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Barry M. Sine, CFA, CMTDirector of Research – CapStone Investments

e-mail: barry@capstoneinvestments.com

If you want a free one-month trial of the Metastock technical analysis software used to prepare the slides in this class, they are available from the instructor.

You will need to fax in the form to be assigned a user ID and password.

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• Philosophy – why technical analysis works• Charting basics Incorporating technical analysis with

fundamental analysis Inter-market analysis

“The market reflects all the jobber knows about the condition of the textile trade; all the banker knows about the money market; all that the best-informed president knows of his own business, together with his knowledge of all other businesses; it sees the general condition of transportation in a way that the president of no single railroad can ever see; it is better informed on crops than the farmer or even the Department of Agriculture. In fact, the market reduces to a bloodless verdict all knowledge bearing on finance, both domestic and foreign.”

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"To understand how economies work and how we can manage them and prosper, we must pay attention to the thought patterns that animate people's ideas and feelings, their animal spirits.We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature.“

From the new book - Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism

First known use was in 1700s in Japan for trading rice

Until after WW II in U.S., technical analysis was the only widely used form of security analysis◦ No reliable fundamental data available until

Securities Act of 1933 implemented◦ Prior to 1930s Fundamental data was not reliable – releasing false

financial information was common Insider trading was legal and common – insiders

sold and passed on info to others. This actually improved accuracy of TA since all information could be utilized in trading.

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1934 – publication of Security Analysis by Graham and Dodd launches fundamental analysis field

1949 – Robert McGee charged with securities violations by SEC for TA-based recommendations

Federal Reserve paper in 2000 cited efficacy of TA Bank of Japan uses TA for currency trading 2005 – SEC accepts CMT exam for technical analysts

in lieu of Series 86 Academia has moved from strong form market

efficiency /anti TA to the point where many universities offer courses in TA. “Sure technical analysis works in practice, but it will never work in theory.”

CFA Body of Knowledge now includes technical analysis

Are stock prices arrived at using fundamental valuation:

OR Are they arrived at

by the forces of supply and demand?

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On a real time basis, the price of any freely traded security is based on the balance between supply and demand

For many market participants, fundamental analysis is the basis of their decisions

But fundamental analysis is only one of many inputs and different analysts produce different valuations

Technical analysis is the study of real time movements in price, volume and trend◦ Interaction between supply and demand

Technical analysis provides a tool to predict securities prices using price and volume data displayed graphically

Keep in mind that technical analysis is often subjective, particularly in recognizing patterns

Also, for nearly every widely accepted technical rule, there is a contrarian rule - if everyone is bullish, there is no one left to buy, so prices will decline.

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All information is contained in charts◦ News is generally correctly anticipated by the markets prior to its

official release or even its occurrence. e.g., political futures markets’ prediction of election outcomes

Chart patterns are due to investor psychology Patterns occur repeatedly and can be used to

forecast markets Technical analysis works for any freely traded

market Equities Fixed Income Commodities Currencies Domestic or International

Technical analysis works for any time frame Day trader Long-term investor

• Behavioral finance uses social psychology to explain market anomalies

• Technical analysis provides a set of tools to track and analyze market action, whether driven by rational or irrational factors

• Humans usually act rationally, but often act irrationally and technical analysis allows for analysis of both inputs

• The field of behavioral finance is recognizing areas of repeated irrational behavior

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• Academia and the CFA curriculum moving away from efficient markets hypothesis and accepting behavioral finance and even (gasp) technical analysis

• Behavioral finance recognizes that human irrationality often impacts investments, while technical analysis provides the tools to recognize and profit from this behavior

• Technical analysis works because humans, either individually or in groups, tend to repeat their behavior

• Technical analysis allows us to identify behavioral patterns in stocks and profit from repetitions of such investor behavior

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Candlestick chart◦ Each candle has two elements: body and wick / shadow

HIGH

CLOSE

OPEN

LOW

White body means market closed UPClose > Open

HIGH

OPEN

CLOSE

LOW

Dark body means market closed DOWNClose < Open

2001 A S O N D 2002 M A M J J A S O N D 2003 M A M J J A S O N D 2004 M A M J J A S O N D 2005 M A M J J A S O N D 2006 M A M J J A

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36TASER INTL (8.69000, 8.70000, 5.83000, 6.17000, -2.48000)

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1. An uptrend is defined as a series of higher lows and a higher highs

2. A downtrend is defined as a series of lower lows and lower highs

2. OB (overbought) is the upper parameter of a trend

3. OS (oversold) is the lower parameter of a trend

Trend lines indicate the relative strength of buyers and sellers

• Upward sloping trendline means more buying pressure than selling pressure

• Downward sloping trendline means more selling pressure than buying pressure

2003 Dec 2004 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2005 Feb Mar Apr May Jun Jul Aug Sep Oct

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333435363738394041424344454647484950515253545556575859606162636465666768EXXON MOBIL (60.5500, 61.0500, 58.9000, 58.9500, -1.60000)

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May June July August September November December 2005 February March April May June July August September

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BELLSOUTH (25.8500, 26.3300, 25.7700, 26.1100, +0.12000)

•Support lines indicate price levels where buyers repeatedly step in to halt declines

•Resistance lines are where sellers repeatedly step in to contain rallies

•Moving average lines are an average of a specified number of prior day’s closing prices

•Moving average crossovers can be used as trading signals

• Short-Term crosses above Long-Term = BUY; ST crosses below LT = SELL

2007 Nov ember December 2008 February March April May June July August September October Nov ember December 2009 February March April May June July August September October

0.40.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.52.62.72.82.93.03.13.23.33.43.53.63.73.83.94.04.14.24.34.44.54.64.74.84.95.05.15.25.35.45.55.65.75.85.96.06.16.26.36.46.56.66.7ENDOLOGIX ORD (6.07000, 6.25000, 6.03000, 6.25000, +0.16000)

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Use technical analysis to provide a quick overview of various markets, e.g., bonds, equities, commodities, currencies

Use technical analysis to provide a quick overview of various national equities markets, e.g., DJIA, S&P 500, FTSE, DAX, CAC, Nikkei, Hong Kong, Shanghai

Technical analysis works on any freely traded market – and you do not even have to know what the market is to analyze it

You can perform more analysis using technicals in a limited time than any other method

Using Technical Analysis To Identify Promising Stocks for Further Fundamental Analysis

Analyze the nine S&P sectors to find best and worst performing sectors

Identify best performing individual stocks in best performing sectors

Identify worst performing individual stocks in worst performing sectors

(Technical analysis can also be used after fundamental work has been done using techniques already covered to gauge timing.)

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Many practitioners will first look at a chart when investigating a new security◦ This immediately identifies the trend determining whether the

market has a favorable or unfavorable view of fundamentals ◦ A chart is perhaps the most efficient way to quickly research a

security TA can be used before fundamental analysis◦ TA screening tools can identify specific securities or sectors

worthy of further fundamental analysis. TA can be used after fundamental analysis ◦ Is the fundamental conclusion consistent with market trends? If not this can suggest that the analyst missed important information

that the market is considering or that the market is itself misinformed, suggesting a potential trading opportunity.

Considering market technicals is like looking both ways before crossing the street, even when the traffic signal is green.

Support and resistance levels Breakdowns of key support levels are a signal of

increased risk for long positions Trend lines Breakdown of key trend lines are another risk signal

Oscillators◦ Look for unusual activity and overbought or oversold levels

Bollinger Bands◦ Breakouts of normal BB trading pattern

Moving average crossovers◦ Short-term MA crossing below long-term is a risk signal

Pattern breakouts◦ Both continuation and reversal patterns can be used to identify risk levels

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Analysis of one financial market to predict direction of a related market◦ Commodities◦ US dollar◦ Bonds◦ Equities

Relationships◦ Commodities and interest rates directly related Commodity prices changes is inflation/deflation◦ Commodities and the US dollar inversely related Commodity prices are really just ratios e.g. $/unit◦ Equities and bonds are directly related – interest

rates and equities inversely related

CRB Index Gold US dollar US T bond prices US ten year bond rate S&P 500

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006 M A M J J A S O N D 2007 M A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N D 20

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490COMMOD RSRCH BUR INDEX (302.400, 313.570, 301.530, 313.560, +12.8900)

006 M A M J J A S O N D 2007 M A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N D 20

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100 OZ GOLD COMPOSITE Continuous (1,360.30, 1,398.00, 1,327.50, 1,397.30, +40.2001)

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006 M A M J J A S O N D 2007 M A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N D 2069.069.5

70.070.571.0

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92.092.5

US DOLLAR INDEX ICE Continuous (77.1050, 77.6250, 75.2350, 76.6910, -0.76600)

006 M A M J J A S O N D 2007 M A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N D 20

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146US T BONDS COMPOSITE Continuous (130.969, 133.000, 129.906, 130.688, -0.25000)

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006 M A M J J A S O N D 2007 M A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N D 20

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5610 Y TSY YLD NDX (25.8800, 26.5400, 24.6000, 25.3600, -0.76000)

A S O N D 2006 M A M J J A S O N D 2007 M A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N D 20

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1650S&P 500 INDEX (1,185.71, 1,227.08, 1,177.65, 1,225.85, +42.5900)

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Stockcharts.com

Bigcharts.com

Google finance

Yahoo! finance

IFTA – International Federation of Technical Analysts – IFTA.org

MTA – Market Technicians Association –MTA.org◦ Administers most widely respected TA charter

program – the Chartered Market Technician (CMT) program◦ Market Technicians Association Educational

Foundation (MTAEF) is a non-profit which produces university level TA course materials

Many countries also have TA societies

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MTA is the main US technical analysis society Administers the Chartered Market Technician

– CMT – program CMT program requires three levels of exams

or two exams and an academic quality paper Market Technicians Association Educational

Foundation – MTAEF◦ Non-profit foundation which produces course

materials for technical analysis education at universities

Level One Topics◦ Terminology of technical analysis◦ Methods of charting◦ Determination of price trends/ basics of pattern recognition◦ Establishing price targets◦ Equity market analysis◦ Applying technical analysis to bonds, currencies, futures and

options Fees ◦ $250 program registration◦ $250 level one exam fee

Level one exam is 2 hours, 120 multiple choice questions

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Technical Analysis of the Financial Markets◦ John J. Murphy

Technical Analysis Explained◦ Martin J. Pring

Technical Analysis of Stock Trends◦ Robert Edwards and John MageeThis book is the classic text on technical analysisOriginal version contained chart examples from the ’20s, 30s and

40s.The above three books are the current readings for CMT Level 1.

The Encyclopedia of Technical Indicators◦ Robert W. ColbyThis is a more advanced book explaining the use of dozens of

technical trading indicators.