Chapter 3: History of Technical Analysis
- Early Financial Markets and Exchanges
- Markets have existed for centuries
- Notes and checks between traders and bankers in Babylon by 2000 BC
- Currency exchange, commodities, mercantile voyages in seaport of Rome second century AD
- Middle ages – wheat, bean, oat, barley – England, 1160 AD
- Large grain market in Toulouse – 1203 AD
- Earliest exchanges – 14th century, Pisa, Venice, Florence, Genoa, Valencia, Barcelona (first exchange building, the Lonja, build in 1393, Barcelona)
- 1530 – Amsterdam – commodities
- 1585 – Amsterdam – public quotes of over 339 items traded on the streets and in coffee houses
- 1608 – Amsterdam – The greatest of the earliest exchanges
- 1621 – Amsterdam – “Tulip Bulb Mania”
- 18th Century – Dutch empire declined and London and Paris Exchanges surpassed Amsterdam Exchange
- Japan – cash-only commodity markets for rice and silver were developing at docks of major seacoast cities – a wealthy trader (Sokyo Honma, born 1716) used technical analysis and trading discipline to amass a fortune
- He used trading rules, not charts.
- He focused on how to limit losses and step away from markets, based on price
- Japan – therefore, first recorded use of technical analysis in the rice markets
- Japan – 1870 – first use of charts, introduced in the silver market by an English man.
- Technical analysis has a poorly recorded history but is probably a very old method of analyzing trading markets and prices
- Markets have existed for centuries
- Modern Technical Analysis
- Charles Dow (1851-1902)
- Father of modern technical analysis.
- Introduced stock indexes to measure performance of stock market
- Newspaper journalist
- 1880 moved to New York, covering the mining industry
- 1882 joined with Edward Jones to form Dow, Jones & Company
- Wrote handwritten news bulletins and distributed by messenger to customers in the Wall Street vicinity
- July 3, 1884 – first version of a stock index published in newsletter
- Price-weighted average
- summed prices of the stocks in the index and divided by the number of stocks
- 11 stocks— 9 railroads and 2 industrials
- February 1885 – 14 stocks, 12 railways and 2 industrial stocks
- January 1886 – 12-stock index: 10 railroads and 2 industrials
- May 1896 – entirely industrial stocks
- May 26, 1896 – first version of the Dow Jones Industrial Average (DJIA) appears in the Wall Street Journal
- only General Electric remains a component of the DJIA today
- American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding, General electric, Laclede Gas, National Lead, North American, Tennessee Coal & Iron, U.S. Leather pfd., U.S. Rubber
- Original intent was to use averages to predict the economy
- Theories became known as the Dow Theory (See Chapter 6)
- Foundation for modern technical analysis
- Dow Theory principles still valid today, but in a different form
- Dow Jones Company in the United States to publicly report stock prices
- This public source of stock prices helped give rise to technical analysis
- Technical analysis is a means for the uninformed to become informed
- Dow mentioned patterns in market averages
- “line”
- “double top”
- Richard D. Wyckoff
- 1931- offered correspondence course in trading and investing using technical analysis theories
- earlier in 1920s published a technical newsletter that reached over 200,000 subscribers.
- Colonel Leonard P. Ayers (1944)
- A/D line
- early measure of business confidence
- Ran a company called “Standard Statistics”
- 1941- merged with company headed by Henry Poor
- merged company became
- Standard and Poor’s
- A/D line
- Richard W. Schabacker
- Financial editor of Forbes magazine and New York Times
- Began to recognize individual stock patterns
- First to use the words:
- triangle
- pennant
- head-and-shoulders
- Authored:
- Stock Market Theory and Practice (1930)
- Technical Analysis and Market Profits (1932)
- Stock Market Profits (1934)
- William Delbert Gann
- special technical theories
- Graham and Dodd
- Security Analysis (1934)
- Fundamental analysis
- Did not believe that fundamental analysis determined price alone
- Market is a “voting machine”
- Individual choices are a product partly of emotion
- Robert Edwards and John Magee
- Technical Analysis of Stock Trends (1948) First Edition
- demonstrated technical patterns observed in hundreds of stocks
- “Bible of Technical Analysis”
- 9th Edition published in 2009
- Joseph Granville
- Most prominent technical analyst of the 1950s
- worked for E.F. Hutton
- wrote book covering
- on-balance volume
- 200-day moving average
- other tools still popular today
- Other technical analysts of this time
- Kenneth Ward
- Edmund Tabell
- E.S.C. Coppock
- D.G. Worden
- Garfield Drew
- George Lindsay
- 1960s
- Rate of change (ROC) or momentum
- 1970s (computers)
- J. Welles Wilder, Jr
- Relative Strength Index (RSI)
- Parabolic System (Directional Movement concept)
- Average True Range (ATR)
- Richard Donchian
- technician and commodity trader
- 10-day and 20-day moving averages crossovers as buy and sell signals
- 4-week rule (a price break above or below the four-week high or low indicated the initial stage of a new trend)
- Martin Zweig
- Options market
- examined the use of the put-call ratio
- Fred Hätscheln and Gerald Appel
- moving-average envelopes
- moving average crossover
- moving-average convergence/divergence (MACD) oscillator
- J. Welles Wilder, Jr
- Academics argued technical analysis was impossible because prices were random
- Efficient Markets Hypothesis argued that markets were efficient and that news, information, and so on was immediately and rationally discounted in the markets
- Professional money managers closed their technical departments
- Technical analysis went into a decline
- Faster computers and large post WWII data set helped explore new technical strategies
- Steve Nison
- introduced candlestick charts into U.S. technical analysis in the late 1980s.
- Other chart types
- Kagi
- Kase
- Renko
- Ichimoku Kinko
- Charles Dow (1851-1902)
- Current Advances in Technical Analysis
- Interest in Technical Analysis has a resurgent interest
- Efficient Markets Hypothesis has several serious flaws
- Stock price motion is being shown to be nonrandom
- Academics are gradually beginning to perform serious studies on technical theory and indicators
- Behavioral Finance
- has shown investors do not necessarily act rationally as is assumed in the Efficient Markets Hypothesis
- instances of predictable investor behavior
- beginning to explain some of the reasons for price patterns known by technical analysts over a hundred years
- Sharp price declines from 2000 to 2002 and from 2007 to 2009
- technical analysis, if applied properly, would have protected an investor from large losses in certain stocks because it would have warned that the price action of these stocks was not consistent with what management was saying to the fundamental analysts.
- Modern technology has demonstrated that prices are not necessarily random, but also that they are not perfectly predictable.
- People buy and sell based on what they believe are reasonable expectations, but also on emotion
- fear
- greed
- inherent and learned bias
- overconfidence
- perception
- prejudice
- People buy and sell based on what they believe are reasonable expectations, but also on emotion
- Commodities, currencies, bonds, and notes have their own technical information and peculiarities
- Interest in Technical Analysis has a resurgent interest
Proceed to Chapter 4: The Technical Analysis Controversy (in Kirkpatrick and Dahlquist)
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