No single book, nor any collection of books, can provide a completeexplanation of technical analysis. Not only is the field too massive, coveringevery thing from Federal Reserve reports to Fibonacci Arcs, but it is alsoevolving so quickly that anything written today becomes incomplete but notobsolete tomorrow. Armed with the above knowledge and well aware of the myriad of technicalanalysis books that are already available, I feel there is a genuine need for aconcise book on technical analysis that serves the needs of both the noviceand veteran investor. That is what I have strived to create. The first half of this book is for the newcomer. It is an introduction totechnical analysis that presents basic concepts and terminology.
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No single book, nor any collection of books, can provide a completeexplanation of technical analysis. Not only is the field too massive, coveringevery thing from Federal Reserve reports to Fibonacci Arcs, but it is alsoevolving so quickly that anything written today becomes incomplete but notobsolete tomorrow. Armed with the above knowledge and well aware of the myriad of technicalanalysis books that are already available, I feel there is a genuine need for aconcise book on technical analysis that serves the needs of both the noviceand veteran investor.
That is what I have strived to create. The first half of this book is for the newcomer. It is an introduction totechnical analysis that presents basic concepts and terminology. The secondhalf is a reference that is designed for anyone using technical analysis.
Itcontains concise explanations of numerous technical analysis tools in areference format. Today, technical analysis is accepted as a viable analytical approachby most universities and brokerage firms. Rarely are large investments madewithout reviewing the technical climate. Yet even with its acceptance, thenumber of people who actually perform technical analysis remains relativelysmall. It is my hope that this book will increase the awareness and use oftechnical analysis, and in turn, improve the results of those who practice it.
This bookwould not be possible without the help of thousands of analysts who havestudied the markets and shared their results. To those from whom I havecompiled this information, thank you.
There are two people who have helped so much that I want to mention themby name. This includes stocks, bonds, commodities, futures, indices,mutual funds, options, etc. In either case, the basic concepts and techniques presented in thisbook are equally adept.
What will prices be tomorrow, next week, or next year? However, if you are reading this book with the hopethat technical analysis will improve your investing, I have good news--it will! Simply put, technical analysis is the study ofprices, with charts being the primary tool. The roots of modern-day technical analysis stem from the Dow Theory,developed around by Charles Dow.
His focus on the basics of security price movement gave rise toa completely new method of analyzing the markets. The human elementThe price of a security represents a consensus. It is the price at which oneperson agrees to buy and another agrees to sell. The price at which aninvestor is willing to buy or sell depends primarily on his expectations. These simple statements are the cause of a majorchallenge in forecasting security prices, because they refer to humanexpectations.
As we all know firsthand, humans are not easily quantifiableor predictable. This fact alone will keep any mechanical trading system fromworking consistently. Our relationships withour family, our neighbors, our employer, the traffic, our income, and ourprevious success and failures, all influence our confidence, expectations,and decisions.
Security prices are determined by money managers and home managers,students and strikers, doctors and dog catchers, lawyers and landscapers,and the wealthy and the wanting. This breadth of market participantsguarantees an element of unpredictability and excitement.
Fundamental analysisIf we were all totally logical and could separate our emotions from ourinvestment decisions, then, fundamental analysis the determination of pricebased on future earnings, would work magnificently. And since we would allhave the same completely logical expectations, prices would only change when quarterly reports or relevant news was released.
This theory concludes that it is impossible to forecast prices, since pricesalready reflect everything that is currently known about the security. The future can be found in the pastIf prices are based on investor expectations, then knowing what a securityshould sell for i. This is done by comparingcurrent price action i. The devout technician mightdefine this process as the fact that history repeats itself while others wouldsuffice to say that we should learn from the past.
The roulette wheelIn my experience, only minorities of technicians can consistently andaccurately determine future prices. However, even if you are unable toaccurately forecast prices, technical analysis can be used to consistentlyreduce your risks and improve your profits.
The best analogy I can find on how technical analysis can improve yourinvesting is a roulette wheel. I use this analogy with reservation, as gamblershave very little control when compared to investors although considering theactions of many investors, gambling may be a very appropriate analogy. But if he buys a stock when it is in a rising trend, after aminor sell off, and when interest rates are falling, he will have improved hisodds of making a profit.
Yet manyinvestors buy securities without attempting to control the odds. Your goal should simply be to improvethe odds of making profitable trades. Even if your analysis is as simple asdetermining the long-, intermediate-, and short-term trends of the security,you will have gained an edge that you would not have without technicalanalysis. Consider the chart of Merck in Figure 1 where the trend is obviously downand there is no sign of a reversal.
Figure 1Automated tradingIf we accept the fact that human emotions and expectations play a role insecurity pricing, we should also admit that our emotions play a role in ourdecision making. Many investors try to remove their emotions from theirinvesting by using computers to make decisions for them. Mechanical trading systems can help us remove our emotions from ourdecisions. Computer testing is also useful to determine what has happenedhistorically under various conditions and to help us optimize our tradingtechniques.
In my totally biased opinion, technical analysissoftware has done more to level the playing field for the average investorthan any other non-regulatory event. But as a provider of technical analysistools, I caution you not to let the software lull you into believing markets areas logical and predictable as the computer you use to analyze them.
Open - This is the price of the first trade for the period e. Itis the point at which there were more sellers than buyers i. Low - This is the lowest price that the security traded during the period. It isthe point at which there were more buyers than sellers i. Close - This is the last price that the security traded during the period. Dueto its availability, the Close is the most often used price for analysis. Therelationship between the Open the first price and the Close the last price are considered significant by most technicians.
This relationship isemphasized in candlestick charts. Volume - This is the number of shares or contracts that were tradedduring the period. The relationship between prices and volume e. Open Interest - This is the total number of outstanding contracts i. Openinterest is often used as an indicator. Bid - This is the price a market maker is willing to pay for a security i. Ask - This is the price a market maker is willing to accept i. These simple fields are used to create literally hundreds of technical toolsthat study price relationships, trends, patterns, etc.
Not all of these price fields are available for all security types, and manyquote providers publish only a subset of these. Table 1 shows the typicalfields that are reported for several security types. In this case, a picture trulyis worth a thousand words. Line chartsA line chart is the simplest type of chart. Dates are displayed along the bottom of the chart and prices aredisplayed on the side s.
Bar charts are the most popular type of security chart. As illustrated in the bar chart in Figure 3, the top of each vertical barrepresents the highest price that the security traded during the period, andthe bottom of the bar represents the lowest price that it traded.
If opening prices are available, they are signified by atick on the left side of the bar. Figure 3 Volume bar chartVolume is usually displayed as a bar graph at the bottom of the chart seeFigure 4. Most analysts only monitor the relative level of volume and assuch, a volume scale is often not displayed.
This means the bottom of eachvolume bar represents the value of zero. This is done bysubtracting the lowest volume that occurred during the period displayedfrom all of the volume bars. Relative adjusted volume bars make it easier tosee trends in volume by ignoring the minimum daily volume. Figure 5 Figure 5 displays the same volume information as in the previous chart, butthis volume is relative adjusted. The bulls push prices higher and thebears push prices lower. The direction prices actually move reveals who iswinning the battle.
Using this analogy, consider the price action of Phillip Morris in Figure 6. Consider Figure 7. Figure 7The price at which a trade takes place is the price at which a bull and bearagree to do business. It represents the consensus of their expectations. Thebulls think prices will move higher and the bears think prices will movelower. Support levels indicate the price where the majority of investors believe thatprices will move higher, and resistance levels indicate the price at which amajority of investors feel prices will move lower.
But investor expectations change with time! For a long time investors did notexpect the Dow Industrials to rise above 1, as shown by the heavyresistance at 1, in Figure 8.
Yet only a few years later, investors werewilling to trade with the Dow near 2, Figure 8 When investor expectations change, they often do so abruptly. Note howwhen prices rose above the resistance level of Hasbro Inc. Note too, that the breakout above the resistance level wasaccompanied with a significant increase in volume.
The development of support and resistance levels is probably the mostnoticeable and reoccurring event on price charts. The cause is not as significant as the effect--newexpectations lead to new price levels. Figure 10 shows a breakout caused by fundamental factors. The breakoutoccurred when Snapple released a higher than expected earnings report.
What will prices be tomorrow, next week, or next year? However, if you are reading this book with the hope that technical analysis will improve your investing, I have good news--it will! Some history The term "technical analysis" is a complicated sounding name for a very basic approach to investing. Simply put, technical analysis is the study of prices, with charts being the primary tool. The roots of modern-day technical analysis stem from the Dow Theory, developed around by Charles Dow. His focus on the basics of security price movement gave rise to a completely new method of analyzing the markets. The human element The price of a security represents a consensus.
Technical Analysis from A to Z - by Steven Achelis
Technical Analysis from A to Z