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—<- PA ED! f - ANALYSIS The Complete Resource for Financial Market Technicians CHARLES D. KIRKPATRICK JULIE R. DAHLQUIST
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CONTENTS Acknowledgments ..........cccccccccccccccccccecccececs, xxiv About the Authors .......... cc cece ccc c cece cesses cceseee Xxxvi…
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Chapter 5 An Overview of Markets 71 Market Capitalization Weighted Average Another way to calculate a market index is to use market…
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72 Part Il_ Markets and Market Indicators price-weighted index is not representative of how most investors purchase stocks, neither is the…
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Chapter 5 An Overview of Markets 73 CONCLUSION In this chapter, we have explored the basics of how markets work. Because our interest lies…
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74 Part Il_ Markets and Market Indicators 6. Explain how to compute a market-weighted average. 7. Explain how to calculate an unweighted…
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CHAPTER 6 Dow THEORY CHAPTER OBJECTIVES By the end of this chapter, you should know ° A brief history of the development of Dow Theory and…
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76 Part Il_ Markets and Market Indicators Charles Dow, the father of modern technical analysis, was the first to create an index that meas-…
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Chapter 6 Dow Theory 77 The first of these hypotheses dealt with the notion of manipulation. Although Rhea believed that the secondary and…
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78 Part Il_ Markets and Market Indicators in direction and thereby could anticipate similar turns in the economy. Their emphasis on study…
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Chapter 6 Dow Theory 79 average to represent airlines, truckers, and other means of shipping goods. Nevertheless, the eco- nomic rationale…
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80 Part Il_ Markets and Market Indicators Minor A Trends | \ 10,500 i +-10,000 +-9,500 +-9,000 8,500 8,000 77,500 u lo la03 Ati 2008 S005…
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x Contents 3 HISTORY OF TECHNICAL ANALYSIS .s.ccosccssccsesccssccseccsescssecsoes 23 Early Financial Markets and Exchanges…
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Chapter 6 Dow Theory 81 purchased; second, selling due to decreased earnings; and third, distress selling, regardless of value, by those…
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82 Part Il_ Markets and Market Indicators Dow, Hamilton, and Rhea would likely be horrified at today’s preoccupation with minute-to- minute…
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Chapter 6 Dow Theory 83 Confirmation of New High in Transports Ky Lt Mw l it! \ fh, | H TT New High Why at M the ttt ttl halt i] H(t ul it…
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84 Part Il_ Markets and Market Indicators 4,210.00 hy 4,156.00. al ee | 1,104.00 at 1,058.00 New High 1,008.00 il a \ 963.00 S&P 500…
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Chapter 6 Dow Theory 85 a 4,220 : rice vane Contato Hel, H, | t t ith i t | 1,200 1,180 Mtl “ 4,140 t { | | | | ao Price 1,120 | { |…
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86 Part Il_ Markets and Market Indicators SUMMARY OF DOW’S WISDOM ...the Dow-Jones averages... have a discretion not shared by all…
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Chapter 6 Dow Theory 87 What is meant by the term confirmation in Dow Theory? What role does volume play in Dow Theory? According to Dow…
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CHAPTER 7 SENTIMENT CHAPTER OBJECTIVES After studying this chapter, you should © Understand what the term sentiment means © Understand the…
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90 Part Il_ Markets and Market Indicators this point, there are dwindling amounts of money available to fuel the demand that has been driv-…
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Contents xi How Does a Market Work? ......ccccccccccccscccsccccssccess 06 Who Are the Market Players?.......cccccccccccscccsccccessss 08…
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Chapter 7 Sentiment 91 Thus, when the crowd has become extraordinarily bullish, a dearth of demand exists. The nonprofessionals are loaded…
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92 Part Il_ Markets and Market Indicators Because maximum optimism and pessimism tend to occur at market price extremes, and because this…
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Chapter 7 Sentiment 93 stock market euphoria. These were not stupid, irrational people, but their inherent biases, those common to all…
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94 Part Il_ Markets and Market Indicators For example, the behavioral finance principle of “representation” suggests that people often…
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Chapter 7 Sentiment 95 BOX 7.4 BOOKS ON THE HISTORY OF MANIAS AND PANICS A number of excellent books have been written about the manias and…
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96 Part Il_ Markets and Market Indicators When individuals think by themselves, they can be very logical and reasonable, but when joined…
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Chapter 7 Sentiment 7 Sentiment indicators are data series that give the technical analyst some feeling for how much prices are at an…
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98 Part Il_ Markets and Market Indicators It depends on leverage for maximum gains, and positions can close worthless on the expiration of…
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Chapter 7 Sentiment 99 The final, simplest, and most consistent method of calculating puts to calls is to calculate a ratio of the total…
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100 Part Il_ Markets and Market Indicators Ken Tower, CMT, chief market strategist at Quantitative Analysis Services, Inc., uses a ratio of…
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xii Contents How Is the Sentiment of Informed Players Measured?......... 118 TIASIACTS…
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Chapter 7 Sentiment 101 its mean, without regard to its trend over a specified period. The most common calculation for volatility is the…
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102 Part Il_ Markets and Market Indicators Tay Data TESTERS THBEOTO Tay Sea Standard & Poor's 500 Stock Index vs VIX Index ‘in9r2010 =…
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Chapter 7 Sentiment 103 information about expectations, sampling problems and other biases associated with poll taking exist. Despite these…
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104 Part Il_ Markets and Market Indicators Standard & Poor's 500 Stock Index —ee Profiable Long Teades: 96% t GainvAnnum: 121% L…
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Chapter 7 Sentiment 105 Colby (2003) also suggests that when a large percentage of advisors are bearish, market prices will rise. He…
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106 Part Il_ Markets and Market Indicators Consensus Bullish Sentiment Index Consensus, Inc., (www.consensus-inc.com) of Independence,…
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Chapter 7 Sentiment 107 Dow Jones Industrial Average “\ ste pt = Bea or tke 1 = 2 Extreme Pessimism = Bullish fr Stocks way _| Consumer…
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108 Part Il_ Markets and Market Indicators is that this enables us to classify accurately and consistently what is and what isn’t a climax.…
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Chapter 7 Sentiment 109 during the period from January 1981 through June 2004, declined to below its lowest threshold, the stock market…
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110 Part Il_ Markets and Market Indicators when the stock market rises. Contrarily, Rydex offers inverse funds in the same style that are…
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Contents xiii 9 TEMPORAL PATTERNS AND CYCLES...cccccsssssssscssccsesscessseesee LOS Periods Longer than Four…
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Chapter 7 Sentiment 111 have placed most of their capital in the market and, thus, may buy stocks on margin to leverage their position.…
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112 Part Il_ Markets and Market Indicators relationship in the percentage of money market assets to total stock market value (see Figure…
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Chapter 7 Sentiment 113 Standard & Poor's 500 Stock Index Drs e ows we 2002 2003, 2004 2005, 2005 007 2008 2009 aio Volume Rao 5-Day…
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114 Part Il_ Markets and Market Indicators Ned Davis Research, Inc., (see Figure 7.15) found that the ratio of the 3-month simple moving…
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Chapter 7 Sentiment 115 should not be used as a mechanical buy signal, however, because the short sellers may be correct in anticipating…
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116 Part Il_ Markets and Market Indicators Unquantifiable Contrary Indicators Over the years, analysts have watched a number of…
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Chapter 7 Sentiment 117 overacting, and if it is, acting contrarily. Another aspect of event trading is gauging whether the market or a…
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118 Part Il_ Markets and Market Indicators short sale ratio, and specialist short sale ratio) had some useful, predictive meaning in the…
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Chapter 7 Sentiment 119 time do insiders transact their shares in a one-sided direction, but the three times that they showed excessive…
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120 The Entertainment Industry showed a modest ranking retreat. There was a much larger percentage increase for the total sells compared…
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xiv Contents Comclusion.....ccccccccccccccccsscccsccccscccscccsscccscee 195 Review Questions. .....ssccccccccccccccccccccscccccccccsces 196…
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Chapter 7 Sentiment 121 Large Blocks Large blocks tend to be transacted on behalf of professionals. There are several ways that large block…
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122 Part Il_ Markets and Market Indicators Art Merrill studied transactions of large blocks of 50,000 or more shares. Merrill divided the…
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Chapter 7 Sentiment 123 large speculator and the hedger. The small speculators tend to be dysfunctional, and their statis- tics are of…
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124 Part Il_ Markets and Market Indicators A number of tests have used COT data in stock futures, as well as data reported by the CFTC. The…
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Chapter 7 Sentiment 125 Treasury Bond COT Data The spread between large speculators and commercial hedgers is positively correlated with…
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126 Part Il_ Markets and Market Indicators at tops and the most short positions at bottoms (see Figure 7.24). The reason for this logical…
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Chapter 7 Sentiment 127 will rise. This has turned out to be a contrary indicator for the T-bill market yield. Money man- agers have tended…
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128 Part Il_ Markets and Market Indicators HULBERT GOLD SENTIMENT INDEX Mark Hulbert publishes a newsletter, the Hulbert Financial Digest,…
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Chapter 7 Sentiment 129 and periods of extreme pessimism, when crashes or panics occur. The uninformed market play- ers tend to be most…
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Contents xv Determining a Trading Range .......ccccccccccccccccceseees 200 What Is Support and Resistance?..... . Why Do Support and…
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CHAPTER 8 MEASURING MARKET STRENGTH CHAPTER OBJECTIVES By the end of this chapter, you should © Understand the importance of measuring…
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132 Part Il_ Markets and Market Indicators BOX 8.1 WHAT IS DIVERGENCE? The most important technical concept for confirmation of a trend is…
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Chapter 8 Measuring Market Strength 133 When looking at indicators, the analyst is generally looking for confirmation or diver- gence.…
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134 Part Il_ Markets and Market Indicators One factor that has caused the old parameters to change is the proliferation on the New York…
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Chapter 8 Measuring Market Strength 135 those breadth figures from common stocks that represent companies that actually produce a product…
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136 Part Il_ Markets and Market Indicators that a NASDAQ breadth line is useless as a divergence indicator in its absolute form and must be…
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Chapter 8 Measuring Market Strength 137 The peaks in 1937 and 1980, for example, occurred without a breadth divergence. After a sizable,…
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138 Part Il_ Markets and Market Indicators S&P 500 vs Breadth Line “0000 Ayton _ Double Negative Divergence Divergence Created using…
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Chapter 8 Measuring Market Strength 139 John Stack in an interview with Technical Analysis of Stocks & Commodities (Hartle, 1994) mentions…
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140 Part Il_ Markets and Market Indicators New York Stock Exchange Composite eee ees 402 ‘he2010 = 6709.51 Weekly NYSE Advance/Dectne Line…
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xvi 14 Contents Comclusion.....ccccccccccccccccsccccscccsscccscccssccsscee Lia Review Questions......ssccccccccccccccccccccccccccccccsses…
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Chapter 8 Measuring Market Strength 141 lished his methodology in a pamphlet (“Measuring Trend Values”) and began privately publishing the…
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142 Part Il_ Markets and Market Indicators BOX 8.3 WHAT IS AN EQUITY LINE? An equity line is a graph of a potential account value beginning…
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Chapter 8 Measuring Market Strength 143 and, thus, a lower peak in the oscillator is suspect. At market bottoms, the opposite appears to be…
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144 Part Il_ Markets and Market Indicators McClellan Summation Index The McClellan summation index is essentially a measure of the area…
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Chapter 8 Measuring Market Strength 145 81%. His report for longs only, which were held for an average of 13 days, only beat the buy-…
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146 Part Il_ Markets and Market Indicators Breadth Ratios Instead of using the difference between daily or weekly advances and declines,…
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Chapter 8 Measuring Market Strength 147 Colby (2003) reports that taking a one-day advance-decline ratio and buying the Dow Jones…
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148 Part Il_ Markets and Market Indicators Standard & Poor's 500 Stock Index & NYSE Advance/Decline Line —e— Standard & Poor's 590 Log…
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Chapter 8 Measuring Market Strength 149 the inclusion of many nonproducing stocks in the breadth statistics—and marketwise—as, for example,…
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150 Part Il_ Markets and Market Indicators The numerator is the ratio of the advances to declines, and the denominator is the ratio of the…
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Contents xvii Part IV: Chart Pattern Analysis 15 Bar CHART PATTERNS .......eecceecceecceeccees 301 What Is a…
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Chapter 8 Measuring Market Strength 151 Colby (2003) introduced a number of calculations that showed promise until the year 2000. A…
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152 Part Il_ Markets and Market Indicators as 2.00, a bearish number, yet the market action was obviously bullish (1,000/100 advances to…
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Chapter 8 Measuring Market Strength 153 10-to-1 Up Volume Days and 9-to-1 Down Volume Days Whereas Desmond combines breadth and volume for…
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154 Part Il_ Markets and Market Indicators Equal-Weighted _NDR_ Institutional _Index “vs Breadth Indicators EquabWelghted NOR" Preotine…
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Chapter 8 Measuring Market Strength 155 The raw data of new highs and new lows is subject to the same problems as breadth in that the…
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156 Part Il_ Markets and Market Indicators High Low Logic Index Norman Fosback (1976) is the developer of the high-low logic index. This…
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Chapter 8 Measuring Market Strength 157 Hindenburg Omen Many indicators use a combination of other indicators to derive a signal. The…
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158 Part Il_ Markets and Market Indicators below their 30-week moving average declines below 30%, the market is at or close to a bottom.…
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Chapter 8 Measuring Market Strength 159 Tray Baa TOTTI THOR Ty See) New York Stock Exchange Composite Index 7 tos . * Signals = 20/60 Rule…
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160 Part Il_ Markets and Market Indicators New highs and new lows show the same results. Trading with the longer-term trend is the best…
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xviii Contents 16 POINT-AND-FIGURE CHART PATTERNS .csscssssssosssscosssssonseesee335 What Is Different About a Point-and-Figure…
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Chapter 8 Measuring Market Strength 161 a Day Dats ODEO TTETTO LG SeaTG) NYSE vs Deviation From Trend NTIK & MKDS. ” ° oes er TOsee NYSE…
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162 Part Il_ Markets and Market Indicators A third major way to gauge internal market strength is to compare the current price of each…
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CHAPTER 9 TEMPORAL PATTERNS AND CYCLES CHAPTER OBJECTIVES By the end of this chapter, you should be familiar with The long (50-60-year)…
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164 Part Il_ Markets and Market Indicators Although a rigid cycle that would result in a specific, narrow rule (e.g., always buy stocks on…
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Chapter 9 Temporal Patterns and Cycles 165 World Powers: The Coevolution of Global Economics and Politics, Modelski and Thompson point to…
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166 Part Il_ Markets and Market Indicators TABLE 9.1 = K-Wave Cycles and the Associated Global leading Sectors (Table adapted from Modelski…
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Chapter 9 Temporal Patterns and Cycles 167 ‘The Birthrate vs Real Stock Prices a a0 B00 0 Moved Anead by 2 seo Joved Ahead by 49 Years seo…
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168 Part Il_ Markets and Market Indicators Notice that during the mid-1930s to mid-1940s and mid-1960s to the early 1980s and since 2000…
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Chapter 9 Temporal Patterns and Cycles 169 One problem with the theory is that a large enough sample is not possible yet, and that such…
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170 Part Il_ Markets and Market Indicators Four-Year or Presidential Cycle Wesley C. Mitchell (1874-1948), economics professor and one of…
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Contents xix Candlestick Patterms ......sccccccccccccccvccsccscccccsceses 390 One- and Two-Bar Candlestick Patterns . Multiple Bar Patterns…
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Chapter 9 Temporal Patterns and Cycles TABLE 9.2 Four-Year Cycle in the Dow Jones Industrial (1896-20 10) 171 (Adapted from Bressert, 1991)…
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172 Part Il_ Markets and Market Indicators of the 13 major lows occurred in the fourth year of a presidency, and more than half (9)…
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Chapter 9 Temporal Patterns and Cycles 173 Economic Research, The Conference Board, and many others, adjust their numbers for seasonal-…
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174 Part Il_ Markets and Market Indicators July 1 (Momsen, 2004). Almost all commodity and stocks have seasonal components that once…
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Chapter 9 Temporal Patterns and Cycles 175 recent years, however, the January effect has not worked very well. Some say it has been arbi-…
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176 Part Il_ Markets and Market Indicators REVIEW QUESTIONS 1. Consider K-wave cycle theory, 34-year cycle theory, and the relationship…
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CHAPTER 10 FLOW OF FUNDS CHAPTER OBJECTIVES By the end of this chapter, you should © Understand why knowledge of the flow of funds is…
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178 Part Il Markets and Market Indicators money market funds, margin debt, and secondary offerings. Second, we look at the availability of…
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Chapter 10. Flow of Funds 179 does not necessarily imply that the money will eventually flow into the stock market. The indica- tor states…
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180 Part Il Markets and Market Indicators above —21%, a buy signal is generated, and when it crosses below 57%, a sell signal is generated.…
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XX Contents Part VI: Other Technical Methods and Rules 19 CYCLES 0.0 c cece cece cece cece ceecceecceee sees A449 What Are Cycles?…
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Chapter 10. Flow of Funds 181 Ned Davis Research uses the number of offerings rather than the dollar amount so that the figures are not…
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182 Part Il Markets and Market Indicators Household Financial Assets Households, like corporations and governments, have different kinds of…
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Chapter 10. Flow of Funds 183 Money Supply Expansion in the money supply is a measure of potential demand for stock, as well as other…
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184 Part Il Markets and Market Indicators versus an average 5.3% buy-and-hold average annual increase. On the other hand, when the ratio…
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Chapter 10. Flow of Funds 185 Dow Jones industrial Average Tay aa TTT BUR BT EOTO y Sa) 1955 1975 1980 1985 1980 Sere a0 Excessive Loan…
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186 Part Il Markets and Market Indicators interest rates begin to rise, while the stock market languishes, investment outlooks begin to…
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Chapter 10. Flow of Funds 187 Long-Term Interest Rates (or Inversely, the Bond Market) Long-term interest rates are related to, but not…
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188 Part Il Markets and Market Indicators has advanced 10.1% per annum. This relationship is shown in Figure 10.9. Clearly, inflationary…
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Chapter 10. Flow of Funds 189 Dow Jones Industrial Average "Won Data SGO7D62™ BOTADTO flog Seal) When Velocity is Above Smoothing, DJIA GPA…
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190 Part Il Markets and Market Indicators Dow Jones Industrial Average Tani Ba TSB BEOTO Tg ST Proftable Trades: 75% GainvAnoum: 102%…
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Contents xxi Part VII: Selection 21 SELECTION oF MARKETS AND IssuES: TRADING AND Which Issues Should I Select for Trading?…
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Chapter 10. Flow of Funds 191 not set by the Federal Reserve, Fed action greatly impacts this rate. If the Federal Reserve makes open…
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192 Part Il Markets and Market Indicators The Federal Reserve Valuation Model Even though the Federal Reserve is in charge of monetary…
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Chapter 10. Flow of Funds 193 Three Steps and a Stumble In line with the desire to measure when the Federal Reserve is tightening credit,…
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194 Part Il Markets and Market Indicators One way to use these two interest rate indicators, which the evidence shows to be superior, is to…
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Chapter 10. Flow of Funds 195 ‘Standard & Poor’s 500 Stock Index Tory Gata 1217008 Ba03010 ag Sas) ‘S&P 500 Gain/Annum When: Yield Curve…
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196 Part Il Markets and Market Indicators REVIEW QUESTIONS 1. Explain how the amount of money in money market mutual funds can be a…
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PART III TREND ANALYSIS CHAPTER 11 HistoRY AND CONSTRUCTION OF CHARTS CHAPTER 12 TRENDS—THE Basics CHAPTER 13 BREAKOUTS, STOPS, AND…
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CHAPTER 11 HISTORY AND CONSTRUCTION OF CHARTS CHAPTER OBJECTIVES By the end of this chapter, you should be familiar with he advantages of…
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200 Part Ill Trend Analysis From these charts, technical analysts recognize patterns and trends that can be useful in trading and…
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xxii Contents Initial Decisions .........c00 Types of Technical Systems. .. How Do I Test a System? ......ccccccccccccccccccccccccccsee DIS…
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Chapter 11 History and Construction of Charts 201 HIsTORY OF CHARTING According to exhaustive research on technical analysis by Lo and…
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202 Part Ill Trend Analysis BOX 11.2 WHAT IS A TICKER TAPE? A tick is any change, up or down, in the price of a stock (or any other traded…
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Chapter 11 History and Construction of Charts 203 programs, such as Microsoft Excel, that can store daily stock price data and create a…
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204 Part Ill Trend Analysis It is difficult to look at the 19 closing prices in this table and get an idea of whether the stock price trend…
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Chapter 11 History and Construction of Charts 205 affects daily calculations of averages and oscillators using highs and lows. It is,…
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206 Part Ill Trend Analysis continued The third method, the continuous contract, is more realistic but is useless for cal- culating…
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Chapter 11 History and Construction of Charts 207 Line Charts Figure 11.2 is an example of a line chart. These simple charts provide…
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208 Part Ill Trend Analysis Line Chart Dow Jones Industrial Average S&P 500 Nasdaq Composite Oct ‘07 Apr Jul Oct ‘08 Apr Jul Oct ‘09 Apr…
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Chapter 11 History and Construction of Charts 209 JNJ - Johnson & Johnson ‘07 ‘08 ‘09 410 Created using TradeStation FIGURE 11.5 Line chart…
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210 Part Ill Trend Analysis Bar Charts Although the line chart visually displays one piece of information for each time interval, a bar…
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Contents xxiii Descriptive Statistics ......ccccccccccccccccccccccssccssceess 50d Measures of Central Tendency Measures of…
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Chapter 11 History and Construction of Charts 211 We can glean a lot of information from a quick visual observation of the bar chart. For…
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212 Part Ill Trend Analysis Candlestick charts are similar to bar charts in their construction. Both charts use the high price, low price,…
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Chapter 11 History and Construction of Charts 213 The thin vertical bars, representing the price extremes of the trading session, are…
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214 Part Ill Trend Analysis Semi-Logarithmic Scale Although the arithmetic scale is the scale most often used, sometimes adjustments need…
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Chapter 11 History and Construction of Charts 215 (monthly bar chart) i hy H Semi-Logarithmic Scale Created using TradeStation FIGURE…
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216 Part Ill Trend Analysis reflects the high and low of the period, whenever it is important. Many technicians believe that the high and…
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Chapter 11 History and Construction of Charts 217 Plot 1 Plot 2 Plot 3 Plot 4 47 46 45 Xx Xx xX 44| xX xX X|X x 43 42 4 40 39 |< ><] ><]…
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218 Part Ill Trend Analysis One-Point One-Box Reversal] Two-Point One-Box Reversal 65 64 x| x 64 x X1X 62 X{x| xX 63 X |X [xX] x] x 60 X x…
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Chapter 11 History and Construction of Charts 219 XEXREEX Ef 0 e, Crude Oil Created using TradeStation FIGURE 11.14 = One-point, three-box…
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220 Part Ill Trend Analysis Arithmetic Scale Scale becomes a problem in plotting point-and-figure charts, especially when the price rises…
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ACKNOWLEDGMENTS To Richard D. Kirkpatrick, my father, and ex-portfolio manager for Fidelity beginning in the 1950s. He introduced me to…
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Chapter 11 History and Construction of Charts 221 Therefore, there is not one correct charting technique but several that can meet a…
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CHAPTER 12 TRENDS—THE BASICS CHAPTER OBJECTIVES By the end of this chapter, you should ° Know why identifying trends is paramount to…
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224 Part Ill. Trend Analysis practice—to be fully recognized. One of the major criticisms of technical analysis is that it has yet to be…
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Chapter 12 Trends—The Basics 225 analyst. The most expensive education in the world is likely the money lost in incorrect, sloppy, and…
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226 Part Ill. Trend Analysis Dow’s final, and perhaps most important, observation was that by their very nature, trends tend to continue…
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Chapter 12 Trends—The Basics 227 are in a temporary equilibrium and that both buyers and sellers are satisfied. Of course, in the financial…
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228 Part Ill. Trend Analysis Peaks and Troughs What is the simplest way to look at prices and determine the trend? The easiest is to look…
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Chapter 12 Trends—The Basics 229 Created using TradeStation FIGURE 12.3 Trend line drawn through troughs (JNJ weekly: November 7, 2008-July…
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230 Part Ill. Trend Analysis DETERMINING A TRADING RANGE Trading ranges (or sideways trends) occur when peaks and troughs appear roughly at…
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Acknowledgments XXV To my children, Abby, Andy, Bear, and Bradlee, for their love and support. And to my grandchildren, India and Mila, who…
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Chapter 12 Trends—The Basics 231 There is little question that a price trough is a point where buyers overwhelmed sellers. In Figure 12.5,…
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232 Part Ill. Trend Analysis more frequently prices halt at a zone, the stronger and more important that zone will likely be in the future.…
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Chapter 12 Trends—The Basics 233 JNJ - Johnson & Johnson, Created using TradeStation FIGURE 12.6 =DeMark-Williams reversal points (JNJ…
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234 Part Ill. Trend Analysis 59.50 59.00 58.50 | oe - 58.00 JNJ - Johnson & Johnson 57.50 ll Sa 54.00 Si iil 11 18 26 Jun 8 15 22 Jule 13…
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Chapter 12 Trends—The Basics 235 68.00 4 il 66.004 64.004 = ty 58.00 4 4 one-day $8.00 high vol 54.004 égversal <—high J INJ - Johnson &…
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236 Part Ill. Trend Analysis Tf a horizontal line is by itself with no other horizontal lines close to it, it is likely an inde- pendent…
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Chapter 12 Trends—The Basics 237 profit versus risk unlikely. Thus, most traders stay away from trading within a trading range and instead…
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238 Part Ill. Trend Analysis What Is a Directional Trend? When a peak and trough occur at higher price levels than the immediately previous…
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Chapter 12 Trends—The Basics 239 Using a Regression Line Mathematic formulas can fit two sets of data, such as price and time, to a…
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240 Part Ill. Trend Analysis 62.00 61.004 60.00 59.00 58.00 57.004 56.00 55.00 54.004 53.00 52.00 JNJ - Johnson & Johnson 51.00 May Jun Jul…
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ABOUT THE AUTHORS Charles D. Kirkpatrick I, CMT, is President, Kirkpatrick & Company, Inc., Kittery, Maine—a private firm specializing in…
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Chapter 12 Trends—The Basics 241 infi tims of An accelerating trend line, of course, is unsustainable because eventually it would reach an…
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242 Part Ill. Trend Analysis decelerating trend lines (or “fan lines”) JNJ - Johnson & Johnson Created using TradeStation FIGURE 12.13…
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Chapter 12 Trends—The Basics 243 72.00 70.00 JNJ 68.00 66.00. adj 64.00 - Johnson & Johnson justed trend line from 1 to 2 Created using…
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244 Part Ill. Trend Analysis JNJ - Johnson & Johnson Created using TradeStation FIGURE 12.15 Trend line with channel line NJ daily: April…
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Chapter 12 Trends—The Basics 245 Retracements The final subject relating to trends is retracements. As mentioned and observed previously, a…
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246 Part Ill. Trend Analysis than 50% of the previous uptrend. The same is true for downtrends. Should the retracement in an uptrend…
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Chapter 12 Trends—The Basics 247 Pullbacks and Throwbacks Variations of retracements that occur after a breakout, usually from a horizontal…
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248 Part Ill. Trend Analysis Trend Lines on Point-and-Figure Charts A trend line may be drawn between successive lows or highs in the…
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Chapter 12 Trends—The Basics 249 and the prices would retrace to them. Modern methods have included marking the Fibonacci ratio numbers of…
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250 Part Ill. Trend Analysis Andrew's pitchfork 46.00 45.00 44.00 43.004 42.00 | 41.00 40.007 4 TYX- 30 year U.S. Treasury Bond Interest…
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About the Authors XxXxvii Julie R. Dahlquist, Ph.D., received her B.B.A. in economics from University of Louisiana at Monroe, her M.A. in…
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Chapter 12 Trends—The Basics 251 [" ul TYX - 30 year U.S. Treasury Bond Interest Rate Created using TradeStation FIGURE 12.22 Gann fan…
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252 Part Ill. Trend Analysis What does the term resistance mean? How is resistance generally drawn on a chart? Explain the psychology…
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Chapter 12 Trends—The Basics 253 7. Using the data that you gathered and the graphs that you created in Chapter 11, “History and…
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CHAPTER 13 BREAKOUTS, STOPS, AND RETRACEMENTS CHAPTER OBJECTIVES By the end of this chapter, you should © Understand what a breakout is °…
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256 Part Ill. Trend Analysis the direction of the previous trend is a confirmation that the trend still exists, and a breakout in the…
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Chapter 13 Breakouts, Stops, and Retracements 257 48.00 intra-bar breakout 4 47.00 46.00 45.00 44.00 43.00 42.00 41.00 TYX - 30 year U.S.…
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258 Part Ill. Trend Analysis Point or Percent Filter Another confirmation method is to establish a breakout zone either a certain number or…
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Chapter 13 Breakouts, Stops, and Retracements 259 Volume Increased volume of trading often occurs with a breakout. Heavier trading…
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260 Part Ill. Trend Analysis * The absolute value of the difference between the prior bar close and the current bar low The ATR is the…
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Chapter 13 Breakouts, Stops, and Retracements 261 R2:9889.12 R1:9870.68 PP:9812.26 R1:9810.82 $1:9743.23 PP:9810.82 Dow Jones Industrial…
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262 Part Ill. Trend Analysis resistance or support level. As a method of confirming breakouts, the logic behind their use is a little more…
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Chapter 13 Breakouts, Stops, and Retracements 263 Anticipating a Breakout Resistance Price Possible Point of Entry FIGURE 13.6 =…
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264 Part Ill. Trend Analysis security price goes up above the original purchase price. The investor’s original opinion was cor- rect, but…
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Chapter 13 Breakouts, Stops, and Retracements 265 protects capital. Not every entry is correct and ends up with a profit. Indeed, many…
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266 Part Ill. Trend Analysis a trailing stop will help you lock in that profit if the uptrend reverses. If you kept the stop at the…
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Chapter 13 Breakouts, Stops, and Retracements 267 When price rises above $50, the stop moves up with the price rise to three times its new…
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268 Part Ill. Trend Analysis Parabolic Stop and Reverse (SAR) Created using TradeStation FIGURE 13.9 Parabolic SAR (TYX daily: December 3,…
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Chapter 13 Breakouts, Stops, and Retracements 269 respective strengths and weaknesses are unknown. To analyze the signal entry, a time stop…
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270 Part Ill. Trend Analysis DIS - Disney, Walt i Mi, H i Created using TradeStation FIGURE 13.10 Gaps (DIS daily: September 4,…
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INTRODUCTION CHAPTER 1 CHAPTER 2 CHAPTER 3 CHAPTER 4 INTRODUCTION TO TECHNICAL ANALYSIS THE BASIC PRINCIPLE OF TECHNICAL ANALYSIS—THE TREND…
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Chapter 13 Breakouts, Stops, and Retracements 271 pullback Created using TradeStation FIGURE 13.11 Breakout and pullback (TYX daily:…
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272 Part Ill. Trend Analysis X- U.S. Steel Corp Previous support and current objective Note: Each breakdown reaches previous support, and…
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Chapter 13 Breakouts, Stops, and Retracements 273 for a stop and reverse. If the short is entered on the downward breakout, the buy stop…
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274 Part Ill. Trend Analysis REVIEW QUESTIONS 1. Explain what is meant by the term whipsaw. What could cause an investor to experience a…
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CHAPTER 14 MOVING AVERAGES CHAPTER OBJECTIVES By the end of this chapter, you should ° Be aware of how moving averages are used to identify…
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276 Part Ill Trend Analysis There obviously is something to moving averages. Traders and trend investors, of course, have known all this…
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Chapter 14 Moving Averages 277 10-Day 26-Day 10-Day 10-Day Date Open High Low Close SMA SMA LWMA EMA 9 5/20/2010 138.05 138.05 133.18…
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278 Part Ill Trend Analysis The most commonly used type of moving average is the simple moving average (SMA), sometimes referred to as an…
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Chapter 14 Moving Averages 279 CLB - Core Laboratories | 17-24 Jun 7 14.21 = 28 Jul6 12 Created using TradeStation FIGURE 14.1 Simple…
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280 Part Ill Trend Analysis The 13-day SMA was overly sensitive to a temporary decrease in price. During this period, the slower 26-day SMA…
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Chapter 14 Moving Averages 281 some traders are willing to take the risk of short-term whipsaws in order not to miss the major trend—a…
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282 Part Ill Trend Analysis The Linearly Weighted Moving Average (LWMA) Let us refer back to the example in Table 14.1 to calculate a…
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Chapter 14 Moving Averages 283 The general formula for determining the weight of the current day’s data in the exponential moving average…
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284 Part Ill Trend Analysis CLB - Core Laboratories — 26-day SMA ---- 26-day EMA | | Ny Jul 12 22 Apr 1219 26 May1017 24Jun7 14 21 Created…
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Chapter 14 Moving Averages 285 Triangular Moving Average Taking a moving average of a moving average gives a doubly smoothed moving…
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286 Part Ill Trend Analysis that represents the investor’s time horizon. For example, many investors use a 200-day moving average. If the…
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Chapter 14 Moving Averages 287 Determining Price Extremes Third, the moving average is an indicator of price extreme. Because the moving…
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288 Part Ill Trend Analysis Giving Specific Signals Fourth, some technical analysts use moving averages to give specific signals. These can…
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Chapter 14 Moving Averages 289 Wilder’s Directional Movement -DM and +DM +DM +DM —DM —DM +DM No DM Whichever Is Larger FIGURE 14.7…
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290 Part Ill Trend Analysis DMI/ADX — DMl+ -77 DMI- extreme. Created using TradeStation FIGURE 14.8 = Directional Movement Indicators (CLB…
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CHAPTER 1 INTRODUCTION TO TECHNICAL ANALYSIS Technical analysis—these words may conjure up many different mental images. Perhaps you think…
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Chapter 14 Moving Averages 291 is usually followed by a dynamic period. This phenomenon can be seen in Figure 14.8 with the low ADX value…
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292 Part Ill Trend Analysis This envelope then becomes the trigger for signals when it is crossed by the price rather than when the moving…
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Chapter 14 Moving Averages 293 . ] 80.00) Bollinger Bands with 20-day sma 78.00} and 2 std deviations } i i 76.00 h i 74.00} re; Wy ce i My…
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294 Part Ill Trend Analysis Trading Strategies Using Bands and Envelopes In line with the basic concept of following the trend, bands and…
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Chapter 14 Moving Averages 295 is greater than when it is smoothed over longer periods. Thus, the inherent whipsaws in short- term data…
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296 Part Ill Trend Analysis 20-day Donchian Channel Created using TradeStation FIGURE 14.11 Donchian Channel on daily closes (CLB daily:…
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Chapter 14 Moving Averages 297 BOX 14.1 TRADING RULES In the past few chapters, we have covered a good deal of material regarding trends.…
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298 Part Ill Trend Analysis 6. Thomas warns Sophia that her strategy can easily lead to whipsaws. Explain what Thomas means by whipsaws,…
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PART IV CHART PATTERN ANALYSIS CuHapTER 15 Bar CHART PATTERNS CHAPTER 16 POINT-AND-FIGURE CHART PATTERNS CHAPTER 17 SHORT-TERM PATTERNS 299…
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4 Part 1. Introduction are influenced by psychological factors as well, most of them indecipherable. Greed, fear, cogni- tive bias,…
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CHAPTER 15 BAR CHART PATTERNS CHAPTER OBJECTIVES By the end of this chapter, you should be familiar with © Controversy over whether…
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302 Part IV Chart Pattern Analysis Wuart Is A PATTERN? In the literature and usage of technical analysis, the terms pattern and formation…
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Chapter 15 Bar Chart Patterns 303 Fractal The bars in a bar chart can be any period: weekly, daily, minute, and so on. Bar chart patterns…
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304 Part IV Chart Pattern Analysis of whether patterns do exist in prices. Technical analysts swear they do but in many cases ana- lysts…
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Chapter 15 Bar Chart Patterns 305 statements contradict other statements or are just plain wrong. An example is that “a descending triangle…
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306 Part IV Chart Pattern Analysis is how the art of technical analysis developed before the computer, and although the computer is now…
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Chapter 15 Bar Chart Patterns 307 BOX 15.1 FOR FURTHER READING There are many good reference books devoted to the study of patterns in…
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308 Part IV Chart Pattern Analysis handle that occurrence. We have observed the peculiarities of drawing trend lines and establish- ing…
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Chapter 15 Bar Chart Patterns 309 that pattern analysis outperforms the market (S&P 500) on average in every instance. This might or might…
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310 Part IV Chart Pattern Analysis Resistance Line Entry Pullback ‘Support Line Breakout a Price FIGURE 15.1 = Double top with breakout…
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Chapter 1 Introduction to Technical Analysis 5 Charles Dow and the timeless book by Edwards and Magee still contain valuable information…
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Chapter 15 Bar Chart Patterns 311 break out, in one direction or the other. The pattern can have a slight tilt upward or downward, but the…
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312 Part IV Chart Pattern Analysis predicting the direction of eventual breakout depending on the breakout direction. More than half the…
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Chapter 15 Bar Chart Patterns 313 A target can be calculated by adding the height of the rectangle formation to the breakout price.…
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314 Part IV Chart Pattern Analysis Breakout Resistance Line Throwback ‘Support Line Price FIGURE 15.4 Triple bottom with breakout up…
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Chapter 15 Bar Chart Patterns 315 TABLE 15.1 Statistics on Triangles Overall Failure to Average Tendency Reaches Performance reach 5%…
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316 Part IV Chart Pattern Analysis Resistance Line Downtrend Line Pullback’ Support Line J Breakout Entry Price FIGURE 15.5 Descending…
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Chapter 15 Bar Chart Patterns 317 Ascending Triangle A horizontal upper bound of resistance combined with an upward sloping lower bound of…
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318 Part IV Chart Pattern Analysis Throwback Breakout FIGURE 15.8 = Symmetrical triangle with breakout up Like the other standard…
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Chapter 15 Bar Chart Patterns 319 BOX 15.6 TRADING TRIANGLES The ideal situation for trading triangles is a definite breakout, a high…
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320 Part IV Chart Pattern Analysis Broadening Patterns A broadening pattern exists when we take the standard rectangle pattern and draw the…
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6 Part | Introduction technical analysis is based on these classic principles. A thorough understanding of these time- less principles…
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Chapter 15 Bar Chart Patterns 321 Diamond Top One of the less-frequent but very profitable patterns is the diamond (see Figure 15.10). It…
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322 Part IV Chart Pattern Analysis the entire prior rise. These figures are only valid for downward breakouts from a top, which occur 67%…
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Chapter 15 Bar Chart Patterns 323 downward reversal will have a lesser slope than the underlying trend line, and if projected into the…
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324 Part IV Chart Pattern Analysis Breakout Throwback S— Climax Trough (Panic) FIGURE 15.12 Declining wedge with breakout up from climax…
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Chapter 15 Bar Chart Patterns 325 BOX 15.8 TRADING WEDGES It pays to wait for that breakout and to act immediately on it. In addition,…
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326 Part IV Chart Pattern Analysis Price Breakout Throwback Handle Cup or Bow! FIGURE 15.13 = Cup or bowl and handle variety of a rounding…
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Chapter 15 Bar Chart Patterns 327 An uptrend, but not necessarily long-term trend, precedes a head-and-shoulders top. Thus, as shown in…
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328 Part IV Chart Pattern Analysis 4 Price Breakout Neckline Entry Throwback Left Shoulder Right Shoulder Head FIGURE 15.15 =…
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Chapter 15 Bar Chart Patterns 329 improves performance, whereas decreasing volume on the breakout from a top pattern increases performance.…
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330 Part IV Chart Pattern Analysis these advantages. Flags and pennants are really variations of the same formation. The flag is a short…
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Chapter 1 Introduction to Technical Analysis 7 most likely to show strong performance. We also discuss individual security selection,…
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Chapter 15 Bar Chart Patterns 331 BOX 15.10 TRADING FLAGS AND PENNANTS—MEASURED RULE Because these patterns have low failure rates, few…
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332 Part IV Chart Pattern Analysis LONG-TERM BAR CHART PATTERNS WITH THE BEST PERFORMANCE AND THE LOWEST RISK OF FAILURE We have selected…
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Chapter 15 Bar Chart Patterns 333 attributes of patterns that in several studies show promise, but the analyst must always adjust…
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Cu APTER 16 POINT-AND-FIGURE CHART PATTERNS CHAPTER OBJECTIVES After studying this chapter, you should be familiar with ° The difference…
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336 Part IV Chart Pattern Analysis Wuat Is DIFFERENT ABOUT A POINT-AND-FIGURE CHART? I should say that if anybody has a good enough memory…
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Chapter 16 Pointand-Figure Chart Patterns 337 activity, especially in foreign exchange, at any time during the 24-hour period.…
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338 Part IV Chart Pattern Analysis the price of stocks” (Hoyle from du Plessis, 2005) both describe a system very similar to present- day…
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Chapter 16 Pointand-Figure Chart Patterns 339 closing prices are used, but more often the high and low are interpreted as representing…
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340 Part IV Chart Pattern Analysis Consolidation Area on the One-Box Chart (Also “Congestion Area’’) As we know from bar chart analysis, a…
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Chapter 16 Pointand-Figure Chart Patterns 341 Symmetrical Triangle with Upward Breakout x xX i: xX XxX Ex X/X/X)_ |X|X|X XTX X/X XX) |…
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342 Part IV Chart Pattern Analysis count. The count includes all squares along a horizontal price line from the left to the right of the…
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Chapter 16 Pointand-Figure Chart Patterns 343 square in the count (see Figure 16.5). The resulting price level projected from the distance…
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344 Part IV Chart Pattern Analysis The Fulcrum The fulcrum is a distinctive one-box reversal chart pattern. Indeed, some analysts call all…
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Chapter 16 Pointand-Figure Chart Patterns 345 constitute ideal buying and selling points. When all of the following appear in the one-box…
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346 Part IV Chart Pattern Analysis Trend Lines with Three-Box Charts Trend lines in three-box reversal charts are drawn at 45-degree…
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Chapter 16 Pointand-Figure Chart Patterns 347 Another, even more questionable, line is drawn on three-box reversal charts. This is a line…
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348 Part IV Chart Pattern Analysis Calculating Vertical Count The vertical count is unique to the three-box reversal. It is calculated by…
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Chapter 16 Pointand-Figure Chart Patterns 349 ¢ Spread triple top or spread triple bottom ¢ Bullish or bearish triangle ¢ Above bullish…
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350 Part IV Chart Pattern Analysis Rising Bottom Declining Top TT x >x) Buy xOX XX X/0 X/0) OX O|X (o}b fe) OX |O|X oO |0 bale) ——> 0) Sell…
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CHAPTER 2 THE BASIC PRINCIPLE OF TECHNICAL ANALYSIS—THE TREND CHAPTER OBJECTIVES After reading this chapter, you should be able to ° Define…
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Chapter 16 Pointand-Figure Chart Patterns 351 The descending triple bottom is the opposite of the top. In this formation, the three rows of…
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352 Part IV Chart Pattern Analysis Davis reported that the spread triple tops were profitable 85.7% of the time, and spread triple bottoms…
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Chapter 16 Pointand-Figure Chart Patterns 353 Prices can penetrate these lines in only two ways. They can break below the bullish support…
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354 Part IV Chart Pattern Analysis trend line. Zieg and Kaufman did not provide statistics from Davis’s work on the profitability of a…
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Chapter 16 Pointand-Figure Chart Patterns 355 when it originally broke out. In addition, the bottom at which a protective stop should be…
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356 Part IV Chart Pattern Analysis >< />< ><, ojooqcdqq000 0 C|00 0 0\0/\000 >< >< >< >< ooo0° <>< FIGURE 16.20 Spike pattern or long…
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Chapter 16 Pointand-Figure Chart Patterns 357 The signal to buy is on the reversal back upward from the double bottom sell signal, as shown…
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358 Part IV Chart Pattern Analysis 3. Explain the major difference between the one-point reversal method and the three-point reversal…
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CHAPTER 17 SHORT-TERM PATTERNS CHAPTER OBJECTIVES After studying this chapter, you should be familiar with © How short-term patterns can be…
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360 Part IV Chart Pattern Analysis Unfortunately, frequent patterns often give false signals. Although most market turning points include…
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10 Part 1. Introduction be more concerned about the trend over the next six months, while a third investor might be most concerned about…
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Chapter 17 ShortTerm Patterns 361 Although short-term patterns are usually reversal patterns, they can be used as continua- tion patterns…
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362 Part IV Chart Pattern Analysis charts is not so much the patterns but the visual ease with which the analyst can “see” intraday…
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Chapter 17 ShortTerm Patterns 363 is interrupted by a long period overnight when no trading activity occurs. In 24-hour markets, short-term…
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364 Part IV Chart Pattern Analysis Gaps often do not occur in market averages that are not themselves traded. For example, the day…
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Chapter 17 Short-Term Patterns Entry Buy Stop ae P| Breakaway om /* — —l_ __ (New High for 20 Days) Pivot Low | Protective Stop FIGURE 17.2…
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366 Part IV Chart Pattern Analysis Opening Down Gap [- (Later Filled During Day) FIGURE 17.3. Opening down gap One way potentially to…
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Chapter 17 ShortTerm Patterns 367 breakout line suggests that the longer-term move will be in the direction of the fill, a reversal of the…
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368 Part IV Chart Pattern Analysis BOX 17.1 GAPS AND CLASSIC PATTERNS—A CASE STUDY OF APPLE COMPUTER Figure 17.4 contains daily bar charts…
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Chapter 17 ShortTerm Patterns 369 . Gap4 occurs and has the initial appearance of a breakout or runaway gap. In neither case should prices…
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370 Part IV Chart Pattern Analysis continued 10. We could sell at the target price, but before the target is reached, a flag pattern…
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TECHNICAL ANALYSIS THE COMPLETE RESOURCE FOR FINANCIAL MARKET TECHNICIANS SECOND EDITION Charles D. Kirkpatrick II, CMT Julie Dahlquist,…
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Chapter 2 The Basic Principle of Technical Analysis—The Trend 11 might differ from what he or she expected. Making the decision of what…
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Chapter 17 ShortTerm Patterns 371 earlier discussion of breakouts, we demonstrated the Specialist Breakout. This is often a spike because…
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372 Part IV Chart Pattern Analysis The DCB is most profitable and more easily recognized after a large downward breakaway gap or downward…
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Chapter 17 ShortTerm Patterns 373 the daily bars. In the British Petroleum chart (Figure 17.6), the rally did not fill the gap in all DCBs.…
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374 Part IV Chart Pattern Analysis closes in the lower half of the bar, and the second bar close ends near its high. Usually high vol- ume…
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Chapter 17 ShortTerm Patterns 375 tive stop. Both Kamich and Bulkowski maintain that the formation in weekly bars is more reliable than in…
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376 Part IV Chart Pattern Analysis one tick above today’s high if (1) today’s low is less than yesterday’s low; (2) today’s high is less…
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Chapter 17 ShortTerm Patterns 377 Tony Crabel (1989) found that without a cluster of other information, a number of inside bar combinations…
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378 Part IV Chart Pattern Analysis During Crabel’s test period, this strategy had an 80% winning percentage. The opposite strategy would…
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Chapter 17 ShortTerm Patterns 379 Hook Reversal Day Hook is a common term for a quick loss when a profit was expected. It comes from the…
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380 Part IV Chart Pattern Analysis Buy (Conventional) Inside Bar Failure (Hikkake Sell) FIGURE 17.12 Hikkake buy failure When an outside…
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12 Part | Introduction Lower Peaks Lower a Troughs Higher Troughs Chart A—Uptrend Chart B—Downtrend Horizontal Peaks Horizontal Troughs…
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Chapter 17 ShortTerm Patterns 381 There are at least two different types of trend correction patterns. One is to recognize a trend and act…
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382 Part IV Chart Pattern Analysis Oops! Larry Williams (1979) coined the expression “Oops!” (see Figure 17.14). The setup for this pat-…
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Chapter 17 ShortTerm Patterns 383 Shark The shark pattern is a three-bar pattern. The most recent bar high must be lower than the previ-…
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384 Part IV Chart Pattern Analysis can be many shark patterns, Downs limited his study to those patterns that fit a specified symme- try.…
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Chapter 17 ShortTerm Patterns 385 protection stop at the first day’s low. If the buy is near the previous day’s low, then lower the stop to…
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386 Part IV Chart Pattern Analysis Tony Crabel designed one method of defining and using narrow-range days. In his method, he determines…
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Chapter 17 ShortTerm Patterns 387 such as the high and low price that occur during the first 15 minutes of trading, or it can be a pre-…
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388 Part IV Chart Pattern Analysis The opening range breakout (ORB) is a popular method of entering a position once a setup has been…
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Chapter 17 ShortTerm Patterns 389 Added Upper Boundary Open 15-Minu Range le ——e = > T T 1 2 3 4 5 6 7 8 9 10 1 12 15-Minute Bars FIGURE…
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390 Part IV Chart Pattern Analysis CANDLESTICK PATTERNS In Chapter 11, “History and Construction of Charts,” we learned how to construct a…
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Chapter 2 The Basic Principle of Technical Analysis—The Trend 13 trend is likely beginning to change direction. Despite the tendency for…
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Chapter 17 ShortTerm Patterns 391 There have been few tests on the effectiveness of candlestick patterns. This is odd because the patterns…
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392 Part IV Chart Pattern Analysis Doji FIGURE 17.19 = Doji candlestick Windows Windows are simply the gaps that we discussed earlier in…
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Chapter 17 ShortTerm Patterns 393 body of the second candle must be within the real body of the first candle. Thus, the open and close…
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394 Part IV Chart Pattern Analysis Hanging Man Hammer r Top Bottom Either Can Be Black r or White | T T T FIGURE 17.21 Hanging man and…
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Chapter 17 ShortTerm Patterns 395 reversing. This bullish engulfing pattern consists of a candle with a small dark body on one bar followed…
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396 Part IV Chart Pattern Analysis r Top Bottom FIGURE 17.23 Candle engulfing pattern The opposite pattern, a piercing line pattern, would…
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Chapter 17 ShortTerm Patterns 397 Dark Cloud Cover Piercing Line r Top Bottom FIGURE 17.24 = Dark cloud cover and piercing line Morning and…
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398 Part IV Chart Pattern Analysis Evening Star Morning Star r Top Bottom 4 | | | Spinning Top Can Be r Black or White a FIGURE 17.25…
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Chapter 17 ShortTerm Patterns 399 location for entry on the retracement. That level is often accompanied by another pattern sug- gesting a…
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400 Part IV Chart Pattern Analysis Inside Down Inside Up r Top Bottom FIGURE 17.27 Inside down and inside up candlestick patterns Three…
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14 Part | Introduction 17.00 16.00 15.00 14.00 13.00 12.00 11.00 CNET-CNET Networks Volume June = July Aug. Sept. Oct. Nov. Dec. 2006 =…
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Chapter 17 ShortTerm Patterns Outside Down 401 Outside Up Top Bottom FIGURE 17.28 Outside down and outside up candlestick patterns…
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402 Part IV Chart Pattern Analysis TABLE 17.1 = Continued Pattern Reversal or Continuation Percent Accurate Abandoned baby Bullish reversal…
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Chapter 17 ShortTerm Patterns 403 5. Define an inside day, outside day, narrow-range day, and wide-range day. Which of these days…
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PART V TREND CONFIRMATION CHAPTER 18 CONFIRMATION 405 Download at www.wowebook.com
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CHAPTER 18 CONFIRMATION CHAPTER OBJECTIVES By the end of this chapter, you should be familiar with © The methods of plotting volume…
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408 Part V Trend Confirmation In this chapter, we look at volume, the oldest confirming indicator, but which has devel- oped some problems…
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Chapter 18 Confirmation 409 overbought negative divergence failure swing \ oscillator oversold FIGURE 18.1 Example of oscillator analysis…
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410 Part V Trend Confirmation each other. A legitimate, strong trend, however, should have all indexes acting in concert. A divergence is,…
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Chapter 2 The Basic Principle of Technical Analysis—The Trend 15 Price, therefore, is the end result of all those inexact factors, and it…
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Chapter 18 Confirmation 411 Thus, she suggests that during the rising trend, the oversold zone be raised to 40 and the over- bought zone be…
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412 Part V Trend Confirmation In markets where considerable arbitrage exists, volume statistics can sometimes be mis- leading. For example,…
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Chapter 18 Confirmation 413 Volume 40,000,000 30,000,000 20,000,000 Created using TradeStation FIGURE 18.2 Price and volume (AAPL daily:…
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414 Part V Trend Confirmation Equivolume Shapes Power Narrow Square Oversquare Easy Difficult Strong Strong movement movement commitment…
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Chapter 18 Confirmation 415 Stock buyer-initiated volume (that which transacts at the ask) minus seller-initiated volume (that which…
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416 Part V Trend Confirmation As in all technical indicators, exceptions to the preceding rules can occur. These rules are only guides.…
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Chapter 18 Confirmation 417 IF 280-0 AAPL-Apple Computer ii | 220.00 “ | 210.00 a 2 | Nay uf + 200.00 ey | 190.00 L-500,000,000.00 OBV-On…
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418 Part V Trend Confirmation Price and Volume Trend Another way of calculating a combination of price and volume is to determine daily the…
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Chapter 18 Confirmation 419 The new volume figure is then added or subtracted from the previous day WVAD and drawn on a price chart. It can…
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420 Part V Trend Confirmation Williams Accumulation Distribution (WAD) Not to be confused with the earlier Williams Variable Accumulation…
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16 Part | Introduction change in direction in the larger, ten-week trend. Thus, whatever trend the trader or investor selects as the trend…
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Chapter 18 Confirmation 421 relationship between volume and trend is longer-term and not something that is useful for trading. li 235.00…
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422 Part V Trend Confirmation Chaikin Oscillator Just to confuse things even more, Marc Chaikin invented the Chaikin Oscillator, as opposed…
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Chapter 18 Confirmation 423 If Day i’s average price is higher than the previous day’s average price, there is positive money flow (PMF).…
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424 Part V Trend Confirmation AAPL-Apple Computer i We en t ah il hy IM hy i ! Ojo nf iil ‘- Created using TradeStation FIGURE 18.9 Money…
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Chapter 18 Confirmation 425 Other Volume Oscillators We have just studied the most commonly used volume oscillators. As always, a large…
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426 Part V Trend Confirmation Volume Spike and Climax A climax usually marks the end of a trend and either a subsequent reversal or…
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Chapter 18 Confirmation 427 Shock Spiral When we looked at the Dead Cat Bounce (DCB) in Chapter 17, we saw that a substantial volume spike…
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428 Part V Trend Confirmation Although open interest is a good tool for estimating the liquidity of a contract, using it for technical…
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Chapter 18 Confirmation 429 case with cattle and is one reason for being skeptical about breaks above and below the zero line. Trend lines…
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430 Part V Trend Confirmation What Is Momentum? Momentum deals with the rate at which prices are changing. For example, in an uptrend,…
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Chapter 2 The Basic Principle of Technical Analysis—The Trend 7 Wuat OTHER ASSUMPTIONS Do TECHNICAL ANALYSTS MAKE? That markets trend is…
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Chapter 18 Confirmation 431 instances, buy signals are generated from an overbought oscillator accompanied by other indica- tors (as we…
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432 Part V Trend Confirmation Most academic studies of price indicators, so far, have focused exclusively on moving averages.…
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Chapter 18 Confirmation 433 Other information can be gleaned from the MACD, however. For example, when the MACD is above zero, suggesting…
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434 Part V Trend Confirmation Rate of Change (ROC) Rate of change (ROC) is likely the simplest oscillator. It is a measure of the amount a…
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Chapter 18 Confirmation 435 260.00 F [250.00 + 240.00 A i! [230.00 2 be EE ri iad |-220.00 1 “if Lero.0 AAPL-Apple Computer | fay t L190.00…
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436 Part V Trend Confirmation After calculating the RSI for the first 14 days, Wilder used a smoothing method to calcu- late RSI for future…
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Chapter 18 Confirmation 437 Thomas (2003), in his testing of the RSI, found that none of the conventional signals had value except the…
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438 Part V Trend Confirmation depend on smoothing techniques that tend to dampen the most recent price action. The stochas- tic takes…
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Chapter 18 Confirmation 439 the “slow” stochastic. The slow stochastic is designed to smooth the original %D again with a three-period…
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440 Part V Trend Confirmation AAPL-Apple Computer slow stochastic oscillator Ra Z Created using TradeStation FIGURE 18.16 == Stochastic…
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18 Part | Introduction BOX 2.2 PROFESSOR ANDREW LO’S ADAPTIVE MARKETS HYPOTHESIS In an attempt to reconcile the existing but different…
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Chapter 18 Confirmation 441 time window, the Williams %R compares the current close with the high that occurred during the time window.…
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442 Part V Trend Confirmation AAPL-Apple Computer fast stochastic (14-3) y | a | Nov Dec 10 Feb Created using TradeStation FIGURE 18.17 CCI…
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Chapter 18 Confirmation 443 The use of the ADX is based on its level and its trend. The level determines the amount by which prices are…
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444 Part V Trend Confirmation 3. Eight-day stochastic %K is greater than the day before and above 70 (upward trend begin- ning). 4.…
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Chapter 18 Confirmation 445 Some of the problems with interpreting price and volume indicators can be ameliorated with the use of the ADX…
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446 Part V Trend Confirmation Day Price of XYZ 17 60 18 55 19 50 20 45 21 42 22 40 23 39 24 40 25 4) 26 43 4. Gather trading information…
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PART VI OTHER TECHNICAL METHODS AND RULES CHAPTER 19 CYCLES CHAPTER 20 ELLIOTT, FIBONACCI, AND GANN 447 Download at www.wowebook.com
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CHAPTER 19 CYCLES CHAPTER OBJECTIVES By the end of this chapter, you should be familiar with ° The controversy about whether cycles exist…
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450 Part VI Other Technical Methods and Rules any cycles that traders think they see are merely imaginary. As we saw in Chapter 4, “The…
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Chapter 2 The Basic Principle of Technical Analysis—The Trend 19 whorl] lia . i! iyi’? | 006 Feb. 3B 130209 Created using TradeStation "220…
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Chapter 19 Cycles 451 the false accusation that technical analysts are “stargazers.” Extremely few analysts have seri- ously made any…
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452 Part VI Other Technical Methods and Rules Wuat ARE CYCLES? In mathematical terms, the cosine (and sine) function describes a cycle.…
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Chapter 19 Cycles 453 Point on Circle Defined by Radius and X' Cosine © = X'/Radius As the radius moves to the left, X' becomes smaller…
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454 Part VI Other Technical Methods and Rules Of course, cycles can have different parameters. They can be long from bottom to bottom, high…
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Chapter 19 Cycles 455 many cycles that, when summed, form the plot of prices. The forecasting problem then is to reverse the process and go…
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456 Part VI Other Technical Methods and Rules spectral or other analysis, may only be 19.2 days, or it may be 20.4 days. Cycle periods,…
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Chapter 19 Cycles 457 Notice that several of the cycles appearing in Table 19.1 are stock market cycles we have mentioned in previous…
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458 Part VI Other Technical Methods and Rules upward trends were long and the corrections were short. These were translating right because…
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Chapter 19 Cycles 459 Auto-Correlation Estimate By Rainbow Power-Spectral Density | Time (sec): 0.01 to 0.32 l zeroFill = 96%" Noise…
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460 Part VI Other Technical Methods and Rules Observation In many cases, the low points of dominant cycles in market data are obvious to…
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20 Part | Introduction more detail. Some of the basic beliefs that technical analysis is built on and that we build upon throughout this…
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Chapter 19 Cycles 461 observe if the times separating each low are at regular intervals. If so, a cycle is suspected to exist in the data.…
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462 Part VI Other Technical Methods and Rules 1, a /! \. w " mi Hi yl h NW detrended - 1/11 SMA 26-day cycle lows > Created using…
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Chapter 19 Cycles Centered Moving Averages 463 ...the time relationship between the moving average and the data it smoothes is not the one…
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464 Part VI Other Technical Methods and Rules becomes even more noticeable as the moving average span increases. The centered moving aver-…
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Chapter 19 Cycles 465 The points at which the 18-day envelope touches, or comes close to, the 35-day envelope and turns upward are the low…
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466 Part VI Other Technical Methods and Rules 70.00 +65.00 | i. wih és \ {60.00 i i i it 155.00 | \ if i \ J {50.00 detrending with 5-day…
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Chapter 19 Cycles 467 Created using TradeStation FIGURE 19.14 Ratio: Close to 18-day centered SMA showing shortterm 18-day cycle highs and…
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468 Part VI Other Technical Methods and Rules Projecting Period To project the time for the next low, we need three facts: the period…
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Chapter 19 Cycles TABLE 19.2 Continued 469 Column No 2 3 4 5 6 7 NO Actual Actual Projected Date (x) Period Day No. Day No. Regression…
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470 Part VI Other Technical Methods and Rules Projecting Amplitude Figure 19.14 also shows how amplitude can vary enormously. Indeed, the…
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Vice President, Publisher: Tim Moore Associate Publisher and Director of Marketing: Amy Neidlinger Executive Editor: Jim Boyd Editorial…
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Chapter 2 The Basic Principle of Technical Analysis—The Trend 21 d. Graph the monthly data for the DJIA from 2000 until the present. Has…
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Chapter 19 Cycles 471 back. If the full cycle was bottoming as represented by the centered moving average, we know that the full cycle…
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472 Part VI Other Technical Methods and Rules Third, the FLD can act as support or resistance. Notice in Figure 19.17 during the decline…
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Chapter 19 Cycles 473 Tillman’s analysis concentrates on what he calls focal points. Focal points occur when three or more half-cycle,…
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474 Part VI Other Technical Methods and Rules @ line extended from pivot through focal point (time from high to focal point = time cae i i…
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Chapter 19 Cycles 475 applied mathematics and trigonometry. Much of the analysis must be done by hand. Because cycle analysis is intensive…
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476 Part VI Other Technical Methods and Rules 5. Download daily data for the S&P 500 for the period July 1, 2009 through July 1, 2010.…
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CHAPTER 20 ELLIOTT, FIBONACCI, AND GANN CHAPTER OBJECTIVES By the end of this chapter, you should be familiar with ° The basic tenets of…
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478 Part VI Other Technical Methods and Rules notion that the market behaves in an irregular cyclic manner. Proponents of EWT believe that…
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Chapter 20 Elliott, Fibonacci, and Gann 479 and a corrective wave. The impulse wave is in the direction of the current trend; the…
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480 Part VI Other Technical Methods and Rules Elliot Wave 1 Corrective Wave 1 Motive Wave 2 Total Waves 3 Subwaves Down (A-B-C) 5 Subwaves…
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Chapter 20 Elliott, Fibonacci, and Gann 481 ¢ Within an impulse wave, subwaves 1, 3, and 5 are themselves impulse waves of a lesser degree,…
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482 Part VI Other Technical Methods and Rules Diagonals A diagonal (see Figure 20.2) is the same as the classic wedge pattern seen in…
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Chapter 20 Elliott, Fibonacci, and Gann 483 Truncation Occasionally, the fifth wave fails to exceed the end of the third wave. This…
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484 Part VI Other Technical Methods and Rules Zigzags The single A-B-C correction in Figure 20.4 is an example of a zigzag correction.…
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Chapter 20 Elliott, Fibonacci, and Gann 485 Flats Sideways patterns are called flats. Flats behave very similarly to zigzags except that…
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486 Part VI Other Technical Methods and Rules Prechter points out that flats characteristically have a 3-3-5 combination of subwaves.…
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Chapter 20 Elliott, Fibonacci, and Gann 487 Alternation Alternation is an EWT guideline. Alternation refers to the common occurrence of one…
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488 Part VI Other Technical Methods and Rules Sometimes, wave 4 falls short of the lower channel line, as shown in Figure 20.7. When this…
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Chapter 20 Elliott, Fibonacci, and Gann 489 Figure 20.9 illustrates a projection that occurs at the end of wave 5 extensions. When wave 5…
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490 Part VI Other Technical Methods and Rules Target Zone FIGURE 20.9 Extended fifth wave estimated target in an uptrend Alternatives to…
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CHAPTER 3 HISTORY OF TECHNICAL ANALYSIS CHAPTER OBJECTIVES In this chapter, you will gain knowledge about ° The history of financial…
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Chapter 20 Elliott, Fibonacci, and Gann 491 As with all the preceding methods, the assumptions underlying the market structure are that…
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492 Part VI Other Technical Methods and Rules always seems to have exceptions, the description of waves often can only be determined after…
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Chapter 20 Elliott, Fibonacci, and Gann 493 Fibonacci Leonardo Pisano, better known by his nickname Fibonacci, was born in 1170 in Pisa,…
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494 Part VI Other Technical Methods and Rules 20.1 for a demonstration of the “mystery” of this number. Mathematicians use the Greek letter…
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Chapter 20 Elliott, Fibonacci, and Gann 495 Look back at Figure 20.1; see how the number of waves, as the pattern becomes more com- plex,…
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496 Part VI Other Technical Methods and Rules in July 1932 and the 13 years between the peak in 1929 and the low in 1942 (see Figure…
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Chapter 20 Elliott, Fibonacci, and Gann 497 ie >|34 Months ke —-- ----4-------------------- 13 Years - — — -> 226.00) Elliott's Use of…
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498 Part VI Other Technical Methods and Rules made several fortunes in the commodities markets, married a number of younger women, and…
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Chapter 20 Elliott, Fibonacci, and Gann 499 to some variation of the Fibonacci sequence. However, it is often impossible to recognize these…
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24 Part 1 Introduction Exchanges were developed later where more complicated negotiable instruments, such as state loan stocks, were…
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PART VII SELECTION CHAPTER 21 SELECTION OF MARKETS AND ISSUES: TRADING AND INVESTING 501 Download at www.wowebook.com
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CHAPTER 21 SELECTION OF MARKETS AND ISSUES: By the en T T ° Ti T T TRADING AND INVESTING CHAPTER OBJECTIVES of this chapter, you should be…
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504 Part VII Selection mechanical systems that are developed for that purpose, but even then, a heavy time commitment is necessary to…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 505 Risk Each trader must determine his or her own level of risk…
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506 Part VII Selection trading hours and can judiciously place orders for the next trading day to enter or exit positions. Many swing…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 507 In the futures markets, selection is usually based on a ratio…
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508 Part VII Selection such as gold and silver; these assets traditionally are considered an inflation hedge. Soft assets are financial…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 509 The broad signal as to when to switch from one asset class to another…
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510 Part VII Selection Industrial Commodities to DJIA v. DJIA 1972-2010 —— DUA === comijia 48 mo sma 100.00 5000.00 DJIA IND COM/DJIA 48…
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Chapter 3. History of Technical Analysis 25 ¥ onderghefehreven van weghen de Camere der Ooft-Indifehe V V. Cots en reed bekennen by defen…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 511 leadership has occurred. We will look in sequence at the dollar…
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512 Part VII Selection Gold and Bonds (Long-Term Interest Rates) The next sequence is typically for industrial prices to lead long-term…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 513 Bonds to DJIA v. DJIA 2000-2010 0.025 16000.00 Gold to Bonds 0.023 —…
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514 Part VII Selection DJIA to Dollar v. Dollar 2000-2010 200.00 150.00 DuIA to Dollar 180.00 -- temo g veo0 — Dollar }\/ r . = 160.00 “\ 2…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 515 Finally, this analysis is not intended to forecast the economy. It is…
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516 Part VII Selection ‘$&P500 Energy (SSENRS) 402.299+1.09 ‘S&P500 Materials (SSMATR) 193.837+3.75 plotted relative to S&P 500 Index…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 517 Relative Strength Most technical screening methods use a concept…
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518 Part VII Selection countries but also in the period following the original paper in the United States, as reported in a subsequent…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 519 80 60 > 40 ° oo ° Alpha = 1.55 ° 20 a a ° & ° < eo 9 ° 0 3S } sea o -…
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520 Part VII Selection Alpha is not considered of any importance. However, in actual markets, alpha does not remain at the zero level and…
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26 Part | Introduction MODERN TECHNICAL ANALYSIS Although the practice of technical analysis in some forms likely dates back many…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 521 William O’Neil CANSLIM Method CANSLIM is an acronym for a method of…
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522 Part VII Selection stocks remaining strong. O’Shaughnessy developed from his testing of data from December 31, 1954, through December…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 523 Current Relative Price Strength Percentile and Relative Price…
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524 Part VII Selection were influenced mostly by wealthy individuals and informed insiders. Substituting “institutions” today for these…
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Chapter 21 Selection of Markets and Issues: Trading and Investing 525 CONCLUSION Trading is often focused on very few issues because each…
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526 Part VII Selection 6. Lauren inherited $10,000 and immediately invested the money in the stock market. Unfor- tunately, she lost 30% of…
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PART VIII SYSTEM TESTING AND MANAGEMENT CHAPTER 22 SySTEM DESIGN AND TESTING CHAPTER 23 MONEY AND RISK MANAGEMENT 527 Download at…
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CHAPTER 22 SYSTEM DESIGN AND TESTING CHAPTER OBJECTIVES By the end of this chapter, you should be familiar with © The importance of using a…
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530 Part VIIl System Testing and Management important. Some would argue that controlling loss is even more important than the profit…
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Chapter 3. History of Technical Analysis 27 TABLE 3.2 = Vall Street Journal Corp. Indeed, reflecting the changes in trans- portation since…
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Chapter 22 System Design and Testing 531 and with a large contact list of people in different specialties. This type of trader is generally…
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532 Part VIIl System Testing and Management most traders have never quantified or understood. In fact, risk control can be one of the most…
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Chapter 22 System Design and Testing 533 begins with some basic personal attitudes. Some of the characteristics of the necessary mind-set…
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534 Part VIIl System Testing and Management but also a measure of risk. These ideas are partially correct, but as anyone who has operated…
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Chapter 22 System Design and Testing 535 The first decision that must be made is that of trading philosophy and premises. In other words,…
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536 Part VIIl System Testing and Management soon after it has begun as can be reliably detected. Contrary to the buy low and sell high…
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Chapter 22 System Design and Testing 537 Inevitably, to avoid whipsaws, a trend-following system will be late in the trend and will thus…
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538 Part VIIl System Testing and Management of defining patterns. Larger patterns do not succumb to easy computer recognition because of…
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Chapter 22 System Design and Testing 539 feeds. This is especially a problem in short-term systems, where the sequence of trades is impor-…
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540 Part VIIl System Testing and Management The continuous, or spread adjusted, contract is more realistic, but it suffers from the fact…
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28 Part | Introduction Richard W. Schabacker, the financial editor of Forbes magazine and of the New York Times, began to recognize…
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Chapter 22 System Design and Testing 541 BOX 22.1 DESIGNING A SYSTEM—THE “NERVES OF STEEL SYSTEM” Let us look at a simple case study of how…
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542 Part VIIl System Testing and Management continued The Donchian channel breakout system gives a buy signal when the weekly closing price…
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Chapter 22 System Design and Testing 543 Some tabulated data from the initial test is shown in Table 22.1. TABLE 22.1 Nerves-of-Steel…
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544 Part Vill System Testing and Management continued ¢ Looking at the number of trades, this system generated 74 trades: 37 long trades…
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Chapter 22 System Design and Testing 545 case, the system exceeded the do-nothing approach, which is a favorable sign. Of course, such…
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546 Part VIIl System Testing and Management OPTIMIZATION Once you determine that the parameters in your system are valid, you may optimize…
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Chapter 22 System Design and Testing 547 of time whether the future will be similar, but we do know that there will be trends and trading…
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548 Part VIIl System Testing and Management This method of OOS optimizes the in-sample data and then tests it on the out-of-sample data.…
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Chapter 22 System Design and Testing 549 amount of risk involved. Remember the law of percentages. Risk of capital loss is the most…
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550 Part VIIl System Testing and Management ¢ Outlier-adjusted profit to loss is a profit factor that has been adjusted for the largest…
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Chapter 3. History of Technical Analysis 29 concepts that are still popular today. Some of the other great technicians during this time…
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Chapter 22 System Design and Testing 551 ¢ The net profit to drawdown ratio is the same as net profit as a percentage of maxi- mum…
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552 Part VIIl System Testing and Management Smoothness and the Equity Curve Some analysts prefer to analyze risk in a graphic, visual…
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Chapter 22 System Design and Testing 553 BOX 22.2 UPGRADE IN THE NERVES-OF-STEEL SYSTEM Now it is time to upgrade our system, based upon…
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554 Part VIIl System Testing and Management continued Figure 22.4 shows the new equity curve for the system. Notice how smooth the curve is…
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Chapter 22 System Design and Testing 555 The underwater curve in Figure 22.5 shows the drawdown for the improved Nerves-of-Steel system in…
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556 Part VIIl System Testing and Management BOX 22.3 WHAT IS A GOOD TRADING SYSTEM? In his book, Beyond Technical Analysis, Tushar Chande…
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Chapter 22 System Design and Testing 557 determine whether the system is suitable for future trading. By following the guidelines laid out…
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CHAPTER 23 MONEY AND RISK MANAGEMENT CHAPTER OBJECTIVES After reading this chapter, you should be familiar with © Definitions and…
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560 Part Vill System Testing and Management reward is a personal decision based on one’s tolerance for risk. Everyone is happy with reward,…
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30 Part | Introduction randomly distributed and had no history embedded in them that could predict future prices. At the same time,…
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Chapter 23 Money and Risk Management 561 money management is more important than any system. The second step is to decide on what markets…
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562 Part Vill System Testing and Management As we will see later in this chapter, with the martingale betting system, a system may be…
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Chapter 23 Money and Risk Management 563 Drawdown and Maximum Drawdown When we discussed drawdowns in the previous chapter, we found that…
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564 Part Vill System Testing and Management (50% win percentage). After a run of five successive losses occurs, using a martingale system,…
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Chapter 23 Money and Risk Management 565 at $45. This $5 difference in price is the capital risk we are taking per share. The entire…
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566 Part Vill System Testing and Management The risk of ruin formula (Kaufman, 1998) is ROR = ((1-ta)+(1+ta)) Where: ROR is the risk of…
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Chapter 23 Money and Risk Management 567 Theory of Runs The chance of going broke from a series of losses is the amount of trading times…
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568 Part Vill System Testing and Management BOX 23.2 CALCULATING OPTIMAL F Again, using the system developed in Chapter 22, let us…
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Chapter 23 Money and Risk Management 569 BOX 23.3 INITIAL CAPITAL—MONTE CARLO SIMULATION In Chapter 22, we developed the Nerves-of-Steel…
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570 Part Vill System Testing and Management Leverage Leverage, or the borrowing of capital to increase the potential for gain, of course,…
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This book is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other…
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Chapter 3. History of Technical Analysis 31 ears of those who suffered large losses by owning these stocks and by being fooled and lied to…
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Chapter 23 Money and Risk Management 571 success begins, lack of confidence also begins, and lack of confidence can cause even more errors…
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572 Part Vill System Testing and Management uncorrelated risk to that of one-third the risk of a single stock. A 16-stock portfolio can…
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Chapter 23 Money and Risk Management 573 Exit strategies are usually twofold: prevention of loss of capital or closing at a target profit…
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574 Part Vill System Testing and Management Maximum Winning Adverse Excursion The protective stop is placed to prevent loss if something…
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Chapter 23 Money and Risk Management 575 Technical Point Versus Money Point The decision about a trailing stop usually centers on whether…
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576 Part Vill System Testing and Management Signal One obvious stop is the signal stop. This occurs when the system gives a signal to enter…
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Chapter 23 Money and Risk Management 577 MONITORING SYSTEMS AND PORTFOLIOS All systems and portfolios must be monitored for changes in…
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578 Part Vill System Testing and Management trading are a matter of determining and controlling loss of capital. Entry is easy; best exit…
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PART IX APPENDICES APPENDIX A BASIC STATISTICS APPENDIX B- TYPES OF ORDERS AND OTHER TRADER TERMINOLOGY 579 Download at www.wowebook.com
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32 Part | Introduction | Monthly TYCO a | i ye t i! yt tt aT pet a 5 a 0 rs 5 x 10 @ 5 @ 30 1 5 RD 20 { iH 5 Ih | | 1996 1997 1998 1999…
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APPENDIX A BASIC STATISTICS This appendix was written by Richard J. Bauer, Jr., PhD, CFA, CMT, Professor of Finance, Bill Greehey School of…
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582 Part IX Appendices More generally, we can express the formula for returns as the following: a (Pet =P) Pls This formula can apply to…
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Appendix A Basic Statistics 583 The concept of combinations has more application in investments. With combinations, the sequence is not…
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584 Part IX Appendices Notice that the average value, 0.7%, is not one of the observed values, even though we are in effect saying that it…
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Appendix A Basic Statistics 585 mean will always be less than the arithmetic mean, with one minor exception: They will be equal if the…
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586 Part IX Appendices Initially, there were 4 degrees of freedom. However, when we calculate the mean, which we need for the standard…
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Appendix A Basic Statistics 587 We saw that a major problem with variance was that the units of measurement were not meaningful. The same…
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588 Part IX Appendices Look at Figure A.1. Notice that there is a general tendency for KO to be up when PEP is up, and for KO to be down…
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Appendix A Basic Statistics 589 the least-squares regression line without actually having to plot the data and experiment with var- ious…
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590 Part IX Appendices The portion of the unexplained Y variable in each period is called the error term or resid- ual. Let us examine a…
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CHAPTER 4 THE TECHNICAL ANALYSIS CONTROVERSY CHAPTER OBJECTIVES After studying this chapter, you should have a good understanding of ° The…
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Appendix A Basic Statistics 591 INFERENTIAL STATISTICS With inferential statistics, we try to use observed data to infer things about…
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592 Part IX Appendices 30 25 Gi Frequency 20 PEP Monthly Returns Frequency a l —20% = 15% -10% -—5% 0% 5% 10% 15%] 20%] worl Bin FIGURE A.3…
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Appendix A Basic Statistics 593 The t distribution or Student’s t (Student was a pen name used by the person who first worked out its…
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594 Part IX Appendices Let us start with the intercept and slope of the regression. The intercept, which is clearly labeled, is 0.0096. The…
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Appendix A Basic Statistics 595 We will flesh out these points as we go along. Consider combinations (or portfolios) of two stocks, X and…
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596 Part IX Appendices 18.000% 100% PEP _— 16.000% 30% KO + 70% PEP 14.000% 12.000% 80% KO + 20% PEP 40.000% 8.000% 7 100% KO Return 6.000%…
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Appendix A Basic Statistics 597 If we were to extend our set of possible stocks to four, the variance of the portfolio would be calculated…
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598 Part IX Appendices We can extend the efficient set concept to what is called the efficient frontier. Let us return to Figure A.5 once…
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Appendix A Basic Statistics 599 in the same manner, and that they agree on the expected returns and standard deviations of all stocks and…
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600 Part IX Appendices unstable. For example, remember that we calculated the beta for PEP over the 1995-1999 period using monthly returns.…
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34 Part 1. Introduction TABLE 4.1 Importance of Financial Topics as Reported by Professors and Practitioners* Topic Instructors’ Mean…
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Appendix A Basic Statistics 601 return, return beyond what we expect based upon the CAPM. Fund managers are sometimes said to be “searching…
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602 Part IX Appendices ADVANCED STATISTICAL METHODS Some researchers have applied some very sophisticated statistical techniques to…
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Appendix A Basic Statistics 603 One other term you may encounter is maximum likelihood. With maximum likelihood, you work backward from the…
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604 Part IX Appendices might mean that you pick stocks that are in the lowest quartile of ROE for a given group of stocks. Similarly,…
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Appendix A Basic Statistics 605 a. Calculate the monthly return for each of these stocks. b. Calculate the following for each of these…
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APPENDIX B TYPES OF ORDERS AND OTHER TRADER TERMINOLOGY In the second half of this book, we cover strategies and tactics that can be used…
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608 Part IX Appendices Market Order An order to execute a stated amount at the bid or offer price currently available in the marketplace.…
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Appendix B Types of Orders and Other Trader Terminology 609 Stop Order An order to execute once a price reaches a certain level away from…
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610 Part IX Appendices Action: Buy/Sell Order Description: Order Type: Limit, Stop, Stop Limit, Market, MOC, MOO, IOC, FOK, AON, and so on.…
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Chapter 4 The Technical Analysis Controversy 35 Do MARKETS FOLLOW A RANDOM WALK? Opponents of technical analysis claim that looking at past…
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BIBLIOGRAPHY Aby, Carroll D. J. Point & Figure Charting: The Complete Guide. Greenville, SC: Traders Press, Inc., 1996. Achelis, Steven B.…
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612 Part IX Appendices Appel, Gerald, and Fred Hitschler. Stock Market Trading Systems: A Guide to Investment Strat- egy for the 1980s.…
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Bibliography 613 Baum, Caroline. “Just in Time to Come Crashing Down.” Los Angeles Business Journal, January 3, 2000. Belford, Peter.…
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614 Part IX Appendices Bressert, Walter. The Power of Oscillator/Cycle Combinations. Tucson, AZ: Walter Bressert and Associates, 1991.…
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Bibliography 615 Campbell, J., A. Lo, and C. MacKinlay. The Econometrics of Financial Markets. Princeton, NJ: Princeton University Press,…
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616 Part IX Appendices Cheung, Y. W., and C. Y. P. Wong. “A Survey of Market Practitioners’ Views on Exchange Rate Dynamics.” Journal of…
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Bibliography 617 Cooper, Jeff. Hit and Run Trading II: Capturing Explosive Short-Term Moves in Stocks. Colum- bia, MD: Marketplace Books,…
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618 Part IX Appendices , and C. C. Thiel. Point and Figure Commodity Trading: A Computer Evaluation. West Lafayette, IN: Dunn & Hargitt’s…
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Bibliography 619 Dreman, David. “Bubbles, and the Role of Analysts’ Forecasts.” Journal of Psychology and Financial Markets 3, no. 1…
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620 Part IX Appendices Fischoff, B., and P. Slovic. “A Little Learning...: Confidence in Multicue Judgment Tasks.” In R. Nickerson (ed.),…
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36 Part | Introduction Fat Tails A normal distribution curve looks like the bell-shaped chart in Figure 4.1. + So 0.3 0.2 04 0.0 i T T T T…
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Bibliography 621 Graham, Benjamin, and D. Dodd. Security Analysis: Principles and Technique. 3d ed. New York, NY: McGraw-Hill, 1951.…
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622 Part IX Appendices Haurlan, P. N. Measuring Trend Values. La Canada, CA: Trade Levels, Inc., 1968. Hauschild, K., and Michael…
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Bibliography 623 ackwerth, Jens Carsten, and Mark Rubinstein. “Recovering Probability Distributions from Options Prices.” Journal of…
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624 Part IX Appendices Keltner, Chester W. How to Make Money in Commodities. Kansas City, MO: Keltner Statistical Service, 1960.…
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Bibliography 625 Lebeau, Charles and David Lucas. Technical Traders Guide to Computer Analysis of the Futures Markets. New York, NY:…
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626 Part IX Appendices , and Jasmina Hasanhodzic. The Evolution of Technical Analysis: Financial Prediction from Babylonian Tablets to…
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Bibliography 627 Markstein, David L. How to Chart Your Way to Stock Market Profits. New York, NY: Arco Pub- lishing, 1972. Marshall, Ben…
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628 Part IX Appendices Miner, Robert C. Dynamic Trading: Dynamic Concepts in Time, Price & Pattern Analysis with Practical Strategies for…
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Bibliography 629 Nison, Steve. Japanese Candlestick Charting Techniques. New York, NY: New York Institute of Finance, 2001. O’Neil, William…
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630 Part IX Appendices Peterson, Richard L. Inside the Investor’s Brain: The Power of Mind Over Money. New York, NY: John Wiley & Sons,…
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Chapter 4 The Technical Analysis Controversy 37 sor 0.06 =0004 =0.02 0.00 0.02 004 006 FIGURE 4.2 Density estimation for GE compared with a…
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Bibliography 631 Ross, Joe. Trading by the Book, 5th edition. Ross Trading, 1994. Rotella, Robert P. The Elements of Successful Trading.…
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632 Part IX Appendices Schwartz, Martin. Pit Bull: Lessons from Wall Street’s Champion Day Trader. New York, NY: Harper Paperbacks, 1999.…
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Bibliography 633 Sperando, Victor. Trader Vic: Methods of a Wall Street Master. New York, NY: John Wiley & Sons, Inc., 1993. Sprandel, R.…
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634 Part IX Appendices Taylor, George Douglass. The Taylor Trading Technique. Greenville, NC: Traders Press, Inc., 2000. Reprint of 1950…
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Bibliography 635 Wang, Jar-Long, and Shu-Hui Chan. “Stock Market Trading Rule Discovery Using Pattern Recognition and Technical Analysis.”…
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636 Part IX Appendices Zhu, Yingzi, and Guofu Zhou. “Technical Analysis: An Asset Allocation Perspective on the Use of Moving Averages.”…
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A A/D line. See advance-decline line AA (Alcoa Corporation) daily bar chart, 210 daily candlestick chart, 212 line chart of daily closing…
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638 Amsterdam Exchange, 24 analysis confirmation analysis classic patterns, 411 crossovers, 411 divergences, 409-410 explained, 408 failure…
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Index bear markets, 80 bearish resistance lines, 248 “The Behavior of Stock Market Prices” (Fama), 35 Behavioral Finance, 30, 49-50,…
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640 morning star, 397-398 piercing line, 395-397 shooting star, 394-395 three black crows, 398-399 three inside down, 399-400 three inside…
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38 Part | Introduction mass, they begin to foretell future returns and are, thus, no longer random or independent. Sor- nette calls these…
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Index Commodity Futures Trading Commission (CFTC), 122 commodity markets. See futures markets common gaps, 367 Common Stocks as Long-Term…
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642 costs of funds, 185 futures versus stock markets, 504 COT (Commitment of Traders) reports, 122-124 count in one-box reversal…
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Index DCB (Dead Cat Bounce), 371-373 dealer markets, 58 decelerating trend lines, 241-242 decennial pattern, 168-169 decision making and…
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644 Donchian channel, 295 Donchian, Richard, 29, 237 Dormier, Buff, 427 Dorsey, Thomas, 218, 339 double divergences, 137 double negative…
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Index equivolume, 412-413 error term, 590 ETFs (exchange-traded funds), 61-62 evening star candlestick pattern, 397-398 event declines, 372…
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646 flow of funds bank loans, 184 cost of funds, 185 explained, 177-178 Fed policy explained, 190-191 Fed policy futures, 191 Three Steps…
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Index GARCH (generalized autoregressive conditional heteroscedasticity), 602-603 Gartley, H. M., 415 GAs (genetic algorithms), 603-604…
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648 trends, 12-13 linear least-squares regression, 12-13 trend lines, 13-14 IFTA (International Federation of Technical Analysts, Inc.), 7…
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Index 649 J Leading Sectors and World Powers: The Jackwerth, Jens Carsten, 36 Coevolution of Global Economics and January barometer, 174…
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650 long-range bar, 370 Long-Term Capital Management (LTCM), 48-49 long-term interest rates, 187 The Long Wave Cycle (Kondratieff), 164…
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Chapter 4 The Technical Analysis Controversy 39 4 2 -3 R4 2 a S- 6 4 7 -8 -0.3 0.2 0.1 0 0.4 0.2 0.3 Drawdown Drawup Courtesy of Didier…
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Index Arms Index, 149-151 breadth and new highs to new lows, 159-160 breadth line (advance-decline line), 134-136 breadth thrust, 147-148…
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652 Index measuring percentage change method, 518-519 gaps, 367 trend slope method, 520 market movement sentiment of informed players…
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Index MESA (Maximum Entropy Spectral Analysis), 459 MAMA (MESA Adaptive Moving Average), 285 Metastock, 203 Meyers, Thomas, 156 Mikkea,…
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654 money market funds, 111-112, 178-179 money market managers, 126-127 money point, 575 money stops, 269 money supply, 183-184 monitoring…
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Index nearest future method, 205 Neely, Glenn, 490 negative divergence, 132, 410 negative failure swings, 409 negative reversals, 133, 410…
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656 Index optimizing systems explained, 546 measuring system results for robustness components, 549 profit measures, 549-550 risk measures,…
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Index three inside down, 399-400 three inside up, 399-400 three outside down, 400 three outside up, 400 three white soldiers, 398-399…
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658 payoff ratio, 550, 564 peaks, 228-229 pegged market, 608 pennants, 329-331 percent breakout filter, 258 percentage change method,…
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Index popsteckle, 443-444 population, 585 portfolios, monitoring, 577 Poser, Steven, 492 position sizing. See money management positive…
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660 Q quadratic equation, standard deviation as, 595 Quantitative Analysis Services, Inc., 100 quotes, 608 R r-squared, 589 random,…
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40 Part | Introduction more thorough research of the literature. In doing so, they found that others (Larson, 1960; Alexander, 1961;…
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Index horn pattern, 375 inside bars, 376-378 island reversals, 373 naked bar upward reversals, 379 one-bar reversals, 373 outside bars,…
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662 rules of trading, 297 runaway gaps, 367 RWH (Random Walk Hypothesis) drawdowns, 37-38 explained, 35 fat tails, 36 origins and…
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Index measuring for uninformed players advisory opinion polls, 103-105 American Association of Individual Investors poll, 105 buying and…
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664 pattern construction and determination, 362 spikes, 370-371 volatility patterns narrow-range bar, 385-386 VIX, 386 wide-range bar,…
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Index Stiglitz, Joseph, 42 Stochastic oscillator, 437-440 stock ahead, 608 The Stock Market Barometer (Hamilton), 76 “Stock Market Prices…
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666 initial systems, 534-535 Nerves-of-Steel system case study, 541-545 pattern recognition systems, 537-538 reliability, 538 requirements,…
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Index catapult, 354-355 double top and double bottom, 349 explained, 345 horizontal count, 347 rising and declining trend lines, 352-354…
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668 trend lines, 13-14 accelerating trend lines, 240-241 Andrews pitchfork, 249-250 channels, 243-244 decelerating trend lines, 241-242…
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Index scale, 240 setting trailing stops with, 266-267 speed lines, 248-249 uptrends, identifying, 238 defined, 11 regression lines, 239…
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670 uptrends, identifying, 238. See also trends regression lines, 239 trend lines, 239-240 accelerating trend lines, 240-241 decelerating…
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Chapter 4 The Technical Analysis Controversy 41 profit. For example, a recurring business cycle is a well-known and accepted economic…
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Index volume spikes climaxes, 426 explained, 425-426 on breakout, 425 shock spiral, 427 volume dips, 427 Volume Price Confirmation…
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42 Part | Introduction yo ‘Asset ( ‘Asset Notice that the Pree The price drits Price price instantaneously upward atte The price increases…
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Chapter 4 The Technical Analysis Controversy 43 Information itself is subject to many problems and thus brings into question the precepts…
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44 Part | Introduction Point-and-Figure Enron Chart March 12—-November 29, 2001 13 wa ee : rie 83x Bex 0x9 + Relative Strength Chart…
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Chapter 4 The Technical Analysis Controversy 45 Advice from Major Wall Street Firms on Enron March 12-November 29, 2001 Date Price 3/12…
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46 Part | Introduction Some of the optimization problems that market participants would need to be solving are beyond the analytical…
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Chapter 4 The Technical Analysis Controversy 47 (Tversky and Kahneman, 1983), miscalibration of probabilities (Lictenstein et al., 1982),…
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48 Part | Introduction a large portion of potential profit. These factors of liquidity and costs often convince the poten- tial arbitrageur…
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Chapter 4 The Technical Analysis Controversy 49 must then be used to increase the size of the position. The danger is that although…
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50 Part | Introduction finance studies have pointed to cognitive biases, such as mental accounting, framing, and over- confidence, which…
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To Ellie—my precious wife, long-term love and companion, and best friend. —Charlie To Richard, Katherine, and Sepp. —Julie Download at…
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Chapter 4 The Technical Analysis Controversy 51 Some investors incorrectly believe that technical analysis is only for the short-term…
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52 Part | Introduction Wuat Is THE EMPIRICAL SUPPORT FOR TECHNICAL ANALYSIS? Despite the theoretical criticisms, can technical analysts use…
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Chapter 4 The Technical Analysis Controversy 53 REVIEW QUESTIONS 1. You walk into a room where some friends have been playing a coin toss…
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PART II MARKETS AND MARKET INDICATORS CHAPTER 5 AN OVERVIEW OF MARKETS CHAPTER 6 Dow THEORY CHAPTER 7 SENTIMENT CHAPTER 8 MEASURING MARKET…
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CHAPTER 5 AN OVERVIEW OF MARKETS CHAPTER OBJECTIVES After studying this chapter, you should be familiar with ° The market characteristics…
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58 Part Il_ Markets and Market Indicators BOX 5.1 FUNGIBILITY Fungibility is the interchangeability of financial assets on identical terms.…
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Chapter 5 An Overview of Markets 59 stand ready to buy and sell at these prices. The NASDAQ is an example of a dealer market for stocks.…
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60 Part Il_ Markets and Market Indicators Cash Market The cash, or spot, market is the oldest type of market. In the cash market, a…
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Chapter 5 An Overview of Markets 61 p-m., in which case it would close for the day. Should the Dow decline 3,150 (30%) points within the…
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62 Part Il_ Markets and Market Indicators are taxed like stocks; and they do not require an uptick to be sold short. They have a lower…
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Chapter 5 An Overview of Markets 63 Futures Markets Futures contracts that are traded in the futures markets are contracts in which the…
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64 Part Il_ Markets and Market Indicators Futures, unlike stocks, are contracts and represent an agreement to purchase or sell a very…
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Chapter 5 An Overview of Markets 65 ruination of many traders. The other major danger is in more illiquid futures markets where what is…
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66 Part Il_ Markets and Market Indicators novice because options include sizable leverage risk and other complications. Options are a sub-…
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Chapter 5 An Overview of Markets 67 has been watching the stock price change and is flexible enough to either buy or sell shares but has no…
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68 Part Il_ Markets and Market Indicators Now what happens to that price when the players interact over time? Obviously, each new price…
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Chapter 5 An Overview of Markets 69 The early Efficient Markets Hypothesis presumed that only informed investors acted within the…
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70 Part Il_ Markets and Market Indicators movement was developed. At the end of the nineteenth century, Charles H. Dow began publish- ing a…