Transcript Document 7542811

CHAPTER EIGHT
BEYOND FUNDAMENTAL ANALYSIS
Practical Investment Management
Robert A. Strong
Outline

Charting
The Underlying Logic
 Types of Charts
 Other Chart Annotations


Technical Indicators
Indicators with Economic Justification
 Indicators of the Witchcraft Variety

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Outline

Old Puzzles and New Developments
Fibonacci Numbers
 Dow Theory
 Kondratev Wave Theory
 Chaos Theory
 Neural Networks


The Future of Technical Analysis
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Charting: The Underlying Logic

The technical analyst believes
that charts can be used to
predict changes in supply and
demand.

Market participants seldom wait
for things to completely unfold.
They try to anticipate events
rather than merely react to
them.
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Stock Price
Charting: Types of Charts
Time
Linear Scale Line Chart
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Stock Price
Charting: Types of Charts
Time
Logarithmic Y-Axis Line Chart
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Stock Price
Charting: Types of Charts
Time
Bar Chart
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Stock Price
Charting: Types of Charts
Irregular Time Intervals
Point and Figure Chart
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Charting: Types of Charts
open
Stock Price
close
close
open
Time
Candlestick Chart
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Charting: Other Chart Annotations

support level

resistance level

congestion area

breakout
Chartists believe investors remember missed
opportunities and look for them to return.
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Technical Indicators

These statistics, either calculated or directly
observed, are alleged to have a relationship
with the future direction of the overall stock
market or with an individual security.

Indicators with economic justification are
based on economic activities that are
measurable and observable.

Indicators of the witchcraft variety have no
logical connections between the
measurements and what the
measurements purport to show.
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Indicators with Economic Justification

The higher the short interest figure, the larger
is the potential demand for the shares.

Increased margin buying has historically been
associated with rising markets.

Cash held by mutual funds represents
potential demand for stock.

When the confidence index gets closer to 1.0,
investors are more likely to be bullish about
the economy, and therefore about corporate
earnings.
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Indicators with Economic Justification

An advance-decline line is a graphical
representation of the net advances over a
period of time.

A high relative strength ratio, such as a high
relative PE, means that investors are willing
to pay more for the past earnings of a
company than average.

Advocates of moving averages in stock
selection believe that changes in the slope of
the line are important.
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Indicators of the Witchcraft Variety

The super bowl indicator states that the stock
market will advance the following year if the
super bowl football game is won by a team
from the original National Football League.

Increased sunspot activity every eleven years
leads to better weather for an improved
harvest, leading in turn to a stronger
economy, and finally to higher stock prices.

Hemline indicator: As shorter dresses for
women become the fashion, the market
advances, and vice versa.
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Old Puzzles and New Developments
Fibonacci Numbers
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, ...

Fibonacci numbers occur frequently and
inexplicably in nature.

1.618, the golden mean of the numbers,
is used to calculate the Fibonacci ratios.

Many Fibonacci advocates in the investment
business use the first two ratios, 0.382 and
0.618, to “compute the retracement
levels of a previous move.”
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Old Puzzles and New Developments
Dow Jones Industrial Average
Dow Theory
Meaningless
Daily
Fluctuations
(ripples)
Secondary
Trend
(waves)
Primary Trend
(tides)
Time
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Old Puzzles and New Developments

Kondratev wave theory states there is a 50- 60
year business cycle.

Chaos theory sees systematic behavior
amidst apparent randomness.

A neural network is a trading system in which
a forecasting model is trained to find a
desired output from past trading data.
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The Future of Technical Analysis

Technical analysis has persisted for more
than 100 years, and it is not likely to
disappear from the investment scene anytime
soon.

Improved quantitative methods coupled with
improved behavioral research will continue to
generate ideas for analysts to test.
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Review

Charting
The Underlying Logic
 Types of Charts
 Other Chart Annotations


Technical Indicators
Indicators with Economic Justification
 Indicators of the Witchcraft Variety

South-Western College Publishing ©1998
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Review

Old Puzzles and New Developments
Fibonacci Numbers
 Dow Theory
 Kondratev Wave Theory
 Chaos Theory
 Neural Networks


The Future of Technical Analysis
South-Western College Publishing ©1998
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