introduction to ta
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IntrdouctioTRANSCRIPT
Technical Analysis –Introduction
Dow Theory, Chart Construction, Concept of Trend
Declan Fallon, B.A. (Mod.) Ph.D.Senior Market Technician, Zignals (www.zignals.com)
Affiliate member of the Market Technicians Association
What is Technical Analysis?
• A decision process where price is a factor in the outcome
• “Fundamentalist studies the cause of market movement, while the technician studies the effect”
George Murphy
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Advantages of Technical Analysis
• All available information in the market place is expressed in the stock’s price
• Level playing field with the “Big Money”• “Big Money” action is readily apparent on a
price chart (‘elephant foot prints’)• Quantitative representation of market
psychology; greed and fear
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Tools of the Trade• Charts
– All chartists are technicians, but not all technicians are chartists
– Supply / Demand (Support/Resistance)• Indicators
– Trend (e.g. Moving averages)– Momentum (e.g. Stochastics)– Volume (e.g. Accumulation/Distribution)
• Sentiment– Percentage of investors bullish or bearish– Professional and Retail money flow
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Technical Analysis vs Fundamental Analysis
There is no ‘right’ and ‘wrong’ each have pros and cons
• Fundamental analysis is heavily dependent on accurate (and fair) reporting
• Technical analysis does not offer yes/no solutions
In both cases it is important to know WHEN to trade
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Chart construction
Types of Chart
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Line
Candlestick
Point-n-Figure
Bar
Displayed Price
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Open
High
Low
Close
High
Open
Close
Low
Rising Prices
Displayed Price
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Open
High
Low
Close
High
Open
Close
Low
Falling Prices
Key Information on a Chart
• Pricey-axis
• Timex-axis
• VolumeTypically runs below timeTotal number of shares traded for a given day
displayed as a histogram
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Zignals Chart Structure
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Time Scale of Charts
• Long termUsually a chart longer than a yearPlotted on logarithmic or arithmetic scale (price)Weekly, Monthly
• Intermediate term (most common)Between 1-6 monthsUsually arithmetic price scaleDaily
• Short termLess than a monthArithmetic scale60, 30, 15, 10, 5 and 1 minute(s)
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Creating a Chart
• Create an account on Zignals.comShould be prompted to download Silverlight 2; this is needed to work the charting service
• Go to ChartsStock: CRH (‘CRG - ISE’)Settings: 2 yearsChart type: Line
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CRH – Sample Chart
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Dow Theory
Dow Theory
• Charles Dow– Father of Technical Analysis– His tenets are the cornerstone of TA– Published first stock market average 1884
• 9 railroad stocks• 2 manufacturers
– Increased to 30 stocks in 1928
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Tenets of Dow Theory [i]
1. Averages Discount Everything“The sum and tendency of the transactions of the Stock Exchange represent the
sum of all Wall Street’s knowledge of the past, immediate and remote, applied to the discounting of the future.”
2. Market Has Three TrendsDow defined an uptrend as a situation in which each successive rally closes higher
than the previous rally high, and each successive rally low also closes higher than the previous rally low. (Vice Versa for a downtrend)
Three parts:[1] Primary - 1 year[2] Secondary - 3 weeks – 3 months[3] Minor - < 3 weeks
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Tenets of Dow Theory [ii]
3. Major Trends Have Three Phases[1] Accumulation
Informed buying; typically “Big Money”
[2] Public ParticipationImproving Business NewsTechnical / Trend traders
[3] Distribution PhaseMedia hypeInformed selling
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Tenets of Dow Theory [iii]
4. Averages Must Confirm Each OtherNo important bull or bear market signal could take
place unless both averages gave the same signal.
What are the “Averages”?Industrial Index (Dow Jones Index)Transport Index
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Tenets of Dow Theory [iv]
5. Volume Must Confirm TrendVolume should expand or increase in the direction of
the major trend.Volume should decrease in the direction of the
countertrend
Dow considered volume a secondary tool
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Tenets of Dow Theory [v]
6. A Trend is Assumed to be in Effect until it Gives Definite Signals that is has Reversed
How is this known?[1] Support/Resistance[2] Price Patterns[3] Trendlines[4] Moving Averages
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Dow Theory In Action
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Dow Jones ETF (DIA) 2006-2007
Dow Theory In Action
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Dow Jones ETF (DIA) 2006-2007
Higher Highs
Higher Lows
Breakdown
Dow Theory In Action
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Dow Transports ETF (IYT) 2006-2007
Higher HighsHigher LowsBreakdown
Dow Theory In Action
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Dow Jones ETF (DIA) 2007-2009
Lower highs
Lower lows
Dow Theory In Action
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Dow Transports ETF (IYT) 2007-2009
Lower highsLower lows
Trends
Importance
• Concept of trend is essential to the technical approach to market analysis
• All tools used by a chartist have the sole purpose of helping to measure trend
• By understanding the underlying trend it is possible to trade in the direction of that trend
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Definition
• Direction of the Market• Movement characterized by zigzags• Zigzags resemble a series of successive
waves with peaks and troughs• Direction of peaks and troughs that
constitutes market trend.
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Direction
• Markets can go1. Up
2. Down
3. Sideways
• Approximately 60% of the time markets go sideways
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Psychology of Trend
• UP Market (“Bullish”)Initial buyers sitting on profits want moreSideline individuals tempted to enter the
marketShorts (people who sell to buy later at a
lower price) forced to buy• DOWN Market (“Bearish”)
Initial buyers eager to dump losing positionSideline individuals disinterested in buyingShorts (people who sell to buy later at a
lower price) in profit and wanting morewww.zignals.com
Trends in different time frames
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Uptrend
Sideways
Downtrend
Trends in Zignals
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Defining Boundaries
• Support and Resistance– Typically Horizontal Price Bands– Help confirm trends
• Bull trends hold support and break resistance• Bear trends break support and hold resistance
• Support– A price area below which buying exceeds selling
• Resistance– A price area above which selling exceeds buying
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Support and Resistance in Zignals
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Manually draw support / resistance
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Use annotations and the crosshair tool to pick your own support and resistance
How Support and Resistance work
• During a trending market, support and resistance levels will break and hold in the direction of trend; in an uptrend support holds and resistance breaks; in a downtrend resistance holds and support breaksBUT
• Whenever support of an uptrend or resistance in a downtrend is penetrated by a significant amount, they reverse their roles and become the opposite
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Support turns Resistance
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Volume in Support and Resistance
• Increased volume (at least double a 2-month average) is frequently associated with breaks of resistance
• Increased volume isn’t necessary to break support
– Low volume on breaks of support suggests complacency
– High volume on breaks of support suggests panic
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Volume and Support Break
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ComplacencyMore fearful
Support turned resistance
Backtest
Trendlines
• A technician’s basic tool• Up-trendline
– Connects successive upward reaction lows
• Down-trendline– Connects successive downward reaction highs
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Rules of Trendlines
1. Evidence of a trend• Two reaction lows for an uptrend• Two reaction highs for a downtrend
2. The middle peak of the two reactions is breached
• The mid-high for an uptrend• The mid-low for a downtrend
3. Confirmation with a third touch of the line
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Benefits of Trendlines
1. Enter a Trade on touches of the line2. A break of a trendline is the first sign of a
trend reversal3. The strongest trendlines run at a 45 degree
angle4. The longer the trendline (and the more
tests) the greater its significance
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What Constitutes a Trendline Break?
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Trendline Breaks
1. Intraday breaks less significant than closing price breaks
2. Price filters• 3% break long term• 1% break short term
3. Time filters• 2-days of closes outside of the line
4. Role reversal
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Fan Principle
1. Used for trendline violations• Common for a break to move away from the
trendline before returning to the old trendline
2. Three Strike rule• Each trendline break results in a new trendline
been drawn• On the third trendline break the trend itself is
considered to have reversed.
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Fan Principle
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1.
2.
3.
Breakdown
Trend Indicators
1. Sometimes trendlines aren’t enough2. Trends can be measured with
• Price overlays• Moving Averages
• Price indicators• MACD
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Moving Averages
1. Smooth Price Action2. Can be adapted to different time frames
1. Long term : 200-day MA or 40-week MA2. Intermediate term: 50-day MA3. Short term: 5-, 10-, or 20-day MA
3. Different kinds1. Simple Moving Average (most common)2. Exponential Moving Average3. Weighted Moving Average
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Zignals Moving Averages
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How do Moving Averages Work?
1. When a Moving Average is rising the trend is bullish
2. When a Moving Average is falling the trend is bearish
3. Depending on the period of the Moving Average, bullish and bearish trends can occur together.
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Trend Indicators
1. Supporting Indicators2. Price derived3. Examples
• Moving Average Convergence Divergence (MACD) – most common
• Directional Indicator (ADX)• Linear Regression• Parabolic SAR
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Moving Average Convergence Divergence (MACD)
1. Two Exponential Moving Averages2. A Third Moving Average on the difference
between the Two Moving Averages3. Triggers on crossover of MA difference and
third Moving Average
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Zignals MACD
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Putting It All Together
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Where is CRH now?
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Using Zignals
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1. Email / SMS Alerts• Price breaks Support or Resistance• Price crosses a Moving Average• One Moving Average crosses another
2. Charts• Trendlines• Support / Resistance• Indicators
Record your thoughts
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1. Blogging• Archive your Analysis• Store your Chart images• Provide Research to your ‘Clients’
2. Zignals YourCall• Make Price Projections• Share with your Friends• Make Yourself a Star!
Tools
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1. BloggingZignals.com/Community (coming soon), Blogger.com, Wordpress.com
2. MicroBlogging (excellent for publishing YourCall)Twitter.com, Stocktwits.com
3. Books“Technical Analysis of the Financial Markets” – John Murphy
4. WebsitesZignals.com, Wikinvest.com, Covestor.com, Cake.com, SocialPicks.com, Stockpickr.com , Instantbull.com, Finviz.com
5. BlogsZignalsblog.blogspot.com, Blog.fallondpicks.com, Ritholz.com/blog, TimothySykes.com, Globaleconomicanalysis.blogspot.com, Traderfeed.blogspot.com, HowardLindzon.com, Paddypowertrader.com/blog
QUESTIONS?Thank you
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