Part 3: Fundamentals VS Technical Analysis

Principles

Stock chart showing levels of support (4,5,6, 7, and 8) and resistance (1, 2, and 3); levels of resistance tend to become levels of support and vice versa.

A fundamental principle of technical analysis is that a market's price reflects all relevant information, so their analysis looks at the history of a security's trading pattern rather than external drivers such as economic, fundamental and news events. Therefore, price action tends to repeat itself due to investors collectively tending toward patterned behavior – hence technical analysis focuses on identifiable trends and conditions.

Market action discounts everything

Based on the premise that all relevant information is already reflected by prices, technical analysts believe it is important to understand what investors think of that information, known and perceived.

Prices move in trends

Back in the early 1970s, I watched "Wall Street Week" on PBS. Later in the 1980s, I met Bob Nurock, a regular Technical Analist on the show. That meeting made me so happy for years. 

Technical analysts believe that prices trend directionally, i.e., up, down, or sideways (flat) or some combination. The basic definition of a price trend was originally put forward by Dow theory.

An example of a security that had an apparent trend is AOL from November 2001 through August 2002. A technical analyst or trend follower recognizing this trend would look for opportunities to sell this security. AOL consistently moves downward in price. Each time the stock rose, sellers would enter the market and sell the stock; hence the "zig-zag" movement in the price. The series of "lower highs" and "lower lows" is a tell tale sign of a stock in a down trend. In other words, each time the stock moved lower, it fell below its previous relative low price. Each time the stock moved higher, it could not reach the level of its previous relative high price.

Note that the sequence of lower lows and lower highs did not begin until August. Then AOL makes a low price that does not pierce the relative low set earlier in the month. Later in the same month, the stock makes a relative high equal to the most recent relative high. In this a technician sees strong indications that the down trend is at least pausing and possibly ending, and would likely stop actively selling the stock at that point.

History tends to repeat itself

Technical analysts believe that investors collectively repeat the behavior of the investors that preceded them. To a technician, the emotions in the market may be irrational, but they exist. Because investor behavior repeats itself so often, technicians believe that recognizable (and predictable) price patterns will develop on a chart Recognition of these patterns can allow the technician to select trades that have a higher probability of success.

Technical analysis is not limited to charting, but it always considers price trends.  For example, many technicians monitor surveys of investor sentiment. These surveys gauge the attitude of market participants, specifically whether they are bearish or bullish. Technicians use these surveys to help determine whether a trend will continue or if a reversal could develop; they are most likely to anticipate a change when the surveys report extreme investor sentiment. Surveys that show overwhelming bullishness, for example, are evidence that an uptrend may reverse; the premise being that if most investors are bullish they have already bought the market (anticipating higher prices). And because most investors are bullish and invested, one assumes that few buyers remain. This leaves more potential sellers than buyers, despite the bullish sentiment. This suggests that prices will trend down, and is an example of contrarian trading.

Recently, Kim Man Lui, Lun Hu, and Keith C.C. Chan have suggested that there is statistical evidence of association relationships between some of the index composite stocks whereas there is no evidence for such a relationship between some index composite others. They show that the price behavior of these Hang Seng index composite stocks is easier to understand than that of the index.

Who Represents the Industry? 

The industry is globally represented by the International Federation of Technical Analysts (IFTA), which is a federation of regional and national organizations. In the United States, the industry is represented by both the Market Technicians Association (MTA) and the American Association of Professional Technical Analysts(AAPTA). The United States is also represented by the Technical Security Analysts Association of San Francisco (TSAASF). In the United Kingdom, the industry is represented by the Society of Technical Analysts (STA). In Canada the industry is represented by the Canadian Society of Technical Analysts. 

Professional technical analysis societies have worked on creating a body of knowledge that describes the field of Technical Analysis. A body of knowledge is central to the field as a way of defining how and why technical analysis may work. It can then be used by academia, as well as regulatory bodies, in developing proper research and standards for the field. The Market Technicians Association (MTA) has published a body of knowledge, which is the structure for the MTA'sChartered Market Technician (CMT) exam.

What About Systematic Trading

Neural networks

Since the early 1990s when the first practically usable types emerged, artificial neural networks (ANNs) have rapidly grown in popularity. They are artificial intelligence adaptive software systems that have been inspired by how biological neural networks work. They are used because they can learn to detect complex patterns in data. In mathematical terms, they are universal function approximators, meaning that given the right data and configured correctly, they can capture and model any input-output relationships. This not only removes the need for human interpretation of charts or the series of rules for generating entry/exit signals, but also provides a bridge to fundamental analysis, as the variables used in fundamental analysis can be used as input.

As ANNs are essentially non-linear statistical models, their accuracy and prediction capabilities can be both mathematically and empirically tested. In various studies, authors have claimed that neural networks used for generating trading signals given various technical and fundamental inputs have significantly outperformed buy-hold strategies as well as traditional linear technical analysis methods when combined with rule-based expert systems.

While the advanced mathematical nature of such adaptive systems has kept neural networks for financial analysis mostly within academic research circles, in recent years more user friendly neural network software has made the technology more accessible to traders. However, large-scale application is problematic because of the problem of matching the correct neural topology to the market being studied.

Backtesting

Systematic trading is most often employed after testing an investment strategy on historic data. This is known as backtesting. Backtesting is most often performed for technical indicators, but can be applied to most investment strategies (e.g. fundamental analysis). While traditional backtesting was done by hand, this was usually only performed on human-selected stocks, and was thus prone to prior knowledge in stock selection. With the advent of computers, backtesting can be performed on entire exchanges over decades of historic data in very short amounts of time.

The use of computers does have its drawbacks, being limited to algorithms that a computer can perform. Several trading strategies rely on human interpretation, and are unsuitable for computer processing.^[46] Only technical indicators which are entirely algorithmic can be programmed for computerised automated backtesting.

Part 2: Fundamentals VS Technical Analysis

Fundamental analysts examine earnings, dividends, new products, research and the like. Technicians employ many methods, tools and techniques as well, one of which is the use of charts. Using charts, technical analysts seek to identify price patterns and market trends in financial markets and attempt to exploit those patterns

Technicians using charts search for archetypal price chart patterns, such as the well-known head and shoulders  or double top/bottom reversal patterns, study technical indicators, moving averages, and look for forms such as lines of support, resistance, channels, and more obscure formations such as flags, pennants, balance days and cup and handle patterns.

Technical analysts also widely use market indicators of many sorts, some of which are mathematical transformations of price, often including up and down volume, advance/decline data and other inputs. These indicators are used to help assess whether an asset is trending, and if it is, the probability of its direction and of continuation. Technicians also look for relationships between price/volume indices and market indicators. Examples include the moving average, relative strength index, and MACD. Other avenues of study include correlations between changes in Options (implied volatility) and put/call ratios with price. Also important are sentiment indicators such as Put/Call ratios, bull/bear ratios, short interest, Implied Volatility, etc.

There are many techniques in technical analysis. Adherents of different techniques (for example, candlestick charting, Dow theory, and Elliott wave theory) may ignore the other approaches, yet many traders combine elements from more than one technique. Some technical analysts use subjective judgment to decide which pattern(s) a particular instrument reflects at a given time and what the interpretation of that pattern should be. Others employ a strictly mechanical or systematic approach to pattern identification and interpretation.

Contrasting with technical analysis is fundamental analysis, the study of economic factors that influence the way investors price financial markets. Technical analysis holds that prices already reflect all the underlying fundamental factors. Uncovering the trends is what technical indicators are designed to do, although neither technical nor fundamental indicators are perfect. Some traders use technical or fundamental analysis exclusively, while others use both types to make trading decisions.

What is Technical Analysis all about?

Technical analysis employs models and trading rules based on price and volume transformations, such as the relative strength index, moving averages,regressions, inter-market and intra-market price correlations, business cycles, stock market cycles or, classically, through recognition of chart patterns.

Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. Technical analysis analyzes price, volume and other market information, whereas fundamental analysis looks at the facts of the company, market, currency or commodity. Most large brokerage, trading group, or financial institutions will typically have both a technical analysis and fundamental analysis team.

Technical analysis is widely used among traders and financial professionals and is very often used by active day traders, market makers and pit traders. In the 1960s and 1970s it was widely dismissed by academics. In a recent review, Irwin and Park reported that 56 of 95 modern studies found that it produces positive results but noted that many of the positive results were rendered dubious by issues such as data snooping, so that the evidence in support of technical analysis was inconclusive; it is still considered by many academics to be pseudoscience. Academics such as Eugene Fama say the evidence for technical analysis is sparse and is inconsistent with the weak form of the efficient-market hypothesis. Users hold that even if technical analysis cannot predict the future, it helps to identify trading opportunities.

In the foreign exchange markets, its use may be more widespread than fundamental analysis. This does not mean technical analysis is more applicable to foreign markets, but that technical analysis is more recognized as to its efficacy there than elsewhere. While some isolated studies have indicated that technical trading rules might lead to consistent returns in the period prior to 1987, most academic work has focused on the nature of the anomalous position of the foreign exchange market.  It is speculated that this anomaly is due to central bank intervention, which obviously technical analysis is not designed to predict.Recent research suggests that combining various trading signals into a Combined Signal Approach may be able to increase profitability and reduce dependence on any single rule.

Here is more about technical analysis

http://www.investopedia.com/terms/t/technicalanalysis.asp

BREAKING DOWN 'TECHNICAL ANALYSIS'

Part 1: Fundamentals VS Technical Analysis

This is an Eagle that lives in my neighborhood. He went fishing in front of my condo but when he tried to take his fish home to feed the family, he dropped the fish at the end of my steps. It looked to me and my neighbors that someone was sending me a threatening message. They thought that I gave someone bad investment advise. 

That gave me an idea! Why not teach someone about technical analysis.

In finance, technical analysis is a security analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume. Behavioral economics and quantitative analysis use many of the same tools of technical analysis, which, being an aspect of active management, stands in contradiction to much of modern portfolio theory. The efficacy of both technical and fundamental analysis is disputed by the efficient-market hypothesis which states that stock market prices are essentially unpredictable.

How did this type of analysis come about?

The principles of technical analysis are derived from hundreds of years of financial market data. Some aspects of technical analysis began to appear in Joseph de la Vega's accounts of the Dutch markets in the 17th century. In Asia, technical analysis is said to be a method developed by Homma Munehisa during early 18th century which evolved into the use of candlestick techniques, and is today a technical analysis charting tool. In the 1920s and 1930s Richard W. Schabacker published several books which continued the work of Charles Dow and William Peter Hamilton in their books Stock Market Theory and Practice and Technical Market Analysis. In 1948 Robert D. Edwards and John Magee published Technical Analysis of Stock Trends which is widely considered to be one of the seminal works of the discipline. It is exclusively concerned with trend analysis and chart patterns and remains in use to the present. As is obvious, early technical analysis was almost exclusively the analysis of charts, because the processing power of computers was not available for statistical analysis. Charles Dow reportedly originated a form of point and figure chart analysis.

Dow theory is based on the collected writings of Dow Jones co-founder and editor Charles Dow, and inspired the use and development of modern technical analysis at the end of the 19th century. Other pioneers of analysis techniques include Ralph Nelson Elliott, William Delbert Gann and Richard Wyckoff who developed their respective techniques in the early 20th century. More technical tools and theories have been developed and enhanced in recent decades, with an increasing emphasis on computer-assisted techniques using specially designed computer software.

We are going to go over 6 blogs dealing with Technical Analysis!

Creating an Investment Strategy

Darnell L Williams

I wish I had $1 for every person that contacts me, asking for some stock that will double in a month and is risk free. Many people do not understand this. They do not understand that they need an investment strategy.

In finance, an investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. These are often described as a tradeoff between risk and return: some investors will prefer to maximize expected returns by investing in risky assets, others will prefer to minimize risk, but most will select a strategy somewhere in between. Surveys show that investors do not believe this, and they expect to have low risk and high return. 

As a result, they often end up with a "buy-high, sell-low" strategy. That is a strategy that takes money out of the pockets of gamblers. For example, I am writing this blog on Sept. 3, 2015 and I bet that we are just about at the bottom of this stock market correction. Why? Because a great amount of people in the market are selling. 


Now this link below is the type of strategy that I use to execute a large portfolio. I think of every possibility possible and put in as many automatic executions as I can think of.  

Click on the link below to see what a personal investment strategy looks like. 

http://ppsc-2012.s3.amazonaws.com/Simon%20Zutshi;%20PIQs%20Investment%20Strategy%20Flow%20Chart.pdf

Investment strategies are employed by investors who try to strike a balance between maximizing their profits from their portfolio and risk they are willing to take. While passive strategies are often used to minimize transaction costs, active strategies such as market timing are an attempt to maximize returns.

One of the better-known investment strategies is buy and hold. Buy and hold is a long term investment strategy, based on the concept that in the long run equity markets give a good rate of return despite periods of volatility or decline. A purely passive variant of this strategy is indexing, where an investor buys a small proportion of all the shares in a market index such as the S&P 500, or more likely, in a mutual fund called an index fund or an exchange-traded fund (ETF).

This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold. The smaller, retail investor more typically uses the buy and hold investment strategy in real estate investment where the holding period is typically the lifespan of their mortgage.

This viewpoint also holds that market timing, that one can enter the market on the lows and sell on the highs, does not work or does not work for small investors, so it is better to simply buy and hold. The smaller, retail investor more typically uses the buy and hold investment strategy in real estate investment where the holding period is typically the lifespan of their mortgage.

Other investment Strategies that you may have heard of are;

No strategy -- Investors who don't have a strategy are known as sheep.

Simulated monkeys -- Simulated monkeys do better than the average investor.

Past performance -- One strategy is to select mutual funds based on past performance.

Buy and hold -- Buy and hold strategy involves buying company shares or funds and hold them for a long period. This is a long term investment strategy, based on the concept that in the long run, equity markets will give a good rate of return.

Value investment -- The value Investing strategy looks at the intrinsic value of a company and value investors seek stocks of companies that they believed are undervalued.

Growth investment -- Growth investment strategy looks at the growth potential of a company and when a company that has expected earning growth that is higher than companies in the same industry or the market as a whole, it will attract the growth investors who are seeking to maximize their capital gain.

Dollar cost averaging --The dollar cost averaging strategy is aimed at reducing the risk of incurring substantial losses resulted when the entire principal sum is invested just before the market falls.

Contrarian investment -- A contrarian investment strategy consists of selecting good companies in time of down market and buying a lot of shares of that company in order to make a long-term profit. In time of economic decline, there are many opportunities to buy good shares at reasonable prices. But, what makes a company to be considered good for shareholders? A good company is one that focuses on the long term value, the quality of what it offers or the share price. This company must have a durable competitive advantage, which means that it has a market position or branding which either prevents easy access by competitors or controls a scarce raw material source. Some examples of companies that response to these criteria are in the field of insurance, soft drinks, shoes, chocolates, home building, furniture and many more. We can see that there is nothing “fancy” or special about these fields of investment: they are commonly used by each and every one of us. 

Many variables must be taken into consideration when making the final decision for the choice of the company. Some of them are:

• The company must be in a growing industry.
• The company cannot be vulnerable to competition.
• The company must have its earnings on an upward trend.
• The company must have a consistent returns on invested capital.
• The company must be flexible to adjust prices for inflation.

Smaller companies -- Historically medium sized companies have outperformed large cap companies on the Stock market. Smaller companies again have had even higher returns. The very best returns by market cap size historically are from micro-cap companies. Investors using this strategy buy companies based on their small market cap size on the stock exchange. One of the greatest investors Warren Buffet made money in small companies early in his career combining it with value investing. He bought small companies with low P/E ratios and high assets to market cap.

What stock and bond exchanges 

do for business and investors. 

If you want to learn more about these strategies, look them up on the internet.