technical analysis (long) with thomson reuters edit

TECHNICAL ANALYSIS

Charting Techniques

Leo Quinitio

www.pse.com.ph

Random Walk Theory

Author Burton Malkiel

"A Random Walk Down Wall Street“

top-seller finance book

Stock price changes have the same distribution

and are independent of each other, so the past

movement or trend of a stock price or market

cannot be used to predict its future movement.

Followers think that the market cannot be

outperformed without assuming additional risk.

Critics say stocks actually form trends at length

and it is possible to beat the market through

careful study of buying & selling points.

Efficient Market Hypothesis

It is impossible to "beat the market" because

stock market efficiency causes existing share

prices to always incorporate and reflect all

relevant information.

Stocks always trade at their fair value on stock

exchanges, making it impossible for investors to

either purchase undervalued stocks or sell stocks

for inflated prices.

It is impossible to outperform the overall market

through expert stock selection or market timing,

and that the only way an investor can possibly

obtain higher returns is by purchasing riskier

investments.

Efficient Market Hypothesis

A cornerstone of modern financial theory

Believers argue it is pointless to search for undervalued

stocks or to try to predict trends in the market through

either fundamental or technical analysis.

Warren Buffett has consistently beaten the market over

long periods of time, which by EMH is impossible

The 1987 stock market crash when the Dow Jones

Industrial Average (DJIA) fell by over 20% in a single day,

is evidence that stock prices can seriously deviate from

their fair values.

Balance Sheet

Cash Flows

Solvency Ratio

FUNDAMENTAL ANALYSIS

TECHNICAL ANALYSIS

INVESTMENT ANALYSIS

Fundamental Analysis Technical Analysis

Traditional economic + Business

concepts = value of investment

Study of past market data such as

prices + volume = predict future

price movements (I.e.

stocks/markets)

Examination of the above variables

is called Valuation process

Proponents believe that the

market’s judgment of an issue’s

fundamentals are determined by

supply and demand variables that

are already reflected in prices.

Method of forecasting future price

movements of a security based on

political, environmental & other

factors

View from financial statements View from charts

Best employed for long term investing Best employed for short term trading

Data utilized come out periodically

Tends to focus on a specific sector

Data utilized come out daily

INVESTMENT ANALYSIS

Focused on what “must” happen Focused on what happens

Top Down Approach Bottom-up Approach

Considers condition affecting

Economy

Financial Markets

Industry

Company

VALUATION PROCESS

Works best in determining market

sentiment and factor it in the

creation of investment or trading

decisions

Works best if all investors are

logical and could separate emotions

from investment decision

Will succeed if the analyst finds

overlooked data in identifying

undervalued securities

VALUATION PROCESS

Technical

analysis is the

answer!?

Technical Analysis will

improve investing?

Make sensible investment

decisions

EXPECTATIONS

Should I buy today? What

will the prices be tomorrow,

next week or next year?

AIM TO REDUCE RISKS &

IMPROVE PROFITS

DON’T AIM TO PREDICT PRICES

CONSISTENTLY & ACCURATELY

DEFINITION

The study of prices, with charts as the

primary tool.

A method of evaluating securities by

analyzing statistics generated by market

activity, such as past prices and volume.

DEFINITION

Once viewed as arcane or mystical but

today it is part of every major investment

or trading decision.

Evolving quickly such that techniques

today may be rendered incomplete or

obsolete tomorrow.

Used as the basis for

automated trading.

ADVANTAGES

Portability

Price based trade or

investment planning

Does not require knowledge of many

mathematical formulas

DISADVANTAGES

May not be used to predict future price

action

Not easy to use with IPOs

May miss 20-25% of the movement

It has a tendency to create self fulfilling

prophecies

Subjectivity

A chart is a picture

A picture is worth a thousand words…

or probably a thousand dollars

Technical analysts

do not attempt to

measure a

security's intrinsic

value, but instead

use charts to

identify patterns

that can suggest

future activity.

Technical

analysts believe

that the historical

performance of

stocks and

markets are

indications of

future

performance.

Equally applicable on any security or tradable

financial instrument (stocks, bonds, commodities,

futures, indices, mutual fund, options)

In a shopping mall

Fundamental analyst: will

go to each store, study the

product and then decide

whether to buy it or not

Technical analyst: will

watch people go into the

stores. Decision would be

based on the patterns or

activity of people going into

each store.

HUMAN ELEMENT

Humans are not easily

quantifiable nor predictable

Many investment decisions are

based on irrelevant criteria

The price of a security is a

consensus of at least two humans

The price depends on human

expectations

HUMAN ELEMENT

The breadth of market participants guarantees

an element of unpredictability and excitement

Why Do Prices Fluctuate?

MARKET PSYCHOLOGY

Each investors would have his or her own opinion

about a certain security or any other object for that

matter

cellphone

MARKET PSYCHOLOGY

THE PRICE IS RIGHT GAME

Cellphone

Five years depreciated

MARKET PSYCHOLOGY

Cellphone

previously owned by Hayden Kho

MARKET PSYCHOLOGY

Designer shoes

MARKET PSYCHOLOGY

MY CHOICE GAME

Designer shoes

MARKET PSYCHOLOGY

MY CHOICE GAME

Designer shoes

MARKET PSYCHOLOGY

MY CHOICE GAME

Designer shoes

MARKET PSYCHOLOGY

MY CHOICE GAME

Designer bags

MARKET PSYCHOLOGY

MY CHOICE GAME

PRACTICAL MARKET PSYCHOLOGY

Logical: buyers want to buy at the lowest price

possible

Competitive: buyers raise their bids in order to attract

sellers

Emotional: buyers tend to be euphoric when price

increases

PRACTICAL MARKET PSYCHOLOGY

Logical: sellers want to sell at the highest price

possible

Competitive: sellers tend to lower their offer price in

order to attract buyers

Emotional: sellers tend to panic when price drops

MARKET CYCLE

More buyers compete to

attract sellers

High price will urge

sellers’ to cash-in

More sellers compete to

attract buyers

Panic sets in

Price becomes too

cheap to be ignored

by buyersNews of increasing price

spreads, price gains

momentum

Euphoria sets in

MARKET CYCLE

Distribution

1. The market discounts

everything

2. Price moves in trends

3. History tends to repeat itself

BASIC ASSUMPTIONS

Dow Jones Theory 1890

Basic Principles of Dow Theory:

1. Averages discount everything

2. Market trends [primary (tide), intermediate or

secondary (waves), tertiary (ripples)]

3. Bull and bear markets

4. Lines (tight sideways band)

5. Averages must confirm

6. A trend continues until it is reversed

7. Volume goes with trend

ORIGINS

EVOLUTION (WEST)

Elliot Wave 1938 Classical Charting

Dow Theory 1890s

EVOLUTION (EAST)

Japanese Charting 1800s

(Meiji Period)

Candlesticks

Equivolume

Kagi 1870s

Heikin-AshiIchimoku

ELLIOT WAVE

Ralph Nelson Elliot

The Wave Principle published

in 1938

Based on Fibonacci ratios

“golden ratio” = Nature's Law

— The Secret of the Universe

ELLIOT WAVE

Profit taking

Bargain hunting

More people join

Consolidation

New out

ELLIOT WAVE

Big move

Accumulation

Big move

Distribution Excess

Despair

ELLIOT WAVE

impulse

corrective

biggest wave

Top of wave 1

short or truncated

Below bottom of

wave 4

ELLIOT WAVE

The Elliott Wave Principle does not provide

certainty about any one market outcome.

Instead, it gives you an objective means of

determining the probability of a future

direction for the market.

CLASSICAL CHARTING

Chart Composition

Chart Types

Chart Trend Channels

Chart Patterns & Formations

Chart Indicators & Oscillators

Open - The first price traded for

the period. An important

consensus as all interested

parties were able to “sleep on it”.

High - The highest price traded

for the period. The point where

there were more sellers than

buyers.

Low - The lowest price traded for

the period. The point where there

were more buyers that sellers.

Close – The last price traded for the

period. Most often used price for analysis.

The relationship of the open and close

prices is considered most significant by

technicians.

CHART COMPOSITION

Price Fields

Volume – The number of shares

traded during the period.

Bid – The price a buyer is willing to

Ask – The price a seller is willing to

accept

CHART COMPOSITION

Price Fields

CHART COMPOSITION

Time lineP

X= time

Y= price

Arithmetic

(or Linear)

CHART COMPOSITION

Grid Scaling

Logarithmic

CHART COMPOSITION

Grid Scaling

Arithmetic Scaling Semi-log Scaling

CHART COMPOSITION

Grid Scaling

CHART TYPES

Line Chart

Pole Chart

CHART TYPES

Bar Chart

CHART TYPES

Bar Chart Plotting Exercise

CHART TYPESPCOR

OPEN HIGH LOW CLOSE

DAY 1 6.00 6.00 6.00 6.00

DAY 2 6.00 6.00 5.90 6.00

DAY 3 5.90 5.90 5.90 5.90

DAY 4 5.80 5.90 5.80 5.90

DAY 5 5.90 5.90 5.80 5.90

DAY 6 5.90 6.00 5.90 6.00

DAY 7 6.00 6.10 6.00 6.00

DAY 8 6.10 6.10 6.00 6.00

DAY 9 6.30 6.70 6.30 6.60

DAY 10 6.70 6.80 6.60 6.70

DAY 11 6.70 6.70 6.60 6.70

DAY 12 6.70 6.80 6.70 6.70

DAY 13 6.70 6.70 6.60 6.70

DAY 14 6.70 6.70 6.70 6.70

DAY 15 6.70 6.80 6.70 6.70

DAY 16 6.70 6.70 6.70 6.70

DAY 17 6.70 6.80 6.70 6.70

DAY 18 6.70 6.80 6.70 6.70

DAY 19 6.80 6.80 6.70 6.70

DAY 20 6.80 6.80 6.70 6.70

Bar Chart Plotting Exercise

CHART TYPES

Point & Figure Chart

CHART TYPES

Point & Figure Chart Plotting Exercise

CHART TYPESEDC

Point & Figure Chart Plotting Exercise

CHART TYPES

xxxxxxx

5.4 X X

5.3 X X O

5.2 O X O X O

5.1 O X

5.0 O X

Candlestick Chart

CHART TYPES

Candlestick Chart Plotting Exercise

CHART TYPESDAY 1 4.95 4.95 4.90 4.90

DAY2 4.95 5.00 4.80 4.80

DAY 3 4.85 5.10 4.85 5.00

DAY 4 5.10 5.20 5.00 5.20

DAY 5 5.20 5.30 5.10 5.20

DAY 6 5.20 5.40 5.20 5.30

DAY 7 5.30 5.50 5.30 5.40

DAY 8 5.20 5.40 5.20 5.40

DAY 9 5.40 5.50 5.30 5.40

DAY 10 5.50 5.50 5.30 5.40

DAY 11 5.30 5.60 5.30 5.60

DAY 12 5.30 5.40 5.20 5.20

DAY 13 5.10 5.30 5.10 5.20

DAY 14 5.00 5.30 4.95 5.20

DAY 15 5.50 5.60 5.40 5.40

DAY 16 5.20 5.20 5.00 5.10

DAY 17 4.95 5.00 4.90 4.95

DAY 18 4.90 5.00 4.90 4.95

DAY 19 4.80 4.85 4.80 4.80

DAY 20 4.90 4.95 4.80 4.85

Candlestick Chart Plotting Exercise

CHART TYPES

Equivolume Chart

volume

CHART TYPES

Heikin-Ashi (average bar) Chart

CHART TYPES

Modified Formula

xClose = (Open+High+Low+Close)/4

o Average price of the current bar

xOpen = [xOpen(Previous Bar) + Close(Previous

Bar)]/2

o Midpoint of the previous bar

xHigh = Max(High, xOpen, xClose)

o Highest value in the set

xLow = Min(Low, xOpen, xClose)

o Lowest value in the set

Heikin-Ashi (average bar) Chart

CHART TYPES

Candlestick converted to Heikin-Ashi

Anchor Chart

CHART TYPES

Kagi (Focus) Chart

CHART TYPES

Thick lines are drawn when

price breaks above

the previous high price

(>4%) and is interpreted as

an increase in demand

Thin lines are used

to represent increased

supply when the price falls

below (>4%) the previous

Renko (brick) Chart

CHART TYPES

Constructed by

placing a brick in

the next column

once the price

surpasses the top

or bottom of the

previous brick by a

predefined amount

CHART TRENDS CHANNELS & LINESPlotting Support & Resistance

CHART TRENDS CHANNELS & LINESEstablishing Trends (channels & range)

The more times a trend line is

tested, the more significant it

becomes

CHART TRENDS CHANNELS & LINESTrend Acceleration or Deceleration

Angle of trends:

Healthy

Overheated

CHART TRENDS CHANNELS & LINESWhen support is broken, it becomes the new

resistance

CHART TRENDS CHANNELS & LINESWhen resistance is broken,

it becomes the new support

CHART TRENDS CHANNELS & LINESIdentifying trends, breakouts & breakdowns

Trend Plotting Exercise

CHART TRENDS CHANNELS & LINESHistorical support and resistance

Historical Support & Resistance Plotting Exercise

CHART TRENDS CHANNELS & LINESRetracements & Reversals

Obtained by drawing a trendline between two extreme points and then dividing

the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8%

and 100%

CHART TRENDS CHANNELS & LINESRetracements & Reversals

Fibonacci Numbers

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc

Any given number is approximately 1.618 times the preceding

number

Each Fibonacci number is approximately 62% of the next higher

number. 38 is the inverse of 62

CHART TRENDS CHANNELS & LINESFanlines

Retracement & Reversal Plotting Exercise

CHART TRENDS CHANNELS & LINESArcs

Retracement & Reversal Plotting Exercise

CHART TRENDS CHANNELS & LINESPitch Forks

handle

tinesX

CHART PATTERNS & FORMATIONSReversal Patterns

Rounding Bottom

Saucer Top

Double Bottom

Double Top

Triple/multiple Bottom

Triple/multiple Top

Reverse Head &

Shoulders

Head & Shoulders

Spike Bottom

Spike Top

CHART PATTERNS & FORMATIONSContinuation Patterns

Rising Tops Falling Tops

CHART PATTERNS & FORMATIONSNeutral Patterns

Wedge/Symmetrical

Triangle

Usually

accompanied by

decreasing volume

CHART PATTERNS & FORMATIONSNeutral Patterns

Ascending & Descending

Triangles

Broadening (Megaphone)

Formation

Flags & pennants

CHART PATTERNS & FORMATIONSCandlestick Continuation Patterns

Three White Soldiers Three Black Crows

CHART PATTERNS & FORMATIONSCandlestick Reversal Patterns

Bullish Engulfing Bearish Engulfing

Bullish Harami Bearish Harami

Doji Star Dark Cloud Cover

CHART PATTERNS & FORMATIONSCandlestick Reversal Pattern

Morning Star

CHART PATTERNS & FORMATIONSCandlestick Nuetral Patterns

Sushi Roll

CHART PATTERNS & FORMATIONSContinuation & Exhaustion Gaps

Exhaustion gap

Runaway (or measuring) gaps

Breakaway gap

CHART PATTERNS & FORMATIONSContinuation & Exhaustion Gaps

Island Reversal

EXERCISE

VOLUME HISTOGRAMS

Volume spikes may indicate

large scale entry or exit of

VOLUME HISTOGRAMS

Steep price increases not

supported by volume are

usually dangerous

CHART INDICATORS & OSCILLATORS

Indicators are essentially calculations based on the price and the

volume of a security and measures factors such as money flow,

trends, volatility and momentum

Indicators are used as a measure to gain further insight into to

the supply and demand of securities

Also used to confirm price movement and the probability that the

given move will continue

Can also be used as a basis for trading as they can form buy-

and-sell signals

Oscillators = indicators that are plotted within a bounded range

fluctuate into overbought and oversold conditions based on set

levels based on the specific oscillator usually 30 and 70

Leading Lagging

Predictive, strongest during

periods of sideways or non-

trending trading ranges

Users need to be careful to make

sure the indicator is heading in

the same direction as the trend

Many buy and sell signals that

make it better for choppy non-

trending markets

Confirmatory, more useful

during trending periods

Better to have less entry and

exit points

Usually gives late entry and

exit points

Leading indicators are those created to proceed the price

movements of a security giving predictive qualities.

Two of the most well-known leading indicators are the Relative

Strength Index (RSI) and the Stochastics Oscillator

The Stochastic Oscillator compares where a security’s price

closed relative to its price range over a given time period.

Graphic Representation

%K Line = main line (solid line)

%D Line = moving average of %K Line (dotted line)

Variables

• %K Periods = time period used in calculation

• %D Periods = time period used in calculating moving average

CHART INDICATORS & OSCILLATORSStochastic Oscillator

Today’s Close - Lowest Low in %K Periods

Highest High in %K Periods - Lowest Low in %K Periods

41 - 38

46 - 38x 10037.5 =

Interpretation:

• Buy when %K or %D lines fall below oversold level

• Sell when %K or %D lines rise above overbought level

• Buy when %K line rises above %D line

• Sell when %K line falls below %D line

• Look for divergences

Negative divergence

Positive divergence

Lagging indicators are those that follows price movements and

have less predictive qualities

Well-known lagging indicators are the moving averages, Bollinger

bands and MACD

Useful during trending periods but not during non-trending

periods

Tend to focus more on the trend and produce fewer buy-and-sell

signals

This indicator is comprised of two moving averages, which help to

measure momentum in the security

MACD = shorter term moving average - longer term moving average

Signal line = 9-day exponential moving average

Indicators are used to form buy and sell signals are through

crossovers and divergence

Indicators are also used through divergence, which occurs when

the direction of the price trend and the direction of the indicator

trend are moving in the opposite direction

Two types of divergence - positive and negative. Positive

divergence occurs when the indicator is trending upward while

the security is trending downward

When to use what

indicator/oscillator?

Study the Directional

Movement Indicator

1978 J. Welles Wilder

Measures the strength of

a prevailing trend or

whether movement

exists in the market

+ DI; - DI; 14 ADX

trading days

Monetary Indicators - provide insights on external monetary

conditions affecting a security’s price. These basically deal with

economic information such as interest rates, money supply,

corporate debt, inflation, GNP, GDP etc. tells us what security

prices should do.

Sentiment Indicators - are studies on investor expectations

based on price. In large markets, studies may be done on odd lot

boards, the number of call/put ratios, premium on stock index

futures, bull/bear ratio. Tells us what investors expect prices to

Momentum Indicators - are deeper studies on price such as

price/volume indicators, breadth index.Tells us what prices are

actually doing.

BLENDING TECHNICAL & FUNDAMENTAL

ANALYSIS (also INTERMARKET ANALYSIS)

• TA may confirm a FA finding

• FA is useful in identifying which security to invest in

• TA is useful for timing the investment

• Volume trends give additional insights to your research

• Tracking short term movements

• Tracking reactions over time

DISADVANTAGES OF BLENDING

It's History!

A simple chart cannot provide the investor with crucial long-

term fundamental information such as the future direction of

cash flows or earnings per share.

The Crowd is Sometimes Wrong

It is possible that a stock that's being accumulated en masse this

week may be under heavy distribution the next. Conversely,

stocks that are being heavily sold this week may be under

accumulation in the weeks to come.

Charts Don't Typically or Consistently Forecast Macro Trends

Charts also are generally unable to accurately forecast

macroeconomic trends.

Example, it is nearly impossible to look at a major player in the

oil and gas sector and decipher definitively whether OPEC

intends to increase the amount of oil it pumps, or whether a fire

that just started at a shipping facility in Venezuela will affect

near-term supplies.

There is Subjectivity

When it comes to reading a chart, a certain amount of subjectivity

comes into play. Some may see a chart and feel that a stock is

basing, while another person might see it and conclude that there

is still more downside to be had.

EXAMPLES OF BLENDING

IMPROVED TRADING/INVESTING

Creating a System

• Information reaches you

• Check fundamentals of the security

• Look at the chart, start with the big picture

• Try to relate known incidents w/ price action

• Make references for current prices vs historical price

• Zoom in to current price performance

• Identify trends, patterns currently affecting price movement

• Check volume histogram & choice indicator/s

• Compute risk vs. reward

•Draw a strategy: how much to invest & when to enter/exit

• Manage your strategy

TECHNICAL REPORTING

THE TECHNICAL JABBER

HEADER:

.Name of Stock

.Type of Chart (line, bar, candlestick, equivolume, etc.)

.Indicators/oscillators used (stochastics, SMA, EMA, RSI, MACD)

.Volume window (simple or with histogram)

Optional:

.Overlays

.Author

CHART IMAGE (Single, double or triple window)

SUMMARY RECOMMENDATION: (hard or soft buy, sell, hold, combination,

other strategies)

TECHNICAL REPORTING

Big Picture

.Historical overview (general observation)

.Study of major trends

.Study of fan lines and retracements

.Study of patterns

.Study of volume

.Study of indicators/oscillators (positive or negative convergence,

divergence, overbought or oversold levels, positions,

configurations)

TECHNICAL REPORTING

Close up

.Current trend

.Confirmatory or predictive configurations

Prognosis

.Possible scenarios (probable, adverse)

.Strategic recommendations (medium to long term activity)

.Tactical recommendations (short to medium term activity)

.Accumulation or distribution points

SOURCES OF CHARTS IN THE

PHILIPPINES:

• The PSE Website: www.pse.com.ph

• Bloomberg/Thomson Reuters

•Technistock & other vendors

• Trading participants/ Brokers

• Other charting software

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