Chapter 3 - Technical Analysis Flashcards
Technical Analysis pg.45
- studies market movements ( SP, indices, volumes)
- determine trends to make predictions and deductions
- basic philosophy: trends repeat (Dow Theory)
- MP already reflects realistic value
- good time to purchase or sell investments
Fundamental analysis
- analysis of financial statements
- try to determine realistic value for shares
- compare realistic value to actual MP (over/undervalued)
- MP< realistic value = BUY
Basic assumptions of TA
- MP is determined by the interaction of the supply and demand
- Supply and demand is influenced by various factors (irrational/ rational).
- Prices tend to form certain trends, these trends continue for a reasonably long time.
- A trend will change due to changes in supply and demand.
What do the basic assumptions of TA mean for technical and fundamental analysts?
- TA agree on first 2 assumptions
- Prices move because market participants don’t get information simultaneously
- TA when price change occurs confirm if there is actually a change
- FA measure book value (over/under valued)
- TA interested in past data and impact on future movement of price.
Charle’s H Dow
- Founded in 1890’s share price index
- birth of technical analysis
- developed the Dow theory, editor of WSJ
- invested the Dow Jones industrial average
Share price index
- Take share prices of larger companies and add them together on different days.
- moves up (+) or down (-)
- SP culmination of supply and demand
- purchase share = demand decrease = share price increase
The uses of share price indexes
- To forecast the economic cycle
- The timing of purchases and sales
- To evaluate the performance of a portfolio
- To quantify risk
- To determine speculative activities
Share prices and forecasting the economic cycle
an economic indicator (economic upswing)
purchase shares= increasing sales, profits = better dividends.
- increase in demand, forces SP to rise
- stocks exchange = leading indicator with a lead time of 6 months - 2 years.
Share prices and timing purchases and sales
- Purchase when prices are at the bottom
- Sell when prices are peak
Share Prices and evaluating the portfolio performance
- evaluate how well portfolio is doing
- determine how effective manager of portfolio is
- compares portfolio growth with market index to indicate if good or bad.
Share prices and quantifying risk
- too much price fluctuation increases risk
- Beta-analysis: used to quantify the sensitivity or volatility of a SP relative to a sector of the general market
- Higher beta = Higher risk
Share Prices and determining speculative activities
•By viewing the market index along with the volume and Rand-value of shares traded, one can determine if the activities and movement are purely speculative
Techniques for calculating share prices
1) price weighting
2) equal weighting
3) market capitalisation
The FTSE/JSE Africa index series
- used to indicate state of SA stock exchange Rand Daily Mail (RDM)(equal weighting) and Financial mail (FM) indexes (price weighting).
- converted to actuarial index in Sept 1979 (market capitalisation)
Charts and Technical indicators
- chart patterns
- technical indicators (mathematical calc. based on historic price and volume information)
- identify trends and assist in trading decisions/ timing.
Dow Theory
-founded by Charles Dow
-comparison of SP to the movement of oceans
- 3 types of price movement: primary (tides)
secondary (waves)
thirdly (short term ripples).
Primary trend
- Long term trend
- upwards and downwards price movements in spite of continuous fluctuations.
Bull market
- primary trend
- upward price movement, next high always higher than previous, troughs also higher than previous trough.
- purchase at start of bull and sell at peak
Bear Market
- primary trend
- downward price movement, highs lower than previous, troughs lower than previous.
secondary trend
Long term trend interrupted by periods in which price moves in the opposite direction
- profit taking / taking a breather
- a secondary trend during bull market = reasonable period of prices declining
- Guidelines that will confirm a secondary trend:
o 3 weeks - 3 months
o must cancel at least one-third of previous price movement
Short term fluctuations
daily fluctuations
eventually build up to longer trends
Bar charts
- express price movements visually
- SP = vertical axis
- Time = horizontal axis
Point and figure chart
- oldest charting technique
- track movements in SP
- one dimensional graph only indicates price or index value on the vertical axis
- Chart used by technical analysts to assist them in analysing price trends of shares
- consecutive price increase = same column
- reversal = new column
point and figure chart scale and point indication
1c-scale - each block represents 1c (most sensitive)
5c scale
PI- 1,2,multiple point = no.of cells price must reverse before indicated
1c= 3 point reversal
Point and figure : double top formation
SP rises to certain level, drops for certain period, rises back up to already reached level (2 occasions where it has risen = double top)
- if price breaks through double top TA see as buy signal
if treble or quadruple top = breakthrough = much stronger buy signal (upward sloping ceiling = stronger than downward)
Point and figure: double bottom
SP drops to certain level, rises and then drops again
if breaks through price floor = sell signal
quadruple = stronger sell signal
Bullish signal formation
falling price trend is reversed after at least one effort succeeds in breaking through upwards.
consecutive highs are higher than previous
- at least 4 columns wide
-reversal in bear price trend must switch to bull price trend
Bearish signal formation
rising price trend reversed after at least one effort of dropping prices fall through the bottom
consecutive highs are lower than previous
- at least 4 columns wide
-reversal in bull market must switch to bear market
Bullish symmetrical triangle formation
rising price trend where price forms a triangular formation and continues on upward journey.
- at least 5 columns wide
- higher troughs in column 2 and 4
- higher peaks in columns 3 and 5
Bearish symmetrical triangle formation
falling price trend forms a triangular formation and continues on a downward journey
- 5 columns wide
- lower peaks in 2 and 4
- lower troughs in 3 and 5
Trend lines
indicate long term price trends/ movement of shares
(bear, bull phase, lateral)
- support lines
-resistance lines
support lines
develops at bottom of formation
- after price has risen for a period it experiences a brief drop due to profit taking
- after brief profit decline more SH will get on board
- price rise
- price falls through support line = sell signal
- price will stabilise at lower level
resistance lines
appear at top of formation
- reasonable period of price decline = price rise of share
- investors will get rid of share to use temporary better price to sell
-price will drop again
- also develops during price increase
- investors will take profits and sell shares = price drop
price breaks through resistance = purchase signal
- price stabilise at higher level
Moving averages pg59-60
indicate whether a trend has been reversed
- useful when share prices are volatile
- smooth price fluctuations
- provide clear view of LT price trend
Purchase signal
- If the 200-day average flattens or starts rising after a decline, and the daily share price breaks through the average line in its upward movement.
- If the share price is above the 200-day line and starts to drop towards the average line but does not cross it, and then starts rising again.
*share price below MA
Sell signal pg 60
- If the 200-day average flattens or starts declining after a rise, and the daily share price breaks through the average line in its downward movement (see point A in Figure 3.12 for an illustration).
- If the share price is below the 200-day line and starts to rise towards the average line but does not cross it, and then starts dropping again.
- share price above MA
Market Breadth
- measures direction of overall market
- Some indices (like the DJIA) reflect only the price movement of a small number of selected companies.
- Even in Market Cap Indices, bigger companies influence the value of the index much more than the small companies.
- JSE = 60 % of market capitalisation
Relative strength index (RSI)
- momentum indicator
- measures speed and change of price movements
- fluctuates between 0 and 100
- internal measure of price strength
- identify SP trends and buy and sell signals
- over bought (RSI= 70) or over sold ( RSI= 30) = possible reversal in share price.
RSI formula
100 - (100/ (1 + RS))
RS
average gain on up periods / average loss on down periods
