Beyond the Fundamentals Technical Analysis

Technical Analysis vs. Fundamental Analysis Fundamental analysis focuses on economic/financial theory and various economic indicators to explain market movements Fundamental analysis focuses on economic/financial theory and various economic indicators to explain market movements Purchasing Power Parity Purchasing Power Parity Interest Parity Interest Parity Trade Balances Trade Balances Balance of Payments Balance of Payments

Technical Analysis vs. Fundamental Analysis Technical analysis is not concerned with the of market movements. Instead, technical analysis focuses on the. Is there information in past price movements that can be used to predict future movements? Technical analysis is not concerned with the causes of market movements. Instead, technical analysis focuses on the movements themselves. Is there information in past price movements that can be used to predict future movements? Chart Analysis Chart Analysis Quantitative Methods Quantitative Methods

Chart Analysis Chart analysis begins with a time series plot of an asset’s price Chart analysis begins with a time series plot of an asset’s price Charts can be hourly, daily, weekly, etc. Charts can be hourly, daily, weekly, etc. Higher frequency data will be more detailed, but noisier. Higher frequency data will be more detailed, but noisier. Chart looks for patterns in the chart to identify resistance (upper bounds) and support levels (lower bounds) Chart looks for patterns in the chart to identify resistance (upper bounds) and support levels (lower bounds)

$/Euro: Weekly data over 3 years

$/Euro: Daily data over 6 months

$/Euro: Hourly data over 5 days What’s this??

$/Euro: minute by minute over 6 hours

A “breakout” indicates a new pattern forming Connect two consecutive highs to get the upper channel A parallel line through a recent low becomes the lower support

Bullish channels tend to have upward breakouts

Find the trend by connecting at least two highs Two lows complete the triangle “Breakout” occurs at the apex, usually with increasing volume

Ascending triangles usually have upward breakouts

Two lows identify the “lead in” trend The “Run”: A breakout from the lead in trend The “Bump”: Increase in trend by more than 50%

Two lows identify the “lead in” trend The left shoulder is the first high above the current trend The head is the first advance past the left shoulder The right shoulder is the first high following the reversal The neckline connects the two shoulders and indicates lower support

What pattern do you see? “Bump” “Run”

Fibonacci Methods Fibonacci, one of the greatest mathematicians of all time discovered a sequence of numbers which are now used across many disciplines. Fibonacci, one of the greatest mathematicians of all time discovered a sequence of numbers which are now used across many disciplines.

The Fibonacci Sequence Suppose you begin with a pair of rabbits. Suppose you begin with a pair of rabbits. Rabbits take one month to mature (M) Rabbits take one month to mature (M) Only Mature rabbits can have offspring. Once mature, a pair offspring are born every month Only Mature rabbits can have offspring. Once mature, a pair offspring are born every month The rabbits never die The rabbits never die

1 Month One Pair (Y) Y = Young, M = Mature Now One Pair (M) 2 Months Two Pair (M, Y) 3 Months Three Pairs (M, M, Y) 4 Months Five Pairs (M, M,Y,Y,M) 5 Months Eight Pairs (M,M,M,Y,Y,Y,M,M) 6 Months Thirteen Pairs (M,M,M,Y,Y,Y,M,M,M,Y,Y,M,M)

Can you find the Pattern? 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, … 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, … Each number in the Fibonacci sequence is the sum of the previous two 1+ 1 = = = 5 ….

The Golden Number Suppose that we divide each number into the previous number Suppose that we divide each number into the previous number 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ……… 1/1 = 15/8 =.625 1/2 =.5 8/13=.615 2/3 =.66713/21 =.619 3/5 =.621/34 =.617

The Golden Number Suppose that we divide each number into the following number Suppose that we divide each number into the following number 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ……… 1/1 = 18/5 = 1.6 2/1 = 113/8 = /2 = 1.521/13 = /3 = /21 = The ratios converge to (PHI)

The Golden Number (.618, 1.618) Note that 1 + phi = PHI Note that 1 + phi = PHI However, we also have that However, we also have that 1/phi = PHI.618 is the basis for Fibonacci methods.618 is the basis for Fibonacci methods The important numbers are The important numbers are ( =.618*.618).382 ( =.618*.618).236 (=.618*.618*.618).236 (=.618*.618*.618)

Fibonacci Arcs Draw an initial trend line between two extreme points Draw arcs that intersect the trend at 61.8%, 50%, and 38.2% of the high The arcs anticipate future support/resistance levels

Fibonacci Rays Draw an initial trend line between two extreme points At the second extreme point, draw a vertical line Draw rays that intersect at 61.8%, 50%, and 38.2%

Fibonacci Retracement Once a reversal occurs, it tends to find support at Fibonacci levels!

Fibonacci times Large price swings tend to occur on “Fibonacci times”! (times could be in days, months, years, etc)

Elliott Waves Elliot wave theory relies on cycles whithin cycles Elliot wave theory relies on cycles whithin cycles Grand Super cycle Grand Super cycle Super cycle Super cycle Cycle Cycle Each cycle consists of 5 moves with the trend (1,3,5 are impulse, 2,4 are corrective) and 3 that are against the trend. A “5-3” wave Each cycle consists of 5 moves with the trend (1,3,5 are impulse, 2,4 are corrective) and 3 that are against the trend. A “5-3” wave

Super Cycle Impulse Correction Beginning of the next wave

Impulse (1) Correction (2) The Super Cycle comprises the first two movements of the Grand Super Cycle.

The Super Cycle has an underlying cycle of its own! Note that the grand super cycle has two movements, the super cycle has 8 movements, the cycle has 34……Fibonacci numbers!!

Oscillating Indicators Oscillating Indicators fluctuate between a maximum and a minimum and are used to predict highs as lows Oscillating Indicators fluctuate between a maximum and a minimum and are used to predict highs as lows

RSI (Relative Strength Indicator) If “Up Points” = 0, RSI = 0 If “Down Points” = 0, RSI = 100 RSI < 30 (Oversold) RSI > 70 (Overbought)

RSI (Relative Strength Indicator) Chart Interval: 15 minutes Period Length: 10 (150 minutes) Total “up” points = 7 Total “down” points = 11

Fast Stochastic Period High: FS = 100 Period Low: FS = 0 Signal < 30 (Oversold) Signal > 70 (Overbought)

Understanding the Lingo Moving Averages Moving Averages Example: Consider the following monthly Inflation Statistics (Monthly % Changes) Inflation Statistics (Monthly % Changes) MayJuneJulyAug.Sept.Oct.Nov.Dec

Understanding the Lingo Moving Averages Moving Averages A moving average takes out the volatility by averaging several observations. For example, a would average the current observation with the previous 2 observations. A moving average takes out the volatility by averaging several observations. For example, a MA(3) would average the current observation with the previous 2 observations. MAMayJuneJulyAug.Sept.Oct.Nov.Dec

Moving Average Convergence/Divergence (MACD) The MACD indicator calculates the difference between moving averages of two different lengths (usually, 12 periods and 26 periods) The MACD indicator calculates the difference between moving averages of two different lengths (usually, 12 periods and 26 periods) The signal is typically a 9 period moving average of the difference The signal is typically a 9 period moving average of the difference A divergence means that “something is happening” A divergence means that “something is happening” Positive to Negative = Sell Signal Negative to Positive = Buy Signal

MACD Suppose that the longer run moving average has a length equal to the number of observations – the series average MA Time MA(N) MA(10) - To + : Buy point + To - : Sell point - To + : Buy point

Punch line Technical methods are useful for short run prediction Technical methods are useful for short run prediction Don’t lose sight of the fundamentals!!! Don’t lose sight of the fundamentals!!!