TECHNICAL ANALYSIS Charting Techniques by Leo Quinitio www.pse.com.ph Random Walk Theory Author Burton Malkiel "A Random Walk Down Wall Street“ top-seller finance book Stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement. Followers think that the market cannot be outperformed without assuming additional risk. Critics say stocks actually form trends at length and it is possible to beat the market through careful study of buying & selling points. Efficient Market Hypothesis It is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. Stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. It is impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. Efficient Market Hypothesis A cornerstone of modern financial theory Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis. Warren Buffett has consistently beaten the market over long periods of time, which by EMH is impossible The 1987 stock market crash when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day, is evidence that stock prices can seriously deviate from their fair values. Balance Sheet Solvency Ratio FUNDAMENTAL ANALYSIS Cash Flows TECHNICAL ANALYSIS INVESTMENT ANALYSIS Fundamental Analysis Technical Analysis Method of forecasting future price movements of a security based on Study of past market data such as political, environmental & other prices + volume = predict future factors price movements (I.e. stocks/markets) Traditional economic + Business concepts = value of investment Proponents believe that the market’s judgment of an issue’s fundamentals are determined by Examination of the above variables supply and demand variables that is called Valuation process are already reflected in prices. INVESTMENT ANALYSIS Fundamental Analysis Technical Analysis View from financial statements View from charts Best employed for long term investing Best employed for short term trading Data utilized come out periodically Data utilized come out daily Tends to focus on a specific sector Focused on what “must” happen Focused on what happens VALUATION PROCESS Fundamental Analysis Technical Analysis Top Down Approach Bottom-up Approach Considers condition affecting Economy Financial Markets Industry Company VALUATION PROCESS Fundamental Analysis Technical Analysis Works best if all investors are logical and could separate emotions from investment decision Works best in determining market sentiment and factor it in the creation of investment or trading Will succeed if the analyst finds decisions overlooked data in identifying undervalued securities EXPECTATIONS Should I buy today? What DON’T AIM TO PREDICT PRICES will the prices be tomorrow, CONSISTENTLY & ACCURATELY next week or next year? Technical analysis is the YES! answer!?NO! Technical Analysis will improve investing? AIM TO REDUCE RISKS & Make sensible investment IMPROVE PROFITS decisions DEFINITION The study of prices, with charts as the primary tool. A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. DEFINITION Once viewed as arcane or mystical but today it is part of every major investment or trading decision. Evolving quickly such that techniques today may be rendered incomplete or obsolete tomorrow. Used as the basis for automated trading. ADVANTAGES Portability Price based trade or investment planning Does not require knowledge of many mathematical formulas DISADVANTAGES May not be used to predict future price action Not easy to use with IPOs May miss 20-25% of the movement It has a tendency to create self fulfilling prophecies Subjectivity A chart is a picture A picture is worth a thousand words… or probably a thousand dollars Technical analysts Technical do not attempt to analysts believe measure a that the historical security's intrinsic performance of value, but instead stocks and use charts to markets are identify patterns indications of that can suggest future future activity. performance. Equally applicable on any security or tradable financial instrument (stocks, bonds, commodities, futures, indices, mutual fund, options) In a shopping mall Fundamental analyst: will go to each store, study the product and then decide whether to buy it or not Technical analyst: will watch people go into the stores. Decision would be based on the patterns or activity of people going into each store. HUMAN ELEMENT Humans are not easily quantifiable nor predictable Many investment decisions are based on irrelevant criteria The price of a security is a consensus of at least two humans The price depends on human expectations HUMAN ELEMENT The breadth of market participants guarantees an element of unpredictability and excitement Why Do Prices Fluctuate? MARKET PSYCHOLOGY Each investors would have his or her own opinion about a certain security or any other object for that matter MARKET PSYCHOLOGY THE PRICE IS RIGHT GAME cellphone MARKET PSYCHOLOGY THE PRICE IS RIGHT GAME Cellphone Five years depreciated MARKET PSYCHOLOGY THE PRICE IS RIGHT GAME Cellphone previously owned by Hayden Kho MARKET PSYCHOLOGY MY CHOICE GAME Designer shoes MARKET PSYCHOLOGY MY CHOICE GAME Designer shoes MARKET PSYCHOLOGY MY CHOICE GAME Designer shoes MARKET PSYCHOLOGY MY CHOICE GAME Designer shoes MARKET PSYCHOLOGY MY CHOICE GAME Designer bags PRACTICAL MARKET PSYCHOLOGY Logical: buyers want to buy at the lowest price possible Competitive: buyers raise their bids in order to attract sellers Emotional: buyers tend to be euphoric when price increases PRACTICAL MARKET PSYCHOLOGY Logical: sellers want to sell at the highest price possible Competitive: sellers tend to lower their offer price in order to attract buyers Emotional: sellers tend to panic when price drops MARKET CYCLE High price will urge sellers’ to cash-in More sellers compete to Euphoria sets in attract buyers Panic sets in Price becomes too cheap to be ignored News of increasing price by buyers spreads, price gains momentum More buyers compete to attract sellers MARKET CYCLE Distribution BASIC ASSUMPTIONS 1. The market discounts everything 2. Price moves in trends 3. History tends to repeat itself ORIGINS Dow Jones Theory 1890 Basic Principles of Dow Theory: 1. Averages discount everything 2. Market trends [primary (tide), intermediate or secondary (waves), tertiary (ripples)] 3. Bull and bear markets 4. Lines (tight sideways band) 5. Averages must confirm 6. A trend continues until it is reversed 7. Volume goes with trend EVOLUTION (WEST) Dow Theory 1890s Elliot Wave 1938 Classical Charting EVOLUTION (EAST) Japanese Charting 1800s (Meiji Period) Kagi 1870s Candlesticks Renko Equivolume Ichimoku Heikin-Ashi ELLIOT WAVE Ralph Nelson Elliot The Wave Principle published in 1938 Based on Fibonacci ratios “golden ratio” = Nature's Law — The Secret of the Universe ELLIOT WAVE New out More people join Consolidation Profit taking Bargain hunting ELLIOT WAVE Excess Distribution Big move Big move Despair Accumulation ELLIOT WAVE short or truncated corrective impulse Top of wave 1 biggest wave Below bottom of wave 4 ELLIOT WAVE The Elliott Wave Principle does not provide certainty about any one market outcome. Instead, it gives you an objective means of determining the probability of a future direction for the market. CLASSICAL CHARTING Chart Composition Chart Types Chart Trend Channels Chart Patterns & Formations Chart Indicators & Oscillators CHART COMPOSITION Price Fields Open - The first price traded for the period. An important consensus as all interested parties were able to “sleep on it”. High - The highest price traded for the period. The point where there were more sellers than buyers. Close – The last price traded for the Low - The lowest price traded for period. Most often used price for analysis. the period. The point where there The relationship of the open and close were more buyers that sellers. prices is considered most significant by technicians. CHART COMPOSITION Price Fields Volume – The number of shares traded during the period. Bid – The price a buyer is willing to pay Ask – The price a seller is willing to accept CHART COMPOSITION Axis Y= price range Price X= time Time line CHART COMPOSITION Grid Scaling Arithmetic (or Linear) CHART COMPOSITION Grid Scaling Semi Logarithmic CHART COMPOSITION Grid Scaling Arithmetic Scaling Semi-log Scaling CHART TYPES Line Chart CHART TYPES high low Pole Chart CHART TYPES Bar Chart CHART TYPES PCOR OPEN HIGH LOW CLOSE DAY 1 6.00 6.00 6.00 6.00 DAY 2 6.00 6.00 5.90 6.00 DAY 3 5.90 5.90 5.90 5.90 DAY 4 5.80 5.90 5.80 5.90 DAY 5 5.90 5.90 5.80 5.90 DAY 6 5.90 6.00 5.90 6.00 DAY 7 6.00 6.10 6.00 6.00 DAY 8 6.10 6.10 6.00 6.00 DAY 9 6.30 6.70 6.30 6.60 DAY 10 6.70 6.80 6.60 6.70 DAY 11 6.70 6.70 6.60 6.70 DAY 12 6.70 6.80 6.70 6.70 DAY 13 6.70 6.70 6.60 6.70 DAY 14 6.70 6.70 6.70 6.70 DAY 15 6.70 6.80 6.70 6.70 DAY 16 6.70 6.70 6.70 6.70 DAY 17 6.70 6.80 6.70 6.70 DAY 18 6.70 6.80 6.70 6.70 DAY 19 6.80 6.80 6.70 6.70 DAY 20 6.80 6.80 6.70 6.70 Bar Chart Plotting Exercise CHART TYPES Bar