Transcript Beyond the Fundamentals: Technical Analysis

FIN 40500: International
Finance
Beyond the Fundamentals; Technical
Analysis
Fundamental analysis focuses on economic/financial theory and
various economic indicators to explain market movements
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Trade Balance Approach
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Price Level Approach
Interest Rate Approach
Monetary Approach
Technical analysis is not concerned with the causes of market
movements. Instead, technical analysis focuses on the movements
themselves. Is there information in past price movements that can be
used to predict future movements?
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Chart Analysis
Quantitative Methods
The forecasting equation for a technical analysis would be
something like this
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$/Euro: Weekly data over 3 years
Chart analysis begins with a time series plot of an asset’s price
Charts can be hourly, daily,
weekly, etc.
Higher frequency data will be
more detailed, but noisier
A chartist looks for patterns in the to identify resistance (upper bounds)
and support levels (lower bounds)
Old Support
level
New Support
level
Connect two
consecutive highs to
get the upper
channel
A parallel line through
a recent low becomes
the lower support
A “breakout” indicates
a new pattern forming
Bullish channels
tend to have
upward breakouts
Find the trend by connecting at least two highs
Two lows complete
the triangle
“Breakout” occurs at the apex, usually with increasing volume
Ascending triangles
usually have
upward breakouts
The “Run”: A breakout from the lead in trend
The “Bump”:
Increase in trend
by more than 50%
Two lows identify the
“lead in” trend
The head is the first advance past the left shoulder
The left shoulder is the first high
above the current trend
The right shoulder is the first
high following the reversal
Two lows identify the “lead in” trend
The neckline connects the two shoulders and indicates lower support
What pattern do you see?
“Run”
“Bump”
Fibonacci, one of the greatest mathematicians of all time discovered
a sequence of numbers which are now used across many disciplines
Suppose that you begin with a pair of rabbits:
Rabbits take one month to mature.
Once mature, they can breed
offspring
Offspring come in pairs (one male and one female).
A pair of
offspring are born each month
The rabbits never die
Now
One Pair
(Y)
1 Month
2 Months
One Pair
(M)
Two Pair
(M, Y)
3 Months
Three Pairs
(M, M, Y)
Y = Young, M = Mature
Can you find the Pattern?
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ……
Each number in the Fibonacci sequence is the
sum of the previous two
1+ 1 = 2
1+2=3
2 + 3 = 5 ….
These numbers seem to appear a lot in nature…
One
Two
Three
White Calla Lily
Euphorbia
Trillium
Five
Eight
Thirteen
Bloodroot
Black-eyed Susan
Buttercups
(By far the most
common)
Ordinary field daisies have 34 petals – a fact to
be remembered when playing “she loves me,
she loves me not”!
(with 34 petals, you will always finish with
“she loves me not!”)
Take a pineapple…hmmm…look at the various spirals formed
Every human has 2 hands with 5 fingers on each. Each finger is made
of 3 segments connected by 2 joints…don’t these numbers sound
familiar?
Each section of your index
finger, from the tip to the
base of the wrist, is larger
than the preceding - fitting
the Fibonacci numbers 2, 3, 5
and 8.
By this scale, your fingernail
is 1 unit in length.
Similar ratios are seen between
your hand and
forearm…coincidence?
Suppose that we divide each number into the following number
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ………
1/1 = 1
2/1 = 1
3/2 = 1.5
5/3 = 1.667
8/5 = 1.6
13/8 = 1.625
21/13 = 1.615
34/21 = 1.619
The ratios converge
to 1.618
Now, suppose that we divide each number into the previous number
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ………
1/1 = 1
1/2 = .5
2/3 = .667
3/5 = .6
5/8 = .625
8/13= .615
13/21 = .619
21/34 = .617
1  .618  1.618
The ratios converge
to .618
AND
1
 1.618
.618
Suppose that
we begin with a
1X1 square
Put another 1X1
square next to it
Now, put a 2X2
underneath
Now, add a 3X3 square
Connect the corners of the squares and you get the golden
spiral…look familiar??
Math is everywhere!!
Anyways, back to technical analysis. Many of the technical methods are
based on PHI (.618) and powers of .618
.618
.382 = .618*.618
First, draw a trend line
.236 = .618*.618*.618
Draw arcs
that
intersect the
trend at
61.8%, 50%,
and 38.2%
of the high
(these will
indicate
future
supports)
Draw an initial trend line between two extreme points
Draw rays
that intersect
at 61.8%,
50%, and
38.2%
At the second extreme point, draw a vertical line
Once a reversal occurs, it tends to find support at
Fibonacci levels!
Large price swings tend to occur on “Fibonacci times”!
(times could be in days, months, years, etc)
Elliott Waves
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Elliot wave theory relies on cycles within cycles
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Grand Super cycle
Super cycle
Cycle
Each cycle consists of 5 moves with the trend (1,3,5
are impulse, 2,4 are corrective) and 3 that are
against the trend. A “5-3” wave
Elliott Waves consist of 5 moves
with the trend (1,3,5 are impulse, 2,4
are corrective) and 3 that are against
the trend. A “5-3” wave cycle
Beginning of the next
wave
Impulse
Correction
The 5-3 wave cycles actually oscillate around a larger “super-cycle” The
super-cycle is also a 5-3 wave.
Impulse (1)
Correction (2)
Finally, the super-cycle oscillates around a “grand super-cycle”
Note that the grand super cycle has two movements, the super cycle
has 8 movements, the cycle has 34……Fibonacci numbers!!
RSI (Relative Strength Indicator)
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RSI  100  
1
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100
Total "Up" points
Total "down" points
If “Up Points” = 0, RSI = 0
If “Down Points” = 0, RSI = 100
RSI < 30 (Oversold)
RSI > 70 (Overbought)
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RSI (Relative Strength Indicator)
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RSI  100  
1 

100
Total "Up" points
Total "down" points
Chart Interval: 15 minutes
Period Length: 20 (300 minutes)
Total “up” points = 7
Total “down” points = 11
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RS     .636
 11 
 100 
RSI  100  
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1  RS 
RSI  38.89
Fast Stochastic
 Close(X) - Low(X) 
FS  
 *100, X  Period Length
 High(X) - Low(X) 
Signal  Y Period Moving Average of FS
Period High: FS = 100
Period Low: FS = 0
Signal < 30 (Oversold)
Signal > 70 (Overbought)
A moving average takes out the volatility by averaging several
observations. For example, a MA(3) would average the current
observation with the previous 2 observations.
Data
May
June July
Aug.
Sept.
Oct. Nov.
Dec.
.6
.3
-.1
.1
.2
.6
.2
MA
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
1
.6
.3
-.1
.1
.2
.6
.2
.2
.45
.1
0
.15
.4
.4
.2
.27
.10
.07
.3
.33
.33
.3
.17
.2
.275
.3
2
3
4
.2
Moving Average Convergence/Divergence
(MACD)
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The MACD indicator calculates the difference
between moving averages of two different lengths
(usually, 12 periods and 26 periods)
The signal is typically a 9 period moving average of
the difference
A divergence means that “something is happening”
Positive to Negative = Sell Signal
Negative to Positive = Buy Signal
MACD
Suppose that the longer run moving
average has a length equal to the number of
observations – the series average
MA
MA(10)
MA(N)
Time
- To + :
Buy point
+ To - :
Sell point
- To + :
Buy point
Punch line
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Technical methods are useful for short run
prediction
Don’t lose sight of the fundamentals!!!