technical analysis 2

Technical Analysis

Bar Chart Information High Open Close Low

Daily Weekly Monthly

Chart formations Trends Planes

Other top and bottom formations Key Reversals Flags, Triangles and Pennants Gaps

Up Trend Connect two or more daily price lows

Preferably 10 days apart

When market closes below an uptrend line, a sell signal is generated

Computer trading vs fundamental Computers may drive prices lower for a few days If fundamentals don’t support this, then prices

will rally

Up Trend

Sell Signal

Down Trend Connect two or more daily price highs

Preferably 10 days apart

When market closes above a down- trend line, a buy signal is generated

Computer trading vs fundamental Computers may drive prices higher for a few days If fundamentals don’t support this, then prices

will decline

Down Trend

False BuySignal

Trend line market signals Speculators

Buy and sell based on signals

Hedgers – Short Place on sell signal May choose to offset on buy signal

Hedgers – Long Place on buy signal May choose to offset on sell signal

Trend Line reliability A close above a major down trend or

below a major up trend will lead to a significant price move about 75% of the time

Resistant Planes Life-of-contract highs can be very difficult

for market to penetrate Strong Fundamental conditions needed to

move market above resistance Sell signal if market fails to take out

resistance Buy signal if market closes above

resistance (particularly 2 closes above)

Resistant Planes There are also intermediate resistance

planes These are not as hard to penetrate as life-

of-contract highs are

Resistance plane

Sell Signal

Resistance plane

Sell SignalBuy Signal

Support Planes The mirror image of Resistance Planes Life-of-contract lows Buy signal if market fails to penetrate Sell signal if low is taken out

Support Planes

Sell Signal

Hedgers and Technical Analysis If understand trends and support and

resistance planes: Time placement of hedge Set realistic market targets Perhaps minimize margin calls

Other Bar Chart Formations Double Top or Double Bottom Head and Shoulders Key Reversal Flags, Triangles and Pennants Gaps

Common, break away, measuring, exhaustion

Double Top (triple top)

Head and Shoulders

Shoulder Shoulder

Head

Neck line

Key Reversal Higher high Lower low Close below prior day

close Sell signal

Close above prior day close Buy signal

Flag

Decline

Project =Decline

Triangle or Pennant Buy Signal if market

breaks out to the top Sell signal if market

breaks out to the bottom

Gaps

Common

Break away

Measuring

Exhaustion

Complements to Chart Patterns Trading Volume Open Interest Relative Strength Index (RSI)

Trading Volume Barometer of level of intensity in the

market If buy/sell signal occurs on a relatively

high volume day, then it is more reliable High/low volume is relative to past trading

and relative to specific contract

Guidelines for trading volume Look at all months being traded for a

particular commodity Interpret volume on limit up/down days

very carefully Usually low prior to holiday, 3 day

weekend, or major report

Open Interest # of contracts that are outstanding

Have not been offset

No binding relationship between Open Interest and Trading Volume Day traders create volume, don’t change open

interest

Open Interest tends to peak and then decline prior to an uptrend reversal Less reliable on downtrend reversal

Relative Strength Index Widely used measure of momentum in

the market 14 day RSI is the most common To calculate

Record last 14 day price changes (closes) Sum the negative changes and positive changes

and divide each by 14 to create (D) down average and (U) up average

RSI=U/(U+D) * 100

RSI Market Indicator RSI > 70

Market is thought to be over bought

RSI < 30 Market is thought to be over sold

Numbers vary by commodity Major change in Supply or Demand may

keep RSI above 70 or below 30 for an extended period of time

RSI example calculations Close 2.40, 2.38, 2.36, 2.38, 2.36, 2.40,

2.44, 2.42, 2.44, 2.48, 2.56, 2.48, 2.52, 2.50, 2.46

Up .02 .04 .04 .02 .04 .08 .04 Up sum = 28/14 =2

Down .02 .02 .02 .02 .08 .02 .04 Down sum = 22/14=1.57

RSI = 2/(2+1.57) * 100 = 56

Point and Figure Charts 2 CRITICAL parameters

The cell size The reversal requirement

Cell size – The value in terms of price increment for each cell

Reversal requirement – Magnitude of price change required for a reversal

Point and Figure Charts There is no time on chart X use to plot uptrending prices O use to plot downtrending prices Only use daily high or low, close doesn’t

matter Buy/Sell signal generated when new

Higher/Lower X/O is plotted

Moving Averages May be a compliment to bar chart

Single Moving Average 40-day Help signal turning points in market

May be an alternative to bar chart Two moving averages employed Example 3-day and 10-day Example 9-day and 18-day Sell signal when shorter cuts longer from top Buy signal when shorter cuts longer from bottom

Buy B and Sell SSignals using the 4-day & 9-dayMoving Average

B

B B

BB

S S

S

S

S

B

Moving Averages Advantages

Provide clear market signals No guessing as to chart formation Good if there are trends in the data

Disadvantage May generate multiple trades Don’t perform well in choppy (sideways) markets

Moving Average Short Hedgers

Place on Sell signals Lift (offset) on Buy signals

Long Hedgers Place on Buy signals Lift (offset) on Sell signals

Speculators Buy and Sell and Offset on all signals

Technical Analysis Summary Technical Analysis does work It requires Work to make it work Need to study past technical analysis for

several years worth of data on a particularly commodity before trading

For hedgers Trends and Support/Resistance Planes Moving Averages