Technical Analysis

Technical Analysis vs.

Fundamental Analysis
Technical analysis involves the development of
trading rules based on past price and volume
data for individual stocks and the overall stock
market.
Fundamental analysis involves economic,
industry, and company analysis that lead to
valuation estimates for companies, which can
then be compared to market prices to aid in
investment decisions.

Technical Analysis
To non-believers,
technical analysis can
sound like a lot of
focus-pocus!

Underlying Assumptions of
Technical Analysis
Trading via technical analysis involve a
number of assumptions about markets
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

Underlying Assumptions of
Technical Analysis
Technical analysis assumptions:
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
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
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

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

Challenges to Technical
Analysis
Challenges to basic assumptions
Empirical tests of Efficient Market Hypothesis (EMH)
show that prices do not move in trends

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 judgement

Technical Analysis Introduction

Looks for peaks, bottoms, trends, patterns,
and other factors affecting a stocks price
movement
Makes a buy/sell decision based on those
factors
Hundreds of different patterns and
indicators investors claim to be successful

Technical Analysis

The Bar Chart

The Bar Chart

Candle Stick Charting

Candle Stick Charting

Been around for hundreds of years
Often referred to as Japanese Candles
because the Japanese would use them to
analyze the price of rice contracts
Similar to bar chart, but uses color to show if
stock was up (green) or down (red) over the day
More than 20 patterns are used by technicians
for candlestick charting.

Candle Stick Charting

Green is an example of a
bullish pattern, the stock
opened near its low and
closed near its high
Red is an example of a
bearish pattern. The
stock opened near its
high and dropped
substantially to close
near its low

Candle Stick Charting

Top example is called a
hammer and is a bullish
pattern only if it occurs
after the stock price has
dropped for several days.
Theory is that pattern
indicates a reversal

Bottom is an example of
a star, typically indicating
a reversal and/or
indecision.

Candle Stick Charting

Point and Figure Chart

Somewhat rare
Plots day-to-day increases and declines in price.
A rising stack of XXXXs represents increases
A rising stack of OOOOs represents decreases.
Typically used for intraday charting
If used for multi-day study, only closing prices
will be used

Point and Figure Chart

Point and Figure Chart

Helps to filter out less-significant price
movements allowing analyst to focus on most
important trends
Used to keep track of emerging price patterns
No time dimension

Two attributes affecting the appearance of a

point & figure chart
Box size
Reversal amount

Using the Moving Average

Shows the average value of a securitys price
over a period of time
Using compared or used in conjunction with EMA

The most commonly used averages are of 20,

30, 50, 100 and 200 days
The longer the time span, the less sensitive the
moving average to daily price changes
Moving averages are used to emphasize the direction
of a trend and smooth out price and volume
fluctuations (noise).

Moving Average

Moving Average
Notice in April when the stock price dropped well
below its 50-day average (the green line).
Bearish signal

February it rose above its 50-day average and

continued to rise for several weeks
Bullish signal

Typically, when a stock moves below its moving

average it is a bad sign, above it is a good sign

Moving Averages
What do the different days mean?
20 days - choppy line. It isn't the most accurate,
but is probably the most useful for short term
traders.
30 day - similar to 20 day but provides a bit more
certainty for the trend.

Moving Averages
What do the different days mean?
50 day - moving averages provide a much less
volatile, smooth line. This can be used to detect
somewhat longer term trends.
100 day - similar to the 50 day, it is less volatile,
and one of the most widely used for long term
trends.
200 day - even less volatile, more of a rolling chart
or smooth line. It doesn't react to quick
movements in the stock price therefore it is rarely
used.

Moving Averages
Trend strength, short vs long term
SMA (50), EMA (50)

Moving Average
as support levels
Take one moving average
Historical back-tracking

Strategies for Moving Averages

Filters
Used to increase confidence about an indicator
No set rules or things to look out for when filtering, just
whatever makes you confident enough to invest your money
For example you might want to wait until a security crosses
through its moving average and is at least 10% above the
average to make sure that it is a true crossover.
Remember, setting the percentile too high could result in
"missing the boat" and buying the stock at its peak.

Another filter is to wait a day or two after the security crosses

over, this can be used to make sure that the rise in the
security isn't a fluke or unsustained.
Again, the downside is if you wait too long then you could end
up missing some big profits.

Strategies for Moving Averages

Crossovers
Not as easy as filtering
Several different types of crossover's, but all of them
involve two or more moving averages.
In a double crossover you are looking for a situation where
the shortest MA crosses through the longer one. This is
almost always considered to be a buying signal since the
longer average is somewhat of a support level for the stock
price.
For extra insurance you can use a triple crossover, whereby
the shortest moving average must pass through the two
higher ones. This is considered to be an even stronger
buying indicator.

Exponential Moving Averages

Calculated by applying a
percentage of today's
closing price to
yesterday's moving
average value.
Use an exponential
moving average to place
more weight on recent
prices.

Relative Strength Index (RSI)

A comparison between the days a stock finishes
up against the days it finishes down.
Big tool with momentum trading
Ranges from 0 to 100
Stock considered overbought around the 70 level
Stock considered oversold around 30

The shorter the number of days used to

calculate the more volatile

Calculating RSI

Relative Strength Index (RSI)

Relative Strength Index (RSI)

Money Flow Index

Measures the strength of money flowing
into and out of a stock
Difference between money flow index and
RSI is that RSI only looks at prices, Money
Flow also looks at volume
Ranges from 0 to 100
Overbought at 70
Oversold at 30

Money Flow Index

Bollinger Bands
Three lines used for Bollinger band indicator:
the upper, lower, and the simple moving
average that is between the two
Upper/lower bands are plotted two standard
deviations away from a simple moving average
Bands widen when markets are more volatile and
contract during less chaotic periods

Closer price moves to upper band, the more

overbought
Closer to lower band, the more oversold

Bollinger Bands

Resistance and Support

Price levels at which movement should stop and reverse
direction.
Act as floor and ceiling
Different strengths (major and minor)

Support
Price level below the current market price at which buying
interest should be able to overcome selling pressure and thus
keep the price from going any lower

Resistance
Price level above the current market price, at which selling
pressure should be strong enough to overcome buying pressure
and thus keep the price from going any higher

Resistance and Support

One of two things can happen when stock approaches
resistance/support

Can act as a reversal

point
When price drops to a
support level, it will go
back up
When price rises to a
resistance level, it will
go back down

Support/Resistance
reverse roles once
penetrated.
Market price falls
below a support level,
then the former
support level becomes
a resistance level
when the market later
trades back up to that
level

Resistance and Support

Resistance

Resistance/Support
Support

Charting Patterns
Cup and Handle
Pattern on bar chart as short as 7 weeks or as long as
65 weeks
Cup in the shape of a U; Handle has a slight
downward drift
Right hand side of pattern has low trading volume
As the stock comes up to test old highs, the stock will
incur selling pressure by the people who bought at or
near the old high
Selling pressure will take the stock price sideways for
4 days to 4 weeks, then it takes off

Charting Patterns

Head and Shoulders

Resembles an M in which a stocks price
Rises to a peak and then declines, then
Rises above the former peak and again declines, and
then
Rises again but not the second peak and again
declines

The first and third peaks are shoulders, and the

second peak forms the head.
Very bearish indicator

Notice how the

breakout is tested, a
good place to sell

DOW JONES INDUSTRIAL INDEX

(Basket of large company stocks)
Formation not relevant until
neckline is broken. Projects
distance between head and
neckline. Projection depends
on where price breaks
neckline.

10800

Neckline

Shoulder

Shoulder
Head

Double Bottom and Tops

Occurs when a stock price drops (go up) to a
similar price level twice within a few weeks or
months
The double-bottom pattern resembles a W or
M
In a perfect double, the second decline
(increase) should normally go slightly lower than
the first decline to create a shakeout of jittery
investors
This is a very bullish indicator

Double Bottom

Double Top
810 was also resistance on the
monthly Nov

Momentum Oscillators
Bounded between ranges 100,-100 or 1,-1
Centered Oscillators MACD
Rate-of-Change
Percentage price change over a period of
time
Difference between current price and previous
Typically +20% and -20% ranges

Leading Indicators: Oscillators

Calculations
Closing today 41
Last ten days 46-38

Leading Indicators: Oscillators

Stochiastic Oscillator
Compares the price of a stock and its
position realtive to a moving price range of
it previous positions
Comprised of a %K and %D line
Main line is %K
Moving Average is %D

%K rises above 20, or falls below 80

%K crosses over %D