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  1. 1. On technical analysis
  2. 2. Technical analysis: The concept <ul><li>Technical analysts believe that , in the long run, prices move towards their fundamentals. </li></ul><ul><li>The flow of information is random, however, the market is slow to respond, thus, generating recurring patterns. </li></ul><ul><li>It pays to exploit these patterns before others can identify them, provided we can recognize them as they emerge. </li></ul><ul><li>Recurring patterns tend to self-destruct. </li></ul>
  3. 3. Technical analysis: Classification <ul><li>Charting </li></ul><ul><li>Sentiment Indicators </li></ul><ul><li>Flow of Funds Indicators </li></ul><ul><li>Market Structure Indicators </li></ul><ul><li>Miscellaneous </li></ul>
  4. 4. Charting <ul><li>The Dow Theory: </li></ul><ul><li>Primary trends, intermediate trends, minor trends, support levels, and resistance levels are analyzed to produce buy or sell signals. </li></ul>
  5. 5. The wisdom behind the Dow Theory <ul><li>On January 31st,1901 Charles H. Dow wrote in the Wall Street Journal: </li></ul><ul><li>&quot;A person watching the tide coming in and who wishes to know the exact spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position where the waves do not come up to it, and finally recede enough to show that the tide has turned. </li></ul><ul><li>This method holds good in watching and determining the flood tide of the stock market.&quot; </li></ul>
  6. 6. The Six Commandments <ul><li>1. The Averages Discount Everything. </li></ul><ul><li>An individual stock's price reflects everything that is known about the security </li></ul><ul><li>2. The Market Is Comprised of Three Trends: Primary trend, Secondary trends, and Minor trends. </li></ul><ul><li>3. Primary Trends Have Three Phases. </li></ul><ul><li>The First phase is made up of aggressive buying by informed investors in anticipation of economic recovery and long-term growth. </li></ul><ul><li>The Second phase is characterized by increasing corporate earnings and improved economic conditions </li></ul><ul><li>The Third phase is characterized by record corporate earnings and peak economic conditions </li></ul><ul><li>4. The Averages Must Confirm Each Other. </li></ul><ul><li>Ex: The Industrials and Transports must confirm each other in order for a valid change of trend to occur. </li></ul><ul><li>5. The Volume Confirms the Trend. </li></ul><ul><li>6. A Trend Remains Intact Until It Gives a Definite Reversal Signal. </li></ul>Source:
  7. 7. A classic buy signal <ul><li>Follow the movements of a stock or market index </li></ul>4. Break up (above the bounce high) 3. Pullback 2. Bounce 1. Market low
  8. 8. Buy signals: Variations Follow the movements of a stock or market index 4. Break up (above the bounce high) 3. Pullback 2. Bounce 1. Market low
  9. 9. A classic sell signal Follow the movements of a stock or market index 4. Break down 3. Bounce 2. Pullback 1. Market high
  10. 10. Sell signals: Variations Follow the movements of a stock or market index 4. Break down 3. Bounce 2. Pullback 1. Market high
  11. 11. The Dow Theory: Support and Resistance <ul><li>“ Think of security prices as the result of a head-to-head battle between a bull (the buyer) and a bear (the seller). </li></ul><ul><li>The bulls push prices higher and the bears push prices lower. </li></ul><ul><li>The direction prices actually move reveals who is winning the battle.” </li></ul><ul><li>Source: </li></ul>
  12. 12. More on “support” and “resistance” levels... Source:
  13. 13. More on “support” and “resistance” levels...
  14. 14. Japanese candlesticks: Bullish signals Bullish doji star Morning star Bullish engulfing lines Piercing line Hammer Long white (empty) line
  15. 15. Japanese candlesticks: Bearish signals Hanging Man Dark cloud cover Bearish engulfing lines Long black (filled-in) line Evening star Shooting star
  16. 16. Voo-doo investing
  17. 17. Sentiment Indicators <ul><li>Trin </li></ul><ul><li>Trin = Vol(declining)/Vol(advancing)][Number(declining)/Number(advancing)] </li></ul><ul><li>If 1 market is bearish (reported in the Wall Street Journal) </li></ul><ul><li>Odd-lot ratio </li></ul><ul><li>odd-lot-ratio = odd-lot buys/odd-lot sales </li></ul><ul><li>Odd-lot traders are believed to miss key market turning points; hence when they buy it is likely that the bull market has already missed its course. </li></ul><ul><li>A ratio > 1 is a bearish signal. (reported in the Wall-Street Journal) </li></ul><ul><li>Barron's Confidence Index </li></ul><ul><li>BCI= avg yield on high grade bonds/avg. yield on top ten intermediate grade bonds; </li></ul><ul><li>An increase in the index signals a bull market, a decrease of the index signals a bear market; The index is always less than one </li></ul><ul><li>Put/Call ratio </li></ul><ul><li>PCR= outstanding put options/outstanding call options </li></ul><ul><li>A ratio over one signals a bearish market </li></ul><ul><li>Mutual fund cash positions </li></ul><ul><li>Measure the sentiment among investors who are believed to be poor market timers. </li></ul><ul><li>An increase in these cash positions shows the funds concerned about falling markets, hence, sending a bullish signal. </li></ul>
  18. 18. Flow of Funds Indicators <ul><li>Short Interest could be an indicator of future latent demand for stock, or it could signal &quot;informed&quot; selling by institutional investors. </li></ul>
  19. 19. Market Structure Indicators <ul><li>Moving averages </li></ul><ul><li>They signal a bear market when they go above current market prices, or a bull market when going below current market prices. </li></ul><ul><li>Market breadth </li></ul><ul><li>It measures the extent to which movements in the market index is representative of the individual stock price movements. </li></ul><ul><li>MB = Number of advancing - Number of declining. </li></ul><ul><li>Relative strength </li></ul><ul><li>It measures the extent to which a security has outperformed its industry or the market. </li></ul>
  20. 20. Miscellaneous <ul><li>The Superbowl Rule : </li></ul><ul><li>In a year that an original NFL team wins the Superbowl the mrket is likely to rise for the rest of the year. The opposite is true when a AFC team wins the Superbowl. </li></ul><ul><li>The Presidential Cycle Rule : </li></ul><ul><li>In the second year of the presidential term, the market is likely to fall, and in the third year it is likely to rise. </li></ul><ul><li>The Hemline Indicator : </li></ul><ul><li>The market index tends to rise and descend with the hemline of women's dresses. </li></ul><ul><li>Etc. </li></ul>
  21. 21. The Value Line Enigma <ul><li>Each week, Value Line Investment Survey reviews almost 1,700 traded companies. </li></ul><ul><li>Stocks are ranked into five groups, according to their expected price appreciation: </li></ul><ul><li>group 1: the best expected performers </li></ul><ul><li>group 5: the worst expected performers </li></ul><ul><li>The ranking is done with a use of a formula that takes into account: </li></ul><ul><li>Earnings momentum </li></ul><ul><li>Stock's relative price </li></ul><ul><li>Relative strength </li></ul>
  22. 22. The Value Line Enigma: The Devil is in the details <ul><li>Between 1965 and 1990, the groups performed as predicted. </li></ul><ul><li>The average annual return of group 1 stocks was 22%. </li></ul>1965 1990 Initial investment: $10,000 $1,500,000 (dividends and transaction costs excluded).
  23. 23. The Value Line Enigma: The Devil is in the details <ul><li>The Value Line Centurion Fund which manages a portfolio made of group 1 stocks has underperformed group 1 by 1,100 bp ! </li></ul>
  24. 24. The Value Line Enigma: Possible reasons for underperformance <ul><li>High turnover = high transaction costs (the portfolio has to be rebalanced every week): </li></ul><ul><li>- bid-ask spread </li></ul><ul><li>- brokerage fees </li></ul><ul><li>Fund overhead </li></ul><ul><li>However, ( transaction costs + fund overhead ) don’t add up to the difference   </li></ul>
  25. 25. The Value Line Enigma: More on possible reasons for underperformance <ul><li>Measuring performance against prediction assumes the stock is purchased on Wednesday at close, yet the fund re-balances the portfolio on Friday and the readers read the survey on Friday morning . </li></ul>Group 1 is being re-evaluated The bulk of the price increase in group 1 stocks takes place between Thursday and Friday. The survey reaches the public The VL Centurion Fund rebalances its portfolio Group 1 is being re-evaluated The survey reaches the public The VL Centurion Fund rebalances its portfolio Wed Thu Fri Sat Sun Mo Tue Wed Thu Fri Group 1 stock stock price Group 1 stock stock price
  26. 26. More on possible reasons for underperformance <ul><li>The US Postal Service could be moving fast in some parts of the country; hence some readers might get their subscription on Thursday. </li></ul><ul><li>Smart investors anticipate the change in ranking in advance. They know the formula and watch closely group 2 stocks. If earning reports come in better than expected, some of them will move up. </li></ul><ul><li>On Friday morning, everyone will want to buy into the same stocks, thus pushing the price very high. </li></ul>
  27. 27. A dramatization <ul><li>A stock sells for $ 10 on Wednesday at close. </li></ul><ul><li>Value Line forecasts it will rise in value over the next weeks or so. </li></ul><ul><li>However, the information does not reach the market effectively until Friday morning. </li></ul><ul><li>At the opening bell, there are hundreds of buy orders for that stock. </li></ul><ul><li>As a result, the stock goes to $ 14.  </li></ul>
  28. 28. Visualization Wed Thu Fri Sat $10 $14 The survey reaches the public Some early birds figure out group 1
  29. 29. A dramatization: Summary <ul><li>Did the stock rise as predicted?  Yes, one-week return = 40% </li></ul><ul><li>Did investors make a good return? No, the majority of them bought at $ 14, (minus transaction costs) Some early birds made a return of 27% (minus transaction costs) </li></ul>
  30. 30. Etc. To learn more: [[]]