copyright © 2000 by harcourt, inc. all rights reserved. chapter 13 technical analysis

Copyright © 2000 by Harcourt, Inc. All rights reserved.

Chapter 13Technical Analysis



Questions to consider:

• How does technical analysis differ from fundamental analysis?

• What are the underlying assumptions of technical analysis?

• What major assumption causes a difference between technical analysis and the efficient market hypothesis?



• What are the major advantages of technical analysis compared to fundamental analysis?

• What are the major challenges to the assumptions of technical analysis and its rules?

• What is the logic for the major contrary opinion rules used by technicians?



• What are some of the significant rules used by technicians who want to follow the smart money and what is the logic of those rules?

• What are the breadth of market measures and what are they intended to indicate?

• What are the types of price movements postulated in the Dow Theory and how are they used by a technician?



• Why do technicians consider the volume of trading important and how do they use it in their analysis?

• What are support and resistance levels, how are they identified, and how are they used by technicians?

• What is the purpose of moving average lines and how does the technician use one or several of them to detect major changes in trends?



• What is the rationale behind the relative strength line for an industry or a stock and how is it interpreted?

• How are bar charts different from point-and-figure charts?

• What are some uses of technical analysis in foreign security markets?

• How is technical analysis used when analyzing bond markets?


Technical Analysis As An Art

• Prices are Determined by Investors’ Attitudes– Prices move in trends

• Changing Attitude Toward– Economic forces– Monetary forces– Political forces– Psychological forces


Technical Analysis As A Science

• Study of the Action of the Market

• Science of Recording in Graphic Form

– Price changes, volume, highs and lows,…

– The averages of above

• Deducing the Probable Future Trend


Is Technical Analysis An Art Or Science?

• Art

– Martin J. Pring

• Science

– Robert D. Edwards and John Magee


Underlying Assumptions of Technical Analysis

1. The market value of any good or service is determined solely by the interaction of supply and demand

2. Supply and demand are governed by numerous factors, both rational and irrational


Underlying Assumptions of Technical Analysis

3. Disregarding minor fluctuations, the prices for individual securities and the overall value of the market tend to move in trends, which persist for appreciable lengths of time

4. Prevailing trends change in reaction to shifts in supply and demand relationships and these shifts can be detected in the action of the market


Advantages of Technical Analysis

• Not heavily dependent on financial accounting statements– Problems with accounting statements:1. Lack information needed by security analysts2. GAAP allows firms to select reporting

procedures, resulting in difficulty comparing statements from two firms

3. Nonquantifiable factors do not show up in financial statements


Advantages of Technical Analysis• Fundamental analyst must process new

information and quickly determine a new intrinsic value, but technical analyst merely has to recognize a movement to a new equilibrium

• Technicians trade when a move to a new equilibrium is underway but a fundamental analyst finds undervalued securities that may not adjust their prices as quickly


Challenges to Technical Analysis• Assumptions - Empirical tests of Efficient Market

Hypothesis (EMH) show that prices do not move in trends

• Trading rules– The past may not be repeated– Patterns may become self-fulfilling prophecies– A successful rule will gain followers and become

less successful– Rules all require subjective judgement


Is There Any Empirical Evidence To Support Technical Analysis

(TA)?• Patterns in Security Prices

– Fall one week, bounce back next week– Monthly returns over a long time– Seasonal patterns

• January effect

• Resent Research Merits TA


Charting• Bar Charts

– Illustrates each days• High, low, and closing price

– Looks at stock price behavior over time• Point-and-Figure Charts

– Identifies stock price reversals – Does not consider time

• Candlestick Charts– Illustrates each days

• Opening, high, low, and closing price


Bar Charts• Trendline

– Drawn on chart to identify trend

• Channel– Pattern formed by 2 trendlines

• Resistance– Downward price movement

• Support– Upward price movement


Technical Trading Rules and Indicators

• Stock cycles typically go through a peak and trough

• Analyze the following chart of a typical stock price cycle and we will show a rising trend channel, a flat trend channel, a declining trend channel, and indications of when a technical analyst would want to trade


Typical Stock Market Cycle Stock Price


Typical Stock Market Cycle Stock Price

Declining Trend

Channel

Trough

Buy Point

Rising Trend Channel

Flat Trend Channel

Sell Point

Peak

Declining Trend

Channel TroughBuy Point


Point-And-Figure Charts

• A Series of Xs and Os

• Same as Bar Charts

• Popular Tool


Candlestick Chart• Candlestick Line

– Real body• Difference between opening and closing price

– Shadow• Vertical line identifying the high and low price

– Can be constructed with Different Time Data• Intraday• Weekly


Summary Of ChartsBar Point-Figure Candlestick

Data HighLowClose

Close OpenHighLowClose

Time Days None Days/Weeks

App Trendlines Trendlines Pattern andShapes


Contrary-Opinion

• Many analysts rely on rules developed from the premise that the majority of investors are wrong as the market approaches peaks and troughs

• Technicians try to determine whether investors are strongly bullish or bearish and then trade in the opposite direction

• These positions have various indicators


Contrary-Opinion Rules

• Mutual fund cash positions• Credit balances in brokerage accounts• Investment advisory opinions• OTC versus NYSE volume• Chicago Board Options Exchange (CBOE)

put/call ratio• Futures traders bullish on stock index

futures


Follow the Smart Money

• Indicators showing behavior of sophisticated investors

• The Barron’s Confidence Index

• T-Bill - Eurodollar yield spread

• Short sales by specialists

• Debit balances in brokerage accounts (margin debt)


Other Market Indicators

• Breadth of market– Advance-decline

– Diffusion index

• Short interest

• Stocks above their 200-day moving average

• Block uptick-downtick ratio


Stock Price and Volume Techniques

• The Dow theory– 1. Major trends are like tides in the ocean– 2. Intermediate trends resemble waves– 3. Short-run movements are like ripples

• Importance of volume– Ratio of upside-downside volume

• Support and resistance levels• Moving average lines

– 5-day– 200-day


Stock Price and Volume Techniques

• Relative-strength indexes (RSI) – For individual stocks and industry groups

• Bar charting

• Multiple indicator charts

• Point-and-figure charts

• Overall feel from a consensus of numerous technical indicators


Dow Theory

• Primary Trend - “Tides”– Cycle in years

• Intermediate Trend - “waves”– 3 Weeks to 6 months

• Short-Term Trend - “ripples”– Volatile and erratic

• Basic Tenets next slide


Basic Tenets Of Dow Theory

• Requires Data on Stock Indexes– No additional information

• Types of Financial Market Movements– Primary– Intermediate– Short-term

• Positive Relationship Between– Trend– Volume of shares traded


RSI• Range From 0% to 100%

• High– Industry stock prices outperform the market– Indicate a sell signal? Buy signal?

• Low The trend is your friend!– Market outperforming the industry stock– Indicates a buy signal? Sell signal?


Technical Indicators• Breadth Indicators

– Advance-decline line (ADL)– Volume– New high/new low

• Sentiment Indicators– Stock market newsletter– Odd-lot trading– Put/call trading– Specialists short selling


Advance-Decline Line

ADLt = At - Dt + ADLt - 1


Technical Analysis of Foreign Markets

• Foreign stock market series

• Technical analysis of foreign exchange rates

• Technical analysis of bond markets

Recap & Further Illustration


Technical Analysis• What is it?

– Historic price and volume behavior– Investor sentiment– Bulls and bears….

• Dow theory– Three trends: primary, secondary, daily– Corrections/confirmations: DJIA/DJTA

• Support and resistance areas– Support level / Bottom feeders– Resistance level / Topping out / profit taking– Breakouts


Dow Theory

Primary trend

Secondary reactions

Daily trend not shown

Time

Pri

ces


ChartingReading the tea leaves…• Advance / decline line: Closing Arms or Trin• Relative strength• Moving averages• High-lo-close chart• Candlestick chart• Point-and-figure chart• Chart formations: head-and-shoulders• Other indicators

– Odd lot / Contrarian / Hemlines


Examples• Closing Arms: Trin

• Relative strength: assume 4 shares of Stock A @ $25 per share and 2 shares of Stock B @ $50 per shareMonth Stock A Stock B Rel. Str.1 $100 $100 1.002 $88 $90 0.983 $88 $80 1.10

Trin = Declining volume / Declines

Advancing volume / Advances


Three Period Moving AverageTime Mini Dow MA

1 112 123 14 12.334 13 13.005 16 14.336 17 15.337 19 17.338 18 18.009 17 18.0010 18 17.67

11 + 12 + 14 = 12.33

3


Moving Average Graph

10

11

12

13

14

15

16

17

18

19

20

0 1 2 3 4 5 6 7 8 9 10 11

Time

Sto

ck

Pri

ce

s

Mini Dow MA


Candlestick MakingHigh

Upper Shadow

Low

Lower Shadow

Open

Bullish Bearish

Body

Close


Candlestick Formations

Dark cloudcover

Bearishengulfing

pattern Harami


Point and Figure Chart605856 054 0 0 0 052 0 0 0 0 050 0 0 0 048 0 0 0 0 0 0 046 0 0 0 0 0 0 044 0 0 0 0 0 042 0 0 0 040 0 0 038 0 036 034323028

Buy

Sell

CongestionAreas


Head and Shoulders Formation

Neckline

LeftShoulder

Head

RightShoulder

ThrowBack


The InternetInvestments Online

www.mta-usa.orgwww.bigcharts.comwww.dailystocks.comwww.investools.comwww.siliconinvestor.comwww.stockmaster.comwww.dbc.com

http://www.mta-usa.org/





http://www.bigcharts.com/



http://www.dailystocks.com/



http://www.investools.com/



http://www.siliconinvestor.com/

http://www.stockmaster.com/



http://www.dbc.com/

http://www.dbc.com/

http://www.dbc.com/

copyright © 2000 by harcourt, inc. all rights reserved. chapter 13 technical analysis

Documents

technical analysis slide

technical analysis questions

fundamental analysis

irrational slide

john magee slide

probable future trend

major changes

market science of recording