Technical Analysis Bill Pope Fundamental Analysis • The study of: – Company, • Products, Management • Sales, Earnings, Cash Flow, Debt, • Stock Price to Book Ratio, Stock Price to Earnings Ratio – Demographic trends, potential demand for products – Monetary policy, etc To determine what a stock should sell for. Fundamental Analysis • Problems: – Getting all the necessary data. – Analyzing all the data – Predicting the future – Efficient Market Theory • “Current price reflects all currently known information and expectations.” – So you must also predict the future better than others. Efficient Market Theory • If Efficient Market Theory were true: – P/E Ratio would always be the same as long as Bond yields remained constant. – A quarterly graph of P/E Ratio would be straight line. But P/E Ratio isn’t flat! So there must be another reason stock prices go up and down. Market Principles • What makes a stock price rise? – A new product? – Maybe – New management? – Sometimes – Low Debt? – Not Generally – Low Price to Book Ratio? – Not By Itself – Higher profits? – You would think so, but no. – Internet stocks rose 1000% on no profits. – Stocks often drop on higher earnings announcements. – More buyers than sellers at a given price? – Yes Market Principles • The Demand / Supply graph Market Principles • What makes more Buyers than Sellers? – A positive change in investor sentiment about fundamentals. • Why trends start, But…. • Must have all the data, • Know how to analyze the company, the economy and Fed Monetary Policy. • Predict the future … better than others – Greed - Fear of missing a move that has already started. • Why Trends continue beyond reasonable values. – Desire to play like the Big Boys (The Follow-the-Leader game) • Why fundamentally weaker stocks rise with others in their sector. Technical Analysis • The study of current and historic Price and Volume action to: – Discover what a stock, fund or index is doing right now. – Note the current/prior range of Trader Greed and Fear. – Watch for changes in Investor Sentiment and Emotion. – Detect when a Trend or Trading Range has probably started or ended. – Predict what a security is likely to do continue doing in the near term. [Inertia] Technical Vs. Fundamental Analysis Fundamental Analysis studies Company Facts and Future Predictions. Technical Analysis studies Investor & Trader Sentiment and Emotion. Premise of Technical Analysis • All known Fundamental Information are shown in Price. • All changes in Emotion and Sentiment are shown in Price and Volume action. Basic Tool of Technical Analysis • The Chart – A picture of changes in Investor Sentiment and Emotions over time. – Shows where Trader Greed became excessive and turned to Fear – “Resistance” – Shows where Trader Fear became excessive and turned to Greed – “Support” – Shows when Investor Sentiment has changed. – “Breakouts” above Resistance or below Support – Show Investor Commitment – Big Volume Breakout – Shows when the Public is jumping in – Up trends – Shows when the Pros are bailing out – Down trends Charts Shows Where: INDEXFAM NASDAQ 100 Index (1,440.00, 1,440.00, 1,440.00, +8.87000) 2200 • Investor Sentiment: 2100 – Turned Negative 2000 – Turned Positive Break 1900 1800 • Pros bailing out Down 1700 • Public jumping in 1600 • Trader Emotion: Breakout 1500 Resistance 1400 – Greed turned to Fear 1300 – Fear turned to Greed 1200 Support 1100 10000 Chart Presentation Styles Bar Chart Line Chart Candlestick Total Return or Comparative Chart Timeframes • Monthly • Weekly • Daily • Intra-day – Hourly – 10 minute – 2 minute, Is the Market Fractal? Yes and No. Market Participants Participant Time in Position Selection Decision Timing Decision Based on: Based on: Long Term (LT) Months to Years Company Fundamentals Charts Investor Fund Manager History Intermediate (IT) Weeks to Months Market Rankings Charts Trader Short Term (ST) 3 – 10 Days Charts Charts “Swing” Trader Day Trader Hours Charts Charts Micro Trader Seconds to Minutes Charts Charts Chart Timeframes by Market Participant Market Participant Time in Position Chart Used for: Trend Entry and Determination Exit Points Long Term Months to Years Monthly Weekly Investor Intermediate Term Weeks to Months Weekly Daily Trader Swing Traders 3 – 10 Days Daily Hourly Day Trader Hours Hourly 10 Minute Micro Trader Seconds to 5-Minute 1 Minute Minutes The “Factor of 5” Rule. The Pope’s Opinion • Technical Analysis works best: – Short Term (“Swing”) Trading • Large-cap mature Stocks . • Asset Class Indices using Closed End or ETF Funds. – Intermediate Term Trading • Small-cap new High Growth Stock. • Asset Class Funds. – Long Term Trading • Mutual Funds on Weekly Chart (due to Redemption Fees). Asset Classes • Asset Categories: Stocks, Bonds, Cash • Sub Category Characteristics: – Capitalization: Large, Middle, Small – Objective: Growth, Value – Geography: • Region: US, Europe, Asia, Latin American • Country: US, Germany, Japan, Mexico, etc. – Yield: High, Medium, Low – Risk (Volatility): High, Medium, Low Asset Class – Securities with similar characteristics and behavior. – Example: Stocks + Small Capitalization + High Volatility + Growth = Small Cap Growth Stocks. – Why similar Behavior? – Follow the Leader game. – Factors influencing a security’s performance: • The General Market 50% factor • The security’s Asset Class 30% (80%) • The security itself 20% Asset Classes (Of Interest) And Now Back to Charts What Questions can Charts Answer? • Universe Selection Questions. • Individual Security Selection Questions. • Timing Questions. Universe Selection Questions? (For IT Sector or Asset Class Rotators) • What Sectors or Asset Classes should I watch? – Which markets fit my trading style and time? – Which are too volatile for my risk tolerance (fear)? – Which are too slow for my needs (greed)? • Who trades the securities in this Sector/Class? – Do they have a shorter time-horizon than the one I can trade? – Can I out trade them? Total Return Comparison Chart Universe Selection Questions: (For ST Swing and Day Traders) • Which Securities have tradable patterns? Short Term Tradable Patterns Swing Tradable Patterns Security Selection Questions: (For IT Sector or Asset Class Rotators) • What should I Buy? – What are the Markets doing right now? – Which are in Up Trends? – Which has the steepest trend? – Which has the best trend? – Which are attracting Investors? – Which are attracting Money? Steepest TREND? How Indicators Help A Cycle Indicator Steepest TREND! BEST Trend? BEST Trend ! Security Selection Questions: (For Stock Pickers) • Which Stock just brokeout on Big Volume? Big Volume Breakout Big Volume Breakout Entry Timing Questions: (For IT Traders, Rotators, Stock Pickers:) – Has Investor sentiment recently changed? • To positive = Breakout • To negative = Breakdown – Are Institutions coming in? • = Big Volume • = Accumulation Pattern – Is the Public being drawn in? • = Up Trend – Have weak players pulled out? • = Pull-back (“Buyer Remorse”) Breakout and Pull-back Patterns Breakout Pull-back Up Trend Patterns Higher High Higher High Higher Low Higher High Higher Low Higher High Higher Low Higher High Higher Low Higher High Higher Low Higher Low Exit Timing Questions (For All) • Has Investor Sentiment become Negative? – Up Trend Line Broken – Support Breakdown – Lower High, Lower Low Pattern • Has Trader Emotion turned to Fear – Big Volume Breakdown – Extreme Momentum Reversal Big Volume Breakdown Topping Patterns How Indicators Help A Momentum Indicator ST Trader Timing Questions: (In Addition to the above:) – Where are other Traders likely to buy and sell? (Where is Support and Resistance?) – What is the measuring objective from the last pattern? – Has the trend on 1, 5, 10 Minute Charts reversed? Technical Analysis Aids • Chart Patterns • Mathematical Indicators Chart Price Patterns Type Pattern Examples Trading Range or Saucer Basing Patterns Cup and Handle Trending Patterns Stairs (High Low progression) Continuation Patterns Flags and Penants Rising Right Triangle in Uptrends Falling Right Triangle in Downtrends Reversal Patterns Head and Shoulders Top Inverted Head and Shoulders Bottom M’s and W (Double Tops and Bottoms) Wedges in uptrends (Tops) False Reversal Patterns Head Shakes Indecision Equalaterial Triangles, Chart Volume Patterns Situation Volume Behavior (Theory) True Breakout > 150% Average Up Trends Higher on up days than down days Down Trends Higher on down days than up days Distribution near Tops Higher but no significant price gain Accumulation near Higher but no significant Bottoms price loss Mathematical Indicators Transforms of Price and/or Volume action • Remove Noise through smoothing (averaging). – Smoothing introduces lag. • Needed for Computerized investing. – Moving Average = Computerized Trend Line • Generate mechanical Buy and Sell Signals. – An attempt to remove subjectiveness and emotion. – Most created as a stand-alone trading system. – All have strong points and weak points. [Over 180 cataloged by International Federation of Technical Analysts.] • Best to use a combination. Types of Indicators • Trading Range • Trend Following • Momentum • Cycle • Volatility • Risk Return • Most are graphical, some are Statistical Trading Range Indicators • Aroon • Directional Movement System • Chande Momentum Oscillator • Commodity Selection Index • MESA Sine Wave • Polarized Fractal Efficiency • Random Walk Index Trend Following Indicators • Moving Averages • Linear Regression Line • Parabolics • Channels • Price Channels • Andrew’s Pitchfork • Envelops • Bollinger Bands • Average True Range Bands Momentum Indicators • Momentum • Moving Average Convergence Divergence (MACD) • Relative Strength Index (RSI) • Stochastic • Williams %R Cycle Indicators • Commodity Channel Index • Detrended Price Oscillator • MESA Sine Wave • Stochastic Volatility Indicators • Standard Deviation • Bollinger Bands and Average True Range Bands • Chakin Volatility Index • Commodity Selection Index • Ulcer Index • Accumulation Pattern Indicator – Pope Risk Adjusted Return • Sharpe’s Ratio- William Sharpe • Ulcer Performance Index – Martin and McCann • Retracement Adjusted Return - Pope • Targeted Retracement Adjusted Return – Pope Market Health Indicators Indicator Usage • Universe Selection • Security Selection • Timing Non-Volatile Markets • Timing Volatile Markets • Assessing General Market Health Universe Selection Security Selection - UPI Security Selection – RAR (Pope) “And The Winners Are” Timing Non-Volatile Markets • Non-Volatile Markets can be timed with: – Single Moving Average – Filtered Moving Average (Percent Bands/Envelope) Single Moving Average Single Moving Average Filtered Moving Average Timing Volatile Trending Markets Volatile Markets are Volatile because Traders play in them! We can either: • Smooth out the Trader’s action, or • Trade only when Traders and Investors Confirm each other’s direction. Dual MA Crossover System • Uses two Moving Averages: – Shorter MA smoothes Trader’s Price Fluctuations. – Longer MA represents the Trend. • Works better on volatile securities than: – Single MA, – Filtered MA. Dual MA Crossover System Dual MA Crossover System Dual MA Confirmation System Dual MA Confirmation System Cycles and Momentum Studies • Adding Cycle and Momentum Indicators can improve your decision making. • Cycle Indicators – Commodity Channel Index – Stochastic – Etc. • Momentum Indicators – Moving Average Convergence Divergence – Relative Strength Index – Etc. Adding Cycles Studies Don’t Buy when Over Bought! Don’t Sell when Over Sold! Momentum Divergences Momentum Divergences & Reversals Trading Non-Trending Markets Trending Vs. Non-Trending Indicators SUMMARY and CONCLUSION The Magic of Technical Analysis is not in Charts, Indicators, or Computers. It’s in what the above enable you to do in your Mind!
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