South-Western / Thomson Learning © 2004 9 - 4Charting: The Underlying Logic The technical analyst believes that charts can be used to predict changes in supply and demand and investor
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Practical Investment Management
Robert A Strong
TECHNICAL ANALYSIS
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Indicators with Economic Justification
Indicators of the Witchcraft Variety
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Charting: The Underlying Logic
The technical analyst believes
that charts can be used to predict changes in supply and
demand and investor behavior.
Market participants seldom wait
for things to completely unfold They try to anticipate events
rather than merely react to them.
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Charting: Types of Charts
The technical analyst uses many types of
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Linear Scale Line Chart
Insert Figure 9-1 here.
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Logarithmic Y-Axis Line Chart
Insert Figure 9-2 here.
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Bar Chart
Insert Figure 9-3 here.
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Point and Figure Chart
Insert Figure 9-4 here.
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Candlestick Chart
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Charting: Other Chart Annotations
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Charting: Other Chart Annotations
Insert Figure 9-6 here.
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Technical Indicators
These statistics, either calculated or directly
observed, are alleged to have a relationship with the future direction of the overall stock market or with an individual security.
Indicators with economic justification are
based on economic activities that are
measurable and observable.
Indicators of the witchcraft variety have no
logical connections between the
measurements and what the
measurements purport to show
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Indicators with Economic Justification
The higher the short interest figure, the
larger is the potential demand for the
shares.
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Short Interest
Insert Table 9-1 here.
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Indicators with Economic Justification
Increased margin buying has historically been associated with rising markets.
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Margin Loans
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Indicators with Economic Justification
Cash held by mutual funds represents
potential demand for stock.
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Mutual Fund Cash Position
Insert Figure 9-8 (Mutual Fund Cash Position Rule) here.
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Mutual Fund Cash Position
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Indicators with Economic Justification
When the confidence index gets closer to 1.0, investors are more likely to be bullish about the economy, and therefore about
corporate earnings.
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Confidence Index
Insert Figure 9-10 here.
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Indicators with Economic Justification
An advance-decline line is a graphical
representation of the net advances over a period of time.
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Advance-Decline Line
Insert Figure 9-11 (Market Breadth) here.
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Indicators with Economic Justification
A high relative strength ratio, such as a
high relative PE, means that investors are willing to pay more for the past earnings of
a company than average.
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Relative Strength Ratio
Insert Table 9-3 here.
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Indicators with Economic Justification
Advocates of moving averages in stock
selection believe that changes in the slope
of the line are important.
Market indicators can help present data in a more intuitive way and may suggest areas for further investigation However, they
cannot always predict the future
movements of a stock or of the overall
market.
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Indicators of the Witchcraft Variety
The super bowl indicator states that the
stock market will advance the following
year if the super bowl football game is won
by a team from the original National
Football League.
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The Super Bowl Indicator
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Indicators of the Witchcraft Variety
Increased sunspot activity every eleven
years leads to better weather for an
improved harvest, leading in turn to a
stronger economy, and finally to higher
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Old Puzzles and New Developments
Fibonacci numbers occur frequently and
inexplicably in nature.
1.618, the golden mean of the numbers,
is used to calculate the Fibonacci ratios.
Many Fibonacci advocates in the investment
business use the first two ratios, 0.382 and 0.618, to “compute the retracement
levels of a previous move.”
Fibonacci Numbers
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233,
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Dow Theory
The Dow theory holds that there are three
components in the movement of stock
prices:
The primary trend is the long-term direction of
the market and is the most important.
The secondary trend refers to a temporary
reversal in the primary trend.
Daily fluctuations in the stock price are
meaningless and contain no useful information.
Old Puzzles and New Developments
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Old Puzzles and New Developments
Insert Figure 9-12 (The Dow Theory) here.
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Old Puzzles and New Developments
The Kondratev wave theory states there is a
50-60 year business cycle.
The Chaos theory sees systematic behavior
amidst apparent randomness.
A neural network is a trading system in which
a forecasting model is trained to find a desired output from past trading data.
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Old Puzzles and New Developments
Insert Figure 9-13 Style Topography) here.
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The Future of Technical Analysis
Technical analysis has persisted for more than 100 years, and it is not likely to
disappear from the investment scene
anytime soon.
Improved quantitative methods coupled
with improved behavioral research will
continue to generate ideas for analysts to test.
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Indicators with Economic Justification
Indicators of the Witchcraft Variety
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