Lecture ThreeTechnical Analysis II

Andy Bowerwww.alchemetrics.org

Advanced Chart Patterns

Fibonacci Levels•Retracements•Clusters

Elliott Wave Analysis•Impulse 5-waves•Corrective 3-Waves

Indicators

Moving Averages•Simple/Exponential/Weighted

Oscillators•Momentum/CCI/RSI/MACD/Stochastics

Fibonacci Levels

Series•1, 1, 2, 3, 5, 8, 13 etc•Ratios 61.8%, 38.2%, 23.6%•Inverse 161.8%

Retracements•Additional retracements 50%, 100%•23.6%, 38.2%, 50%, 61.8%, 100%

Extensions•100%, 161.8%

Fibonacci RetracementsExamples

NasdaqNasdaq 100 ETF Weekly 2005100 ETF Weekly 2005

Fibonacci RetracementsExamples

SPY S&P100 ETF DailySPY S&P100 ETF Daily20032003--20042004

Fibonacci ClustersExamples

BroadcomBroadcom 15min15min20052005

Elliott Wave Analysis

Patterns•Impulse waves in direction of trend•Impulse waves have 5 steps•Correction waves against trend•Corrections have 3 steps

Ratios•Retracement and extension follow fibonacci

ratios

Time•Multiple time frames

Elliott Wave AnalysisPatterns

2211

33

44 55 aabb

cc

ImpulseImpulse••W3 or 5 mayW3 or 5 may ““extendextend””••W4 canW4 can’’t overlap w1t overlap w1••Often, when w3 extends w1=w5Often, when w3 extends w1=w5

CorrectionsCorrections••ZigZig--zagzag••FlatsFlats••TrianglesTriangles

162% Wave 3 ExtensionExample

Nasdaq100 ETF DailyNasdaq100 ETF Daily20022002--20052005

11

33

22

44

IndicatorsMoving Averages

Simple•Sum over period, divide by period•Smoothing• but.. Substantial lag

Exponential•Weight each prior price point using:

EMA% = 2/(n + 1) where n is the number of days•Faster response than Simple Moving Average (SMA)

Uses•Crossover systems (poor in consolidating markets)•Support and Resistance trend lines

Moving AverageTrend Lines

Long term trend usingLong term trend using178 period EMA178 period EMA

Short term trend usingShort term trend using89 period SMA89 period SMA

IndicatorsOscillators

Attempt to capture “momentum”informationfrom price action

Oscillators vary between bounds• Upper bound=“overbought”• Lower bound=“oversold”

Basic momentum:M=V0-VnNo upper/lower boundary

Common Oscillators• Commodity Channel Index (CCI)• Relative Strength Index (RSI)• Stochastics (K%D)

Relative Strength Index(RSI)

RSI = 100-100/(1+RS)

RS= Avg of n days’up closesAvg of n days’down closes

•Varies between 0-100.•Overbought generally > 70•Oversold generally < 30•Often used to detect “fading trend momentum”

based on a divergence between RSI peaks/troughscompared with price action peaks/troughs

RSI-Price DivergenceNasdaqNasdaq 100 ETF Daily 2005100 ETF Daily 2005

RSIRSI

RSI SmoothedRSI Smoothed

Computer Pattern Matching

Strategy•Isolate tradable patterns.. Then test

Backtesting•Evaluation of a trading strategy using historical price

data to measure performance.

Metrics•Equity Curve•Profit Factor, Sharpe Ratio•Drawdown•Avg Trade %

BacktestingEquity Curve

BacktestingPeriod Returns

BacktestingPerformance Report

BacktestingOptimization

Strategies may have parameters•Optimize to maximize profitability•Need to be wary of “curve fitting”

Split data into segments•Backtest & Optimize on some segments•Then forward test on remaining segments

Minimize number of variables

Genetic Algorithms

Parameter Optimization•Searching a large multi-dimensional space•Typically better at avoid local optima

Use for Optimizing•Indicator based systems•Neural Network topology

Backtesting•Curve fitting issues are very important

Neural Networks

Used to isolate “unknown”patterns

BackpropagationBackpropagationNeural NetNeural Net

Real NeuronsReal Neurons

Neural Networks

Used to isolate “unknown”patternsInputs•Indicators/Other Networks

Outputs•Profit/Sharpe Ratio/etc

Network configuration•Optimize using Genetic Algorithms

Backtesting•Curve Fitting issues are very important