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

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

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

South-Western College Publishing © 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.

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

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

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

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

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

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

South-Western College Publishing © 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.

South-Western College Publishing © 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.

South-Western College Publishing © 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.

South-Western College Publishing © 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.

South-Western College Publishing © 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, 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,...

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

South-Western College Publishing © Old Puzzles and New Developments  Kondratev wave theory states there is a 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.

South-Western College Publishing © 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.

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

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