Vietnam’s One-stop Financial PortalYour Comprehensive Guideto Financial Charts andTechnical Analysis ofthe Stock Markets  ...
About Stox.vnStox.vn is a trademark of StoxPlus, a financial media company providing a complete suite of financialinformat...
Table of Contents:Part    Contents                                                                                      Pa...
Part 1- OverviewVolume 1/3   Your Guide • Financial Charts • Technical analysis • Page 5
OverviewWhat is Technical Analysis?Technical Analysis is the forecasting of future financial price movements based on an e...
Why Analyze Securities?Security Analysis - Does it Matter?Wall Street has scores of analysts, strategists and portfolio ma...
Aswath Damara, of the Stern Business School at New York University, defines an efficient marketas one in which the market ...
Which Form Exists in the Market Today?Many in academia, including Gordon Gemmill of the University of Warwick and Aswath D...
•   After reporting earnings that were below expectations on 15-Feb, Ascribe and Fitch fell from    24 to 15.Even though t...
What is Technical Analysis?Technical Analysis is the forecasting of future financial price movements based on an examinati...
Technical analysis is applicable to stocks, indices, commodities, futures or any tradable instrumentwhere the price is inf...
Prices Movements are not Totally RandomMost technicians agree that prices trend. However, most technicians also acknowledg...
General Steps to Technical EvaluationMany technicians employ a top-down approach that begins with broad-based macro analys...
Chart AnalysisTechnical analysis can be as complex or as simple as you want it. The example below representsa simplified v...
Momentum: Momentum is usually measured with an oscillator such as MACD. If MACD is aboveits 9-day EMA (exponential moving ...
The annotated example above shows a stock that opened with a gap up. Before the open, thenumber of buy orders exceeded the...
Assist with Entry PointTechnical analysis can help with timing a proper entry point. Some analysts use fundamentalanalysis...
ConclusionsTechnical analysts consider the market to be 80% psychological and 20% logical. Fundamentalanalysts consider th...
What is Fundamental Analysis?Fundamental analysis is the examination of the underlying forces that affect the well being o...
Group SelectionIf the prognosis is for an expanding economy, then certain groups are likely to benefit more thanothers. An...
Narrow Within the GroupOnce the industry group is chosen, an investor would need to narrow the list of companies beforepro...
Financial AnalysisThe final step to this analysis process would be to take apart the financial statements and come upwith ...
This methodology assumes that a company will sell at a specific multiple of its earnings, revenuesor growth. An investor m...
Weaknesses of Fundamental AnalysisTime ConstraintsFundamental analysis may offer excellent insights, but it can be extraor...
Analyst BiasThe majority of the information that goes into the analysis comes from the company itself.Companies employ inv...
Random Walk TheoryRandom Walk Theory - Describes the Random Walk Theory of financial markets which is at oddswith both Tec...
Should Random Walkers Take a Hike?While there are some good points to be gleaned from the random walk theory, it appears t...
The New York Times on 6-Sept-98, notes a study that was published in the Journal of Finance byStephen Brown of New York Un...
Financial markets are predictable to some degree, but far from being a symptom of inefficiency orirrationality, predictabi...
Part 2- Chart AnalysisVolume 1/3   Your Guide • Financial Charts • Technical analysis • Page 31
Chart AnalysisThis section describes the various kinds of financial charts. There are articles that describe howthe charts...
What Are Charts?A price chart is a sequence of prices plotted over a specific time frame. In statistical terms, chartsare ...
How to Pick a Time FrameThe time frame used for forming a chart depends on the compression of the data: intraday, daily,we...
Daily data is made up of intraday data that has been compressed to show each day as a singledata point, or period. Weekly ...
How Are Charts Formed?We will be explaining the construction of line, bar, candlestick and point & figure charts. Although...
Bar ChartPerhaps the most popular charting method is the bar chart. The high, low and close are required toform the price ...
Bar charts can be effective for displaying a large amount of data. Using candlesticks, 200 datapoints can take up a lot of...
Point & Figure ChartThe charting methods shown above, all, plot one data point for each period of time. No matter howmuch ...
Price ScalingThere are two methods for displaying the price scale along the y-axis: arithmetic and logarithmic.An arithmet...
The chart above uses the 4th-Quarter performance of VeriSign to illustrate the difference in scaling.On the semi-log scale...
Support and ResistanceSupport and resistance represent key junctures where the forces of supply and demand meet. Inthe fin...
Where Is Support Established?Support levels are usually below the current price, but it is not uncommon for a security to ...
Where Is Resistance Established?Resistance levels are usually above the current price, but it is not uncommon for a securi...
Support Equals ResistanceAnother principle of technical analysis stipulates that support can turn into resistance and visa...
Where does this overhead supply come from? Demand was obviously increasing around 18 fromOct-98 to Mar-99 (green oval). Th...
In Nov/Dec-99, Lucent Technologies (LU) formed a trading range that resembled a head andshoulders pattern (red oval). When...
Returning to the analysis of Halliburton (HAL) , we can see that the November high of the tradingrange (33 to 44) extended...
Trend LinesTechnical analysis is built on the assumption that prices trend. Trend Lines are an important tool intechnical ...
Downtrend LineA downtrend line has a negative slope and is formed by connecting two or more high points. Thesecond high mu...
In the case of EMC , there was a large price change over a long period of time. While there werenot any false breaks below...
In the case of Amazon.com (AMZN) , there were two false breaks above the downtrend line asthe stock declined during 2000 a...
The chart of Microsoft (MSFT) shows an uptrend line that has been touched 4 times. After thethird touch in Nov-99, the tre...
On the Wal-Mart (WMT) example, the second high point appears to be too close to the first highpoint for a valid trend line...
The long-term trend line for the S&P 500 ($SPX) extends up from the end of 1994, and passesthrough low points in Jul-96, S...
ConclusionTrend lines can offer great insight, but if used improperly, they can also produce false signals.Other items - s...
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com
Upcoming SlideShare
Loading in …5
×

Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com

1,739 views

Published on

Published in: Business, Economy & Finance
0 Comments
1 Like
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total views
1,739
On SlideShare
0
From Embeds
0
Number of Embeds
5
Actions
Shares
0
Downloads
180
Comments
0
Likes
1
Embeds 0
No embeds

No notes for slide

Volume1of3-YourComprehensiveGuidetoFinancialChartsandTechnicalAnalysis _VanLuong.BlogSpot.Com

  1. 1. Vietnam’s One-stop Financial PortalYour Comprehensive Guideto Financial Charts andTechnical Analysis ofthe Stock Markets Volume 1/3
  2. 2. About Stox.vnStox.vn is a trademark of StoxPlus, a financial media company providing a complete suite of financialinformation solutions and educational services to Private Investors and Financial Companies inVietnam and internationally. Our vision is to become the Best Stock Market Research and FinancialInformation Portal in Vietnam.Our senior management team has over 35 years of extensive and diverse experience in Investmentand Technology, Banking, Corporate Finance, in the United Kingdom, Switzerland, Australia andIndochina.About this GuideTechnical analysis is the study of investor behaviour and its effect on the subsequent price actionof financial instruments. The main data that we need to perform our studies are the price histories ofthe instruments, together with time and volume information. These enable you to determine trend,market sentiment and various buy and sell signals in order make some extremely profitable investingdecisions.We are very pleased to present “Your Comprehensive Guide to Financial Charts and Technicalanalysis of the Stock markets”. This Guide can be obtained from www.stox.vn and partly available inVietnamese .We believe that this will be a helpful guidebook for investors in Vietnam. For furtherinformation about our services, please visit our website at www.stox.vn.© 2008 Stox.vn: Vietnam’s One-stop Financial PortalVolume 1/3 Your Guide • Financial Charts • Technical analysis • Page 3
  3. 3. Table of Contents:Part Contents Page1 Overview - Articles that help you understand what Technical Analysis is and is 5 not, what Fundamental Analysis is, why someone should analyze securities at all, and more.2 Chart Analysis - Articles describing the various kinds of financial chart 31 analysis including trendline analysis, support and resistance, chart pattern analysis and Japanese candlestick charting.3 Technical Indicators and Overlays - In-depth descriptions of all the technical 171 indicators, market indicators and chart overlays.4 Market Analysis - Articles on various schools of market analysis including 333 Dow Theory and Elliott Wave Theory5 Trading Strategies - Articles about how to use technical analysis to make 353 better trading decisions.6 Recommended Sites - Links to other helpful financial web sites. 385Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 4
  4. 4. Part 1- OverviewVolume 1/3 Your Guide • Financial Charts • Technical analysis • Page 5
  5. 5. OverviewWhat is Technical Analysis?Technical Analysis is the forecasting of future financial price movements based on an examinationof past price movements. Like weather forecasting, technical analysis does not result in absolutepredictions about the future. Instead, technical analysis can help investors anticipate what is"likely" to happen to prices over time. Technical analysis uses a wide variety of charts that showprice over time.More Articles for New Chartists:• Why Analyze Securities? - This article examines the three types of market analysts, what they believe about financial markets and why. It will help you understand the big picture when it comes to deciding the "best" way to invest.• Technical Analysis - This article explains what Technical Analysis is, how it works, and the general steps one should take when using technical charts and indicators to analyze stocks. It concludes with a look at the strengths and weaknesses of using charts to make investment decisions.• Fundamental Analysis - This article describes Fundamental Analysis and explains the general steps that a fundamental analyst takes when evaluating a stock. It also looks at the strengths and weaknesses of fundamental analysis.• Random Walk Theory - Describes the Random Walk Theory of financial markets which is at odds with both Technical Analysis and Fundamental Analysis.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 6
  6. 6. Why Analyze Securities?Security Analysis - Does it Matter?Wall Street has scores of analysts, strategists and portfolio managers hired to do one thing: beatthe market. Analysts are hired to find undervalued stocks. Strategists are hired to predict thedirection of the market and various sectors. Portfolio managers are hired to put it all together andoutperform their benchmark, usually measured as the S&P 500. Granted, there are many studiesand disputes raging on the performance of equity mutual funds, but it is safe to assume that about75% of equity mutual funds underperform the S&P 500. With these kinds of stats, individualinvestors would surely be better off simply investing in an index fund rather than attempting to beatthe market wouldnt they?The added value of analysis is in the eye of the beholder. A fundamental analyst believes thatanalyzing strategy, management, product, financial statistics and many other readily and not-so-readily quantifiable numbers will help choose stocks that will outperform the market. They are alsolikely to believe that there is little or no value in analyzing past prices and that technical analystswould be better off stargazing. (Humph!) The technical analyst believes that the chart, volume,momentum and an array of mathematical indicators hold the keys to superior performance.Technicians are just as likely to believe that fundamental data is hogwash pure and simple. Andthen there are the Random Walkers who believe that any attempt to try and outwit the market isfutile.So whom do we believe? Is fundamental analysis worth the time and effort? Are technicians abunch of quacks? Or is it all a lesson in random futility? Lets start to clarify things by looking at theefficient market hypothesis and see where the fundamentalists, technicians and random walkersstand on the question of market efficiency. After we have explored this area, we will then take acloser look at the random walk theory, fundamental analysis and technical analysis.Are Markets Efficient?The question concerning the value of analysis begins with the debate on market efficiency. Justwhat is represented by the current price of a security? Is a securitys current price an accuratereflection of its fair value? Or, do anomalies exist that allow traders and investors the opportunity tobeat the market by finding undervalued or overvalued securities?Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 7
  7. 7. Aswath Damara, of the Stern Business School at New York University, defines an efficient marketas one in which the market price is an unbiased estimate of the true value of the investment. Fairenough, but it is not quite that simple. In an efficient market, the current price of a security fullyreflects all available information and is the fair value. "All" because the price is the sum value of allviews (bullish, bearish or otherwise) held by market participants. It is the fair value because themarket agreed on a price to buy and sell the security. As new information becomes available, themarket assimilates the information by adjusting the securitys price up (buying) and down (selling).In an efficient market, deviations above and below fair value are possible, but these deviations areconsidered to be random. Over the long run, the price should accurately reflect fair value.The hypothesis further asserts that if markets are efficient, then it should be virtually impossible tooutperform the market on a sustained basis. Even though deviations will occur and there will beperiods when securities are overvalued or undervalued, these anomalies will disappear as quicklyas they appeared, thus making it almost impossible to profit from them.From experience, most of us would agree that the market is not perfectly efficient. Anomalies doexist and there are investors and traders that outperform the market. Therefore, there are varyingdegrees of market efficiency, which have been broken down into three levels. These three levelsalso happen to correspond to the beliefs of the fundamentalists, technicians and random walkers.Strong-form: TechniciansThe strong-form of market efficiency theorizes that the current price reflects all informationavailable. It does not matter if this information is available to the public or privy to topmanagement; if it exists at all, it is reflected in the current price. Because all possible information isalready reflected in the price, investors and traders will not be able to find or exploit inefficienciesbased on fundamental information. Generally, pure technical analysts believe that the markets arestrong-form efficient and all information is reflected in the price.Semi-Strong Form: Random WalkersThe semi-strong form of market efficiency theorizes that the current price reflects all readilyavailable information. This information will likely include annual reports, SEC filings, earningsreports, announcements and other relevant information that can be readily gathered. However,there is other information not readily available to the public that is not fully reflected in the price.This could be information held by insiders, competitors, contractors, suppliers or regulators, amongothers. Anomalies exist when information is withheld from the public and the only way to profit isby using information not yet known to the public. This is sometimes called insider trading. Oncethis information becomes public knowledge, prices adjust instantaneously, so it is virtuallyimpossible to profit from such news. The Random Walk theory is an example of the semi-strongform of market efficiency.Weak-form: FundamentalistsThe weak-form of market efficiency theorizes that the current price does not reflect fair value andis only a reflection of past prices. Furthermore, the future price cannot be determined using past orcurrent prices (sorry technical analysts). Fundamental analysts are champions of weak-formmarket efficiency and believe that the true value of a security can be ascertained through financialmodels using information readily available. The current price will not always reflect fair value, andthese models will help identify anomalies.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 8
  8. 8. Which Form Exists in the Market Today?Many in academia, including Gordon Gemmill of the University of Warwick and Aswath Damara ofNYU, believe that security prices are semi-strong efficient. Recall that semi-strong efficient impliesthat all public knowledge is reflected in the price and it is virtually impossible to exploit deviationsfrom the true value based on public information. Only new information will affect the price. Judgingfrom the reaction of many stocks to news events, there seems to be evidence to support this case.The flow of information has become faster with the Internet, and surprises are factored in instantly.Few will argue that a surprise, both positive and negative, can violently move the price of asecurity. A few examples include:• After Prue-announcing that earnings would come in below expectations on 6-Jan-00, Lucent fell from 59 to 43 in one day.• After positive comments from an influential analyst on 23-Feb-00, Time Warner shot up 49 to 59 in 2 days.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 9
  9. 9. • After reporting earnings that were below expectations on 15-Feb, Ascribe and Fitch fell from 24 to 15.Even though these are but a few examples, it is obvious that new information can move the priceof a security in non-random ways.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 10
  10. 10. What is Technical Analysis?Technical Analysis is the forecasting of future financial price movements based on an examinationof past price movements. Like weather forecasting, technical analysis does not result in absolutepredictions about the future. Instead, technical analysis can help investors anticipate what is"likely" to happen to prices over time. Technical analysis uses a wide variety of charts that showprice over time.Technical Analysis - This article explains what Technical Analysis is, how it works, and the generalsteps one should take when using technical charts and indicators to analyze stocks. It concludeswith a look at the strengths and weaknesses of using charts to make investment decisions.What is Technical Analysis?Technical Analysis is the forecasting of future financial price movements based on an examinationof past price movements. Like weather forecasting, technical analysis does not result in absolutepredictions about the future. Instead, technical analysis can help investors anticipate what is"likely" to happen to prices over time. Technical analysis uses a wide variety of charts that showprice over time.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 11
  11. 11. Technical analysis is applicable to stocks, indices, commodities, futures or any tradable instrumentwhere the price is influenced by the forces of supply and demand. Price refers to any combinationof the open, high, low, or close for a given security over a specific time frame. The time frame canbe based on intraday (1-minute, 5-minutes, 10-minutes, 15-minutes, 30-minutes or hourly), daily,weekly or monthly price data and last a few hours or many years. In addition, some technicalanalysts include volume or open interest figures with their study of price action.The Basis of Technical AnalysisAt the turn of the century, the Dow Theory laid the foundations for what was later to becomemodern technical analysis. Dow Theory was not presented as one complete amalgamation, butrather pieced together from the writings of Charles Dow over several years. Of the many theoremsput forth by Dow, three stand out:• Price Discounts Everything• Price Movements Are Not Totally Random• What Is More Important than WhyPrice Discounts EverythingThis theorem is similar to the strong and semi-strong forms of market efficiency. Technicalanalysts believe that the current price fully reflects all information. Because all information isalready reflected in the price, it represents the fair value, and should form the basis for analysis.After all, the market price reflects the sum knowledge of all participants, including traders,investors, portfolio managers, buy-side analysts, sell-side analysts, market strategist, technicalanalysts, fundamental analysts and many others. It would be folly to disagree with the price set bysuch an impressive array of people with impeccable credentials. Technical analysis utilizes theinformation captured by the price to interpret what the market is saying with the purpose of forminga view on the future.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 12
  12. 12. Prices Movements are not Totally RandomMost technicians agree that prices trend. However, most technicians also acknowledge that thereare periods when prices do not trend. If prices were always random, it would be extremely difficultto make money using technical analysis. In his book, Schwager on Futures: Technical Analysis,Jack Schwager states:"One way of viewing it is that markets may witness extended periods of random fluctuation,interspersed with shorter periods of nonrandom behavior. The goal of the chartist is to identifythose periods (i.e. major trends)."A technician believes that it is possible to identify a trend, invest or trade based on the trend andmake money as the trend unfolds. Because technical analysis can be applied to many differenttime frames, it is possible to spot both short-term and long-term trends. The IBM chart illustratesSchwagers view on the nature of the trend. The broad trend is up, but it is also interspersed withtrading ranges. In between the trading ranges are smaller uptrends within the larger uptrend. Theuptrend is renewed when the stock breaks above the trading range. A downtrend begins when thestock breaks below the low of the previous trading range."What" is More Important than "Why"In his book, The Psychology of Technical Analysis, Tony Plummer paraphrases Oscar Wilde bystating, "A technical analyst knows the price of everything, but the value of nothing". Technicians,as technical analysts are called, are only concerned with two things:1. What is the current price?2. What is the history of the price movement?The price is the end result of the battle between the forces of supply and demand for thecompanys stock. The objective of analysis is to forecast the direction of the future price. Byfocusing on price and only price, technical analysis represents a direct approach. Fundamentalistsare concerned with why the price is what it is. For technicians, the why portion of the equation istoo broad and many times the fundamental reasons given are highly suspect. Technicians believeit is best to concentrate on what and never mind why. Why did the price go up? It is simple, morebuyers (demand) than sellers (supply). After all, the value of any asset is only what someone iswilling to pay for it. Who needs to know why?Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 13
  13. 13. General Steps to Technical EvaluationMany technicians employ a top-down approach that begins with broad-based macro analysis. Thelarger parts are then broken down to base the final step on a more focused/micro perspective.Such an analysis might involve three steps:• Broad market analysis through the major indices such as the S&P 500, Dow Industrials, NASDAQ and NYSE Composite.• Sector analysis to identify the strongest and weakest groups within the broader market.• Individual stock analysis to identify the strongest and weakest stocks within select groups.The beauty of technical analysis lies in its versatility. Because the principles of technical analysisare universally applicable, each of the analysis steps above can be performed using the sametheoretical background. You dont need an economics degree to analyze a market index chart.You dont need to be a CPA to analyze a stock chart. Charts are charts. It does not matter if thetime frame is 2 days or 2 years. It does not matter if it is a stock, market index or commodity. Thetechnical principles of support, resistance, trend, trading range and other aspects can be applied toany chart. While this may sound easy, technical analysis is by no means easy. Success requiresserious study, dedication and an open mind.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 14
  14. 14. Chart AnalysisTechnical analysis can be as complex or as simple as you want it. The example below representsa simplified version. Since we are interested in buying stocks, the focus will be on spotting bullishsituations.Overall Trend: The first step is to identify the overall trend. This can be accomplished with trendlines, moving averages or peak/trough analysis. As long as the price remains above its uptrendline, selected moving averages or previous lows, the trend will be considered bullish.Support: Areas of congestion or previous lows below the current price mark support levels. Abreak below support would be considered bearish.Resistance: Areas of congestion and previous highs above the current price mark the resistancelevels. A break above resistance would be considered bullish.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 15
  15. 15. Momentum: Momentum is usually measured with an oscillator such as MACD. If MACD is aboveits 9-day EMA (exponential moving average) or positive, then momentum will be considered bullish,or at least improving.Buying/Selling Pressure: For stocks and indices with volume figures available, an indicator thatuses volume is used to measure buying or selling pressure. When Chaikin Money Flow is abovezero, buying pressure is dominant. Selling pressure is dominant when it is below zero.Relative Strength: The price relative is a line formed by dividing the security by a benchmark. Forstocks it is usually the price of the stock divided by the S&P 500. The plot of this line over a periodof time will tell us if the stock is outperforming (rising) or under performing (falling) the major index.The final step is to synthesize the above analysis to ascertain the following:• Strength of the current trend.• Maturity or stage of current trend.• Reward to risk ratio of a new position.• Potential entry levels for new long position.Top-Down Technical AnalysisFor each segment (market, sector and stock), an investor would analyze long-term and short-termcharts to find those that meet specific criteria. Analysis will first consider the market in general,perhaps the S&P 500. If the broader market were considered to be in bullish mode, analysis wouldproceed to a selection of sector charts. Those sectors that show the most promise would besingled out for individual stock analysis. Once the sector list is narrowed to 3-4 industry groups,individual stock selection can begin. With a selection of 10-20 stock charts from each industry, aselection of 3-4 of the most promising stocks in each group can be made. How many stocks orindustry groups make the final cut will depend on the strictness of the criteria set forth. Under thisscenario, we would be left with 9-12 stocks from which to choose. These stocks could even bebroken down further to find the 3-4 of the strongest of the strong.Strengths of Technical AnalysisFocus on PriceIf the objective is to predict the future price, then it makes sense to focus on price movements.Price movements usually precede fundamental developments. By focusing on price action,technicians are automatically focusing on the future. The market is thought of as a leadingindicator and generally leads the economy by 6 to 9 months. To keep pace with the market, itmakes sense to look directly at the price movements. More often than not, change is a subtlebeast. Even though the market is prone to sudden knee-jerk reactions, hints usually developbefore significant moves. A technician will refer to periods of accumulation as evidence of animpending advance and periods of distribution as evidence of an impending decline.Supply, Demand, and Price ActionMany technicians use the open, high, low and close when analyzing the price action of a security.There is information to be gleaned from each bit of information. Separately, these will not be ableto tell much. However, taken together, the open, high, low and close reflect forces of supply anddemand.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 16
  16. 16. The annotated example above shows a stock that opened with a gap up. Before the open, thenumber of buy orders exceeded the number of sell orders and the price was raised to attract moresellers. Demand was brisk from the start. The intraday high reflects the strength of demand(buyers). The intraday low reflects the availability of supply (sellers). The close represents the finalprice agreed upon by the buyers and the sellers. In this case, the close is well below the high andmuch closer to the low. This tells us that even though demand (buyers) was strong during the day,supply (sellers) ultimately prevailed and forced the price back down. Even after this sellingpressure, the close remained above the open. By looking at price action over an extended periodof time, we can see the battle between supply and demand unfold. In its most basic form, higherprices reflect increased demand and lower prices reflect increased supply.Support/ResistanceSimple chart analysis can help identify support and resistance levels. These are usually marked byperiods of congestion (trading range) where the prices move within a confined range for anextended period, telling us that the forces of supply and demand are deadlocked. When pricesmove out of the trading range, it signals that either supply or demand has started to get the upperhand. If prices move above the upper band of the trading range, then demand is winning. If pricesmove below the lower band, then supply is winning.Pictorial Price HistoryEven if you are a tried and true fundamental analyst, a price chart can offer plenty of valuableinformation. The price chart is an easy to read historical account of a securitys price movementover a period of time. Charts are much easier to read than a table of numbers. On most stockcharts, volume bars are displayed at the bottom. With this historical picture, it is easy to identify thefollowing:• Reactions prior to and after important events.• Past and present volatility.• Historical volume or trading levels.• Relative strength of a stock versus the overall market.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 17
  17. 17. Assist with Entry PointTechnical analysis can help with timing a proper entry point. Some analysts use fundamentalanalysis to decide what to buy and technical analysis to decide when to buy. It is no secret thattiming can play an important role in performance. Technical analysis can help spot demand(support) and supply (resistance) levels as well as breakouts. Simply waiting for a breakout aboveresistance or buying near support levels can improve returns.It is also important to know a stocks price history. If a stock you thought was great for the last 2years has traded flat for those two years, it would appear that Wall Street has a different opinion. Ifa stock has already advanced significantly, it may be prudent to wait for a pullback. Or, if the stockis trending lower, it might pay to wait for buying interest and a trend reversal.Weaknesses of Technical AnalysisAnalyst BiasJust as with fundamental analysis, technical analysis is subjective and our personal biases can bereflected in the analysis. It is important to be aware of these biases when analyzing a chart. If theanalyst is a perpetual bull, then a bullish bias will overshadow the analysis. On the other hand, ifthe analyst is a disgruntled eternal bear, then the analysis will probably have a bearish tilt.Open to InterpretationFurthering the bias argument is the fact that technical analysis is open to interpretation. Eventhough there are standards, many times two technicians will look at the same chart and paint twodifferent scenarios or see different patterns. Both will be able to come up with logical support andresistance levels as well as key breaks to justify their position. While this can be frustrating, itshould be pointed out that technical analysis is more like an art than a science, somewhat likeeconomics. Is the cup half-empty or half-full? It is in the eye of the beholder.Too LateTechnical analysis has been criticized for being too late. By the time the trend is identified, asubstantial portion of the move has already taken place. After such a large move, the reward torisk ratio is not great. Lateness is a particular criticism of Dow theory.Always Another LevelEven after a new trend has been identified, there is always another "important" level close at hand.Technicians have been accused of sitting on the fence and never taking an unqualified stance.Even if they are bullish, there is always some indicator or some level that will qualify their opinion.Traders RemorseNot all technical signals and patterns work. When you begin to study technical analysis, you willcome across an array of patterns and indicators with rules to match. For instance: A sell signal isgiven when the neckline of a head and shoulders pattern is broken. Even though this is a rule, it isnot steadfast and can be subject to other factors such as volume and momentum. In that samevein, what works for one particular stock may not work for another. A 50-day moving average maywork great to identify support and resistance for IBM, but a 70-day moving average may workbetter for Yahoo. Even though many principles of technical analysis are universal, each securitywill have its own idiosyncrasies.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 18
  18. 18. ConclusionsTechnical analysts consider the market to be 80% psychological and 20% logical. Fundamentalanalysts consider the market to be 20% psychological and 80% logical. Psychological or logicalmay be open for debate, but there is no questioning the current price of a security. After all, it isavailable for all to see and nobody doubts its legitimacy. The price set by the market reflects thesum knowledge of all participants, and we are not dealing with lightweights here. Theseparticipants have considered (discounted) everything under the sun and settled on a price to buyor sell. These are the forces of supply and demand at work. By examining price action todetermine which force is prevailing, technical analysis focuses directly on the bottom line: What isthe price? Where has it been? Where is it going?Even though there are some universal principles and rules that can be applied, it must beremembered that technical analysis is more an art form than a science. As an art form, it is subjectto interpretation. However, it is also flexible in its approach and each investor should use only thatwhich suits his or her style. Developing a style takes time, effort and dedication, but the rewardscan be significant.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 19
  19. 19. What is Fundamental Analysis?Fundamental analysis is the examination of the underlying forces that affect the well being of theeconomy, industry groups, and companies. As with most analysis, the goal is to derive a forecastand profit from future price movements. At the company level, fundamental analysis may involveexamination of financial data, management, business concept and competition. At the industrylevel, there might be an examination of supply and demand forces for the products offered. For thenational economy, fundamental analysis might focus on economic data to assess the present andfuture growth of the economy. To forecast future stock prices, fundamental analysis combineseconomic, industry, and company analysis to derive a stocks current fair value and forecast futurevalue. If fair value is not equal to the current stock price, fundamental analysts believe that thestock is either over or under valued and the market price will ultimately gravitate towards fair value.Fundamentalists do not heed the advice of the random walkers and believe that markets are weak-form efficient. By believing that prices do not accurately reflect all available information,fundamental analysts look to capitalize on perceived price discrepancies.General Steps to Fundamental EvaluationEven though there is no one clear-cut method, a breakdown is presented below in the order aninvestor might proceed. This method employs a top-down approach that starts with the overalleconomy and then works down from industry groups to specific companies. As part of the analysisprocess, it is important to remember that all information is relative. Industry groups are comparedagainst other industry groups and companies against other companies. Usually, companies arecompared with others in the same group. For example, a telecom operator (Verizon) would becompared to another telecom operator (SBC Corp), not to an oil company (ChevronTexaco).Economic ForecastFirst and foremost in a top-down approach would be an overall evaluation of the general economy.The economy is like the tide and the various industry groups and individual companies are likeboats. When the economy expands, most industry groups and companies benefit and grow. Whenthe economy declines, most sectors and companies usually suffer. Many economists linkeconomic expansion and contraction to the level of interest rates. Interest rates are seen as aleading indicator for the stock market as well. Below is a chart of the S&P 500 and the yield on the10-year note over the last 30 years. Although not exact, a correlation between stock prices andinterest rates can be seen. Once a scenario for the overall economy has been developed, aninvestor can break down the economy into its various industry groups.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 20
  20. 20. Group SelectionIf the prognosis is for an expanding economy, then certain groups are likely to benefit more thanothers. An investor can narrow the field to those groups that are best suited to benefit from thecurrent or future economic environment. If most companies are expected to benefit from anexpansion, then risk in equities would be relatively low and an aggressive growth-oriented strategymight be advisable. A growth strategy might involve the purchase of technology, biotech,semiconductor and cyclical stocks. If the economy is forecast to contract, an investor may opt for amore conservative strategy and seek out stable income-oriented companies. A defensive strategymight involve the purchase of consumer staples, utilities and energy-related stocks.To assess a industry groups potential, an investor would want to consider the overall growth rate,market size, and importance to the economy. While the individual company is still important, itsindustry group is likely to exert just as much, or more, influence on the stock price. When stocksmove, they usually move as groups; there are very few lone guns out there. Many times it is moreimportant to be in the right industry than in the right stock! The chart below shows that relativeperformance of 5 sectors over a 7-month time frame. As the chart illustrates, being in the rightsector can make all the difference.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 21
  21. 21. Narrow Within the GroupOnce the industry group is chosen, an investor would need to narrow the list of companies beforeproceeding to a more detailed analysis. Investors are usually interested in finding the leaders andthe innovators within a group. The first task is to identify the current business and competitiveenvironment within a group as well as the future trends. How do the companies rank according tomarket share, product position and competitive advantage? Who is the current leader and how willchanges within the sector affect the current balance of power? What are the barriers to entry?Success depends on an edge, be it marketing, technology, market share or innovation. Acomparative analysis of the competition within a sector will help identify those companies with anedge, and those most likely to keep it.Company AnalysisWith a shortlist of companies, an investor might analyze the resources and capabilities within eachcompany to identify those companies that are capable of creating and maintaining a competitiveadvantage. The analysis could focus on selecting companies with a sensible business plan, solidmanagement and sound financials.Business PlanThe business plan, model or concept forms the bedrock upon which all else is built. If the plan,model or concepts stink, there is little hope for the business. For a new business, the questionsmay be these: Does its business make sense? Is it feasible? Is there a market? Can a profit bemade? For an established business, the questions may be: Is the companys direction clearlydefined? Is the company a leader in the market? Can the company maintain leadership?ManagementIn order to execute a business plan, a company requires top-quality management. Investors mightlook at management to assess their capabilities, strengths and weaknesses. Even the best-laidplans in the most dynamic industries can go to waste with bad management (AMD insemiconductors). Alternatively, even strong management can make for extraordinary success in amature industry (Alcoa in aluminum). Some of the questions to ask might include: How talented isthe management team? Do they have a track record? How long have they worked together? Canmanagement deliver on its promises? If management is a problem, it is sometimes best to moveon.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 22
  22. 22. Financial AnalysisThe final step to this analysis process would be to take apart the financial statements and come upwith a means of valuation. Below is a list of potential inputs into a financial analysis.Accounts Payable Good WillAccounts Receivable Gross Profit MarginAcid Ratio GrowthAmortization IndustryAssets - Current Interest CoverAssets - Fixed InternationalBook Value InvestmentBrand Liabilities - CurrentBusiness Cycle Liabilities - Long-termBusiness Idea ManagementBusiness Model Market GrowthBusiness Plan Market ShareCapital Expenses Net Profit MarginCash Flow Pageview GrowthCash on hand PageviewsCurrent Ratio PatentsCustomer Relationships Price/Book ValueDays Payable Price/EarningsDays Receivable PEGDebt Price/SalesDebt Structure ProductDebt:Equity Ratio Product PlacementDepreciation RegulationsDerivatives-Hedging R&DDiscounted Cash Flow RevenuesDividend SectorDividend Cover Stock OptionsEarnings StrategyEBITDA Subscriber GrowthEconomic Growth SubscribersEquity Supplier RelationshipsEquity Risk Premium TaxesExpenses Trademarks Weighted Average Cost of CapitalThe list can seem quite long and intimidating. However, after a while, an investor will learn whatworks best and develop a set of preferred analysis techniques. There are many different valuationmetrics and much depends on the industry and stage of the economic cycle. A complete financialmodel can be built to forecast future revenues, expenses and profits or an investor can rely on theforecast of other analysts and apply various multiples to arrive at a valuation. Some of the morepopular ratios are found by dividing the stock price by a key value driver.Ratio Company TypePrice/Book Value OilPrice/Earnings RetailPrice/Earnings/Growth NetworkingPrice/Sales B2BPrice/Subscribers ISP or cable companyPrice/Lines TelecomPrice/Page views Web site BiotechPrice/PromisesVolume 1/3 Your Guide • Financial Charts • Technical analysis • Page 23
  23. 23. This methodology assumes that a company will sell at a specific multiple of its earnings, revenuesor growth. An investor may rank companies based on these valuation ratios. Those at the high endmay be considered overvalued, while those at the low end may constitute relatively good value.Putting it All TogetherAfter all is said and done, an investor will be left with a handful of companies that stand out fromthe pack. Over the course of the analysis process, an understanding will develop of whichcompanies stand out as potential leaders and innovators. In addition, other companies would beconsidered laggards and unpredictable. The final step of the fundamental analysis process is tosynthesize all data, analysis and understanding into actual picks.Strengths of Fundamental AnalysisLong-term TrendsFundamental analysis is good for long-term investments based on long-term trends, very long-term.The ability to identify and predict long-term economic, demographic, technological or consumertrends can benefit patient investors who pick the right industry groups or companies.Value SpottingSound fundamental analysis will help identify companies that represent a good value. Some of themost legendary investors think long-term and value. Graham and Dodd, Warren Buffett and JohnNeff are seen as the champions of value investing. Fundamental analysis can help uncovercompanies with valuable assets, a strong balance sheet, stable earnings, and staying power.Business AcumenOne of the most obvious, but less tangible, rewards of fundamental analysis is the development ofa thorough understanding of the business. After such painstaking research and analysis, aninvestor will be familiar with the key revenue and profit drivers behind a company. Earnings andearnings expectations can be potent drivers of equity prices. Even some technicians will agree tothat. A good understanding can help investors avoid companies that are prone to shortfalls andidentify those that continue to deliver. In addition to understanding the business, fundamentalanalysis allows investors to develop an understanding of the key value drivers and companieswithin an industry. A stocks price is heavily influenced by its industry group. By studying thesegroups, investors can better position themselves to identify opportunities that are high-risk (tech),low-risk (utilities), growth oriented (computer), value driven (oil), non-cyclical (consumer staples),cyclical (transportation) or income-oriented (high yield).Knowing Whos WhoStocks move as a group. By understanding a companys business, investors can better positionthemselves to categorize stocks within their relevant industry group. Business can change rapidlyand with it the revenue mix of a company. This happened to many of the pure Internet retailers,which were not really Internet companies, but plain retailers. Knowing a companys business andbeing able to place it in a group can make a huge difference in relative valuations.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 24
  24. 24. Weaknesses of Fundamental AnalysisTime ConstraintsFundamental analysis may offer excellent insights, but it can be extraordinarily time-consuming.Time-consuming models often produce valuations that are contradictory to the current priceprevailing on Wall Street. When this happens, the analyst basically claims that the whole streethas got it wrong. This is not to say that there are not misunderstood companies out there, but it isquite brash to imply that the market price, and hence Wall Street, is wrong.Industry/Company SpecificValuation techniques vary depending on the industry group and specifics of each company. Forthis reason, a different technique and model is required for different industries and differentcompanies. This can get quite time-consuming, which can limit the amount of research that can beperformed. A subscription-based model may work great for an Internet Service Provider (ISP), butis not likely to be the best model to value an oil company.SubjectivityFair value is based on assumptions. Any changes to growth or multiplier assumptions can greatlyalter the ultimate valuation. Fundamental analysts are generally aware of this and use sensitivityanalysis to present a base-case valuation, a best-case valuation and a worst-case valuation.However, even on a worst-case valuation, most models are almost always bullish, the onlyquestion is how much so. The chart below shows how stubbornly bullish many fundamentalanalysts can be.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 25
  25. 25. Analyst BiasThe majority of the information that goes into the analysis comes from the company itself.Companies employ investor relations managers specifically to handle the analyst community andrelease information. As Mark Twain said, "there are lies, damn lies, and statistics." When it comesto massaging the data or spinning the announcement, CFOs and investor relations managers areprofessionals. Only buy-side analysts tend to venture past the company statistics. Buy-sideanalysts work for mutual funds and money managers. They read the reports written by the sell-side analysts who work for the big brokers (CIBC, Merrill Lynch, Robertson Stephens, CS FirstBoston, Paine Weber, DLJ to name a few). These brokers are also involved in underwriting andinvestment banking for the companies. Even though there are restrictions in place to prevent aconflict of interest, brokers have an ongoing relationship with the company under analysis. Whenreading these reports, it is important to take into consideration any biases a sell-side analyst mayhave. The buy-side analyst, on the other hand, is analyzing the company purely from aninvestment standpoint for a portfolio manager. If there is a relationship with the company, it isusually on different terms. In some cases this may be as a large shareholder.Definition of Fair ValueWhen market valuations extend beyond historical norms, there is pressure to adjust growth andmultiplier assumptions to compensate. If Wall Street values a stock at 50 times earnings and thecurrent assumption is 30 times, the analyst would be pressured to revise this assumption higher.There is an old Wall Street adage: the value of any asset (stock) is only what someone is willing topay for it (current price). Just as stock prices fluctuate, so too do growth and multiplierassumptions. Are we to believe Wall Street and the stock price or the analyst and marketassumptions?It used to be that free cash flow or earnings were used with a multiplier to arrive at a fair value. In1999, the S&P 500 typically sold for 28 times free cash flow. However, because so manycompanies were and are losing money, it has become popular to value a business as a multiple ofits revenues. This would seem to be OK, except that the multiple was higher than the PE of manystocks! Some companies were considered bargains at 30 times revenues.ConclusionsFundamental analysis can be valuable, but it should be approached with caution. If you arereading research written by a sell-side analyst, it is important to be familiar with the analyst behindthe report. We all have personal biases, and every analyst has some sort of bias. There is nothingwrong with this, and the research can still be of great value. Learn what the ratings mean and thetrack record of an analyst before jumping off the deep end. Corporate statements and pressreleases offer good information, but they should be read with a healthy degree of skepticism toseparate the facts from the spin. Press releases dont happen by accident; they are an importantPR tool for companies. Investors should become skilled readers to weed out the importantinformation and ignore the hype.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 26
  26. 26. Random Walk TheoryRandom Walk Theory - Describes the Random Walk Theory of financial markets which is at oddswith both Technical Analysis and Fundamental Analysis.A Random Walk Down Wall Street, written by Burton Malkiel in 1973, has become a classic ininvestment literature. Random walk theory jibes with the semi-strong efficient hypothesis in itsassertion that it is impossible to outperform the market on a consistent basis. Malkiel puts bothtechnical analysis and fundamental analysis to the test and reasons that both are largely a wasteof time. In fact, he goes to great lengths to show that there is no proof to suggest that either canconsistently outperform the market. Any success outperforming the market with technical analysisor fundamental analysis can be attributed to lady luck. If enough people try, some are bound tooutperform the market, but most are still likely to underperform.The basic random walk premise is that price movements are totally random. Judging from thechart, the price movements of Newmont Mining (NEM) over this 5-month period would appear tobe quite random. Prices have no memory, therefore past and present prices cannot be used topredict future prices (as implied in technical analysis). Prices move at random and adjust to newinformation as it comes available. The adjustment to this new information is so fast that it isimpossible to profit from it. Furthermore, news and events are also random and trying to predictthese (fundamental analysis) is also a lesson in futility.Malkiel maintains that a buy and hold strategy is best and individuals should not attempt to time (orbeat) the market. Attempts based on technical, fundamental or any other analysis are futile.Admittedly, he does have a point. Statistics have shown that the majority of equity mutual funds failto outperform the market, as measured by the S&P 500. Investors can easily buy index-basedsecurities with very low transactions costs.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 27
  27. 27. Should Random Walkers Take a Hike?While there are some good points to be gleaned from the random walk theory, it appears to be abit dated and does not accurately reflect the current investment climate.Random walk theory was introduced over 25 years ago when institutions dominated the market.These institutions had superior access to resources and the individual was at the mercy of thelarge brokerage houses for quality research. With the advent of online trading, power and influenceare shifting from institutions to the individual. Resources are now widely available to all at minimalcost, if not free. Not only can individuals access information, but the Internet ensures that everyonewill receive it almost instantaneously. They also have access to real time data and can trade likethe pros. With the availability of real time data and almost instant executions, individuals can acton information like never before.As little as 5 years ago, transactions costs were high and figured into any investment or tradingstrategy. Again, with the advent of online trading, transactions costs have become minimal. Thishas increased the amount of trading volume and probably volatility. Higher volatility increases thepossibility that anomalies will develop. With better trading resources and low commissions, moretraders and investors than ever are able to capitalize on potential anomalies.For obvious reasons, the Wall Street establishment is not thrilled about random walk theory. Afterall, Wall Street is in the business of analysis, strategy and money management. However, it is afact that about 75% of equity mutual funds underperform the S&P 500 year after year. Some of thisunderperformance can be blamed on transaction costs and management fees. However, with theadvent of index-linked securities, the onus will be on the money managers to figure out a way tooutperform the market, or lose business.In truth, 75% of equity mutual funds underperforming is not as bad as it sounds. When theRandom Walk theory was introduced in 1973, or even 15 years ago, around 90% of equity mutualfunds underperformed the market. Since this number seems to have risen, it would appear thateither stock picking is getting better or fees are getting smaller, or both. 15 years ago, the stockmarket and mutual funds were much more homogeneous. Even though there were tech stocks,they did not exert nearly as much influence. With the explosion of the NASDAQ, tech stocks play amuch larger role in todays market. Internet stocks, which have also come to the forefront, did noteven exist 15 years ago. With an increase in specialty mutual funds catering to tech and Internet,the total number of mutual funds has proliferated over the last few years. With the increase inmutual funds has also come and increase in the diversity of such funds. There are funds for almostevery sector, industry or index imaginable and investors have a wide array of choices. The morehomogeneous mutual funds there are, the less chance there is to outperform. However, thisspecialization has created a hierarchy among mutual funds and helped to increase the percentagefunds that outperform the S&P 500 from 10% to 25%.History has proved that a buy and hold strategy outperforms most attempts to time the market inabsolute returns. In risk-adjusted returns, the argument loses some of its credibility. Buy and holdmay take the guesswork out of beating the market, but it does little to compensate for the riskassociated with a continuous investment in the market. There is a direct correlation with risk andreturn: the higher the expected return, the higher the associated risk. A portfolio with a timingstrategy that seeks to move into risk-free treasuries when a bear market is signaled (Dow Theoryfor example), significantly reduces the amount of risk associated with that portfolio.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 28
  28. 28. The New York Times on 6-Sept-98, notes a study that was published in the Journal of Finance byStephen Brown of New York University, William Goetzmann of Yale, and Alok Kumar of theUniversity of Notre Dame. The Dow theory system was tested against buy-and-hold for the periodfrom 1929 to Sept-98. Over the 70-year period, the Dow theory system outperformed a buy-and-hold strategy by about 2% per year. In addition, the portfolio carried significantly less risk. Ifcompared as risk-adjusted returns, the margin of outperformance would even be greater. Over thepast 18 years, the Dow theory system has underperformed the market by about 2.6% per year.However, when adjusted for risk, the Dow theory system outperformed buy-and-hold over the past18 years. Keep in mind that 18 years is not a long time in the history of the market.A Non-Random Walk Down Wall StreetThere is another school of thought that considers the markets efficient yet predictable. One of theleading proponents is Andrew Lo. Lo earned his Ph.D in economics at the University of Chicagoand is currently a Professor of Finance at the Sloan School of Management at MIT. Lo is a bit ofan odd ball among academics because of his beliefs regarding the efficient market hypothesis andhis attraction to technical analysis. Lo and Mackinlays book A Non-Random Walk Down WallStreet debunks many of the theories put forth in the 1973 classic with a similar name. (Rememberthat most academics subscribe to the random walk theory.) Los research concluded the following:Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 29
  29. 29. Financial markets are predictable to some degree, but far from being a symptom of inefficiency orirrationality, predictability is the oil that lubricates the gears of capitalism.It is not only plausible that markets are efficient, but participants can also profit from efficientmarkets. However, Lo asserts that even though it is possible to outperform the markets, it requiresongoing research, continuous improvement and constant innovation. Beating the market does notcome easy, nor is it something that is easy to maintain. Lo likens the pursuit of above-averagereturns to that of a company trying to maintain its competitive advantage. After introducing a hotnew product, a company cannot just sit back and wait for the money to roll in. In order to remainabove the competition, management must be flexible and look for ways to continuously improveand innovate. Otherwise the competition will overtake them. Money managers, traders andinvestors who find ways to outperform the market must also remain flexible and innovative. Justbecause a method works today, does not mean it will work tomorrow. In an interview withTechnical Analysis of Stocks and Commodities, Lo sums it up by stating:"The more creativity you bring to the investment process, the more rewarding it will be. The onlyway to maintain ongoing success, however, is to constantly innovate. Thats much the same in allendeavors. The only way to continue making money, to continue growing and keeping your profitmargins healthy, is to constantly come up with new ideas."ConclusionsThese rebuttals to random walk theory are not meant to suggest that the vast majority ofindividuals are going to suddenly start outperforming the market. Even though this may be trueover the past 3 years, history suggests that it is not likely to be the case 10 years from now. Inother words, history suggests that this is an anomaly and there will be a reversion to the mean.Nonetheless, the investment and trading landscape has changed drastically over the last 20 years,even over the last 5 years. Individuals have access to more information and tools, transactionscosts are negligible, trades are executed almost instantaneously, equity mutual funds haveimproved their performance and the buy-and-hold strategy does not appear to be a profitmaximizing strategy. It should come as no surprise that analysis can make a difference. The onlyquestion is which type: fundamental analysis, technical analysis or both?Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 30
  30. 30. Part 2- Chart AnalysisVolume 1/3 Your Guide • Financial Charts • Technical analysis • Page 31
  31. 31. Chart AnalysisThis section describes the various kinds of financial charts. There are articles that describe howthe charts are constructed and how they can be used to make better investing decisions.Table of Contents Page1 What are Charts? - What charts are, how to pick timeframes, how charts are 33 formed, and price scaling.2 Support and Resistance - What support and resistance are, where they are 42 established, and methods used.3 Trend Lines - What trend lines are, scale settings, validation, angles, and more. 494 Introduction to Chart Patterns - A brief review of what chart patterns are, and 57 how to recognize them.5 Chart Patterns - A collection of articles describing common chart patterns. 616 Introduction to Candlesticks - An overview of candlesticks, including history, 121 formation, and key patterns.7 Candlesticks and Support - How candlestick chart patterns can mark support 137 levels.8 Candlesticks and Resistance - How candlestick chart patterns can mark 140 resistance levels.9 Candlestick Bullish Reversal Patterns - Detailed descriptions of bullish reversal 142 candlestick patterns10 Candlestick Bearish Reversal Patterns - Detailed descriptions of common 152 bearish reversal candlestick patterns.11 Candlestick Pattern Dictionary - A comprehensive list of common candlestick 162 patterns.12 Gaps and Gap Analysis - A gap is an area on a price chart in which there were 166 no trades. Gaps show that something important has important has happened to the fundamentals of or the mass psychology surrounding a stock.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 32
  32. 32. What Are Charts?A price chart is a sequence of prices plotted over a specific time frame. In statistical terms, chartsare referred to as time series plots.On the chart, the y-axis (vertical axis) represents the price scale and the x-axis (horizontal axis)represents the time scale. Prices are plotted from left to right across the x-axis with the mostrecent plot being the furthest right. The price plot for IBM extends from January 1, 1999 to March13, 2000.Technicians, technical analysts and chartists use charts to analyze a wide array of securities andforecast future price movements. The word "securities" refers to any tradable financial instrumentor quantifiable index such as stocks, bonds, commodities, futures or market indices. Any securitywith price data over a period of time can be used to form a chart for analysis.While technical analysts use charts almost exclusively, the use of charts is not limited to justtechnical analysis. Because charts provide an easy-to-read graphical representation of a securitysprice movement over a specific period of time, they can also be of great benefit to fundamentalanalysts. A graphical historical record makes it easy to spot the effect of key events on a securitysprice, its performance over a period of time and whether its trading near its highs, near its lows, orin between.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 33
  33. 33. How to Pick a Time FrameThe time frame used for forming a chart depends on the compression of the data: intraday, daily,weekly, monthly, quarterly or annual data. The less compressed the data is, the more detail isdisplayed.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 34
  34. 34. Daily data is made up of intraday data that has been compressed to show each day as a singledata point, or period. Weekly data is made up of daily data that has been compressed to showeach week as a single data point. The difference in detail can be seen with the daily and weeklychart comparison above. 100 data points (or periods) on the daily chart is equal to the last 5months of the weekly chart, which is shown by the data marked in the rectangle. The more thedata is compressed, the longer the time frame possible for displaying the data. If the chart candisplay 100 data points, a weekly chart will hold 100 weeks (almost 2 years). A daily chart thatdisplays 100 days would represent about 5 months. There are about 20 trading days in a monthand about 252 trading days in a year. The choice of data compression and time frame depends onthe data available and your trading or investing style.• Traders usually concentrate on charts made up of daily and intraday data to forecast short- term price movements. The shorter the time frame and the less compressed the data is, the more detail that is available. While long on detail, short-term charts can be volatile and contain a lot of noise. Large sudden price movements, wide high-low ranges and price gaps can affect volatility, which can distort the overall picture.• Investors usually focus on weekly and monthly charts to spot long-term trends and forecast long-term price movements. Because long-term charts (typically 1-4 years) cover a longer time frame with compressed data, price movements do not appear as extreme and there is often less noise.• Others might use a combination of long-term and short-term charts. Long-term charts are good for analyzing the large picture to get a broad perspective of the historical price action. Once the general picture is analyzed, a daily chart can be used to zoom in on the last few months.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 35
  35. 35. How Are Charts Formed?We will be explaining the construction of line, bar, candlestick and point & figure charts. Althoughthere are other methods available, these are 4 of the most popular methods for displaying pricedata.Line ChartSome investors and traders consider the closing level to be more important than the open, high orlow. By paying attention to only the close, intraday swings can be ignored. Line charts are alsoused when open, high and low data points are not available. Sometimes only closing data areavailable for certain indices, thinly traded stocks and intraday prices.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 36
  36. 36. Bar ChartPerhaps the most popular charting method is the bar chart. The high, low and close are required toform the price plot for each period of a bar chart. The high and low are represented by the top andbottom of the vertical bar and the close is the short horizontal line crossing the vertical bar. On adaily chart, each bar represents the high, low and close for a particular day. Weekly charts wouldhave a bar for each week based on Fridays close and the high and low for that week.Bar charts can also be displayed using the open, high, low and close. The only difference is theaddition of the open price, which is displayed as a short horizontal line extending to the left of thebar. Whether or not a bar chart includes the open depends on the data available.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 37
  37. 37. Bar charts can be effective for displaying a large amount of data. Using candlesticks, 200 datapoints can take up a lot of room and look cluttered. Line charts show less clutter, but do not offeras much detail (no high-low range). The individual bars that make up the bar chart are relativelyskinny, which allows users the ability to fit more bars before the chart gets cluttered. If you are notinterested in the opening price, bar charts are an ideal method for analyzing the close relative tothe high and low. In addition, bar charts that include the open will tend to get cluttered quicker. Ifyou are interested in the opening price, candlestick charts probably offer a better alternative.Candlestick ChartOriginating in Japan over 300 years ago, candlestick charts have become quite popular in recentyears. For a candlestick chart, the open, high, low and close are all required. A daily candlestick isbased on the open price, the intraday high and low, and the close. A weekly candlestick is basedon Mondays open, the weekly high-low range and Fridays close.Many traders and investors believe that candlestick charts are easy to read, especially therelationship between the open and the close. White (clear) candlesticks form when the close ishigher than the open and black (solid) candlesticks form when the close is lower than the open.The white and black portion formed from the open and close is called the body (white body orblack body). The lines above and below are called shadows and represent the high and low.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 38
  38. 38. Point & Figure ChartThe charting methods shown above, all, plot one data point for each period of time. No matter howmuch price movement, each day or week represented is one point, bar, or candlestick along thetime scale. Even if the price is unchanged from day to day or week to week, a dot, bar, orcandlestick is plotted to mark the price action. Contrary to this methodology, point & figure Chartsare based solely on price movement, and do not take time into consideration. There is an x-axisbut it does not extend evenly across the chart.The beauty of point & figure charts is their simplicity. Little or no price movement is deemedirrelevant and therefore not duplicated on the chart. Only price movements that exceed specifiedlevels are recorded. This focus on price movement makes it easier to identify support andresistance levels, bullish breakouts and bearish breakdowns. This P&F article has a more detailedexplanation of point & figure charts.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 39
  39. 39. Price ScalingThere are two methods for displaying the price scale along the y-axis: arithmetic and logarithmic.An arithmetic scale displays 10 points (or dollars) as the same vertical distance no matter what theprice level. Each unit of measure is the same throughout the entire scale. If a stock advances from10 to 80 over a 6-month period, the move from 10 to 20 will appear to be the same distance as themove from 70 to 80. Even though this move is the same in absolute terms, it is not the same inpercentage terms.A logarithmic scale measures price movements in percentage terms. An advance from 10 to 20would represent an increase of 100%. An advance from 20 to 40 would also be 100%, as would anadvance from 40 to 80. All three of these advances would appear as the same vertical distance ona logarithmic scale. Most charting programs refer to the logarithmic scale as a semi-log scale,because the time axis is still displayed arithmetically.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 40
  40. 40. The chart above uses the 4th-Quarter performance of VeriSign to illustrate the difference in scaling.On the semi-log scale, the distance between 50 and 100 is the same as the distance between 100and 200. However, on the arithmetic scale, the distance between 100 and 200 is significantlygreater than the distance between 50 and 100.Key points on the benefits of arithmetic and semi-log scales:• Arithmetic scales are useful when the price range is confined within a relatively tight range.• Arithmetic scales are useful for short-term charts and trading. Price movements (particularly for stocks) are shown in absolute dollar terms and reflect movements dollar for dollar.• Semi-log scales are useful when the price has moved significantly, be it over a short or extended time frame• Trend lines tend to match lows better on semi-log scales.• Semi-log scales are useful for long-term charts to gauge the percentage movements over a long period of time. Large movements are put into perspective.• Stocks and many other securities are judged in relative terms through the use of ratios such as PE, Price/Revenues and Price/Book. With this in mind, it also makes sense to analyze price movements in percentage terms.ConclusionsEven though many different charting techniques are available, one method is not necessarilybetter than the other. The data may be the same, but each method will provide its own uniqueinterpretation, with its own benefits and drawbacks. A breakout on the point & figure chart may notoccur in unison with a breakout in a candlestick chart. Signals that are available on candlestickcharts may not appear on bar charts. How the securitys price is displayed, be it a bar chart orcandlestick chart, with an arithmetic scale or semi-log scale, is not the most important aspect. Afterall, the data is the same and price action is price action. When all is said and done, it is theanalysis of the price action that separates successful technicians from not-so-successfultechnicians. The choice of which charting method to use will depend on personal preferences andtrading or investing styles. Once you have chosen a particular charting methodology, it is probablybest to stick with it and learn how best to read the signals. Switching back and forth may causeconfusion and undermine the focus of your analysis. Faulty analysis is rarely caused by the chart.Before blaming your charting method for missing a signal, first look at your analysis.The keys to successful chart analysis are dedication, focus, and consistency:• Dedication: Learn the basics of chart analysis, apply your knowledge on a regular basis, and continue your development.• Focus: Limit the number of charts, indicators and methods you use. Learn how to use them, and learn how to use them well.• Consistency: Maintain your charts on a regular basis and study them often (daily if possible).Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 41
  41. 41. Support and ResistanceSupport and resistance represent key junctures where the forces of supply and demand meet. Inthe financial markets, prices are driven by excessive supply (down) and demand (up). Supply issynonymous with bearish, bears and selling. Demand is synonymous with bullish, bulls and buying.These terms are used interchangeably throughout this and other articles. As demand increases,prices advance and as supply increases, prices decline. When supply and demand are equal,prices move sideways as bulls and bears slug it out for control.What Is Support?Support is the price level at which demand is thought to be strong enough to prevent the price fromdeclining further. The logic dictates that as the price declines towards support and gets cheaper,buyers become more inclined to buy and sellers become less inclined to sell. By the time the pricereaches the support level, it is believed that demand will overcome supply and prevent the pricefrom falling below support.Support does not always hold and a break below support signals that the bears have won out overthe bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive tobuy. Support breaks and new lows signal that sellers have reduced their expectations and arewilling sell at even lower prices. In addition, buyers could not be coerced into buying until pricesdeclined below support or below the previous low. Once support is broken, another support levelwill have to be established at a lower level.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 42
  42. 42. Where Is Support Established?Support levels are usually below the current price, but it is not uncommon for a security to trade ator near support. Technical analysis is not an exact science and it is sometimes difficult to set exactsupport levels. In addition, price movements can be volatile and dip below support briefly.Sometimes it does not seem logical to consider a support level broken if the price closes 1/8 belowthe established support level. For this reason, some traders and investors establish support zones.What Is Resistance?Resistance is the price level at which selling is thought to be strong enough to prevent the pricefrom rising further. The logic dictates that as the price advances towards resistance, sellersbecome more inclined to sell and buyers become less inclined to buy. By the time the pricereaches the resistance level, it is believed that supply will overcome demand and prevent the pricefrom rising above resistance.Resistance does not always hold and a break above resistance signals that the bulls have won outover the bears. A break above resistance shows a new willingness to buy and/or a lack ofincentive to sell. Resistance breaks and new highs indicate buyers have increased theirexpectations and are willing to buy at even higher prices. In addition, sellers could not be coercedinto selling until prices rose above resistance or above the previous high. Once resistance isbroken, another resistance level will have to be established at a higher level.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 43
  43. 43. Where Is Resistance Established?Resistance levels are usually above the current price, but it is not uncommon for a security to tradeat or near resistance. In addition, price movements can be volatile and rise above resistancebriefly. Sometimes it does not seem logical to consider a resistance level broken if the price closes1/8 above the established resistance level. For this reason, some traders and investors establishresistance zones.Methods to Establish Support and Resistance?Support and resistance are like mirror images and have many common characteristics.Highs and LowsSupport can be established with the previous reaction lows. Resistance can be established byusing the previous reaction highs.The above chart for Halliburton (HAL) shows a large trading range between Dec-99 and Mar-00.Support was established with the October low around 33. In December, the stock returned tosupport in the mid-thirties and formed a low around 34. Finally, in February the stock againreturned to the support scene and formed a low around 33 1/2.After each bounce off support, the stock traded all the way up to resistance. Resistance was firstestablished by the September support break at 42.5. After a support level is broken, it can turn intoa resistance level. From the October lows, the stock advanced to the new support-turned-resistance level around 42.5. When the stock failed to advance past 42.5, the resistance level wasconfirmed. The stock subsequently traded up to 42.5 two more times after that and failed tosurpass resistance both times.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 44
  44. 44. Support Equals ResistanceAnother principle of technical analysis stipulates that support can turn into resistance and visaversa. Once the price breaks below a support level, the broken support level can turn intoresistance. The break of support signals that the forces of supply have overcome the forces ofdemand. Therefore, if the price returns to this level, there is likely to be an increase in supply, andhence resistance.The other turn of the coin is resistance turning into support. As the price advances aboveresistance, it signals changes in supply and demand. The breakout above resistance proves thatthe forces of demand have overwhelmed the forces of supply. If the price returns to this level,there is likely to be an increase in demand and support will be found.In this example of the NASDAQ 100 Index ($NDX) , the stock broke resistance at 935 in May-97and traded just above this resistance level for over a month. The ability to remain above resistanceestablished 935 as a new support level. The stock subsequently rose to 1150, but then fell back totest support at 935. After the second test of support at 935, this level is well established.From the PeopleSoft (PSFT) example, we can see that support can turn into resistance and thenback into support. PeopleSoft found support at 18 from Oct-98 to Jan-99 (green oval), but brokebelow support in Mar-99 as the bears overpowered the bulls. When the stock rebounded (red oval),there was still overhead supply at 18 and resistance was met from Jun-99 to Oct-99.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 45
  45. 45. Where does this overhead supply come from? Demand was obviously increasing around 18 fromOct-98 to Mar-99 (green oval). Therefore, there were a lot of buyers in the stock around 18. Whenthe price declined past 18 and to around 14, many of these buyers were probably still holding thestock. This left a supply overhang (commonly known as resistance) around 18. When the stockrebounded to 18, many of the green-oval-buyers (who bought around 18) probably took theopportunity to sell. When this supply was exhausted, the demand was able to overpower supplyand advance above resistance at 18.Trading RangeTrading ranges can play an important role in determining support and resistance as turning pointsor as continuation patterns. A trading range is a period of time when prices move within a relativelytight range. This signals that the forces of supply and demand are evenly balanced. When theprice breaks out of the trading range, above or below, it signals that a winner has emerged. Abreak above is a victory for the bulls (demand) and a break below is a victory for the bears (supply).After an extended advance from 27 to 64, WorldCom (WCOM) entered into a trading rangebetween 55 and 63 for about 5 months. There was a false breakout in mid-June when the stockbriefly poked its head above 62 (red oval). This did not last long and a gap down a few days laternullified the breakout (black arrow). The stock then proceeded to break support at 55 in Aug-99and trade as low as 50. Here is another example of support turned resistance as the stockbounced off 55 two more times before heading lower. While this does not always happen, a returnto the new resistance level offers a second chance for longs to get out and shorts to enter the fray.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 46
  46. 46. In Nov/Dec-99, Lucent Technologies (LU) formed a trading range that resembled a head andshoulders pattern (red oval). When the stock broke support at 60, there was little or no time to exit.Even though the there is a long black candlestick indicating an open at 59, the stock fell so fastthat it was impossible to exit above 44. In hindsight, the support line could have been drawn as anupward sloping neckline (blue line), and the support break would have come at 61. This is only 1point higher and a trader would have had to take action immediately to avoid a sharp fall. However,the lows match up rather nicely on the neckline, and it is something to consider when drawingsupport lines.After Lucent declined, a trading range was established between 40.5 and 47.5 for almost twomonths (green oval). The resistance level of the trading range was well marked by three reactionpeaks at 47.5. The support level was not as clearly marked, but appeared to be between 40 and41. Some buying interest began to become evident around 44 in mid- to late-February. Notice thearray of candlesticks with long lower shadows, or hammers, as they are known. The stock thenproceeded to form two up gaps on 24-Feb and 25-Feb, and finally closed above resistance at 48.This was a clear indication of demand winning out over supply. There were still two moreopportunities (days) to get in on the action. On the third day after the breakout, the stock gappedup and moved above 56.Support and Resistance ZonesBecause technical analysis is not an exact science, it is useful to create support and resistancezones. This is contrary to the strategy mapped out for Lucent Technologies (LU), but it issometimes the case. Each security has its own characteristics, and analysis should reflect theintricacies of the security. Sometimes, exact support and resistance levels are best, and,sometimes, zones work better. Generally, the tighter the range, the more exact the level. If thetrading range spans less than 2 months and the price range is relatively tight, then more exactsupport and resistance levels are best suited. If a trading range spans many months and the pricerange is relatively large, then it is best to use support and resistance zones. These are only meantas general guidelines, and each trading range should be judged on its own merits.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 47
  47. 47. Returning to the analysis of Halliburton (HAL) , we can see that the November high of the tradingrange (33 to 44) extended more than 20% past the low, making the range quite large relative to theprice. Because the September support break forms our first resistance level, we are ready to setup a resistance zone after the November high is formed, probably around early December. At thispoint though, we are still unsure if a large trading range will develop. The subsequent low inDecember, which was just higher than the October low, offers evidence that a trading range isforming, and we are ready to set the support zone. As long as the stock trades within theboundaries set by the support and resistance zone, we will consider the trading range to be valid.Support may be looked upon as an opportunity to buy, and resistance as an opportunity to sell.ConclusionIdentification of key support and resistance levels is an essential ingredient to successful technicalanalysis. Even though it is sometimes difficult to establish exact support and resistance levels,being aware of their existence and location can greatly enhance analysis and forecasting abilities.If a security is approaching an important support level, it can serve as an alert to be extra vigilantin looking for signs of increased buying pressure and a potential reversal. If a security isapproaching a resistance level, it can act as an alert to look for signs of increased selling pressureand potential reversal. If a support or resistance level is broken, it signals that the relationshipbetween supply and demand has changed. A resistance breakout signals that demand (bulls) hasgained the upper hand and a support break signals that supply (bears) has won the battle.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 48
  48. 48. Trend LinesTechnical analysis is built on the assumption that prices trend. Trend Lines are an important tool intechnical analysis for both trend identification and confirmation. A trend line is a straight line thatconnects two or more price points and then extends into the future to act as a line of support orresistance. Many of the principles applicable to support and resistance levels can be applied totrend lines as well. It is important that you understand all of the concepts presented in our Supportand Resistance article before you continue.DefinitionUptrend LineAn uptrend line has a positive slope and is formed by connecting two or more low points. Thesecond low must be higher than the first for the line to have a positive slope. Uptrend lines act assupport and indicate that net-demand (demand less supply) is increasing even as the price rises. Arising price combined with increasing demand is very bullish, and shows a strong determination onthe part of the buyers. As long as prices remain above the trend line, the uptrend is consideredsolid and intact. A break below the uptrend line indicates that net-demand has weakened and achange in trend could be imminent.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 49
  49. 49. Downtrend LineA downtrend line has a negative slope and is formed by connecting two or more high points. Thesecond high must be lower than the first for the line to have a negative slope. Downtrend lines actas resistance, and indicate that net-supply (supply less demand) is increasing even as the pricedeclines. A declining price combined with increasing supply is very bearish, and shows the strongresolve of the sellers. As long as prices remain below the downtrend line, the downtrend is solidand intact. A break above the downtrend line indicates that net-supply is decreasing and that achange of trend could be imminent.For a detailed explanation of trend changes, which are different than just trend line breaks, pleasesee our article on the Dow Theory.Scale SettingsHigh points and low points appear to line up better for trend lines when prices are displayed usinga semi-log scale. This is especially true when long-term trend lines are being drawn or when thereis a large change in price. Most charting programs allow users to set the scale as arithmetic orsemi-log. An arithmetic scale displays incremental values (5,10,15,20,25,30) evenly as they moveup the y-axis. A $10 movement in price will look the same from $10 to $20 or from $100 to $110. Asemi-log scale displays incremental values in percentage terms as they move up the y-axis. Amove from $10 to $20 is a 100% gain, and would appear to be a much larger than a move from$100 to $110, which is only a 10% gain.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 50
  50. 50. In the case of EMC , there was a large price change over a long period of time. While there werenot any false breaks below the uptrend line on the arithmetic scale, the rate of ascent appearssmoother on the semi-log scale. EMC doubled three times in less than two years. On the semi-logscale, the trend line fits all the way up. On the arithmetic scale, three different trend lines wererequired to keep pace with the advance.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 51
  51. 51. In the case of Amazon.com (AMZN) , there were two false breaks above the downtrend line asthe stock declined during 2000 and 2001. These false break outs could have led to prematurebuying as the stock continued to decline after each one. The stock lost 60% of its value three timesover a two year period. The semi-log scale reflects the percentage loss evenly, and the downtrendline was never broken.ValidationIt takes two or more points to draw a trend line The more points used to draw the trend line, themore validity attached to the support or resistance level represented by the trend line. It cansometimes be difficult to find more than 2 points from which to construct a trend line Even thoughtrend lines are an important aspect of technical analysis, it is not always possible to draw trendlines on every price chart. Sometimes the lows or highs just dont match up, and it is best not toforce the issue. The general rule in technical analysis is that it takes two points to draw a trend lineand the third point confirms the validity.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 52
  52. 52. The chart of Microsoft (MSFT) shows an uptrend line that has been touched 4 times. After thethird touch in Nov-99, the trend line was considered a valid line of support. Now that the stock hasbounced off of this level a fourth time, the soundness of the support level is enhanced even more.As long as the stock remains above the trend line (support), the trend will remain in control of thebulls. A break below would signal that net-supply was increasing and that a change in trend couldbe imminent.Spacing of PointsThe lows used to form an uptrend line and the highs used to form a downtrend line should not betoo far apart, or too close together. The most suitable distance apart will depend on the time frame,the degree of price movement, and personal preferences. If the lows (highs) are too close together,the validity of the reaction low (high) may be in question. If the lows are too far apart, therelationship between the two points could be suspect. An ideal trend line is made up of relativelyevenly spaced lows (or highs). The trend line in the above MSFT example represents well-spacedlow points.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 53
  53. 53. On the Wal-Mart (WMT) example, the second high point appears to be too close to the first highpoint for a valid trend line; however, it would be feasible to draw a trend line beginning at point 2and extending down to the February reaction high.AnglesAs the steepness of a trend line increases, the validity of the support or resistance level decreases.A steep trend line results from a sharp advance (or decline) over a brief period of time. The angleof a trend line created from such sharp moves is unlikely to offer a meaningful support orresistance level. Even if the trend line is formed with three seemingly valid points, attempting toplay a trend line break or to use the support and resistance level established it will often provedifficult.The trend line for Yahoo! (YHOO) was touched four times over a 5-month period. The spacingbetween the points appears OK, but the steepness of the trend line is unsustainable, and the priceis more likely than not to drop below the trend line. However, trying to time this drop or make aplay after the trend line is broken is a difficult task. The amount of data displayed and the size ofthe chart can also affect the angle of a trend line. Short and wide charts are less likely to havesteep trend lines than long and narrow charts. Keep that in mind when assessing the validity andsustainability of a trend line.Internal Trend LinesSometimes there appears to be the possibility for drawing a trend line, but the exact points do notmatch up cleanly. The highs or lows might be out of whack, the angle might be too steep or thepoints might be too close together. If one or two points could be ignored, then a fitted trend linecould be formed. With the volatility present in the market, prices can over-react, and producespikes that distort the highs and lows. One method for dealing with over-reactions is to drawinternal trend lines. Even though an internal trend line ignores price spikes, the ignoring should bewithin reason.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 54
  54. 54. The long-term trend line for the S&P 500 ($SPX) extends up from the end of 1994, and passesthrough low points in Jul-96, Sept-98 and Oct-98. These lows were formed with selling climaxes,and represented extreme price movements that protrude beneath the trend line. By drawing thetrend line through the lows, the line appears to be at a reasonable angle, and the other lows matchup extremely well.Sometimes, there is a price cluster with a high or low spike sticking out. A price cluster is an areawhere prices are grouped within a tight range over a period of time. The price cluster can be usedto draw the trend line, and the spike can be ignored. The Coca Cola (KO) chart shows aninternal trend line that is formed by ignoring price spikes and using the price clusters, instead. InOctober and November 1998, Coke formed a peak, with the November peak just higher than theOctober peak (1). If the November peak had been used to draw a trend line, then the slope wouldhave been more negative, and there would have appeared to be a breakout in Dec-98 (gray line).However, this would have only been a two-point trend line, because the May-June highs are tooclose together (black arrows). Once the Dec-99 peak formed (green arrow), it would have beenpossible to draw an internal trend line based on the price clusters around the Oct/Nov-98 and theDec-99 peaks (blue line). This trend line is based on three solid touches, and it accuratelyforecasts resistance in Jan-00 (blue arrow).Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 55
  55. 55. ConclusionTrend lines can offer great insight, but if used improperly, they can also produce false signals.Other items - such as horizontal support and resistance levels or peak-and-trough analysis -should be employed to validate trend line breaks. While trend lines have become a very popularaspect of technical analysis, they are merely one tool for establishing, analyzing, and confirming atrend. Trend lines should not be the final arbiter, but should serve merely as a warning that achange in trend may be imminent. By using trend line breaks for warnings, investors and traderscan pay closer attention to other confirming signals for a potential change in trend.The uptrend line for VeriSign (VRSN) was touched 4 times, and seemed to be a valid supportlevel. Even though the trend line was broken in Jan-00, the previous reaction low held, and did notconfirm the trend line break. In addition, the stock recorded a new higher high prior to the trend linebreak.Volume 1/3 Your Guide • Financial Charts • Technical analysis • Page 56

×