Lecture 1 (intro to TA & Dow theory) Flashcards
What is Technical Analysis
It is the study of market action, which consists of price, volume and open interest through the analysis of price charts and oscillators in order to forecast future prices.
What are the 6 assumptions of TA
-Humans behave in a similar manner: history repeats itself, if not it rhymes
-prices are determined by supply and demand
-price reflects all information
-prices trend
-prices develop a pattern
-patterns and trends are FRACTAL in time and size
What is a basic assumption of TA in a trend
A trend in motion is likely to stay in motion until it changes
What is a primary trend?
Months & years
What is a secondary/intermediate trend?
months to weeks
What is a minor/short trend
days
What is a daily/intraday trend
hours and minutes
What are the 3 types of trends?
1) up
2) down
3) sideways
How many touch points does a trend need to have to be valid?
two or more touch points are needed, just connect the peaks or throughs (bottom of a V touchpoint)
How do we know that a trend is powerful and that it is most important when it is broken?
The more points that price touches the trend line and the longer the trend, the more powerful it is to last and more important it is when it is broken
What are the three forms of EMH
-Weak form
-Semi-stromg form
-Strong form
What problem has empirical analyses consistenly found with the EMH
Stocks with low price to earnings outperform other stocks
What does weak form EMH say about TA
That the trend is represented in the price and that TA does not work
What does Semi-strong form EMH say about fundamental analysis (FA)?
Implies that it useless, but low P/B, P/E and P/CF, high dividend stocks show otherwise
What a strong form EMH and what do studies tend to day about it?
Strong form EMH says that prices refelect all public and non-public (insider) info.
Studies show that the strong form EMH doesn’t tend to hold since abnormal returns can be made on non-public (insider) info.
How can new studies show that TA can go against weak-form EMH
Since the computing power, new softwares have been developed that may use TA (with the help of algorithms) to predict prices which goes against weak form EMH.
What are the 6 tenets of Dow Theory?
1) the averages discount everything
2) the market has 3 trends
3) primary trends have 3 phases
4) the averages must confirm each other
5) volume confirms the trends
6) a trend should be assumed to persist until it gives definite signals that it is reversed
Name and describe the 1st tenet of Dow theory
The averages discount everything
-stock prices reflect both CURRENT & FUTURE expectations of general economic activity. So, people act on CURRENT information and FUTURE economic expectations.
Name a describe the 2nd tenet of Dow Theory
The market has 3 trends
-the 3 trends are: primary, secondary and minor
What is the primary trend in the 2nd tenet of Dow Theory
Primary trend represents the TIDE (longest trend). It represents the overall, broad, LONGTERM movement of the security’s price
Upward primary trend: Bull market
Downward primary trend: Bear market
What is the secondary trend in the 2nd tenet of Dow Theory
Secondary trend represents is the trend acts as the CORRECTIVE reactions to the primary one (does the opposite movement of the primary trend)
Secondary trend in Bull market: goes downwards
Secondary trend in a Bear market: goes upwards
What is the third trend in the 2nd tenet of Dow theory
Minor trends are ripples in a wave, they are short term and don’t last as long as the primary and secondary trend. Minor trends are listened to as “Noise” in comparison to the other two.
Minor trends can be the result of daily supply and demand disruption by small investors trying to liquidate their positions.
Name and describe the 3rd tenet of Dow theory
Primary trends have 3 phases
Primary Trends in BULL Market:
1st: Accumulation phase: begins at the end of the last stages of a bear market. Prices are depressed and economic news is negative.
2nd: improving economic conditions and improving corporate earnings. The media catches on and public begins to buy again.
3rd: positive economic conditions, bullish stories and newscasts and a buying frenzy. Investors believe the market is unstoppable and bid up prices to high level.
Primary Trends in BEAR Market:
1st: Distribution phase: starts at the “peak” of the bull market, economy is positive but investors start selling as they fear there is no room to head higher.
2nd: strong selling due to negative economic activity and deteriorating earnings, more and more people start to sell.
3rd: negative news stories as fed on by the media. Prices are extremely low, so much volume, farsighted investors start to buy cheap stocks and the cycle repeats (move on to start of bull market)
Name and describe the 4th tenet of Dow theory
The averages must confirm each other
Dow Theory can only be confirmed if BOTH averaged (DJIA and DJTA) reach new highs or new lows.
This does not have to be done simultaneously, but one signal should soon follow the other before the first average reverses to its initial trend.
Name and describe the 5th tenet of Dow Theory
Volumes confirms the trend:
-Volume should correspond currently to the major trend. Volume should be used to confirm other tools of analysis.
In an upward trend: (move together)
-Volume should be UP when prices are UP &
-Volume should be DOWN when prices are DOWN
In a downward trend: (move opposite)
-Volume should be UP when prices are DOWN &
-Volume should be DOWN when prices are UP
Name and describe the 6th tenet in Dow theory
A trend should be assumed to persist until it gives definite signals that it is reversed (broken).
-We are best to assume the trend is in effect until there is clear evidence of a reversal
