/Divergence (MACD) Relative Strength Index (RSI) On
Balance Volume Bollinger Bands 37. Trend indicators:Simple Moving
Average:Moving averages are one of the easiest toolsavailable for
technical analysis. They smooth adata series and make it easier to
mark trendswhich are very helpful in volatile markets. 38. MACD
MACD was developed by Gerald Appel as a way to keeptrack of a
moving average crossover system. Appel defined MACD as the
difference between a 12-day and 26-day moving average. A 9-day
movingaverage of this difference is used to generate signals. When
this signal line goes from negative to positive, abuy signal is
generated. When the signal line goes from positive to negative,
asell signal is generated. MACD is best used in choppy (trendless)
markets, and issubject to whipsaws (in and out rapidly with little
or noprofit). 39. MACD Example Chart 40. Relative Strength Index
(RSI) RSI was developed by Welles Wilder as an oscillator togauge
overbought/oversold levels. RSI is a rescaled measure of the ratio
of average pricechanges on up days to average price changes on
downdays. The most important thing to understand about RSI is thata
level above 70 indicates a stock is overbought, and alevel below 30
indicates that it is oversold (it can rangefrom 0 to 100). Also,
realize that stocks can remain overbought oroversold for long
periods of time, so RSI alone isntalways a great timing tool. 41.
RSI Example ChartOverbought Oversold 42. A Stock Chart 43. Dow
Theory This theory was first stated by Charles Dow in aseries of
columns in the WSJ between 1900 and1902. Dow (and later Hamilton
and Rhea) believed thatmarket trends forecast trends in the
economy. A change in the trend of the DJIA must beconfirmed by a
trend change in the DJTA inorder to generate a valid signal. 44.
Markets performance is based upon long-term pricetrend (primary
trend) in overall market Used to signal end of both bull andbear
markets An after-the-fact measure with nopredictive power 45. Dow
Theory Trends (1) Primary Trend Called the tide by Dow, this is the
trend thatdefines the long-term direction (up to several
years).Others have called this a secular bull or bearmarket.
Secondary Trend Called the waves by Dow, this is
shorter-termdepartures from the primary trend (weeks to months) Day
to day fluctuations Not significant in Dow Theory 46. The Dow
Theory in Operation 47. Too Many Others To List As noted, there are
literally hundreds of indicators and thousands oftrading systems.
To close, just note that there is nothing so crazy that
somebodydoesnt use it to trade. For example, many people use
astrology, geometry (Gann angles),neural networks, chaos theory,
etc. Theres no doubt that each of these (and others) would have
madeyou lots of money at one time or another. The real question is
canthey do it consistently? As the carneys used to say, You pays
your money, and you takesyour chances.
