presentation 4 technical analysis inSAPM

1. Technical Analysis

2. Technical Analysis
 To “non-believers,”
technical analysis can
sound like a lot of
focus-pocus!

3. Introduction
 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.

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 Technical
Analysis
 The market discounts everything.
 Price moves in trends.
 History tends to repeat itself
 The market and/or an individual stock acts like a
barometer rather than thermometer.
 The market value of any good or service is
determined solely by the interaction of supply and
demand.
 Supply and demand are governed by numerous
factors, both rational and irrational.

6. Advantages of Technical Analysis
 Unlike fundamental analysis, technical analysis
is not heavily dependent on financial accounting
statements
 Problems with accounting statements:
 Lack information needed by security analysts
 GAAP allows firms to select reporting procedures, resulting
in difficulty comparing statements between firms
 Many psychological and other non-quantifiable factors do
not show up in financial statements

7. 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 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 less
successful.
 Rules all require subjective judgment.

9. Typical Stock Market Cycle
Stock
Price

10. Typical Stock Market Cycle
Stock
Price
Declining Peak
Trend
Channel
Flat Trend Channel
Sell Point
Rising Trend Channel
Declining
Buy Point Trend Buy Point
Channel Trough
Trough

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 patterns
which may indicate future price movements.
 They also analyze volume and other
psychological indicators (breadth, % of bulls vs
% of bears, put/call ratio, etc.).
 Strict chartists don’t care about fundamentals at
all.

13. Drawing Bar (OHLC) Charts and
Japanese candlestick chart
 Each bar is composed of 4
elements:
 Open
 High High High
 Low Close Open
 Close
 Note that the candlestick body
is empty (white) on up days,
and filled (some color) on Open Close
down days Low Low
Standard Japanese Standard Japanese
Bar Chart Candlestick Bar Chart Candlestick

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 of
Candlesticks
 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 Candlestick
Pattern
 Morning and Evening Star Pattern

26. Drawing Point & Figure Charts
 Point & Figure charts are
independent of time.
 An X represents an up move.
 An O represents a down
move.
 The Box Size is the number of
points needed to make an X or
O. X
 The Reversal is the price X
change needed to recognize a X X O
X X O
change in direction. XO O
 Typically, P&F charts use a 1- XO O
X
point box and a 3-point
reversal.

27. Point & Figure Charts

28. Basic Technical Tools
 Trend Lines
 Moving Averages
 Price Patterns
 Indicators

29. Trend Lines
 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.

30. Support & Resistance
 Support and resistance lines
indicate likely ends of trends.
 Resistance results from the
Breakout
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

31. Support and resistance
95 BALLARPUR INDS (104.900, 109.500, 104.500, 107.750, +3.45000) 95
90 90
85 85
80 80
75 75
70 70
65 65
60 60
55 55
50 50
45 45
40 40
35
Support 35
Nov Dec 2001 Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2002 Mar Apr May Jun Jul Aug Sep Oct Nov 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)
85 85
80 80
75 75
70
Resistance 70
65 65
60 60
55 55
50 50
45 45
40 40
35 35
30 30
Aug Sep Oct Nov Dec 2002 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2003 Feb Mar Apr May Jun Jul Aug Sep Oct

32. Simple Moving Averages
 A moving average is simply
the average price (usually the
closing price) over the last N MSFT Daily Prices with 10-day MA
9/23/93 to 9/21/94
periods.
60
55
 They are used to smooth out
fluctuations of less than N
50
periods.
Price
45
 This chart shows MSFT with 40
a 10-day moving average. 35
Note how the moving average 30
1 21 41 61 81 101 121 141 161 181 201 221 241
shows much less volatility Date
than the daily stock price.

33. Price Patterns
 Technicians look for many patterns in the
historical time series of prices.
 These patterns are reputed to provide
information regarding the size and timing of
subsequent price moves.
 But don’t forget that the EMH says these
patterns are illusions, and have no real meaning.
In fact, they can be seen in a randomly generated
price series.

34. Some Popular Chart Formations

35. Head and Shoulders
H&S Top
 This formation is Head
characterized by two
small peaks on either Left Shoulder Right Shoulder
side of a larger peak.
 This is a reversal pattern, Neckline
meaning that it signifies H&S Bottom
a change in the trend. Neckline
Left Shoulder
Right Shoulder
Head

36. Head & Shoulders Example
Sell Signal
Minimum Target Price
Based on measurement rule

37. Double Tops and Bottoms
Double Top
 These formations are
similar to the H&S
formations, but there is
no head.
 These are reversal Target
patterns with the same Target
measuring implications
as the H&S.
Double Bottom

38. Double Bottom Example

39. Triangles
 Triangles are
continuation formations.
 Three flavors: Ascending
 Ascending
 Descending Symmetrical
 Symmetrical
 Typically, triangles Symmetrical
should break out about
half to three-quarters of
Descending
the way through the
formation.

40. Rounded Tops & Bottoms
 Rounding formations are Rounding
characterized by a slow Bottom
reversal of trend.
Rounding Top

41. Rounded Bottom Chart Example

42. Broadening Formations
 These formations are like
reverse triangles. Broadening Bottoms
 These formations usually
signal a reversal of the
trend.
Broadening Tops

43. Technical Indicators
 There are, literally, hundreds of technical indicators used
to 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

44. Trend indicators:
Simple Moving Average:
Moving averages are one of the easiest tools
available for technical analysis. They smooth a
data series and make it easier to mark trends
which are very helpful in volatile markets.

45. 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).

46. MACD Example Chart

47. 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.

48. RSI Example Chart
Overbought Oversold

49. A Stock Chart

50. Dow Theory
 This theory was first stated by Charles Dow in a
series of columns in the WSJ between 1900 and
1902.
 Dow (and later Hamilton and Rhea) believed that
market trends forecast trends in the economy.
 A change in the trend of the DJIA must be
confirmed by a trend change in the DJTA in
order to generate a valid signal.

51.  Market’s performance is based upon long-term price
trend (primary trend) in overall market
 Used to signal end of both bull and
bear markets
 An after-the-fact measure with no
predictive power

52. Dow Theory Trends (1)
 Primary Trend
 Called “the tide” by Dow, this is the trend that
defines the long-term direction (up to several years).
Others have called this a “secular” bull or bear
market.
 Secondary Trend
 Called “the waves” by Dow, this is shorter-term
departures from the primary trend (weeks to months)
 Day to day fluctuations
 Not significant in Dow Theory

53. The Dow Theory in Operation

54. Too Many Others To List
 As noted, there are literally hundreds of indicators and thousands of
trading systems.
 To close, just note that 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
you lots of money at one time or another. The real question is can
they do it consistently?
 As the carneys used to say, “You pays your money, and you takes
your chances.”