Technical Analysis Introduction Ben Acton-Bond & Jorgen Drageset March. 13, 2018 BSFS Committee Meeting Principles of Technical Analysis • Technical analysis is based on the assumption that historical behavioral Historical Behavior patterns tend to repeat given a basic psychological framework Patterns • Patterns are shown in trends and formations • Trends become present over time whilst formations shows changes in trends Trends and • Formations give rise to uncertainty over the possibility of the continuation of a Formations trend • Hedge funds use TA, though it is very difficult to establish whether it’s profitable for them or not Applications • Technical analysis alone does not predict price movements Definition (1/4) Reading diagrams through candlesticks • Candlesticks uses time series • To construct a candlestick chart you must have access to the highest, lowest, opening and closing prices Interpreting Candlesticks • Long positively/negatively colored real bodies represent that the instrument has strengthened/weakened through the period. This is a bull/bear signal • If a candlestick has no shadows it is known as a Marubozu. This shows very strong bull/bear behavior • If the opening and closing price are identical, the candlestick will be represented in a cross. This is also called a Doji. This is an indicator of uncertainty as the price has moved through the day, yet closes near opening price Definition (2/4) Volumes as Technical Indicators • Volume is used as a technical indicator in technical analysis • It indicates the magnitude of the turnover in a stock • Volume should follow price changes as an increase in price should be justified by an increase in interest for the instrument Technical Price Volume Strength Increase Increase Strong Increase Decrease Neutral Volume Decrease Increase Weak (1) Decrease Decrease Neutral (1) Chart from Trendtech, following the OBX index. Definition (3/4) Support and resistance in technical charts • Support and resistance are measures that quantify potential psychological reactions in markets • These levels are determined through upper and lower bounds of horizontal trend channels • A safety margin of 3% is commonly used to account for ‘random’ movements around support and Resistance resistance levels • Trend channels are ever changing, thus making in vital for technical traders to reevaluate markets frequently. • The more data used to justify resistance and support SupportVlume levels, the more accurate these levels should be. Note that safety margin should be greater/smaller in longer/shorter trends. (1) (1) Chart from Trendtech, following the OBX index. Definition (4/4) Finding trends • A trend is the direction the price of an instrument is moving at a given time. In TA, trends are usually drawn in trend channels consisting of an upper and a lower trend line. These are found through finding trends in recent peaks and troughs. This process should be self explanatory. (1) Chart from Trendtech, not following real data Formations (2/3) Finding patterns • Technical analysis is based on the fact that historical behavioral patterns in the financial markets tend to repeat 4 Major Patterns 1 2 3 4 Head & Double Top / Flag Pennant Shoulders Double Bottom • Continuation Pattern • Continuation Pattern • Reversal Pattern • Reversal Pattern • Forms a tight flag • Chart looks like a small • Psychological • Psychological shape after an triangle motivation: failure to Motivation: failure to established trend and • Psychological reach new highs / lows beat previous highs / breaks out motivation: profit shakes traders out lows • Psychological taking motivation: profit taking Formations (2/3) Finding patterns: continuations 1 2 Charts from Trendtech, not following real data. Formations (3/3) Finding patterns: reversals 3 4 Support Charts from Trendtech, not following real data. Other Technical Indicators For advanced TA using appropriate software • RSI compares the sum of a price increase to that of a decrease over a RSI period • RSI = 100 * RSIup/(RSIup + RSIdown) • A Stochastic analysis will compare the moving average of one instrument Stochastics to another instrument and the relative convergence/divergence of the two can indicate strength/weakness • MACD can be applied by comparing 12-day vs 26-days moving average MACD • If the 12 day average lays above the 26 day average it indicates positive momentum Moving Average • Moving Averages measure the average price of an instrument over time.