class 1: intro

Question 1

Technical analysis (TA) key points:

Answer 1

The study of market action is the study of human psychology, i.e. behavioral finance.

Is actionable and shows you how to make money.

Is not a “Holy Grail” or guarantee to making money in financial markets.

Is an another very useful tool to “have in your toolbox.”

Under certain market conditions these tools may not work (i.e. trading ranges), overbought and oversold markets, and long-term forecasting.

Market (prices) always lead fundamentals.

In the short-term markets are driven by sentiment and technical analysis, says the late Leon Tuey

Must have a profound knowledge of TA to be a successful trader and gain actionable ideas to build a consistent trading system

Question 2

Assumptions of TA

Answer 2

Humans behave in a similar manner: history repeats, if not it rhymes.

Prices are determined by supply and demand.

Price discounts all information: records transactions of all market participants.

Prices trend; “the trend is your friend”.

Prices develop acknowledged patterns.

Patterns and trends are fractal in time and size.
Trends act similar over different periods of time, shorter trends make up longer trends.

Question 3

Analysis of trend includes the analysis of longer and shorter trends

which are these?

Answer 3

Primary (months or yrs)

secondary/intermediate (months - wks)

minor/short term (days)

daily/intraday (hours or minutes).

Question 4

the 3 types of trends

Answer 4

1) up

2) down

3) sideways (trading range).

Question 5

fundamental analysis founder?

Professional designations?

which question does it answer?

methods of analysis?

Answer 5

founder: Graham & Dodd 1934

Professional designations: CFA

which question does it answer: What should I buy?

methods of analysis: studies cause of market movements with data

Question 6

technical analysis

founder?

Professional designations?

which question does it answer?

methods of analysis?

Answer 6

founder: Robert Rhea Dow 1932 + Edwards & McGee 1948

Professional designations: CMT (Chartered Market Technician)

which question does it answer: What should I buy? + When?

methods of analysis: studies effect through market action

Question 7

disadvaantages of fundamental vs technical

Answer 7

fundamental:

–> info provided could be wrong
–> time consuming

technical analysis:

–> often subjective
–> short term bias
–> generally does not outperform buy and hold strategy

fundamental and technical are often in conflict with each other

Question 8

Efficient Market Hypothesis (EMH) and it’s three forms

Answer 8

1. Weak form
2. semi-strong form
3. strong form

Question 9

weak form of EMH

Answer 9

Past prices(information) are fully reflected in current market prices.

Implies: trends in prices, i.e.: technical analysis does not work and should not be able to consistently outperform the market.

Question 10

semi-strong form of EMH

Answer 10

Prices instantaneously adjust to reflect all public and new information.

Implies: No abnormal returns can be made by acting on publicly available information; i.e. You can’t make money by fundamental analysis of public information like annual reports.

Implies that fundamental analysis is worthless, but low P/B, P/E and P/CF, high dividend stocks show otherwise.

Question 11

strong form of EMH

Answer 11

Prices reflect all pertinent public and non-public “insider” information.

Implies: No one not even company insiders can make abnormal, excess returns. Laws and regulation should prevent insiders from trading on such information.

Studies show that strong form does not generally hold.

Question 12

Charles H Dow

Answer 12

was the first editor of the Wall Street Journal and one of the founders of the Dow Jones Company

He is widely regarded as the father of modern technical analysis. He created the Industrial Average – (which later became the DJIA – Dow Jones Industrial Average) and the Rail Average – (which became the Dow Jones Transportation Average - DJTA).

Question 13

the 6 tenets of DOW Theory

Answer 13

1. THE AVERAGES DISCOUNT EVERYTHING
2. THE MARKET HAS 3 TRENDS
3. PRIMARY TRENDS HAVE THREE PHASES

4.THE AVERAGES MUST CONFIRM EACH OTHER

5. VOLUME CONFIRMS THE TREND
6. A TREND SHOULD BE ASSUMED TO PERSIST UNTIL IT GIVES DEFINITE SIGNALS THAT IT HAS REVERSED

Question 14

Dow Theory: 1. THE AVERAGES DISCOUNT EVERYTHING

Answer 14

-> Stock prices reflect both, current and future expectations of general economic activity

–> Market participants act on both current information as well as future economic expectations, and their actions (buying and selling) will affect the averages. Even ‘Acts of God’ (natural disasters) which obviously cannot be anticipated, are very quickly discounted into the averages

Question 15

Dow Theory: 2. THE MARKET HAS 3 TRENDS

Answer 15

–> Primary: represents the TIDE

—> the longest of the trends

–> Secondary: represents the WAVES

—-> known as intermediate trend, are the CORRECTIVE REACTIONS to the primary trend.
—-> last years

—-> They often retrace 33 – 66% of the preceding gain / loss, although they usually end at a 50% retracement. They usually last 3 weeks to 3 months

–> Minor: represents the RIPPLES

—-> They are short term and usually last less than 4 weeks
—->They can be misleading and are likened to ‘NOISE’ with respects to the larger trend

Question 16

Dow Theory: 6. A TREND SHOULD BE ASSUMED TO PERSIST UNTIL IT GIVES DEFINITE SIGNALS THAT IT HAS REVERSED

Answer 16

a trend in motion remains in motion until it gives signals of a reversal

–> We are best served by assuming that the trend is still in effect until there is clear evidence of a reversal

We should not get arrogant and believe that it will turn soon, and take action against it. We must wait for there to be a clear reversal signal before taking action

Question 17

Dow Theory: 4.THE AVERAGES MUST CONFIRM EACH OTHER

Answer 17

DOW THEORY can only be confirmed if BOTH averages, the DJIA and the DJTA reach new highs or new lows

–> They do not have to do so simultaneously, but one signal should soon follow the other before the first average reverses its initial trend

In order for the INDUSTRIALS to be profitable, they need to get their products to market, i.e. they have to be shipped or transported to their respective destinations. To Dow, a bull market in industrials could not occur unless the railway average rallied as well. Only once this is done, is a healthy economy truly confirmed.

Question 18

Dow Theory: 5. VOLUME CONFIRMS THE TREND

Answer 18

In an upward trend:
–> Volume should ↑ when prices are ↑
–> Volume should ↓ when prices are ↓ during corrective sell offs

In a downward trend:
–> Volume should ↑ when prices are ↓ &
–> Volume should ↓ when prices are ↑ during corrective rallies.

Question 19

Criticisms of the Dow Theory

Answer 19

Investors will act after than and before market tops and bottoms

There are lags between the actual turn in the primary trend and the recognition of the change in the trend. The theory does not recognize a turn until long after it has occurred and has been confirmed

Different trends are not strictly defined. Often the interpretation of price swings is difficult to assign to a specific trend type. Secondary trend beginnings often appear like primary trend beginning