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Book Notes - Technical Analysis

Book Notes - Technical Analysis - TECHNICAL ANALYSIS...

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Unformatted text preview: TECHNICAL ANALYSIS PART ONE: 1. Technical Analysis a. History i. Def: Study of prices to make better investments – primary tool charts ii. Stem from Dow Theory (Charles Dow) b. Human Element i. Price of a security – price at which a person buys and another sells ii. Depends on human expectations – unpredictable c. Fundamental Analysis i. Def: Determination of price based on future earnings ii. efficient market theory – a security’s price represents everything known at that moment in time – impossible to forecast prices d. Future found in the Past i. Big variable in security’s price is the premium or discount investors add to the correct price ii. Technical analysis analyzes the past security’s prices to determine future prices e. Weatherman  ­ Current and historical price action is needed f. Computerized Trading – MetaStock 2. Price Fields – technical analysis depends on analysis of price and volume a. Open = price of first trade for period b. High = highest price security was traded during period c. Low = lowest price traded d. Close = last price traded (relationship between open and close in candlestick charts) e. Volume = number of shares (contracts) traded during the period f. Open interest = # of outstanding contracts of a future or option (used as indicator) i. Open contract – has not been exercised, closed out, or expired ii. Open interest increases when new contract (buyer initiates long, seller short) iii. Open interest decreases when liquidate contracts (buyer sells long, seller short) iv. Open interest shows the liquidity of a contract or market v. Rising volume and rising open interest confirm direction of current trend vi. Falling volume and falling open interest signal end of trend g. Bid = price willing to pay h. Ask = price willing to accept 3. Charts – foundation of technical analysis a. Line charts – simple, uncluttered, clear, displays closing prices b. Bar charts – displays open, high, low, ad closing prices – most popular c. Linear scaling – arithmetic d. Semi ­log scaling – logarithmic or ratio scaling e. Volume bar chart – zero ­based (bottom is at zero) vs relative ­adjusted (see changes) 4. Periodicity – basic price movement is the same regardless of the period a. Shorter periodicities – harder to predict and make decisions 5. Time Element 6. Support and Resistance a. Bull (buyer) and bear (seller) – bull pushes prices higher and bears push prices lower b. c. d. e. f. g. h. TECHNICAL ANALYSIS Support – price falls to a level, then stops because buyer begin to buy (buyer control) i. Investor Belief price level will go higher Resistance – sellers take control and prevent prices form going higher i. Investor Belief price levels will fall Trade price – where bull and bear agree Investor expectations can change abruptly Like Supply and demand Trader’s Remorse i. Prices temporarily return to a support/resistance level following a price breakout ii. Bull trap (false breakout) – think price high, then buy, but price then falls iii. Bear trap (sell short) iv. Quantify price breakouts by change in volume 1. If prices break with high volume – expectations will hold 2. If prices break with moderate volume – return to original expec. Resistance becomes Support i. When resistance level is successfully penetrated, that level usually becomes a new support level ii. Phenomenon is extremely common Summary 1. Security price = agreement of buyers (bulls) and sellers )bears) 2. Price changes result from changes in investor expec. of security’s future price 3. Support level – prices do not go lower 4. Resistance level – prices do not go higher 5. Penetration indicates changes in expec. and shift on supply/demand 6. Volume useful for determining real strength of the change in expec. 7. Trader’s remorse follows the penetration as prices move back to original levels 8. Once penetrated – support levels become resistance levels and vice versa 7. Trends a. Def: represents a consistent change in prices, represent change b. Support/resistance levels represent barriers to change c. Rising trend – higher low prices – rising support – bull control d. Falling trend – lower high prices – falling resistance – bear control 8. Moving Averages – oldest and most popular tool a. Def: average price of a security at a given time (need to know “n” time periods) b. Price > moving average – investors are bullish (buy) c. Price < moving average – investors are bearish (sell) d. Higher profits in shorter moving averages e. Merits: always on the right track of the market f. Disadvantage: always buy and sell late 9. Indicators a. Def: mathematical calculation that is applied to a security’s price and volume levels TECHNICAL ANALYSIS b. Result is used to anticipate changes c. Moving average is an example d. MACD (moving average convergence divergence) i. = (12 day m.a. of price) – (26 day m.a. of price) ii. Result oscillates above and below zero iii. >0 – 12 day > 26 day – bullish shift iv. Signal/trigger line – convergence of the 2 averages e. Lagging indicator – moving averages and MACD – buy and sell late, less profit, but right side of the market f. Leading indicator – profit by predicting what prices will do next – increased risk g. Trending prices – prices move strongly in one direction – use lagging indic. h. Trading prices – moving sideways – use leading indic. i. Divergence – trend of security price does not agree with trend of indicator 10. Market Indicators a. They gauge the entire market, not just a security b. Typically analyze stocks c. Contain more info. than just price and volume d. Categories i. Monetary – concentrate on economic data (interest rates, MS, inflation) ii. Sentiment – focus on investor expectations iii. Momentum – show what prices are doing (m.a. , MACD) 11. Line Studies – lines drawn on top of a security’s price and or indicator 12. Sample approach a. Determine overall market condition (interest rate, NYSE, investor sentiment) b. Pick the securities c. Determine overall trend of security d. Pick your entry points Elliot Wave (Ralph Nelson Elliott) • Movement of the stock market can be predicted by observing and identifying a repetitive pattern of waves • Influences all human activities • Concepts 1. Action is followed by reaction 2. 5 waves in the direction of the main trend followed by 3 corrective waves (5 ­3 move) 3. 5 ­3 move completes a cycle and becomes 2 subdivision of the next higher 5 ­3 move 4. 5 ­3 pattern remains constant even though time span varies • Grand Supercycle – longest wave count • Practitioners use wave count and Fibonacci numbers to predict time span and magnitude of future market moves • Difficult to find accurate wave count Japanese candlesticks • Method of technical analysis to analyze price of rice contracts • Shows the open, high, low, and closing prices ...
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