1. CHAPTER EIGHT BEYOND FUNDAMENTAL ANALYSIS Practical Investment Management Robert A. Strong

2. South-Western College Publishing ©1998 2 Outline  Charting  The Underlying Logic  Types of Charts  Other Chart Annotations  Technical Indicators  Indicators with Economic Justification  Indicators of the Witchcraft Variety

3. South-Western College Publishing ©1998 3 Outline  Old Puzzles and New Developments  Fibonacci Numbers  Dow Theory  Kondratev Wave Theory  Chaos Theory  Neural Networks  The Future of Technical Analysis

4. South-Western College Publishing ©1998 4 Charting: The Underlying Logic  The technical analyst believes that charts can be used to predict changes in supply and demand.  Market participants seldom wait for things to completely unfold. They try to anticipate events rather than merely react to them.

5. South-Western College Publishing ©1998 5 Charting: Types of Charts Linear Scale Line Chart Stock Price Time

6. South-Western College Publishing ©1998 6 Charting: Types of Charts Logarithmic Y-Axis Line Chart Stock Price Time

7. South-Western College Publishing ©1998 7 Charting: Types of Charts Bar Chart Stock Price Time

8. South-Western College Publishing ©1998 8 Charting: Types of Charts Point and Figure Chart Stock Price Irregular Time Intervals

9. South-Western College Publishing ©1998 9 Charting: Types of Charts Candlestick Chart Stock Price Time close open

10. South-Western College Publishing ©1998 10 Charting: Other Chart Annotations  support level  resistance level  congestion area  breakout Chartists believe investors remember missed opportunities and look for them to return.

11. South-Western College Publishing ©1998 11 Technical Indicators  These statistics, either calculated or directly observed, are alleged to have a relationship with the future direction of the overall stock market or with an individual security.  Indicators with economic justification are based on economic activities that are measurable and observable.  Indicators of the witchcraft variety have no logical connections between the measurements and what the measurements purport to show.

12. South-Western College Publishing ©1998 12 Indicators with Economic Justification  The higher the short interest figure, the larger is the potential demand for the shares.  Increased margin buying has historically been associated with rising markets.  Cash held by mutual funds represents potential demand for stock.  When the confidence index gets closer to 1.0, investors are more likely to be bullish about the economy, and therefore about corporate earnings.

13. South-Western College Publishing ©1998 13 Indicators with Economic Justification  An advance-decline line is a graphical representation of the net advances over a period of time.  A high relative strength ratio, such as a high relative PE, means that investors are willing to pay more for the past earnings of a company than average.  Advocates of moving averages in stock selection believe that changes in the slope of the line are important.

14. South-Western College Publishing ©1998 14 Indicators of the Witchcraft Variety  The super bowl indicator states that the stock market will advance the following year if the super bowl football game is won by a team from the original National Football League.  Increased sunspot activity every eleven years 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.

15. South-Western College Publishing ©1998 15 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,...

16. Old Puzzles and New Developments Dow Theory Dow Jones Industrial Average Time South-Western College Publishing ©1998 16 Secondary Trend (waves) Meaningless Daily Fluctuations (ripples) Primary Trend (tides)

17. South-Western College Publishing ©1998 17 Old Puzzles and New Developments  Kondratev wave theory states there is a 50- 60 year business cycle.  Chaos theory sees systematic behavior amidst apparent randomness.  A neural network is a trading system in which a forecasting model is trained to find a desired output from past trading data.

18. South-Western College Publishing ©1998 18 The Future of Technical Analysis  Technical analysis has persisted for more than 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.

19. South-Western College Publishing ©1998 19 Review  Charting  The Underlying Logic  Types of Charts  Other Chart Annotations  Technical Indicators  Indicators with Economic Justification  Indicators of the Witchcraft Variety

20. South-Western College Publishing ©1998 20 Review  Old Puzzles and New Developments  Fibonacci Numbers  Dow Theory  Kondratev Wave Theory  Chaos Theory  Neural Networks  The Future of Technical Analysis