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Fundamental or Technical Analysis?

Financial statement (Huge amount of data)

Time lag

Inadequate disclosure

Subjectivity

Confidence on market

Conceptual framework

Quick response

Fundamental analysis – the belief that every security eventually sells for its intrinsic value

Technical analysis – the belief that security prices follow recurrent, predictable patterns

Judicious blend of both approaches is required to arrive at better results

Market Dynamics

Supply and Demand

Demand

SupplyP

rice

Quantity

Edwards & Magee (1997) state the basic assumptions of technical analysis A security’s market value is based on supply and demand Supply and demand are based on both rational and irrational

factors Security prices tend to move in persistent trends Changes in trends occur due to shifts in supply and demand Shifts in supply and demand can be detected using charts of

market transactions Some chart patterns tend to repeat themselves

Theoretical Foundation

History repeats itself

Bird’s Eye View of Technical Analysis

Technical analysis is the attempt to forecast stock prices on the basis of market-derived data.

Technicians (also known as quantitative analysts or chartists) usually look at price, volume and psychological indicators over time.

They are looking for trends and patterns in the data that indicate future price movements.

Technical Analysis

View Points

Price Change in price reflects changes in investors attitude

Time Movement in price is a function of time

Volume Intensity of price change is reflected in volume

Breadth Price change is measured across sectors or industries

Strengths

Can be used on almost any instrument Can be used to analyse data over a wide range of time

periods There are many charting tools and techniques The basic principle of charting is easy to understand

Weaknesses

It is subjective ie. open to individual interpretation The past does not necessarily repeat itself It is based on probability not certainty The data used must be timely and accurate

Volume characteristics

Dow Theory Charles Dow (1900)

Average discounts everything Market has three movements

Primary movements (bull or bear market, “the tide”) Secondary movements (corrections, “the wave”) Minor movements (daily fluctuations, “of little importance”)

Primary trends (up & down) usually has three movements 1st results from sighted investors Increased company earnings causes 2nd move When all financial news are good the final move accompanied

by rampant speculation To signal a bull or bear trend two averages must confirm each

other Only closing prices are used A trend remains effective until a reversal has been signaled by

both averages

Trends and movements

Dow Jones Industrial Average, January 2, 2001 to October 3, 2003

7,000

8,000

9,000

10,000

11,000

12,000

01/01 04/01 07/01 10/01 01/02 04/02 07/02 10/02 01/03 04/03 07/03 10/03

Date

Level

The primary direction is either bullish or bearish, and reflects the long-run direction of the market.

Secondary trends,

temporary departures

Corrections, reversions to the primary direction

Chart Type

Line Chart (close only) Bar Chart Point & Figure Chart Japanese Candlestick

Plotting the past price history of a security to look for patterns that suggest shifts in the underlying supply and demand relationship or investor attitudes

Charting Stocks

Candlesticks Bars

Bullish

Bullish

Bearish Bearish

Neutral Patterns

Neutral Patterns

Reversal Patterns

Reversal Patterns

Reversal Patterns

Bullish Patterns

Bullish Patterns

Bullish Patterns

Bearish Patterns

Bearish Patterns

Bearish Patterns

Bearish Patterns

Reversal days

The two-day reversal

Point and Figure Charts, I. Point-and-figure charts attempt to show only major price moves and

their direction. The point and figure chart maker decides what price move is

major. That is, it could be $2, $5, or any other level. (Point)

A major up-move is marked with an “X” A major down-move is marked with an “O” Start a new column when there is a direction change.

Buy and sell signals are generated when new highs or new lows are reached.

Congestion area, the area between buy and sell signals—a time of market indecision concerning its trend.

Point and Figure Charts, II.

Point & Figure Chart

Stock Price Formation

Point and Figure Charts, III.

Technical Investors for long term investors by W Clay Allen

Further Reference

Basic Technical Tools

Trend Lines Short term Medium trend Long term

Moving Averages Price Patterns Indicators Cycles

Trend Lines and Channels

There are three basic kinds of trends: An Up trend where prices are

generally increasing. A Down trend where prices

are generally decreasing. A Trading Range.

Three Stages of a Trend

Accumulation

Big Move

Excess

Distribution

Big Move

Despair

Bull Market Bear Market

Properties of Trend Line

The greater the number of touches the more important the trend line becomes.

The angle of Trendline Extension of Trend line. Trendline with Chart patterns Spacing of the two points

Number of Touches

Extension of Trendline

Incorrect Angle

Trendline with Chart Patterns

Spacing between 2 points

Support & Resistance

Support and resistance lines indicate likely ends of trends.

Resistance results from the inability to surpass prior highs.

Support results from the inability to break below to prior lows.

What was support becomes resistance, and vice-versa. Support Resistance

Breakout

PIVOT POINT ANALYSIS FOR RESISTANCE AND SUPPORT

PIVOT POINT =( HIGH+LOW+CLOSE)/3

RESISTANCE-1=2*PIVOT POINT-LOW

SUPPORT-1=2*PIVOT POINT-HIGH

RESISTANCE-2=PIVOT POINT+(HIGH-LOW)

SUPPORT-2=PIVOT POINT-(HIGH-LOW)

Price Patterns

Reversal pattern

Bullish reversal

Bearish reversal Continuation pattern

Usually accompanied and confirmed by volume

Reversal pattern

Head and shoulders (Top, Bottom)

Rounding Tops and Bottoms ( Saucers)

Ascending and descending Triangles (used more as a

continuation pattern)

Double and triple Tops and Bottoms

Diamonds

Rising and falling Wedges

V formation (Spikes)

5 Major Chart Patterns

51

Head & shoulders

W

Wedge & triangles

Rounded bottom

Cup & handle

5 Major Chart patterns (either way up)

52

Head & shoulders

W

Cup & handle

Wedge & trianglesRounded top

Head and shoulders

55

Head and Shoulders

Rounding top and Bottom

Rounding Top

Rounding Bottom

Rounding formations are characterized by a slow reversal of

trend (they are also known as cup & handle).

58

Rounded Bottom

 

60

Cup and Handle !!!

Hard to find but worthwhile

Triangles

Triangles are reversal as well as continuation formations.

Three flavors: Ascending Descending Symmetrical

Typically, triangles should break out about half to three-quarters of the way through the formation.

Ascending

Descending

Symmetrical

Symmetrical

64

Triangle or Wedge

More contact points = greater reliability

Target line

Descending Triangle

Broadening Formations

These formations are like reverse triangles.

These formations usually signal a reversal of the trend.

Broadening Tops

Broadening Bottoms

Rising and falling Wedges

Continuation pattern

Flags Rectangles Pennants Island Gap

Common Least important Breakaway Heavy volume Runaway Heavy volume Exhaustion an end of a trend

Flags

RECTANGLES

Moving Averages

Simple moving average

Weighted moving average

Exponential moving average

Calculation of moving averages

Day 1 2 3 4 5 6 7 8 9

Price ($) 16 17 17 10 17 18 17 17 17

5 Day SMA         15.4 15.8 15.8 15.8 17.2

Day 1 2 3 4 5

Price ($) 16 17 17 10 17

Weighting 1/15 2/15 3/15 4/15 5/15

Weighted value 1.07 2.27 3.40 2.67 5.67

5 Day WMA         15.07

Simple moving average

Weighted moving average

Calculation of moving averages EMA(current) = ( (Price(current) - EMA(prev) ) x Multiplier) +

EMA(prev) For a percentage-based EMA, "Multiplier" is equal to the EMA's specified

percentage. For a period-based EMA, "Multiplier" is equal to 2 / N where N is the specified

number of periods.

Day Price EMA(prev) diff Diff*mult EMA1 16 - - - 152 17 15 2 0.04 15.043 19 15.04 3.96 0.079 15.1194 17 15.119 1.881 0.037 15.1565 20 15.156 4.844 0.096 16.2526 17 16.252 0.748 0.015 16.2677 21 16.267 4.733 0.095 16.3628 17 16.362 0.368 0.013 16.3759 19 16.375 2.624 0.052 16.427

multiplier for 100 days EMA = 2/100=0.02

Relative Strength Index (RSI)

RSI was developed by Welles Wilder as an oscillator to gauge

overbought/oversold levels.

RSI is a rescaled measure of the ratio of average price changes on up days

to average price changes on down days.

The most important thing to understand about RSI is that a level above 70

indicates a stock is overbought, and a level below 30 indicates that it is

oversold (it can range from 0 to 100).

Also, realize that stocks can remain overbought or oversold for long

periods of time, so RSI alone isn’t always a great timing tool.

RSI Example Chart

Stochastic

Advance analysis

On balance volume Moving average envelop Bollinger band Relative strength index Stochastic Oscillator

ROC (Rate of Change oscillator) Moving average oscillator ( MACD)

And many more

On Balance Volume

On Balance Volume was developed by Joseph Granville, one of the most

famous technicians of the 1960’s and 1970’s.

OBV is calculated by adding volume on up days, and subtracting volume

on down days. A running total is kept.

Granville believed that “volume leads price.”

To use OBV, you generally look for OBV to show a change in trend (a

divergence from the price trend).

If the stock is in an uptrend, but OBV turns down, that is a signal that the

price trend may soon reverse.

OBV Example Chart

Divergence, OBV failed

OBV confirmstrend changebut doesn’t lead

MACD

MACD was developed by Gerald Appel as a way to keep track of a moving average crossover system.

Appel defined MACD as the difference between a 12-day and 26-day moving average. A 9-day moving average of this difference is used to generate signals.

When this signal line goes from negative to positive, a buy signal is generated.

When the signal line goes from positive to negative, a sell signal is generated.

MACD is best used in choppy (trendless) markets, and is subject to whipsaws (in and out rapidly with little or no profit).

MACD Example Chart

Elliot Wave Principle (1)

R.N. Elliot formulated this idea in a series of articles in Financial World in 1939.

Elliot believed that the market has a rhythmic regularity that can be used to predict future prices.

The Elliot Wave Principle is based on a repeating 8-wave cycle, and each cycle is made up of similar shorter-term cycles.

Elliot Wave adherents also make extensive use of the Fibonacci series.

The Elliot Wave Principle (2)

1

2

3

4

5

A

B

C

Fibonacci Numbers

Fibonacci numbers are a series where each succeeding number is the sum of the two preceding numbers.

The first two Fibonacci numbers are defined to be 1, and then the series continues as follows: 1, 1, 2, 3, 5, 8, 13, 21…

As the numbers get larger, the ratio of the numbers approaches the Golden Mean: 1.618:1.

This ratio is found extensively in nature, and has been used in architecture since the ancient Greeks (who believed that a rectangle whose sides had the ratio of 1.618:1 was the most aesthetically pleasing).

Technical analysts use this ratio and its inverse, 0.618, extensively to provide projections of price moves.

Too Many Others To List

There are literally hundreds of indicators and thousands of trading systems. A whole semester could easily be spent on just a handful of these. There is nothing so crazy that somebody doesn’t use it to trade. For example, many people use astrology, geometry (Gann angles), neural

networks, chaos theory, etc. There’s no doubt that each of these (and others) would have made lots of money

at one time or another. The real question is can they do it consistently? As the carneys used to say, “You pay your money, and you take your chances.”

References (Books)

The Technical Analysis course by Thomas A Meyers The psychology of Technical Analysis by Tony Plummer The Technical Analysis of Stock Option & Future advance trading system &

techniques by William F Eng Using Technical Analysis The Basic by Clifford Pistolese Technical Analysis of Stock Trends by Robert D Edwards, John Magee Technical Analysis Explained by Martin J Pring Mathematics of Technical Analysis by Clifford J Sherry Technical Analysis Plain and Simple Technical Analysis of Financial Market by John J Murphy Technical Analysis for Long Term Investors by W Clay Allen The Midas Method of Technical Analysis by Paul Levine

References (WWW) Nseindia Investopedia Stockcharts Smartinvesor Stockta Tradingcoach Daytrading Wilkipedia Chartsmart Deepinsight Ft Litwick (for candle stick analysis) Traders

and many more