by Steve Kern
on June 5, 2015
Chapter 8: Measuring Market Strength
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- Chapter Objectives
- Understand the importance of measuring internal market strength
- Understand what is meant by market breadth
- Be familiar with how the advance-decline line measures market breadth
- Be familiar with how up and down volumes relate to market strength
- Be familiar with how new high and new low statistics measure market strength
- Be familiar with the relationship between the number of stocks above their historical moving average and market strength
- Importance of measuring internal market strength
- Market Breadth
- The Breadth Line or Advance-Decline Line
- Double Negative Divergence
- Traditional Advance-Decline Methods That No Longer Are Profitable
- Advance-decline line moving average
- One-day change in advance-decline line
- Advance-Decline Line to Its 32-Week Simple Moving Average
- Breadth Differences
- Haurlan Index
- McClellan Oscillator
- McClellan Ratio-Adjusted Oscillator
- McClellan Summation Index
- Plurality Index
- Absolute Breadth Index
- Unchanged Issues Index
- Breadth Ratios
- Advance-Decline Ratio
- Breadth Thrust
- Summary of Breadth Indicators
- Up and Down Volume Indicators
- The Arms Index
- Modified Arms Index
- Ninety Percent Downside Days (NPDD)
- 10-to-1 Up Volume Days and 9-to-1 Down Volume Days
- Net New Highs and Net New Lows
- New Highs Versus New Lows
- High Low Logic Index
- Hindenburg Omen
- Using Moving Averages
- Number of Stocks above Their 30-Week Moving Average
- Very Short-Term Indicators
- Breadth and New Highs to New Lows
- Net Ticks
- Conclusion
- Review Questions
Proceed to Chapter 9: Temporal Patterns and Cycles (in Kirkpatrick and Dahlquist)
Chapter list for Kirkpatrick and Dahlquist
by Steve Kern
on June 5, 2015
Chapter 6: Dow Theory
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- Chapter Objectives
- A brief history of the development of Dow Theory and the major contributors to this development
- The theorems of Dow Theory
- The three types of trends– primary, secondary, and minor– of Dow Theory
- The concept of confirmation in Dow Theory
- The role of volume in Dow Theory
- The criticisms of Dow Theory
- A brief history of the development of Dow Theory and the major contributors to this development
- Dow Theory Theorems
- The three types of trends
- The Primary Trend
- The Secondary Trend
- The Minor Trend
- Concept of Confirmation
- Criticisms of the Dow Theory
- Conclusion
- Review Questions
Proceed to Chapter 8: Measuring Market Strength (in Kirkpatrick and Dahlquist)
Chapter list for Kirkpatrick and Dahlquist
by Steve Kern
on June 5, 2015
Part II: Markets and Market Indicators
Chapter 5: An Overview of Markets
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- Chapter Objectives
- The market characteristics required for investors to use technical analysis
- The types of markets in which technical analysis can be used
- The differences between informed, uninformed, and liquidity market players
- The differences among:
- price-weighted
- market capitalization weighted, and
- equally weighted averages
- In What Types of Markets Can Technical Analysis Be Used?
- Types of Contracts
- Cash Market
- Derivative Markets
- Futures Markets
- Options Markets
- Swaps and Forwards
- How Does a Market Work?
- Who Are the Market Players?
- How Is the Market Measured?
- Price-Weighted Average
- Market Capitalization Weighted Average
- Equally Weighted (or Geometric) Average
- Conclusion
- Review Questions
Proceed to Chapter 6: Dow Theory (in Kirkpatrick and Dahlquist)
Chapter list for Kirkpatrick and Dahlquist
by Steve Kern
on June 5, 2015
Chapter 5: Potential Bear Market in 2014; Bearish Secular Residue and Then Buying Opportunity
- Preparing for a (Say, 20 Percent) Bear Market
- Sentiment and Valuation Indicators, If One Wanted to Be Bearish
- Other Sentiment Indicators
- Valuation Problems
- Trend Indicators to Plan for a Potential Pullback– Follow the Leaders
- More Leading Indicators of Market Peaks
- Four-Year Presidential Cycle Risks
- Macro Backdrop: Debt Bubble Update
- Watching Fed Policy to Prepare for a Major Pullback in 2014
- Watch Financial Conditions and Interest Rates
- What do Demographics Say?
by Steve Kern
on June 5, 2015
Chapter 4: The Technical Analysis Controversy
(Check back soon for more detailed outline– sign up for email list updates)
- Chapter Objectives
- Importance of Financial Topics as Reported by Professors and Practitioners
- Do Markets Follow a Random Walk?
- Fat Tails
- Drawdowns
- Proportions of Scale
- Can Past Patterns Be Used to Predict the Future?
Proceed to Chapter 5: An Overview of Markets in Kirkpatrick and Dahlquist
Chapter list for Kirkpatrick and Dahlquist
by Steve Kern
on June 5, 2015
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
- 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
- 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
- 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
- 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
- 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
- Commodities, currencies, bonds, and notes have their own technical information and peculiarities
Proceed to Chapter 4: The Technical Analysis Controversy (in Kirkpatrick and Dahlquist)
Chapter list for Kirkpatrick and Dahlquist
by Steve Kern
on June 5, 2015
Chapter 2: The Basic Principle of Technical Analysis– The Trend
- Pring: The art of technical analysis– for it is an art– is to identify trend changes at an early stage and to maintain an investment position until the weight of the evidence indicates that the trend has reversed.
- Technical analysis is based on one major assumption– trend. Markets trend.
- Trends exist in all lengths, but tend to have the same characteristics regardless of length.
- To help identify trend early, we use charts, moving averages, oscillators, support and resistance, and more techniques
- Decide when to enter, and when to exit at either a profit or a loss
- Trend can suddenly change direction unexpectedly so it’s important to be aware of risks and protect against large losses
- Advantage of technical analysis: price point can be established at which the investor knows that something is wrong either with the analysis or the financial asset’s price behavior.
- Risk of loss can therefore be determined right at the beginning of the investment.
- What is a trend?
- Types of Trends
- Rising trend (uptrend): prices reach higher peaks and higher troughs
- Declining trend (downtrend): prices reach lower troughs and lower peaks.
- Sideways trend (flat trend): prices trade in a range without significant underlying upward or downward movement
- From a technical analyst’s perspective, a trend is a directional movement of prices that remains in effect long enough to be identified and still be playable.
- How are Trends Identified?
- Linear least-squares regression
- statistical technique
- not of much use to technical analyst for trend analysis
- dependent on sizable amount of past price data for accurate results
- by the time enough historical data is accumulated, the trend is likely beginning to change direction
- slope of regression line represents the trend
- See Appendix A “Basic Statistics” for details.
- Moving averages
- smooth out shorter and smaller trends within the trend of interest and identifies the longer trends
- Chapter 13: “Breakouts, Stops, and Retracements” discusses the use of moving averages.
- Trend lines
- draw lines between extreme points, tops, and bottoms, separated by reasonable time periods
- originated before computer graphic software, when trend lines were hand drawn
- you must define reversal points
- Chapter 12: “Trends– The Basics” covers several methods of determining reversal points
- get a “feeling” of price direction and limits
- get a “feeling” of slope, or rate of change of prices
- trend lines can define limits to price action which if broken can warn that the trend might be changing.
- Trends Develop from Supply and Demand
- each buyer (demand) bids for a certain quantity at a certain price
- each seller (supply) offers a certain quantity and “asks” for a certain price
- when buyer and seller agree and transact, they establish a price for that instant in time
- the number of players and different reasons for their participation in supply and demand is close to infinite
- therefore, technical analyst believes it is futile to analyze components of supply and demand except through the prices it creates
- economic information affecting prices is often vague, late, or misplaced.
- prices are readily available, are extremely accurate, have historic records, and are specific
- prices determine profit or loss for trades, not corporate earnings nor Federal Reserve policy
- price is what determines success and fortunately, for whatever reason, prices tend to trend.
- What Trends Are There?
- What Other Assumptions Do Technical Analysts Make?
- price is determined by the interaction of supply and demand
- price discounts everything
- prices are nonrandom (corollary to the notion that markets trend)
- history will repeat itself, and humans will behave similarly to how they have in the past in similar circumstances.
- like trend lines, these patterns are fractal
- emotions are affected by earlier emotions through emotional feedback
- Conclusion
- Review Questions
Proceed to Chapter 3: History of Technical Analysis (in Kirkpatrick and Dahlquist)
Chapter list for Kirkpatrick and Dahlquist
CMT 1 Reading List
by Steve Kern
on June 5, 2015
Chapter 1: Introduction to Technical Analysis
- Technical analysis is the study of prices in freely traded markets with the intent of making profitable trading or investing decisions.
- Technical Analysis is rooted in basis economic theory:
- Stock prices are determined solely by interaction of supply and demand
- Stock prices tend to move in trends
- Shifts in demand and supply cause reversals in trend
- Shifts in demand and supply can be detected in charts
- Chart patterns tend to repeat themselves
- Technical analysts study the action of the market itself rather than the goods in which the market deals.
- Psychological factors affect markets in an almost indecipherable way: greed, fear, cognitive bias, misinformation, expectations, and other factors.
- Technical analyst disregards all of these factors
- Technical analyst studies how the marketplace is accepting the multitude of various information
- Technical analyst looks for secrets in the market action that have predictive potential
- Technical analysis is used in two major ways:
- predictive
- market letter writers
- technical market gurus in the financial news
- well-known people
- like publicity, which helps market their services
- reactive
- use technical analysis (TA) to react to particular market conditions to make own decisions
- watch market and react when particular technical condition is met such as watching for moving average crossover
- not well-known people; publicity may distract them from their work
- the focus of this book is reactive, not predictive
Proceed to Chapter 2: The Basic Principle of Technical Analysis—The Trend (in Kirkpatrick and Dahlquist)
Chapter list for Kirkpatrick and Dahlquist
CMT 1 Reading List
by Steve Kern
on June 5, 2015
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