practical investment management by robert.a.strong slides ch09
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CHAPTER NINE
Practical Investment Management
Robert A. Strong
TECHNICAL ANALYSIS
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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 believesthat charts can be used to
predict changes in supply and
demand and investor behavior.
Market participants seldom wait
for things to completely unfold.
They try to anticipate events
rather than merely react tothem.
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Charting: Types of Charts
The technical analyst uses many types ofcharts:
line charts
bar charts point and figure charts
candlestick charts
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Linear Scale Line Chart
Insert Figure 9-1 here.
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Logarithmic Y-Axis Line Chart
Insert Figure 9-2 here.
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Bar Chart
Insert Figure 9-3 here.
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Point and Figure Chart
Insert Figure 9-4 here.
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Candlestick Chart
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Charting: Other Chart Annotations
support level
resistance level
congestion area
breakout
Chartists believe investors remember missedopportunities and look for them to return.
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Charting: Other Chart Annotations
Insert Figure 9-6 here.
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Technical Indicators
These statistics, either calculated or directly
observed, are alleged to have a relationshipwith the future direction of the overall stock
market or with an individual security.
Indicators with economic justification arebased on economic activities that are
measurable and observable.
Indicators of the witchcraft varietyhave 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 interestfigure, thelarger is the potential demand for the
shares.
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Short Interest
Insert Table 9-1 here.
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Indicators with Economic Justification
Increased margin buyinghas historicallybeen associated with rising markets.
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Margin Loans
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Indicators with Economic Justification
Cash held by mutual funds representspotential demand for stock.
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Mutual Fund Cash Position
Insert Figure 9-8 (Mutual Fund
Cash Position Rule) here.
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Mutual Fund Cash Position
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Indicators with Economic Justification
When the confidence indexgets closer to1.0, investors are more likely to be bullish
about the economy, and therefore about
corporate earnings.
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Confidence Index
Insert Figure 9-10 here.
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Indicators with Economic Justification
An advance-decline line is a graphicalrepresentation of the net advances over a
period of time.
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Advance-Decline Line
Insert Figure 9-11 (Market Breadth)
here.
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Indicators with Economic Justification
A high relative strength ratio, such as ahigh relative PE, means that investors are
willing to pay more for the past earnings of
a company than average.
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Relative Strength Ratio
Insert Table 9-3 here.
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Indicators with Economic Justification
Advocates ofmoving averages in stockselection believe that changes in the slope
of the line are important.
Market indicators can help present data ina more intuitive way and may suggest
areas for further investigation. However,
they cannot always predict the future
movements of a stock or of the overallmarket.
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Indicators of the Witchcraft Variety
The super bowl indicatorstates that thestock market will advance the following
year if the super bowl football game is won
by a team from the original National
Football League.
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The Super Bowl Indicator
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Indicators of the Witchcraft Variety
Increased sunspot activityevery elevenyears 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 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.
Fibonacci Numbers
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144,
233, ...
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Dow Theory
The Dow theory holds that there are three
components in the movement of stock
prices:
The primary trend is the long-term direction ofthe market and is the most important.
The secondary trend refers to a temporary
reversal in the primary trend.
Daily fluctuations in the stock price aremeaningless and contain no useful information.
Old Puzzles and New Developments
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Old Puzzles and New Developments
Insert Figure 9-12 (The Dow Theory) here.
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Old Puzzles and New Developments
The Kondratev wave theorystates there is a50-60 year business cycle.
The Chaos theorysees systematic behavior
amidst apparent randomness. A neural networkis a trading system in which
a forecasting model is trained to find a desired
output from past trading data.
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Old Puzzles and New Developments
Insert Figure 9-13 (Investment-
Style Topography) here.
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The Future of Technical Analysis
Technical analysis has persisted for morethan 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
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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