chapter eight beyond fundamental analysis © 2001 south-western college publishing
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CHAPTER EIGHT
BEYOND FUNDAMENTAL ANALYSIS
© 2001 South-Western College Publishing
2
Outline
Charting The Underlying Logic Types of Charts Other Chart Annotations
Technical Indicators Indicators with Economic Justification Indicators of the Witchcraft Variety
3
Outline
Old Puzzles and New Developments Fibonacci Numbers Dow Theory Kondratev Wave Theory Chaos Theory Neural Networks
The Future of Technical Analysis
4
Charting: The Underlying Logic
The technical analyst believesthat charts can be used to predict changes in supply and demand and investor behavior.
Market participants seldom waitfor things to completely unfold. They try to anticipate events rather than merely react to them.
5
Charting: Types of Charts
Linear Scale Line Chart
Sto
ck P
rice
Time
6
Charting: Types of Charts
Logarithmic Y-Axis Line Chart
Sto
ck P
rice
Time
7
Charting: Types of Charts
Bar Chart
Sto
ck P
rice
Time
8
Charting: Types of Charts
Point and Figure Chart
Sto
ck P
rice
Irregular Time Intervals
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Charting: Types of Charts
Candlestick Chart
Sto
ck P
rice
Time
close
close
open
open
10
Charting: Other Chart Annotations
support level
resistance level
congestion area
breakout
Chartists believe investors remember missed opportunities and look for them to return.
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Charting: Other Chart Annotations
Potential Supply and Demand
Sto
ck P
rice
Time
PotentialSupply
A
B
C
D
PotentialDemand
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Technical Indicators
These statistics, either calculated or directly observed, are alleged to have a relationship with the future direction of the overall stock market or with an individual security.
Indicators with economic justification are based on economic activities that are measurable and observable.
Indicators of the witchcraft variety have no logical connections between the measurements and what the measurements purport to show.
13
Indicators with Economic Justification
The higher the short interest figure, the larger is the potential demand for the shares.
Increased margin buying has historically beenassociated with rising markets.
Cash held by mutual funds represents potential demand for stock.
When the confidence index gets closer to 1.0,investors are more likely to be bullish about the economy, and therefore about corporate earnings.
14
Indicators with Economic Justification
An advance-decline line is a graphical representation of the net advances over a period of time.
A high relative strength ratio, such as a highrelative PE, means that investors are willing to pay more for the past earnings of a company than average.
Advocates of moving averages in stock selection believe that changes in the slope of the line are important.
15
Indicators of the Witchcraft Variety
The super bowl indicator states that the stock market will advance the following year if the super bowl football game is won by a team from the original National Football League.
Increased sunspot activity every eleven yearsleads to better weather for an improved harvest, leading in turn to a stronger economy, and finally to higher stock prices.
Hemline indicator : As shorter dresses for women become the fashion, the market advances, and vice versa.
16
Old Puzzles and New Developments
Fibonacci numbers occur frequently and inexplicably in nature.
1.618, the golden mean of the numbers,is used to calculate the Fibonacci ratios.
Many Fibonacci advocates in the investment business use the first two ratios, 0.382 and 0.618, to “compute the retracement levels of a previous move.”
Fibonacci Numbers
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, ...
Old Puzzles and New Developments
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Dow TheoryD
ow
Jo
ne
s In
du
stri
al A
vera
ge
Time
SecondaryTrend
(waves)
Meaningless Daily Fluctuations (ripples)
Primary Trend(tides)
18
Old Puzzles and New Developments
Kondratiev wave theory states there is a 50-60 year business cycle.
Chaos theory sees systematic behavioramidst apparent randomness.
A neural network is a trading system in which a forecasting model is trained to find a desired output from past trading data.
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The Future of Technical Analysis
Technical analysis has persisted for more than 100 years, and it is not likely to disappear from the investment scene anytime soon.
Improved quantitative methods coupled with improved behavioral research will continue to generate ideas for analysts to test.
20
Review
Charting The Underlying Logic Types of Charts Other Chart Annotations
Technical Indicators Indicators with Economic Justification Indicators of the Witchcraft Variety
21
Review
Old Puzzles and New Developments Fibonacci Numbers Dow Theory Kondratev Wave Theory Chaos Theory Neural Networks
The Future of Technical Analysis