Chapter 1 - An Overview of Technical Analysis (Done)

Question 1

What is the difference between technical analysis and fundamental analysis?

Answer 1

Technical analysis studies the effects of supply and demand on a particular asset or market (i.e., price and volume), while fundamental analysis studies the causes of changes in supply and demand. Fundamental analysis focuses on financial statements and economic indicators to assess an asset’s intrinsic value, making it more suitable for long-term investment decisions. Alternatively, technical analysis examines share price movements and trends to identify investment opportunities.

Question 2

What is technical analysis?

Answer 2

Technical analysis is the process of analyzing historical market activity and investor behavior in an effort to determine probable future price trends.

Question 3

What is sentiment analysis?

Answer 3

Analysis of sentiment indicators, which tend to be used as contrarian signals, help determine what the majority of investors expect prices to do in the future. Contrarian investing is an investment style in which investors purposefully go against prevailing market trends by selling when others are buying and buying when most investors are selling. A contrarian investor believes the people who say the market is going up do so only when they are fully invested and have no further purchasing power. At this point, the market is at a peak and must go down. When people predict a downturn, they have already sold out, at which point the market can only go up.

Question 4

What is quantitative analysis?

Answer 4

Quantitative analysis is the mathematical manipulation of market data to help in the identification or confirmation of market trends.

Question 5

What is cycle analysis? What are the four general categories of cycle lengths?

Answer 5

Cycle analysis attempts to uncover repetitive patterns in the price of an asset, and it uses this information to predict future price movements. Chart analysis, quantitative analysis, and sentiment analysis help technical analysts forecast a market’s most probable direction and the extent of the move. Cycle analysis helps forecast when the market will start moving in that direction and when the ultimate peak or trough will be achieved. The four general categories of cycle lengths are:

• Long-term (more than 2 years)
• Seasonal (1 year)
• Intermediate (9 to 26 weeks)
• Trading (4 weeks)

Question 6

What is chart analysis?

Answer 6

Chart analysis is the study of graphical representations of any market data that may be relevant in determining market trends and changes in trends.

Question 7

What are the benefits of technical analysis?

Answer 7

Market timing, price forecasting, and the fact that it is a leading indicator.

Question 8

What is the purpose of market timing?

Answer 8

Market timing helps determine market entry and exit points. It is the act of moving investment money in or out of a financial market - or switching funds between asset classes - based on predictive methods.

Question 9

What is the purpose of price forecasting?

Answer 9

Forecasting price movements helps determine trends and trend turning points. Price forecasting is the process of using past data, statistical methods, and other analytical techniques to predict the future prices of a particular product, service, or asset.

Question 10

What is the purpose of a leading indicator?

Answer 10

Leading indicators point to changes in a market trend before the fundamentals reflect the change. Leading indicators are measurable pieces or sets of data that may suggest future economic, business, or investment trends.

Question 11

What are the three assumptions upon which technical analysis is based?

Answer 11

Technical analysis is based on the following three assumptions:

• All influences on market action are automatically accounted for, or discounted, in price activity
• Prices move in trends and those trends tend to persist for relatively long periods of time
• The future can be found in the past

Question 12

What is behavioral finance?

Answer 12

Behavioral finance studies the psychology of market participants to help explain why markets are inefficient and exploitable.

Question 13

What is the Efficient Market Hypothesis (EMH)?

Answer 13

The Efficient Market Hypothesis (EMH) is a market theory that states that market prices fully reflect all available information, and that prices randomly fluctuate around an intrinsic value.

Question 14

What is a leading indicator?

Answer 14

A leading indicator is an indicator (statistical or otherwise) that changes direction before the market does.

Question 15

What is market action?

Answer 15

The primary sources of information available to a technical analyst - price, time, volume, and in the case of futures contracts, open interest.

Question 16

What is the Random Walk Theory?

Answer 16

The Random Walk Theory is a market theory that basically states that price action is independent and random.

Question 17

What is market sentiment?

Answer 17

Market sentiment is the emotion or psychology of investors, which both affects market action and is affected by market action.

Question 18

What is a sentiment indicator?

Answer 18

A sentiment indicator is any number or index that measures what the majority of investors expect prices to do in the future.

Question 19

What is an assumption that technical analysts make?

Answer 19

Technicians assume that all known market influences are reflected in prices, and therefore believe that all that is left is to study market action itself.

Question 20

“All influences on market action are automatically accounted for, or discounted, in price activity.” What is meant by this key assumption that technical analysts make?

Answer 20

The statement “All influences on market action are automatically accounted for, or discounted, in price activity” reflects the efficient market hypothesis, emphasizing that all information affecting an asset is factored into its current price. Technical analysts, assuming this, study price movements, trends, and chart patterns to make trading decisions, disregarding separate fundamental analysis. This approach hinges on the belief that market prices incorporate both fundamental and psychological factors, offering insights into future movements.

Question 21

What is trading volume?

Answer 21

The volume of trade refers to the total number of shares or contracts exchanged between buyers and sellers of a security during trading hours on a given day. Trading volume records both buys and sells. When you sell 100 shares and someone buys those 100 shares, it counts as 100 shares of trading volume, not 200. Essentially, each transaction has two sides—a buy and a sell—but it’s counted as a single transaction in the trading volume.

Question 22

What is open interest?

Answer 22

Open interest is the total number of outstanding derivative contracts for an asset—such as options or futures—that have not been settled. Open interest is the total of either outstanding long or short positions, not the total of longs and shorts. This is because one futures contract is comprised of a long and a short position.

Question 23

What does intrinsic value mean?

Answer 23

Intrinsic value is a measure of what an asset is worth. This measure is arrived at by means of an objective calculation or complex financial model. Intrinsic value is different from the current market price of an asset.

Question 24

What is the FOMC?

Answer 24

The Federal Open Market Committee is a branch of the Federal Reserve System. The FOMC determines the direction of monetary policy by directing open market operations (the purchase and sale of securities).

Question 25

What is price action?

Answer 25

Price action is the movement of a security’s price over time, which forms the basis for a securities price chart and makes technical analysis possible.

Question 26

What is another term for the closing price of a security?

Answer 26

The last trade price.

Question 27

Why is technical analysis so important for derivatives contracts?

Answer 27

Technical analysis is very important for derivatives contracts because a buy-and-hold strategy is not viable when it comes to trading these. Due to the instruments’ limited time to expiration and leverage, timing is an essential part of the investment decision process, if not the most important.

Question 28

When is the formation of a head and shoulders completed?

Answer 28

The formation of a head and shoulders pattern is considered completed when the price breaks below the “neckline,” which is a support level connecting the lows between the head and the shoulders. This breakout confirms the reversal pattern, indicating a potential trend change from bullish to bearish.

Question 29

What are the three categories of indicators?

Answer 29

All indicators fall into one of three categories: Leading indicators, lagging indicators, and coincident indicators. Leading indicators point toward possible future events. Lagging indicators may confirm a pattern that is in progress. Coincident indicators occur in real-time and help clarify the state of the economy.

Question 30

What does a successful trading plan require?

Answer 30

• Accurate forecasting
• Excellent timing
• Proper money management techniques