Technical Analysis

What is Technical AnalysisTechnical analysis is a method of evaluating securities by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.

Basic Assumptions:

1) Market discounts everything2) Price moves in trends3) History tends to repeat itself

The Bottom Line:

Technical Analysis helps define price objectives, define risk, and take emotion out of the trade

Technical analysts examine what investors fear or think about fundamental developments

Technical Analysis combines the concept of psychology and supply/demand.

Price action also tends to repeat itself because investors collectively tend toward patterned behavior – hence technicians' focus on identifiable trends and conditions.

Static vs. DynamicHerd MentalityZero-Sum Game

Market Discounts Everything A major criticism of technical analysis is that it only considers

price movement, ignoring the fundamental factors of the company.

However, technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company - including fundamental factors.

Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately.

This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market.

Identifying the Trend:“The trend is your friend”

What is a Trendline?What Does a Trendline Mean?

A line that is drawn over pivot highs or under pivot lows to show the prevailing direction of price. Trendlines are a visual representation of support and resistance in any time frame.

Two types of trends:1) Uptrend2) Downtrend

Three Types of Markets:1) Up2) Down3) Sideways

Moving Averages: Moving averages can be used to identify the

direction of the trend or define potential support and resistance levels

Types of Moving Averages:– Simple Moving Average– Exponential Moving Average– Time Series– Volume Weighted Moving Average (VWAP)– Triangular Moving Average– Variable Moving Average

How to use moving averages is more important than the definitions. Most people don’t know how to use moving averages properly

Simple Moving Average A simple moving average is formed by computing

the average price of a security over a specific number of periods. Most moving averages are based on closing prices. As its name implies, a moving average is an average that moves.

Popular time frames:– 10 day– 20 day– 50 day– 100 day– 200 day

Exponential Moving Average Exponential moving averages reduce the lag by

applying more weight to recent prices. The weighting applied to the most recent price depends on the number of periods in the moving average.

Popular time frames:– 5 day– 10 day– 20 day– 30 day– 50 day– 100 day

Which ema should you use and when?

Moving Average Crossovers Used to identify changes in the trend Most widely known is the golden cross where the 50 day

moving average crosses above the 100 day moving average

Market Data Analysis Technical Analysis includes methods outside of just using charts

Statistical analysis Machine learning methods

Supervised learning Regression Classification (Tree models, random forests)

Unsupervised learning Dimensionality reduction (PCA) Clustering (K-means)

FX Example - Making Sense of Price Data

Date AUD CAD CHF CNY DKK GBP HKD HRK IDR JPY KRW MYR4/1/2005 1.6803 1.5736 1.5527 10.7255 7.4502 0.6867 10.1063 7.4220 12,272.17 139.07 1,306.01 4.92434/4/2005 1.6777 1.5691 1.5535 10.6626 7.4502 0.6870 10.0480 7.4250 12,219.53 139.18 1,305.60 4.89544/5/2005 1.6758 1.5683 1.5541 10.6022 7.4500 0.6841 9.9914 7.4190 12,163.10 139.16 1,303.42 4.86774/6/2005 1.6804 1.5708 1.5508 10.6436 7.4500 0.6851 10.0302 7.4150 12,191.28 139.75 1,303.23 4.88674/7/2005 1.6798 1.5746 1.5497 10.6957 7.4493 0.6874 10.0790 7.4110 12,263.93 139.84 1,308.45 4.91064/8/2005 1.6717 1.5749 1.5505 10.6096 7.4489 0.6859 9.9979 7.4020 12,178.05 139.46 1,301.38 4.87114/11/2005 1.6745 1.5927 1.5489 10.7354 7.4491 0.6864 10.1166 7.3950 12,309.48 139.76 1,316.56 4.92894/12/2005 1.6738 1.6022 1.5494 10.7470 7.4502 0.6854 10.1272 7.3950 12,318.87 139.97 1,315.90 4.93424/13/2005 1.6598 1.5979 1.5499 10.6949 7.4500 0.6834 10.0783 7.3910 12,253.29 138.71 1,306.93 4.91034/14/2005 1.6598 1.5956 1.5547 10.6105 7.4517 0.6814 9.9982 7.3750 12,204.64 138.64 1,303.28 4.87154/15/2005 1.6717 1.6000 1.5532 10.6502 7.4531 0.6820 10.0354 7.3800 12,272.21 139.08 1,315.75 4.88974/18/2005 1.6900 1.6193 1.5476 10.7321 7.4536 0.6832 10.1129 7.3820 12,422.39 139.60 1,322.24 4.92744/19/2005 1.6947 1.6209 1.5450 10.7561 7.4529 0.6807 10.1357 7.3650 12,443.67 139.54 1,317.53 4.93844/20/2005 1.6840 1.6162 1.5440 10.8000 7.4518 0.6813 10.1775 7.3830 12,508.12 139.50 1,316.51 4.95854/21/2005 1.6872 1.6226 1.5427 10.8075 7.4494 0.6848 10.1844 7.3800 12,633.62 140.27 1,314.03 4.96194/22/2005 1.6773 1.6148 1.5435 10.8232 7.4497 0.6829 10.1943 7.3860 12,652.00 138.96 1,313.06 4.96924/25/2005 1.6637 1.6082 1.5441 10.7313 7.4490 0.6787 10.1095 7.3940 12,641.85 137.31 1,295.30 4.92704/26/2005 1.6661 1.6112 1.5418 10.7437 7.4489 0.6812 10.1235 7.3850 12,572.10 137.54 1,296.54 4.93274/27/2005 1.6654 1.6121 1.5434 10.6932 7.4472 0.6796 10.0761 7.3750 12,351.52 137.35 1,295.75 4.90954/28/2005 1.6591 1.6172 1.5397 10.6808 7.4470 0.6773 10.0646 7.3650 12,362.99 136.63 1,293.86 4.90384/29/2005 1.6565 1.6191 1.5374 10.7239 7.4460 0.6775 10.1017 7.3620 12,386.89 136.24 1,291.94 4.92365/2/2005 1.6481 1.6189 1.5402 10.6461 7.4454 0.6763 10.0288 7.3550 12,264.87 135.54 1,287.71 4.88785/3/2005 1.6625 1.6153 1.5438 10.6403 7.4443 0.6800 10.0226 7.3550 12,258.20 135.23 1,288.81 4.88525/4/2005 1.6652 1.6176 1.5410 10.7206 7.4439 0.6818 10.0920 7.3500 12,318.30 135.21 1,294.91 4.92205/5/2005 1.6589 1.6158 1.5457 10.7214 7.4449 0.6807 10.0960 7.3460 12,319.25 135.28 1,295.01 4.92395/6/2005 1.6622 1.6058 1.5485 10.7156 7.4433 0.6821 10.0897 7.3440 12,283.47 135.71 1,292.24 4.9198

You can use price data to discover trends/patterns that you can’t see visually looking at a chart

FX Example - Where to Begin??• What are you looking for?

• What are the underlying factors causing the rate fluctuations?• If I’m holding these currencies in my portfolio, what risks am I

exposed to?• Price data is best to analyze using returns as opposed to absolute

prices (note: use log returns)• Possible useful methods to identify patterns or trends in data like

this:• Principal component analysis• K-means clustering

Dimensionality Reduction• The data you have is high-

dimensional data. You have 2,466 daily observations of 19 different currencies.

• To make sense of it you need to use a dimensionality reduction method such as PCA.

• PCA essentially “draws lines” through the data in order to represent your data in less dimensions (maybe 2 or 3) while maintaining the most important features of your data.

• The 1st principal component will represent the most variation in the data, the 2nd will represent the 2nd most, etc.

PCA

PCA

PC 2 PC 1

PCA

PC 1

PC 2

FX Example – Using PCA

PC 1 PC 2 PC 3 PC 4USD 0.91 0.11 0.19 0.04MYR 0.88 -0.06 0.00 0.19SGD 0.88 -0.02 0.12 0.26PHP 0.88 -0.04 0.00 0.15THB 0.83 0.06 0.13 0.10IDR 0.73 -0.04 -0.03 0.17

RUB 0.59 -0.10 -0.09 0.21JPY 0.55 0.14 0.60 -0.14

KRW 0.55 -0.17 -0.20 0.30TRY 0.47 -0.25 -0.48 0.32CAD 0.46 -0.21 0.00 0.55GBP 0.37 -0.06 0.20 0.49ZAR 0.25 -0.39 -0.43 0.37

AUD 0.16 -0.20 -0.20 0.85CHF 0.11 -0.02 0.80 0.01NZD 0.10 -0.11 -0.11 0.88NOK 0.02 -0.86 -0.02 0.16SEK -0.04 -0.83 -0.08 0.15

So you run PCA on the daily currency return data and get results that look like this…. But what does this tell you?

It is up to you to interpret what the Principal Components represent

PC scores range from -1 to 1

The higher/lower the score, the more correlated that currency is with the factor.

A score of 0 means that principal component doesn’t explain any of that currency’s price fluctuations

Interpreting Factors

Factor 1 has a negative loading associated with every currency, suggesting it is a global macro factor. Asian countries ex-SGD are less affected. From 2005 – 2014, a few major macro events occurred. Throughout this time Asia was less affected than the rest of the world. Within Asia trade stayed fairly strong, keeping demand and trade levels more stable.

Factor 2 can be identified as the effect of interest rate differentials between countries. JPY and CHF were popular carry trade currencies

Factor 3 seems to represent commodity prices. Countries who are major exporters of raw products have positive loadings, countries whose exports are driven by manufactured goods have negative loadings.

Supporting Factor Interpretations

Useful to test your interpretations of factors with other data

Plotting Factor 2 scores against the countries’ interest rates seem to support our interpretation

Shifts over Time IMPORTANT: Factors will most likely shift over time Before the financial crisis currencies could be sorted into 3 distinct

clusters: Asian currencies, European and commodity currencies

Shifts over Time The currencies have shifted into new clusters. Cluster 1 can now be interpreted as a “safe haven” cluster With global turmoil affecting international trade, SGD is clustered

with the rest of the currencies instead of the Asian cluster

Recap and Suggestions Machine learning and statistical analysis can be used to identify

patterns and trends in asset prices

Its an art not a science

Suggestions: Rolling windows Use volume data instead of prices Analyze multiple assets together to discover relationships Incorporate other data sources Combine with fundamental analysis: “quandamental”

Useful sources: Investopedia Quandl.com Coursera.com Datacamp.com

Further Analysis Example

Using 56 different asset (ETFs, oil prices, bonds, etc.)

10 factors explain 80% of the variation in the global markets

Ichimoku Clouds The Ichimoku Cloud is a versatile indicator that defines

support and resistance, identifies trend direction, gauges momentum and provides trading signals.

With one look, chartists can identify the trend and look for potential signals within that trend.

Trading Using the Cloud

We’ll go in more detail in later SAW presentations

Support & Resistance

We’ve mentioned moving averages and trendlines can act as support or resistance, but what does that really mean?

Is Support and Resistance analogous to Supply and Demand?

Is the market really just one large auction made up of buyers and sellers?

Support & Resistance

Support and resistance represent key junctures where the forces of supply and demand meet.

Prices are driven by excessive supply (down) and demand (up)

Supply = bearish, bears and selling Demand = bullish, bulls and buying

As demand increases, prices advance As supply increases, prices decline

When supply and demand are equal, prices move sideways as bulls and bears fight for control

Support:The price level at which demand is thought to be strong enough to prevent the price from declining further.

The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell.

Resistance:The price level at which selling is thought to be strong enough to prevent the price from rising further

The logic dictates that as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy.

Note:Technical analysis is not an exact science and it is sometimes difficult to set exact support & resistance levels. In addition, price movements can be volatile and dip below support & resistance briefly. Sometimes it does not seem logical to consider a support level broken if the price closes 1/8 below the established support level. For this reason, some traders and investors establish support zones.

Also, its often common for resistance to become support or support to become resistance when a stock rises or falls

Possibly (not exact) = Dynamic???

So where does volume come into the equation and can it be used as a confirmation since we established the market is just one big auction?

How do you define a support or resistance zone and how do you interpret that?

What does volume mean?

Volume The number of shares or contracts traded in a

security or an entire market during a given period of time. It is simply the amount of shares that trade hands from sellers to buyers as a measure of activity 

Used to measure the worth of a market move. If the markets have made strong price move either up or down the perceived strength of that move depends on the volume for that period

Bottom Line: The higher the volume during that price move the more significant the move

Volume as Confirmation:

Support & Resistance Zones (by Volume)

We’ll go over in more detail Volume by Price in later SAW presentations

BUT Volume by Price is a great way to define support and resistance zones by showing the level of strength of the zone by the amount of market participants

Volume by Price – Showing Gaps We’ll go over

trading Gaps in more detail in later SAW presentations, but vol. by price help identify gaps.

Basically, gaps act as resistance or support and usually get filled.

There are some very profitable trading tactics to profit from gaps we’ll discuss in future SAWs

Volume by Price ExamplesThe chart shows a long Volume by Price bar marking support around 42-44 in mid August.

Also notice that the stock forged at least three reaction lows around 42 from early July to mid August. This support (demand) zone is clearly marked.

Volume by Price Examples

The chart shows SNDK breaking below the previously identified Volume by Price support zone with high volume.

Demand crumbled, supply won the day and prices moved sharply lower.

Market IndicatorsThis is where it gets fun

I have counted over 100 different types of market indicators on Think or Swim platform and that number will continue to grow as traders come up with new indicators

Popular indicators:– Average True Range (ATR) – Commodity Channel Index (CCI)– Chaikin Money Flow (CMF)– Detrended Price Oscillator (DPO)– Moving Average Convergence-Divergence (MACD)– Money Flow Index (MFI)– On Balance Volume (OBV)– Percentage Price Oscillator (PPO)– TRIX– Ultimate Oscillator– Williams %R– Relative Strength Index

Is the Market Trending or Oscillating?

How the market is acting will determine which indicators we should use

You SHOULD NEVER USE oscillating indicators when the market is trending or vice versa…NEVER!

Oscillating: Moving up and down with

no apparent trend

Popular Oscillating Indicators:1) Full Stochastics2) Williams %R3) Force Index

We’ll discuss more in greater detail in future SAWs. For now we’ll focus on the most important one…Full Stochastics

Stochastic Calculus?Stochastic calculus is a branch of mathematics that operates on stochastic processes. It allows a consistent theory of integration to be defined for integrals of stochastic processes with respect to stochastic processes. It is used to model systems that behave randomly

Stochastic Calculus and how it relates to interpreting cycles and stock patterns in the market is what I’m currently doing my research on. Part of my thesis relates to taking static indicators and making them dynamic. I’ve taken this concept and have been creating my own indicator that can show whether the market is trending or oscillating and how to trade that cycle.

Some interesting phenomenon occurs when you use stochastic calculus on a summation index, price ratios, etc. Basically anything put price.

• For our purposes though, we’ll just start off with using the Full Stochastic Indicator

Full Stochastic

How do you know what time frame to use?

How do you know what parameters to use?

Is it easier to short or go long using Stochastics?

Notice how combining Full Stochastics and support/resistance make for profitable trades

Is the Market Trending or Oscillating?

How the market is acting will determine which indicators we should use

You SHOULD NEVER USE oscillating indicators when the market is trending or vice versa…NEVER!

Trending: Rising

prices or declining prices over indicated time period

Popular Trending Indicators:1) MACD2) RSI3) ROC

We’ll discuss more in greater detail in future SAWs. For now we’ll focus on the most important ones…RSI & MACD

Relative Strength Index (RSI) The Relative Strength Index (RSI) is a momentum oscillator

that measures the speed and change of price movements

Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30

Signals can also be generated by looking for divergences, failure swings and centerline crossovers.

RSI can also be used to identify the general trend

Using RSIRSI tends to fluctuate between 40 and 90 in a bull market (uptrend) with the 40-50 zones acting as support. These ranges may vary depending on RSI parameters, strength of trend and volatility of the underlying security.

Exact opposite occurs for bear markets

Bear Markets

DivergencesYou want RSI to be increasing with the upward trend or decreasing when the stock is downward trend. This is convergence and anything else is divergence

Notice: Stock fell after bearish divergence and stock rose after bullish divergence

Does this mean a new trend or just a reallocation of supply or demand?

Moving Average Convergence Divergence (MACD)

Moving Average Convergence-Divergence (MACD) is one of the simplest and most effective momentum indicators available

MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average

As a result, MACD offers the best of both worlds: trend following and momentum

MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge

Traders can look for signal line crossovers, centerline crossovers

and divergences to generate signals

Because MACD is unbounded, it is not particularly useful for identifying overbought and oversold levels.

Interpretation

Positive MACD indicates that the 12-day EMA is above the 26-day EMA. Positive values increase as the shorter EMA diverges further from the longer EMA. This means upside momentum is increasing

Negative MACD indicates

that the 12-day EMA is below the 26-day EMA. Negative values increase as the shorter EMA diverges further below the longer EMA. This means downside momentum is increasing

Signal Line Crossovers

A bullish crossover occurs when MACD turns up and crosses above the signal line

A bearish crossover occurs when MACD turns down and crosses below the signal line

Crossovers can last a few days or a few weeks, it all depends on the strength of the move

Divergences Similar to what we said for RSI

Notice: Stock fell after bearish divergence and stock rose after bullish divergence

Does this mean a new trend or just a reallocation of supply or demand?

Candlestick Patterns

Fundamental Analysis

Would I buy this entire company?????

What is it?

Attempting to value a company through economic, financial and other qualitative and quantitative factors.– Macroeconomic– Industry-related– Company-specific

Macroeconomic

What affects all companies? GDP, inflation, interest rates,

commodity prices, exchange rates, etc.

Industry-related

Comparing company to peers on sales, price levels, product competition…

Company Related

Price Ratios– Liquidity analysis

Current ratios– Long-term solvency analysis

Debt ratios– Profitability analysis

Ex. ROA and ROE

Know What You Own

Looking at more than the chart– Examining a company’s financial

statements – Reviewing corporate governance– Visiting company locations and

examining consumer behavior– Investigating management

Are revenues growing?Is the company making a profit?

How much debt do they have and can they repay it?

Management?

Get a Feel for Management

Listen to Conference Calls Look at Management Discussion and

Analysis in the Annual Report Look at ownership and insider buys/

sells Past performance analysis

– Look at bios for previous companies

Financials

10-K– Annual Report

10-Q– Quarterly Report

8-K– Material Definitive Agreements not

made in ordinary course of businessChanges in management, directors,

accountants, asset sales/purchases, bankruptcies, etc.

Breaking Down Financial Statements

On Company’s and SEC’s website http://

www.sec.gov/edgar/searchedgar/companysearch.html

Efficient Markets?

In completely efficient markets, no analysis would make a difference

“A Random Walk Down Wallstreet” Long-term-efficient Short-term-????

“Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble…to give way to hope, fear and greed." – Benjamin Graham

Invest In What You Know

Coined by Peter Lynch– Allows individuals to find value

companies before fund managers– Look for companies you normally

encounter in your day-to-day lives– Good starting point for investing– Books:

One Up on WallStreetBeating the Street

Strengths

Good for spotting long-term trends:– Economic, demographic, technological,

or consumer habits Spotting value

– Uncover valuable assets, strong balance sheets, stable earnings, earning power

*It helps you better understand the business and how it makes money

Weaknesses

Very time consuming Some models are very subjective

– As much as an art as a science– Intrinsic value is in the eye of the

beholder

Value Investing

How to find value

Find intrinsic value, determine if company is trading below it– Fundamental analysis

Study famous value investors strategies– www.gurufocus.com

Things to look for

High dividend yields (not too high) Low:

– Price to book ratio– Price to earnings (PE) ratio– Price to cash flows

The Intelligent Investor

Read it!

Resources

Company websites News sources

– WSJ, Reuters, Bloomberg, SEC, etc. The area around you

– Visiting malls, talking to family and friends

Recent Action

Future?

Future Problems?

Commercial Real estate DEBT! DEBT! DEBT! Lack of revenue growth in companies

– “Those earnings are not the achievement of risk-takers. These are gifts, hidden gifts, from the government.” – George Soros

Event Driven Examples

Sanderson Farms

Dolby

Volkswagen

Valient

M&AEx: HAL/BHI,

Sanderson Farms (SAFM)

Avian Influenza Confirmed in the United States in December, 2014.

Volkswagen

Valeant Pharmaceuticals

Dolby

ENV Acquiring YDLE

Websites

www.investopedia.com www.seekingalpha.com www.fool.com www.gurufocus.com finance.yahoo.com www.stockcharts.com

Other Cool websites

www.updown.com www.equitrader.com

www.freetradingvideos.com