class 1: intro Flashcards
Technical analysis (TA) key points:
The study of market action is the study of human psychology, i.e. behavioral finance.
Is actionable and shows you how to make money.
Is not a “Holy Grail” or guarantee to making money in financial markets.
Is an another very useful tool to “have in your toolbox.”
Under certain market conditions these tools may not work (i.e. trading ranges), overbought and oversold markets, and long-term forecasting.
Market (prices) always lead fundamentals.
In the short-term markets are driven by sentiment and technical analysis, says the late Leon Tuey
Must have a profound knowledge of TA to be a successful trader and gain actionable ideas to build a consistent trading system
Assumptions of TA
Humans behave in a similar manner: history repeats, if not it rhymes.
Prices are determined by supply and demand.
Price discounts all information: records transactions of all market participants.
Prices trend; “the trend is your friend”.
Prices develop acknowledged patterns.
Patterns and trends are fractal in time and size.
Trends act similar over different periods of time, shorter trends make up longer trends.
Analysis of trend includes the analysis of longer and shorter trends
which are these?
Primary (months or yrs)
secondary/intermediate (months - wks)
minor/short term (days)
daily/intraday (hours or minutes).
the 3 types of trends
1) up
2) down
3) sideways (trading range).
fundamental analysis founder?
Professional designations?
which question does it answer?
methods of analysis?
founder: Graham & Dodd 1934
Professional designations: CFA
which question does it answer: What should I buy?
methods of analysis: studies cause of market movements with data
technical analysis
founder?
Professional designations?
which question does it answer?
methods of analysis?
founder: Robert Rhea Dow 1932 + Edwards & McGee 1948
Professional designations: CMT (Chartered Market Technician)
which question does it answer: What should I buy? + When?
methods of analysis: studies effect through market action
disadvaantages of fundamental vs technical
fundamental:
–> info provided could be wrong
–> time consuming
technical analysis:
–> often subjective
–> short term bias
–> generally does not outperform buy and hold strategy
fundamental and technical are often in conflict with each other
Efficient Market Hypothesis (EMH) and it’s three forms
- Weak form
- semi-strong form
- strong form
weak form of EMH
Past prices(information) are fully reflected in current market prices.
Implies: trends in prices, i.e.: technical analysis does not work and should not be able to consistently outperform the market.
semi-strong form of EMH
Prices instantaneously adjust to reflect all public and new information.
Implies: No abnormal returns can be made by acting on publicly available information; i.e. You can’t make money by fundamental analysis of public information like annual reports.
Implies that fundamental analysis is worthless, but low P/B, P/E and P/CF, high dividend stocks show otherwise.
strong form of EMH
Prices reflect all pertinent public and non-public “insider” information.
Implies: No one not even company insiders can make abnormal, excess returns. Laws and regulation should prevent insiders from trading on such information.
Studies show that strong form does not generally hold.
Charles H Dow
was the first editor of the Wall Street Journal and one of the founders of the Dow Jones Company
He is widely regarded as the father of modern technical analysis. He created the Industrial Average – (which later became the DJIA – Dow Jones Industrial Average) and the Rail Average – (which became the Dow Jones Transportation Average - DJTA).
the 6 tenets of DOW Theory
- THE AVERAGES DISCOUNT EVERYTHING
- THE MARKET HAS 3 TRENDS
- PRIMARY TRENDS HAVE THREE PHASES
4.THE AVERAGES MUST CONFIRM EACH OTHER
- VOLUME CONFIRMS THE TREND
- A TREND SHOULD BE ASSUMED TO PERSIST UNTIL IT GIVES DEFINITE SIGNALS THAT IT HAS REVERSED
Dow Theory: 1. THE AVERAGES DISCOUNT EVERYTHING
-> Stock prices reflect both, current and future expectations of general economic activity
–> Market participants act on both current information as well as future economic expectations, and their actions (buying and selling) will affect the averages. Even ‘Acts of God’ (natural disasters) which obviously cannot be anticipated, are very quickly discounted into the averages
Dow Theory: 2. THE MARKET HAS 3 TRENDS
–> Primary: represents the TIDE
—> the longest of the trends
–> Secondary: represents the WAVES
—-> known as intermediate trend, are the CORRECTIVE REACTIONS to the primary trend.
—-> last years
—-> They often retrace 33 – 66% of the preceding gain / loss, although they usually end at a 50% retracement. They usually last 3 weeks to 3 months
–> Minor: represents the RIPPLES
—-> They are short term and usually last less than 4 weeks
—->They can be misleading and are likened to ‘NOISE’ with respects to the larger trend
Dow Theory: 6. A TREND SHOULD BE ASSUMED TO PERSIST UNTIL IT GIVES DEFINITE SIGNALS THAT IT HAS REVERSED
a trend in motion remains in motion until it gives signals of a reversal
–> We are best served by assuming that the trend is still in effect until there is clear evidence of a reversal
We should not get arrogant and believe that it will turn soon, and take action against it. We must wait for there to be a clear reversal signal before taking action
Dow Theory: 4.THE AVERAGES MUST CONFIRM EACH OTHER
DOW THEORY can only be confirmed if BOTH averages, the DJIA and the DJTA reach new highs or new lows
–> They do not have to do so simultaneously, but one signal should soon follow the other before the first average reverses its initial trend
In order for the INDUSTRIALS to be profitable, they need to get their products to market, i.e. they have to be shipped or transported to their respective destinations. To Dow, a bull market in industrials could not occur unless the railway average rallied as well. Only once this is done, is a healthy economy truly confirmed.
Dow Theory: 5. VOLUME CONFIRMS THE TREND
In an upward trend:
–> Volume should ↑ when prices are ↑
–> Volume should ↓ when prices are ↓ during corrective sell offs
In a downward trend:
–> Volume should ↑ when prices are ↓ &
–> Volume should ↓ when prices are ↑ during corrective rallies.
Criticisms of the Dow Theory
Investors will act after than and before market tops and bottoms
There are lags between the actual turn in the primary trend and the recognition of the change in the trend. The theory does not recognize a turn until long after it has occurred and has been confirmed
Different trends are not strictly defined. Often the interpretation of price swings is difficult to assign to a specific trend type. Secondary trend beginnings often appear like primary trend beginning
