1. Technical Analysis of Equity Markets:
Fact or Fiction?
Prepared by:
Allen D. Hahn, CFA, CMT
November 16, 2016
Discussion Topics
What is Technical
Analysis (TA)?
Basic Tenets of TA
A focus on price
Tools from the TA
Toolbox
Questions
2. 2
What is Technical Analysis?
TA is oldest
approach to the study
of markets
Since TA is the
study of price and
volume, techniques of
analysis can be
applied to many
different types of
markets
A method for predicting the future direction of security
prices based on the study of two parameters:
1. Price History
2. Volume
3. 3
Why is Price Important in Technical
Analysis (TA)?
TA analyzes price
because that is end
result of supply and
demand forces.
Prices are readily
available, extremely
accurate, have
historical record and
are specific.
May produce
insight into the
psychological
dimensions of the
market
• Imagine ignoring all
fundamental events
and allow the market to
evaluate current and
future information
• The price level
summarizes the
conclusions of all
market participants
FEAR and GREED
4. Three (3) Basic Tenets Behind
Technical Analysis
The Market Discounts Everything
Prices Move in Trends
Human behavior/psychology is repetitive
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5. Tenet 1: The Market Discounts Everything
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The current price
fully reflects all
information: supply
vs. demand
fundamental, political
and psychological
factors
Reaction to new
information by
investors is not
random;
6. Tenet 2: Prices have a “Memory”
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Share prices
exhibit serial
dependencies: the
price of a stock today
has an impact on its
likely price tomorrow
A trend in motion
is more likely to
continue than reverse
Trends of different
time intervals tend to
have the same
characteristics:
movements in the
opposite direction
7. Tenet 3: History tends to Repeat
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Distinctive patterns
of price behavior are
found at every degree
of trend; human
behavior/psychology
is repetitive.
History never
repeats itself exactly;
rather, it tends to
rhyme….
8. The Cornerstone of TA: Price Movement
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When opening price
is lower (higher) than
closing price, buying
(selling) enthusiasm
was high
How high and low
intra period prices
relate to the opening
and closing price
provides insight to the
“mood” of the market
A “bar” represents price
movement during a unit of
time, e.g. minute, hour, day,
week, month…
Each price bar is composed of
4 elements:
Open
High (intra)
Low (intra)
Close
The price bar “body” is green
(empty) for up periods, and red
(filled) for down periods.
9. Interpretation of Price Movement
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Characteristics:
body at upper end of
range; shadow or wick
should be 2x length of
body; little or no upper
shadow
Price movement:
supply overwhelmed
demand at the
beginning of the period
but attracted buyers for
the remainder
Interpretation: The
market is “hammering
out a base; often
marks a change in the
market’s mood from
bearish to bullish
10. Recording Price Movement Through
Time: The Chart
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Line Charts Bar Charts
OHLC (American Candlestick) Japanese Candlestick
11. Tools from the TA Toolbox
Trend lines
Moving Averages
Price Patterns
Indicators
Cycles
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12. The TA Toolbox: Trendlines
12
Advancing wave of
price produces ripples
in opposite direction,
bottoms tend to form an
upward slanting line –
the primary trendline
A parallel “return
line” will often form at
the tops of intermediate
price advances
“Touches”
determine strength;
breakdowns signal
potential change in
supply/demand
13. TA Toolbox: Support and Resistance
Trendlines
13
Support and
resistance mark the
end of trends and
bound consolidation
ranges
Resistance
(support) indicates
overwhelming supply
(demand) or the
exhaustion of buyers
(sellers)
What was support
becomes resistance,
and vice-versa
When price trends
sideways, support and
resistance trendlines
are often used as
buy/sell signals.
14. The TA Toolbox: Moving Averages
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Moving averages
smooth out shorter
term fluctuations in
price movement
making the true
underlying trend
easier to evaluate
Because a moving
average is based on N
past prices, there is a
lag in signaling a
change in trend
Moving averages
are used to determine
trend; support and
resistance; price
extremes and generate
buy/sell signals
Buy
Sell
20 Day SMA
50 Day SMA
15. TA Toolbox: Price Patterns
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There are many
repetitive price
patterns in the
historical time series
of stock prices
Patterns believed to
be result of human
behavior
Valid patterns
provide information
regarding the size of
subsequent price
moves
16. 16
“Perception and Paradigm”
Pattern Recognition: Do You
See What I See?
EMH posits these
patterns are illusions;
can often be found in
a randomly generated
price series
Randomness of
stock prices is a valid
question; no longer a
dogmatic assumption
Behavioral Finance
has shown that
humans have a desire
to develop predictive
relationships from
past experience
17. TA Toolbox: Price Indicators
17
Hundreds of
technical indicators
used to generate buy
and sell signals
Computer
technology increased
ability to calculate
complex indicators;
less emphasis on price
pattern analysis
The MACD is
useful in trending
markets
18. TA Toolbox: Cycle Analysis
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Cycles are periodic
events or extremes
that can be measured
in time but necessarily
amplitude
Examples of cycles
exist everywhere at all
intervals of time
An identified cycle
tends to be a fraction
of a larger or a
multiple of a smaller
cycle
Cycles analysis in
stock prices is
controversial: (1)
mathematics (2) root
cause
Cycles are
ephemeral and have
great variability
19. Career Advice for a Technical
Research Analyst
Strong Quantitative Skills
Statistics
Mathematics
Economics
Strong Communication Skills
Written – research reports
Verbal – presentations/clients
People Oriented
Companies with an Investment Focus
Find a Strong Mentor
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21. One Last Observation...
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One of the funny things about the stock market
is that every time one man buys, another sells,
and both think they are astute..
– William Feather
