Friday, October 26, 2007
Bond market Fixed income Corporate bond Government bond Municipal bond Bond valuation High-yield debt Stock market Stock Preferred stock Common stock Stock exchange Foreign exchange market Retail forex Derivative market Credit derivative Hybrid security Options Futures Forwards Swaps Other Markets Commodity market OTC market Real estate market Spot market Finance series Financial market Financial market participants Corporate finance Personal finance Public finance Banks and Banking Financial regulation "Technical analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends.".
The principles of technical analysis derive from the observation of financial markets over hundreds of years.
Many more technical tools and theories have been developed and enhanced in recent decades, with an increasing emphasis on computer-assisted techniques.
Technicians say that a market's price reflects all relevant information, so their analysis looks more at "internals" than at "externals" such as news events. Price action also tends to repeat itself because investors collectively tend toward patterned behavior -- hence technicians' focus on identifiable trends and conditions.
Principles of technical analysis
Based on the premise that all relevant information is already reflected by prices, technical analysts believe it is redundant to do fundamental analysis -- they say news and news events do not significantly influence price, and cite supporting research such as the study by Cutler, Poterba, and Summers titled "What Moves Stock Prices?"
On most of the sizable return days [large market moves]…the information that the press cites as the cause of the market move is not particularly important. Press reports on adjacent days also fail to reveal any convincing accounts of why future profits or discount rates might have changed. Our inability to identify the fundamental shocks that accounted for these significant market moves is difficult to reconcile with the view that such shocks account for most of the variation in stock returns.
Market action discounts everything
See also: Market trends
Technical analysts believe that prices trend. Technicians say that markets trend up, down, or sideways (flat). This basic definition of price trends is the one put forward by Dow Theory. In other words, each time the stock edged lower, it fell below its previous relative low price. Each time the stock moved higher, it could not reach the level of its previous relative high price.
Note that the sequence of lower lows and lower highs did not begin until August. Then AOL makes a low price that doesn't pierce the relative low set earlier in the month. Later in the same month, the stock makes a relative high equal to the most recent relative high. In this a technician sees strong indications that the down trend is at least pausing and possibly ending, and would likely stop actively selling the stock at that point.
Prices move in trends
Technical analysts believe that investors collectively repeat the behavior of the investors that preceded them. "Everyone wants in on the next Microsoft," "If this stock ever gets to $50 again, I will buy it," "This company's technology will revolutionize its industry, therefore this stock will skyrocket" -- these are all examples of investor sentiment repeating itself. To a technician, the emotions in the market may be irrational, but they exist. Because investor behavior does repeat itself so often, technicians believe that recognizable (and predictable) price patterns will develop on a chart.
Technical analysis is not limited to charting, yet is always concerned with price trends. For example, many technicians monitor surveys of investor sentiment. These surveys gauge the attitude of market participants, specifically whether they are bearish or bullish. Technicians use these surveys to help determine whether a trend will continue or if a reversal could develop; they are most likely to anticipate a change when the surveys report extreme investor sentiment. Surveys that show overwhelming bullishness, for example, are evidence that an uptrend may reverse -- the premise being that if most investors are bullish they have already bought the market (anticipating higher prices). And because most investors are bullish and invested, one assumes that few buyers remain. This leaves more potential sellers than buyers, despite the bullish sentiment. This suggests that prices will trend down, and is an example of contrarian trading.
History tends to repeat itself
The Wall Street Journal Europe states "Whether technical analysis is really useful ... is a matter of some dispute on Wall Street. Some investors believe that it is impossible to forecast the market's ups and downs. Academic studies have shown that when most people, professionals and amateurs alike, try to move money in and out of stocks to beat market fluctuations, they tend to wind up with losses." The same article shows how several technical analysts can simultaneously make contradictory predictions.
Critics of technical analysis include well known fundamental analysts. For example, Peter Lynch once commented, "Charts are great for predicting the past." Warren Buffett has said, "I realized technical analysis didn't work when I turned the charts upside down and didn't get a different answer" and "If past history was all there was to the game, the richest people would be librarians."
Some academic studies say technical analysis has little predictive power, but other studies say it may produce excess returns. For example, measurable forms of technical analysis, such as non-linear prediction using neural networks, have been shown to occasionally produce statistically significant prediction results.
Efficient market hypothesis
The random walk hypothesis may be derived from the weak-form efficient markets hypothesis, which is based on the assumption that market participants take full account of any information contained in past price movements (but not necessarily other public information). In his book A Random Walk Down Wall Street, Princeton economist Burton Malkiel said that technical forecasting tools such as pattern analysis must ultimately be self-defeating: "The problem is that once such a regularity is known to market participants, people will act in such a way that prevents it from happening in the future."
Random walk hypothesis
Globally, the industry is represented by The International Federation of Technical Analysts (IFTA). In the United States the industry is represented by two national organizations: the Market Technicians Association (MTA), and the American Association of Professional Technical Analysts (AAPTA). In Canada the industry is represented by the Canadian Society of Technical Analysts.
Many traders say that trading in the direction of the trend is the most effective means to be profitable in financial or commodities markets. John W. Henry, Larry Hite, Ed Seykota, Richard Dennis, William Eckhardt, Victor Sperandeo, Michael Marcus and Paul Tudor Jones (some of the so-called Market Wizards in the popular book of the same name by Jack D. Schwager) have each amassed massive fortunes via the use of technical analysis and its concepts. George Lane, a technical analyst, coined one of the most popular phrases on Wall Street, "The trend is your friend!"
Many non-arbitrage algorithmic trading systems rely on the idea of trend-following, as do many hedge funds. A relatively recent trend, both in research and industrial practice, has been the development of increasingly sophisticated automated trading strategies. These often rely on underlying technical analysis principles (see algorithmic trading article for an overview).
Use of technical analysis
Systematic trading and technical analysis
Since the early 90's when the first practically usable types emerged, artificial neural networks (ANNs) have rapidly grown in popularity. They are artificial intelligence adaptive software systems that have been inspired by how biological neural networks work. Their use comes in because they can learn to detect complex patterns in data. In mathematical terms, they are universal non-linear function approximators
While the advanced mathematical nature of such adaptive systems have kept neural networks for financial analysis mostly within academic research circles, in recent years more user friendly neural network software has made the technology more accessible to traders.
Rule-based trading is an approach to make one's trading plans by strict and clear-cut rules. Unlike some other technical methods or most fundamental analysis, it defines a set of rules that determines all trades, leaving minimal discretion.
For instance, a trader might make a set of rules stating that he will take a long position whenever the price of a particular instrument closes above its 50-day moving average, and shorting it whenever it drops below.
John Murphy in his book "Technical Analysis of the Financial Markets", says that the principal sources of information available to technicians are price, volume and open interest. Other data, such as indicators and sentiment analysis are considered secondary.
However, many technical analysts reach outside pure technical analysis, combining other market forecast methods with their technical work. One such approach, known as Fusion Analysis [] overlays fundamental with technical analysis, in an attempt to improve portfolio manager performance. Another advocate for this approach is John Bollinger, who coined the term Rational Analysis as the intersection of technical analysis and fundamental analysis[].
Technical analysis is also often combined with quantitative analysis and economics.For example, neural networks may be used to help identify intermarket relationships []. A few market forecasters combine financial astrology with technical analysis. Chris Carolan's article "Autumn Panics and Calendar Phenomenon," which won the Market Technicians Association Dow Award for best technical analysis paper in 1998, demonstrates how technical analysis and lunar cycles can be combined [].
Investor and newsletter polls, and magazine cover sentiment indicators, are also used by technical and market analysts. []
Combining Technical Analysis with other Market Forecast Methods
Widely-known technical analysis concepts include:
Accumulation/distribution index—based on the close within the day's range
Average true range - averaged daily trading range
Bollinger bands - a range of price volatility
Breakout - when a price passes through and stays above an area of support or resistance
Commodity Channel Index - identifies cyclical trends
Elliott wave principle and the golden ratio to calculate successive price movements and retracements
Hikkake Pattern - pattern for identifying reversals and continuations
MACD - moving average convergence/divergence
Momentum - the rate of price change
Money Flow - the amount of stock traded on days the price went up
Moving average - lags behind the price action
On-balance volume - the momentum of buying and selling stocks
PAC charts - two-dimensional method for charting volume by price level
Parabolic SAR - Wilder's trailing stop based on prices tending to stay within a parabolic curve during a strong trend
Pivot point - derived by calculating the numerical average of a particular currency's or stock's high, low and closing prices
Point and figure charts - charts based on price without time
Profitability - measure to compare performances of different trading systems or different investments within one system
Relative Strength Index (RSI) - oscillator showing price strength
Resistance - an area that brings on increased selling
Rahul Mohindar Oscillator - a trend indentifying indicator
Stochastic oscillator, close position within recent trading range
Support - an area that brings on increased buying
Trend line - a sloping line of support or resistance
Trix - an oscillator showing the slope of a triple-smoothed exponential moving average, developed in the 1980s by Jack Hutson Charting terms and indicators
Ichimoku Charts, Nicole Elliott, Harriman House, 2007, ISBN 9781897597842
Getting Started in Technical Analysis, Jack D. Schwager, Wiley, 1999, ISBN 0-471-29542-6
New Concepts in Technical Trading Systems, J. Welles Wilder, Trend Research, 1978, ISBN 0-89459-027-8
Reminiscences of a Stock Operator, Edwin Lefèvre, John Wiley & Sons Inc, 1994, ISBN 0-471-05970-6
Street Smarts, Connors/Raschke, 1995, ISBN 0-9650461-0-9
Technical Analysis: The Complete Resource for Financial Market Technicians, Kirkpatrick/Dahlquist, 2007, ISBN 0-1315311-3-1
Technical Analysis of Futures Markets, John J. Murphy, New York Institute of Finance, 1986, ISBN 0-13-898008-X
Technical Analysis of Stock Trends, 8th Edition (Hardcover), Robert D. Edwards, John Magee, W. H. C. Bassetti (Editor), American Management Association, 2001, ISBN 0-8144-0680-7
Technical Analysis of the Financial Markets, John J. Murphy, New York Institute of Finance, 1999, ISBN 0-7352-0066-1
The Free E-Book of Technical Analysis, Wallstreetcourier, 
The Profit Magic of Stock Transaction Timing, J.M. Hurst, Prentice-Hall, 1972, ISBN 0-13-726018-0 Notes
Technical analysis software
Posted by iamyrfans at 8:56 AM