Technical

Analysis
OPEN LEARNING
Workbook
An introduction
US gross national
debt $4 trillion
1992
Klondyke
gold rush
1896
Ford introduces
the Model T
1908
Prohibition
repealed
1933
The Great Crash
1929
Bretton Woods
Conference
1944
Sputnik launched
1957
First silicon
chip
1958
First man on
the moon
1969
US drops
gold standard
1971
OPEC raises
oil prices
1979
Stock market
crash
1987
A century of the Dow Jones Industrial Average, 1896 - 1996
6000
5000
4000
3000
2000
1000
0
1990
1980
1970
1960
1950
1940
1930
1920
1910
1900
1896
First I BM PC
1981
Technical
Analysis
OPEN LEARNING
An introduction
Workbook
Designed, co-authored and Desk Top Published by
Keith A. Rogers, Training and Learning Design (01280) 848562
Co-author, Glyn Bradney, Reuters UKI Product Management
Graphics and Technical Analysis
Project sponsored by Amanda Rogers, Reuters European
The designer and authors wish to thank the following subject
matter experts for their valuable contributions to this workbook:
Linzie Barratt, Reuters National
Pinder Grewal, Reuters UKI Training
John Le Hunte, Reuters International
Annette James, Reuters UKI Training
Heather Jarrett, Reuters European
Richard Lyons, Reuters European
Sanjay Tanna, Reuters National
Andrea Tinker, Reuters International
Howard Friend, Senior Technical Analyst, MCM, London
Thanks are also due to Dow-Jones Telerate, Wall Street Journal Europe
for supplying and giving permission to use the photograph of
Charles Dow
Version 1.0
December 1996
Reuters Ltd 1996
Contents
Technical Analysis
1
C
o
n
t
e
n
t
s
Technical
Analysis
Before you start
Page
3
Introduction
Section 1
Page
5
Chart types
Section 2
Page
25
Time
Place Pace
Patterns
Section 3
Page
55
Indicators
Section 4
Page
91
Waves, numbers and
cycles
Section 5
Page
113
o
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A day in the life of a
technical analyst
Section 6
Page
135
1, 1, 2, 3, 5, 8, 13, ?
Contents
Technical Analysis
2
Section 1 Introduction
Introduction
Producing a chart
The development of technical analysis
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Page
7
12
16
21
21
22
23
24
Section 3 Patterns
Introduction
Trendlines
Continuation/consolidation pattterns
Reversal patterns
Support and resistance lines
Moving averages
Relative performance
Gaps
Charting exercises
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Page
57
60
62
66
72
76
80
82
85
87
87
88
89
90
Section 2 Chart types
Introduction
Line charts
Bar charts
Candlestick charts
Volume charts
Open interest charts
Point and figure charts
Charting exercises
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Page
27
28
34
36
38
40
42
49
51
51
52
53
54
Section 4 Indicators
Introduction
Relative Strength Index
Stochastic oscillators
Moving Average Convergence Divergence
Charting exercises
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Page
93
96
98
102
106
109
109
110
111
112
Section 6 A day in the life of a technical analyst
Introduction
Its what people say...
An early start...
Summary
Whats next?
Page
137
139
144
148
148
Section 5 Waves, numbers and cycles
Introduction
Elliott Wave Theory and Fibonacci numbers
Gann charts
Charting exercise
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Page
115
120
124
128
129
129
131
132
133
Before you start
Technical Analysis
3
Time
Place Pace
What does this workbook contain? What is this package and who is it for?
Time
Place Pace
Before you start
This section!
Introduction
This summarises the development of technical
analysis and the Dow Theor y.
Chart types
This section deals with the main ways in which prices
and financial data can be plotted on a chart together
with the uses for each chart type.
Patterns
Should I buy or sell? Charting techniques often give
rise to patterns which can be used to help you
decide.
Indicators
Can you predict future market trends? This section
describes the various types of indicators available.
Waves, numbers and cycles
Markets follow cycles and patterns of buying and
selling move in waves... or do they? Perhaps the
markets are governed by mathematical laws or are
they ruled by chaos?
A day in the life of a technical analyst
This is what it is really like!
This workbook contains the following sections each of which are
indicated by the following icons:
I n order to provide an effective quality ser vice you
need to understand the markets in which your
customers operate. This workbook is an open learning
package designed to give you a basic understanding of
technical analysis. The workbook has also been
designed to cater for the needs of a number of different groups.
Technical analysis has become one of the key techniques available to
Reuters customers with the introduction of the 3000 series of
products and the access they provide to historical price data.
Whether you are in sales, customer support, or client training, if you
are involved in selling or supporting 3000 products, this workbook is
for you.
I t will take you through technical analysis from first principles, from
creating your first chart with pencil and paper, to using sophisticated
analysis tools and techniques. By the time you have completed this
workbook you will be able to use most of the main market
techniques and understand when they should be applied.
You may find it useful to have access to the 3000 products and
Reuters Graphics to do the exercises in the workbook. Going
through the exercises will help you to become familiar with the
software, as well as learning the analysis techniques.
You may also find the workbook useful as Technical Analysis is one
of the subjects which forms part of the examination syllabus leading
to either Fellowship or Associateship of the ACI I nstitute.
o
ox
oxo
oxo
oxo
oxo
ox
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1, 1, 2, 3, 5, 8, 13, ?
Before you start
Technical Analysis
4
Time
Place Pace
How to use the package
Before you start using the package you should discuss with
your line manager how he/she will help by giving time for
study and giving you feedback and support. Although your
learning style is unique to you, you will find that your
learning is much more effective if you allocate reasonable
sized periods of time for study. The most effective learning
period is about 30 minutes so use this as a basis. I f you tr y
to fit your learning into odd moments in a busy schedule
you will not get the best from the materials or yourself. You
might like to schedule learning periods into your day just as
you would business meetings.
Being a successful open learner means more than just reading.
Open learning is interactive it is designed to enhance your
learning by getting you to be active. There is an old Chinese saying
which may help:
The various types of activities and their icons have already been
mentioned even thinking is an activity.
Tr y to make sure your study is uninterrupted. This probably means
that your workplace is not a good environment! You will need to
find both the time and place where you can study you may have
access to a quiet room at work, you may have a room at home, you
may need to use a librar y.
I ts important to remember that learning is not a race ever yone
learns at their own rate. Some people find things easy, some not
quite so easy. So dont rush your learning make sure you get the
most from the package.
Remember its your learning so its over to you...
I hear and I forget
I see and I remember
I do and I understand
Throughout the workbook you will find that important terms or
concepts are shown in bold, for example, DowTheory. You will also
find that at certain points activities are included which are designed
to enhance your learning. The various activities use the following
icons:
This means stop and think about the point being
made. You may want to jot a few words in the box
provided it doesnt matter if you dont.
This indicates an activity for you to do. I t is usually
something written for example, a definition, notes, a
calculation.
This is the answer or response to an activity and it
usually follows the activity or is close to it.
R
This indicates that you should use Reuters 3000 and
follow the instructions. A screen dump of what you
should see is included as well. It is important to
understand that the activities here assume you have a
basic understanding of the product functionality.
RT
At the end of most sections there is a Quick question quiz, with
answers, so you can test yourself on your knowledge and
understanding. All sections have an Overviewwhich is a graphical
revision aid for the learning materials covered. There may be other
resources you will need access to which are not supplied in the
package. These materials are listed in the Further resources section.
I t is worth checking the availability of these resources before you
start your study.
This indicates that you should use Reuters Graphics
and follow the instructions. A screen dump of what
you should see is included as well. It is important to
understand that the activities here assume you have a
basic understanding of the product functionality.
RG
Introduction
Section 1
5
7
12
16
21
21
22
23
24
This section of the module should take no more
than 60 minutes of study time. You may not take
as long as this or it may take a little longer
remember your learning is individual to you.
12
3
6
9
1
2
4
5 7
8
11
10
C
o
n
t
e
n
t
s
Introduction
Producing a chart
The development of technical analysis
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Section 1
Introduction
6
He was an experienced newspaper reporter, with an early training
under Samuel Bowles, the great editor of the Springfield
Republican. Dowwas a NewEnglander, intelligent, self-repressed,
ultra-conservative, and he knewhis business... Knowing and liking
Dow, with whom I worked in the last years of his life, I was often,
with many of his friends, exasperated by his conservatism... In the
language of the prize ring, he pulled his punches.
How Good is theDow Theory? Part 1 by Bill Dunbar
Technical Analysis of Stocks and Commodities , Vol. 3:2 (59-63), 1985
Introduction
Section 1
7
Introduction
From the early days of shares being bought and sold and trading in
commodities such as rice, traders and investors have noted trends
and patterns in prices over time. Modern markets abound in sayings
such as:
Most investors, individual and institutional, traders, brokers, dealers
etc are seeking the best return on their investments or best profit on
their deals. I t is therefore obvious that any methods these market
players can use to reduce the risk of losing their money and improve
their chances of rewards will be welcomed. But is it possible to
forecast when it is a good time to buy or sell shares, trade futures
contracts etc?
Charts and analytical techniques are used to forecast prices and
influence trading strategies in all financial markets. Some of the
more familiar chart uses involve the following:
O Whole stock markets
O Stock market sectors
O I ndividual shares
O Currencies
O I nterest rates
O Commodities agriculturals, metals, energy and softs
O Futures
There are two basic types of market analysis available to guide
market players, each having its own experts:
O Fundamental analysis
O Technical analysis or charting
I n practice investors and traders will probably practice and/or use
tools and techniques from both types of analysis.
The trend is your friend
Go with the trend
But what do these mean? Charts such as the one shown below of the
Dow Jones I ndustrial I ndex over the last ten years can be seen in
financial publications such as the Financial Times and TheWall Street
Journal and on electronic data systems such as the RT.
You may have asked yourself questions such as:
O Where did these sayings originate?
O Are these sayings true and what use are they?
O Who uses these charts?
O What do these charts indicate?
Section 1
Introduction
8
Fundamental analysis
Fundamental analysis may be defined as follows:
A method of forecasting based on basic economic, political and
environmental factors.
I n essence the fundamental analyst forecasts prices concerned with
supply and demand, based on factors such as historical price data,
weather conditions and government policy. I f there is a decrease in
supply but the level of demand remains the same, then there will be
an increase in market prices. An increase in supply produces the
opposite effect.
Fundamental analysts study company prospects, commodities and
financial instruments in order to forecast where the market prices
ought to be. One of the important tools used in fundamental
analysis is statistics.
Technical analysis
Technical analysis may be defined as follows:
A method of predicting price movements and future market
trends by studying charts of past market action which take into
account price of instruments, volumes of trading and, where
applicable, open interest in the instruments.
Technical analysis, or Chartism, is concerned with what has actually
happened in the market, rather than what should happen. Technical
analysis uses charts as its primar y focus which are derived from the
actions of people the market players. The charts are not derived
from the results of economical, political and environmental analysis.
Technical analysis is therefore ver y much a subjective art or skill
and even experienced chartists can disagree on the interpretation of
a chart. So why is Technical analysis so important in the market
places?
The underlying principles of Technical analysis
Technical analysis is based on three underlying principles:
1. Market action
discounts everything
This means that the actual price is a
reflection of ever ything that is known
to the market that could affect it, for
example, supply and demand,
political factors and market sentiment.
The pure chartist is only concerned
with price movements not with the
reasons for any changes.
2. Patterns exist Chartism is used to identify patterns
of market behaviour which have long
been recognised as significant. For
many given patterns there is a high
probability that they will produce the
expected results. Also there are
recognised patterns which repeat
themselves on a consistent basis.
3. History repeats itself Chart patterns have been recognised
and categorised for over 100 years and
the manner in which many patterns
are repeated leads to the conclusion
that human psychology changes little
with time.
I f all the above principles were valid, then Technical analysis would
be closer to a science than an art. The reality is that histor y does not
always repeat itself exactly and patterns do not always occur exactly
as before. The result is that Technical analysis is a subjective skill
with the interpretation of charts and market behaviour forecasting
dependent on the skills of individual chartists. The future cannot be
predicted necessarily, with certainty, from past events. Technical
analysts consider the probability that a given situation will produce a
given result in some cases this probability is ver y high.
Introduction
Section 1
9
Technical v Fundamental analyses
The following chart broadly summarises the differences between the
two types of analysis:
Fundamental analysis
O Focuses on what ought to
happen in a market
O Factors involved in price
analysis include:
Supply and demand
Seasonal cycles
Weather
Government policy
Technical analysis
O Focuses on what actually
happens in a market
O Charts are based on market
action involving:
Price
Volume all markets
Open interest futures only
O Seasonality in commodities
I n practice many market players use Technical analysis in
conjunction with Fundamental analysis to determine their trading
strategy. One major advantage of Technical analysis is that
experienced chartists can follow many markets and market
instruments whereas the fundamental analyst needs to know a
particular market intimately.
same in all markets there are some important differences between
two of the more important markets dealing with shares and
commodity futures. These differences are summarised in the table
below:
Factor
Instrument
life span
Pricing
structure
Margin
payments
Shares
Share prices have
unlimited time spans -
provided the company
stays in business! I f
investors miss buy or sell
signals then there may
well be other trading
opportunities in the long
term.
Within the same stock
exchange share prices are
quoted in the same units.
Buying or selling shares is
usually transacted at the
full price. There is no
system of margin
payments. However,
shareholders are usually
entitled to any dividends
which may be paid on
their shares.
Commodity futures
Most commodities futures
contracts are short term
with 3 month expir y
dates. This means any
charting can only be for a
short term. Some charts
are produced for hourly
price changes. However,
using continuation
charts, produced by
joining/splicing data for
consecutive periods,
means that the contracts
can be charted over a
longer period than each
individual contracts life.
The variation for
commodity futures
contracts units and
amounts is considerable.
Futures contracts are
usually traded on margin
typically 10% of the
contract value is paid as
initial margin.
Subsequently contracts
are marked to market at
the end of each days
trading and variation
margin is credited to/
debited from the traders
account. Small price
movements in either
direction can make or
lose large sums ver y
quickly.
Technical analysis for different markets
The first known recording of prices and their subsequent analysis is
attributed to Munehisa Honma, the inventor of Japanese
candlesticks, in the early 1700s. However, most analysts consider the
charting principles pioneered by Charles H. Dowin the 1880s as the
birth of modern Technical analysis. Dow was a member of the New
York Stock Exchange and applied his techniques to the US stock
market. He was the same man who subsequently established the
Dow Jones news ser vice and TheWall Street Journal.
Charting techniques are now applied to a wide range of shares,
stock indices, interest rates, foreign exchange and derivatives
contracts for commodities. Although the basic techniques are the
Section 1
Introduction
10
The strengths and weaknesses of technical analysis
The following chart broadly summarises the strengths and
weaknesses of technical analysis.
Strengths
O Chartism can be used to
follow a wide range of
instruments in almost any
market place
O Charts can be used to
analyse data for time
periods ranging from hours
to a centur y the Dow
Jones I ndustrial I ndex has
been in constant use since
May 26th 1896
O There are many charting
tools and techniques
available which have been
developed to cater for the
needs of different market
sectors
O The basic principles of
charting are easy to
understand and have been
developed from the way
markets operate charting
is concerned with what is
actually happening in
markets
Weaknesses
O Because charting is
subjective to a degree and
charts are open to individual
interpretation, there is a
danger that makers of
charting predictions can
become emotionally
attached to the advice they
offer
O I t is not necessarily a valid
assumption that the past
can always be used to
predict future events
O Charting is concerned with
the degree of probability
that an event will happen
not the certainty of the event
O Some modern charting
techniques require
complex mathematical
calculations and are not
easy to understand or use
this weakness is being
overcome with the
increasing availability and
use of sophisticated
computer applications
O I t is vital for the success of
charting that the
information used is both
accurate and timely
Whatever the weaknesses, charting is now firmly established as an
investment tool and is practised and used by a growing number of
market players for many reasons including:
O An increased market awareness of the success of Technical
analysis techniques
O The ever increasing power, falling costs and availability of
personal computers and sophisticated charting software
Trading theories, market players and analysis
There is a vast amount of data and a wide range of analytical
techniques now available to help market players choose what
instruments to invest in and when to do so. How individuals select
their trading theor y or strategy depends much on the market in
which individual market players operate. A few years ago a futures
trader, Grant D. Noble, suggested that there were three theories of
trading which highlighted different market players and their use of
technical and fundamental analysis. Although some of the terms
used for each theor y may be unfamiliar now, by the time you finish
this workbook you will have covered most of them. I f you compare
the contents of the workbook with this practitioners view you will see
there is little difference just the way the techniques are combined.
Theory A Market equilibrium
O Indicators Oscillators, eg, Relative Strength I ndex (RSI )
O Number theory Fibonacci numbers, Gann numbers
O Waves Elliott Wave Theor y
O Gaps High/Low, Open/Closing
Favoured by experts
Introduction
Section 1
11
Theory C Supply and demand fundamentals
O Spreads Months, Exchanges, Cash/futures
O Flowof funds Volume and open interest
O Seasonals Weather, economy
O Reports Expectations versus reality
Favoured by floor traders
Whichever type of market player you are interested in will influence
the way you use this workbook. However, all the factors involved in
the above theories have either been mentioned already or are
discussed later.
Having had a look at the various theories in the
previous section, before moving on, it may be useful to
note here if there are any charting techniques and
their application to a market sector that particularly
interest you. For example, if you are interested in
buying and selling shares which techniques would you
like to know more about?
Theory B Classical charting
O Trends following Moving averages etc
O Chart formations Triangles, Head & Shoulders etc
O Trend lines Channels
O Cycles
Favoured by public advisors
Section 1
Introduction
12
Producing a chart
This workbook has been designed to give you the basic knowledge
and understanding of the principles and techniques used in
charting and the Reuters products associated with charting. This
knowledge and understanding will help you identify, meet and
support the needs of your customers.
However, before moving on to learn about the more detailed aspects
of charting tr y the following activity ...
Producing a chart: Exercise 1
The data opposite shows the closing prices for Reuters
shares over a 50 day period in early 1996.
All you need to do on the graph paper on the opposite page is
mark the closing price on the vertical axis for each day. Use a
pencil to mark each price with a cross or dot any mistakes
can easily be erased. Then join your marks to produce your
chart you may find using a colour helps.
Although many computer graphing or charting programmes
will produce the same results, by carr ying out this exercise you
will see how straightfor ward charting can be at a basic level.
You will produce the simplest form of chart which connects
consecutive closing prices for an instrument it is called a
line chart.
Once you have drawn your chart have a close look and see if
you can see any patterns. I f there are, then indicate them on
your chart.
Thechart of what you should seeis shown on page14.
Day Price Day Price
1 5 . 6 6 7 6 2 7 9 7
2 0 7 7 7 2 4 8 7
3 9 6 7 8 2 9 8 7
4 8 5 7 9 2 9 8 7
5 1 5 7 0 3 9 7 7
6 9 4 7 1 3 8 7 7
7 5 . 3 5 7 2 3 0 7 7
8 7 7 7 3 3 5 6 7
9 4 9 7 4 3 5 6 7
0 1 2 8 7 5 3 6 5 7
1 1 4 6 7 6 3 5 . 0 5 7
2 1 1 7 7 7 3 7 4 7
3 1 3 7 7 8 3 5 5 7
4 1 3 7 7 9 3 5 . 1 5 7
5 1 1 6 7 0 4 6 5 7
6 1 2 5 7 1 4 6 4 7
7 1 8 5 7 2 4 6 4 7
8 1 0 5 7 3 4 6 5 7
9 1 3 4 7 4 4 2 6 7
0 2 5 4 7 5 4 7 7 7
1 2 7 4 7 6 4 1 8 7
2 2 4 6 7 7 4 7 7 7
3 2 9 8 7 8 4 7 6 7
4 2 0 8 7 9 4 7 6 7
5 2 2 9 7 0 5 5 . 0 6 7
Introduction
Section 1
13
P
r
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o
f

s
h
a
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Days
800
790
780
770
760
750
740
10 20 30 40 50
Section 1
Introduction
14
800
790
780
770
760
750
740
10 20 30 40 50
P
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o
f

s
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Days
Introduction
Section 1
15
Producing a chart: Exercise1
You should have produced a chart similar to that
shown on the previous page.
Having drawn the chart, which should not have been
all that difficult, you may have seen the patterns
indicated here:
' A pattern showing a downward trend in the
prices from day 10 to 19
The pattern between day 22 and 30 resembles a
head and shoulders of a person
Looking at this chart if an investor had bought
shares about day 21 at 747 and sold them about day
31 at 770 then his or her profit, excluding any
brokerage, would have been 23p per share.
R
'

You have now produced your first chart! The exercise should not
have been that demanding and from your results you can probably
appreciate the practical use charting can be put to in a ver y simple
way. However, market players will be basing their trading strategies
on a little more than a line chart over 50 days for any particular
share!
800
790
780
770
760
750
740
10 20 30 40 50
Section 1
Introduction
16
The development of technical analysis
The origins of modern technical analysis
or charting can be traced back to the
work and theories of Charles Henr y Dow
(1851 1902). As a young man Dow
arrived in New York, in 1879, to be a
reporter for a financial news ser vice. By
1882 he and Edward D. Jones had
founded Dow Jones and Company and
were delivering their own news items to
Wall Street financial houses.
By studying the closing prices of shares
Dow concluded that it was possible to
produce a market barometer or stock
index which could be used by investors to measure the overall
performance of the stock market. I n July 1884 Dow produced his
first market measure calculated from the average of eleven stocks.
This was called the Railroad Index because nine of the stocks were
railroad companies. This first stock index was published,
intermittently, in his companys Customers Afternoon Letter which was
the forerunner of TheWall Street Journal first published in 1889.
Along with his financial publishing interests Dow was also a member
of the New York Stock Exchange between 1885 and 1891. Dow
continued to study the market data and by 1896 he had decided that
his original index presented only a partial picture of the economy.
Dow had concluded that two separate measures of the economy
would provide confirmation of any broad market trend. So he
introduced the Industrial Index which was the average closing price
of 12 stocks of, what were then considered to be highly speculative,
industrial companies.
The Dow Jones I ndustrial Average was first published on May 26th
1896 in TheWall Street Journal. Along with the Railroad index, now
known as the Transportation Average, these indices have been
published in ever y issue of TheWall Street Journal ever since.
The original 12 companies in the I ndustrial I ndex were expanded to
30 in 1928 and remain at this number today. Only one company
remains in the average under its original name the General
Electric Company. The composition of the companies used to
calculate the average changes from time-to-time in order to reflect
changes in the economy and maintain its broad market
representation.
The first day average close was 40.94 which was almost repeated
again in 1932 during the depths of the US Depression. I t took until
1972 for the index to reach 1000 but only a few years to rise from
4000 to over 5500 its current level in 1996. The present day value
is some 140 times its original value but the Dow Jones I ndustrial
Average is still seen as a popular barometer of the US stock market.
The chart opposite shows the fortunes of the Dow Jones I ndustrial
Average over the past 100 years together with some important
historical events.
Charles Henry Dow
The original Dow 12
American Cotton Oil
American Sugar Refining Co.
American Tobacco
Chicago Gas
Distilling & Cattle Feeding Co.
General Electric Co.
Laclede Gas Light Co.
National Lead
North American Co.
Tennessee Coal, I ron & Railroad Co.
US Leather
US Rubber Co.
Introduction
Section 1
17
US gross national
debt $4 trillion
1992
Klondyke
gold rush
1896
Ford introduces
the Model T
1908
Prohibition
repealed
1933
The Great Crash
1929
Bretton Woods
Conference
1944
Sputnik launched
1957
First silicon
chip
1958
First man on
the moon
1969
US drops
gold standard
1971
OPEC raises
oil prices
1979
Stock market
crash
1987
A century of the Dow Jones Industrial Average, 1896 - 1996
6000
5000
4000
3000
2000
1000
0
1990 1980 1970 1960 1950 1940 1930 1920 1910 1900 1896
First I BM PC
1981
Section 1
Introduction
18
As has already been mentioned Dow was a member of the New York
Stock Exchange and in his continuing studies of the markets he
formulated what is now known as DowTheory.
Dow never wrote a book about his theories but he published them as
a series of TheWall Street Journal editorials around the turn of the
centur y. These editorials were collected together and reprinted in
1903, a short time after Dows death in December 1902.
Dow had noted that a simple line plot of index price against time
gave rise to zig-zag patterns which had certain characteristics
depending on market trends. I t is these basic patterns which
chartists still use today, albeit with many refinements.
Dow formulated six basic principles from his study of the markets
which are summarised as follows:
1. Average prices
discount everything
2. The market moves in
trends
Dow used closing prices exclusively to
calculate his averages. He also
assumed that the prices discounted
ever ything still an underlying
assumption of Technical analysis.
Uptrends have a pattern of rising
peaks and troughs the opposite for
downtrends.
Dow identified three distinct types of
trend:
Primary or major. These lasted a
year or more and could be
considered to be like a tide.
Secondary or intermediate. These
were like waves and lasted 3 weeks
to 3 months.
Minor. These were like ripples and
lasted for less than 3 weeks.
Uptrend
Downtrend
Primarytrend
Intermediate
trend
Minor
trend
Introduction
Section 1
19
3. Major trends have
three phases
Phase 1
This is an accumulation phase which
moves sideways and where astute
investors are buying on an informed
analytical basis.
Phase 2
This is an uptrend period where more
investors begin to participate based
on analysis and business news.
Although the trend is up, the market
prices zig-zag during corrections or
pullbacks.
Phase 3
After a market price peak there is
another accumulation period during
which there is increased investor
activity as the market news becomes
more widely available.
The end of Phase 3 is marked by a
downtrend and a return to a period
of accumulation.
Ralph Nelson Elliott
developed theDow
Theory further in the
1920s to providean
overall perspectiveof
market movement
expounded as Elliott
Wave Theory this is
described later in
Section 5.
4. Averages must
confirm each other
Dow was convinced that both the
I ndustrial and the Railroad indices
had to be moving in the same
direction to confirm a market trend.
'

J
' Accumulation
Uptrend
Pullbacks
J Peak
Accumulation
Downtrend
Thesecharts show modern Dow Jones averageindicies theupper
charts show confirmation whereas in thelower charts themarkets are
moving apart.
Chart of DJIA
Chart of DJTA
Chart movements in broad
agreement confirming themarket
trend
Chart of DJIA
Chart of DJ 20Bonds
Chart movements
showing divergence
Section 1
Introduction
20
5. Volume must confirm
the trend
6. A trend is assumed to
be in effect until it
gives definite signals
that it has reversed
Volume represents the total trading
activity for a financial instrument in a
particular time period. Dow
considered that volume was important
additional information in confirming
market signals. The volume should
expand in the direction of the major
trend.
This is the basis of trend analysis but it
is not always easy to identify a trend
reversal. For example, is a change just
a correction or the start of a down-
trend?
Modern chartists have a number of
tools and techniques available to help
which are described later:
Support and resistance levels
Trend lines
Moving averages
Criticisms of the Dow Theory
Dows theories were never intended to indicate specific stocks which
should be bought or sold but were intended to identify the stock
markets major trend based on closing price information. Because
this type of charting is based on trend-following it cannot predict
exact beginnings and reversals of trends. Nor can the charting
predict the exact duration and extent of trends. However, despite
these limitations the Dow Theor y has been used to give 40 correct
signals in the period 1897 1991. During this period only 5
incorrect signals were forecast.
Dow intended his indices to be market barometers which meant that
the selection of individual stocks to buy or sell was entirely in the
hands of investors. Originally it was not possible to buy or sell a stock
index. However, since the early 1980s trading in stock index futures
contracts has been possible the Chicago Mercantile Exchange
launched Standard & Poor 500 Stock I ndex futures in 1982 and
LI FFE offered FT-SE 100 Stock I ndex futures and options in 1984.
Although the Dow Theor y has its limitations, it has provided the
basis of many of the charting techniques which are described later
in this workbook.
Confirmation when:
Increasing volumeon
uptrend highs and
decreasing volumeon
uptrend lows
oppositefor downtrend
Volume
data
Introduction
Section 1
21
Summary
You have now finished the first section of the workbook and you
should have a clear understanding of:
The differences between technical and fundamental
analysis
The underlying principles and uses of technical analysis
The production of a basic chart
The development of technical analysis and the Dow
Theor y
As a check on your understanding of this section you should tr y the
Quick quiz questions. You may also find the section Over view a
useful revision aid.
Quick quiz questions
1. Which of the following statements are true concerning the
underlying principles of technical analysis?
a) The main focus is on what ought to
happen in the market
b) Patterns exist in market behaviour
c) Histor y repeats itself
d) Market action discounts nothing
True False
2. According to Dow Theor y, briefly describe what is happening
in the various phases of a major trend numbered 1 to 6 in this
diagram.
'

J
'

You can check your answers on page24.

Section 1
Introduction
22
Overview
Technical v Fundamental analysis
O Fundamental analysis
O Technical analysis
O Underlying principles of technical analysis
O Summar y of differences
The development of technical analysis
O Charles Henr y Dowfirst published the DowJones
Industrial Average in TheWall Street Journal in 1896
O Dows six basic principles:
1. Average prices discount ever ything
2. The market moves in trends
3. Major trends have three phases
4. Averages must confirm each other
5. Volume must confirm the trend
6. A trend is assumed to be in effect until it gives
definite signals that it has reversed
O Trading theories
Introduction
US gross national
debt $4 trillion
1992
Klondyke
gold rush
1896
Ford introduces
the Model T
1908
Prohibition
repealed
1933
The Great Crash
1929
Bretton Woods
Conference
1944
Sputnik launched
1957
First silicon
chip
1958
First man on
the moon
1969
US drops
gold standard
1971
OPEC raises
oil prices
1979
Stock market
crash
1987
A century of the Dow Jones Industrial Average, 1896 - 1996 6000
5000
4000
3000
2000
1000
0
1990 1980 1970 1960 1950 1940 1930 1920 1910 1900 1896
First I BM PC
1981
A method of forecasting based on basic economic, political and
environmental factors.
A method of predicting price movements and future market
trends by studying charts of past market action which take into
account price of instruments, volumes of trading and, where
applicable, open interest in the instruments.
1. Market action
discountseverything
This means that the actual price is a
reflection of ever ything that is known
to the market that could affect it, for
example, supply and demand,
political factors and market sentiment.
The pure chartist is only concerned
with price movements not with the
reasons for any changes.
2. Patternsexist Chartism is used to identify patterns
of market behaviour which have long
been recognised as significant. For
many given patterns there is a high
probability that they will produce the
expected results. Also there are
recognised patterns which repeat
themselves on a consistent basis.
3. Historyrepeatsitself Chart patterns have been recognised
and categorised for over 100 years and
the manner in which many patterns
are repeated leads to the conclusion
that human psychology changes little
with time.
Fundamental analysis
O Focuses on what ought to
happen in a market
O Factors involved in price
analysis include:
Supply and demand
Seasonal cycles
Weather
Government policy
Technical analysis
O Focuses on what actually
happens in a market
O Charts are based on market
action involving:
Price
Volume all markets
Open interest futures only
O Seasonality in commodities
Theory A Market equilibrium
O Indicators Oscillators, eg, Relative Strength I ndex (RSI )
O Number theory Fibonacci numbers, Gann numbers
O Waves Elliott Wave Theor y
O Gaps High/Low, Open/Closing
Favoured by experts
Theory C Supply and demand fundamentals
O Spreads Months, Exchanges, Cash/futures
O Flowof funds Volume and open interest
O Seasonals Weather, economy
O Reports Expectations versus reality
Favoured by floor traders
Theory B Classical charting
O Trends following Moving averages etc
O Chart formations Triangles, Head & Shoulders etc
O Trend lines Channels
O Cycles
Favoured by public advisors
Introduction
Section 1
23
Further resources
Books
Technical Analysis of the Futures Markets
John J. Murphy, New York I nstitute of Finance, 1986
I SBN 0 13 898008 X
Technical Analysis Explained
Martin Pring, McGraw-Hill, 1991
I SBN 0 0705 1042 3
The NewCommodity Trading Systems and Methods
Perr y Kaufman, J. Wiley & Sons, 1987
I SBN 0 4718 7879 0
Technical Analysis from A X
Steven Achelis, Probus Publishing Co., 1995
I SBN 1 55738 816 4
Timing the Market Howto profit in Bull and Bear Markets with
Technical Analysis
Curtis M. Arnold, Probus Publishing Co., Revised Edition 1993
I SBN 1 55738 496 7
Charters on Charting Howto improve your stockmarket decision
making
David Charters, Rushmere Wynne, 1995
I SBN 0 948035 21 8
Technical Analysis of Stocks and Commodities
Taking Stock of Commodity Trading Methods by B. Venitis
Vol. 1:6 (129-132), 1982/3
A map for the trading jungle by G.D. Noble
Vol. 4:2 (81-82), 1986
Real world technical analysis by K. Calhoun
Vol. 9:3 (103-103), 1991
DowTheory by M.F. Bowman and T. Hartle
Vol. 8:9 (359-363), 1990
Financial Times
A series of articles by Gillian OConnor in Weekend Money
Picking the pops from the charts 19.8.95
Howthe trend can become your friend 2.9.95
Howcandlesticks can shed light on trends 9.9.95
Indicators confirm your first thoughts 16.9.95
Waves that boom and crash 30.9.95
Simple approaches to a complex jigsaw 14.10.95
In search of the stars 21.10.95
Investors Chronicle
A series of articles by Robin Grffiths
Making a science of an art form 8.9.95
The pencil is mightier than the PC 15.9.95
What are the charts telling us now 22.9.95
Section 1
Introduction
24
Quick quiz answers Your notes
1. Which of thefollowing statements aretrueconcerning theunderlying
principles of technical analysis?
a) Themain focus is on what ought to
happen in themarket
b) Patterns exist in market behaviour
c) History repeats itself
d) Market action discounts nothing
True False
v
v
v
v
2. According to Dow Theory, briefly describewhat is happeningin the
various phases of a major trend numbered 1 to 6 in this diagram.
'

J
' Phase 1: Accumulation where price action is moving sideways
Phase 2: Uptrend where investors begin to participate
Phase 2: Corrections or pullbacks to market prices
J Market peak
Phase 3: Accumulation period after peak
Phase 3: End marked by a downtrend
Chart types
Section 2
25
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o
n
t
e
n
t
s
27
28
34
36
38
44
46
49
51
51
52
53
54
12
3
6
9
1
2
4
5 7
8
11
10
This section of the module should take about 90
minutes to 2 hours of study time. You may not
take as long as this or it may take a little longer
remember your learning is individual to you.
Introduction
Line charts
Bar charts
Candlestick charts
Point and figure charts
Volume charts
Open interest charts
Charting exercises
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Section 2
Chart types
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26
The Will Rogers theory has only two rules.
Rule 1: If it dont go up, dont buy it.
Rule 2: If it dont go down, dont sell it.
TheWill Rogers Theory of Point and FigureTrading by J. AdamHewison
Technical Analysis of Stocks and Commodities , Vol. 9:8 (320-322), 1991
Chart types
Section 2
27
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Introduction
The chartist has a wide variety of technical analysis tools and
techniques to choose from. All of them require some type of chart
plotting. Charts can be plotted by hand as you have already carried
out, or more likely today charts are produced with computer
applications such as Reuters Graphics and Reuters 3000 products.
Although this wide choice exists most chartists tend to have
favoured chart types and analytical methods which they prefer using.
This section covers the basic types of charts available, how they are
created and, to some extent, how they are used. Chart types range
from simple line plots and bar charts, point and figure charts to
complex candlestick plots which originated in Japan. Line charts are
the simplest form of chart connecting consecutive closing prices and
show the result of market movements. Candlesticks chart Open/
High/Low/Close prices and provide edited highlights of what is
happening.
The chart types covered include:
O Line
O Bar
O Candlestick
O Point and figure
O Volume
O Open interest
For some of these chart types there are activities for you to carr y out
to illustrate particular points you will benefit if you take the time
to perform the activities but if you do not have time then the
answers are always illustrated. You may find it useful to use a pencil
for these activities its a lot easier to erase any mistakes! You may
also find it useful to photocopy the original blank charts as a backup.
Each chart type is discussed using the following process:
?
?
What is it?
Howis it used?
Important information
Useful diagrams
Examples
Section 2
Chart types
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28
The line chart is the simplest form of chart joining a series of points
for instrument data on the vertical axis (Y-axis) and a timescale on
the horizontal axis (X-axis).
?
?
Line charts are not frequently used today. Typically Bid, Ask, High,
Low or Close prices are used for the vertical axis and timescales used
can var y from tick (ever y price plotted consecutively) to hourly, daily
and weekly.
There are a number of ways in which line chart data can be plotted
two involve the vertical axis and one the timescale.
Arithmetic vertical scale
The most common method is to use an arithmetic scale where each
division represents the same price difference.
Logarithmic vertical scale
This method uses a price scale where the Y-axis is constructed using
a logarithmic scale. The chart still uses an arithmetic timescale so
the chart is often termed semi-logarithmic. The main purpose for
using a logarithmic scale is to keep price movements involving ver y
large rises and falls in perspective. I n the Equity market many
players believe that it is better to chart stocks which have seen ver y
large rises/falls in prices using a logarithmic Y-axis rather than use
an arithmetic scale.
Timescale
Depending on the timescale used for each arithmetic division on
the horizontal scale, the appearance of a line chart can var y
dramatically. For example, the appearance of a chart using 1
division per week for a closing price line chart will look ver y
compressed compared with one using one division per day. Chartists
select the most appropriate timescale divisions depending on the
type of analysis and trading needs they have.
Arithmetic chart Semi-Log chart
In both cases a movement from2 4 and 4 8 is
100%. In thearithmetic chart themovement looks
twiceas big as it reallyis. In thesemi-logarithmic
chart themovements look thesame. Whynot
measurethelinelengths to check?
Dailyprices
Weeklyprices
Thesameprices havebeen plotted using dailyand weekly
timescales. You can seehow much morecompressed the
dailychart looks.
9
8
7
6
5
4
3
2
1
10
9
8
7
6
5
4
3
2
1
Line charts
Arithmetic charts
Chart types
Section 2
29
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Thesecharts show theweeklybar charts for theHang Seng Index.
Thetop chart shows theshareprices plotted on an arithmetic
scale; thebottomchart shows thesameprices using a semi-
logarithmic scale. Thechannels which areindicated bythered
lines givean indication of thedifferencein appearanceof the
pricemovements.
Line charts
Arithmetic chart
Exercise 2a
Using the blank Arithmetic and Semi-
logarithmic charts and closing prices for
I omega Corporation, plot the data and
compare the charts.
Exercise 2b
Using the blank charts, daily and weekly
closing prices for the FT-SE 100 I ndex,
plot the data and compare the charts.
Semi-logarithmic chart
Section 2
Chart types
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30
10
11
15
12
13
14
16
20
17
18
19
21
25
22
23
24
10
11
15
12
13
14
16
20
17
18
19
21
22
23
24
Arithmetic chart Semi-logarithmic chart
1 0 0 . 0 1
2 3 6 . 0 1
3 0 5 . 0 1
4 4 4 . 0 1
5 5 2 . 0 1
6 5 2 . 0 1
7 0 5 . 0 1
8 0 0 . 0 1
9 8 3 . 0 1
0 1 0 0 . 0 1
1 1 8 3 . 0 1
2 1 0 0 . 1 1
3 1 5 2 . 3 1
4 1 5 7 . 3 1
5 1 0 5 . 4 1
6 1 0 0 . 5 1
7 1 0 0 . 5 1
8 1 3 1 . 4 1
9 1 5 7 . 4 1
0 2 0 5 . 4 1
1 2 0 5 . 4 1
2 2 3 1 . 4 1
3 2 8 8 . 3 1
4 2 0 5 . 4 1
5 2 5 2 . 5 1
6 2 5 7 . 4 1
7 2 3 6 . 4 1
8 2 5 2 . 4 1
9 2 3 1 . 4 1
0 3 3 6 . 4 1
1 3 1 3 . 5 1
2 3 0 5 . 6 1
3 3 0 0 . 8 1
4 3 0 0 . 2 2
5 3 5 2 . 3 2
6 3 0 0 . 0 2
7 3 0 0 . 1 2
8 3 0 5 . 1 2
9 3 5 2 . 0 2
0 4 0 0 . 1 2
Day Price
I omega Corp daily
closing prices
Chart types
Section 2
31
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3800
3790
3780
3770
3760
3750
3740
3730
3720
3710
3700
3800
3790
3780
3770
3760
3750
3740
3730
3720
3710
3700
Daily chart Weekly chart
Day Price
FT-SE 100 I ndex daily
closing prices
1 6 7 7 3
2 2 5 7 3
3 3 2 7 3
4 7 0 7 3
5 8 2 7 3
6 4 5 7 3
7 9 5 7 3
8 6 7 7 3
9 4 5 7 3
0 1 0 9 7 3
1 1 8 7 7 3
2 1 9 8 7 3
3 1 4 6 7 3
4 1 7 4 7 3
5 1 2 5 7 3
6 1 0 6 7 3
7 1 5 7 7 3
8 1 7 4 7 3
9 1 8 4 7 3
0 2 9 3 7 3
2 2 5 7 3
6 4 5 7 3
0 1 0 9 7 3
5 1 2 5 7 3
9 1 8 4 7 3
Week
(= day
above)
Price
FT-SE 100 I ndex weekly
closing prices
Section 2
Chart types
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32
10
11
15
12
13
14
16
20
17
18
19
21
22
23
24
10
11
15
12
13
14
16
20
17
18
19
21
25
22
23
24
Exercise2a
Your charts
should have
looked
something
like these.
R
Arithmetic chart Semi-logarithmic chart
Chart types
Section 2
33
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3800
3790
3780
3770
3760
3750
3740
3730
3720
3710
3700
3800
3790
3780
3770
3760
3750
3740
3730
3720
3710
3700
Daily chart Weekly chart
Exercise2b
Your charts
should have
looked
something
like these.
R
Section 2
Chart types
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34
The bar chart is the most common way of indicating price data used
by Western chartists. A bar chart plots instrument data activity as a
series of vertical bars each of which covers a specific period.
?
?
I n most cases the period bar indicates High, Lowand Close prices
for historical data and High, Lowand Last for real-time prices. Some
bars indicate Open/ High/ Low/ Close prices especially for
exchange traded instruments but Open prices are not always
available for historical data. Just as for line charts, bar charts can use
an arithmetic or a logarithmic scale for the vertical axis an
arithmetic scale is most commonly used.
Drawing a bar
Bars are drawn as follows:
1. Draw a vertical line between the High and Lowprices.
2. Add a short bar to the right of the vertical bar as the Close or
Last price. The close price is, as its name implies, the price at the
close of the market. When the market next opens and the
financial instrument is traded once again the close price
becomes the last price.
3. Add a short bar to the left of the vertical bar representing the
Open price.
Bar charts are useful as they provide highlights of
what is happening in the market but as you will see,
in compact charts it is not always easy to read the
bars!
High
Low
Closeor Last
During a strong uptrend the closing
price will usually be near the price
High.
I f you see this pattern during a strong
uptrend it is usually taken as a
warning signal.
High
Low
Closeor Last
During a strong downtrend the
closing price will usually be near the
price Low.
I f you see this pattern during a strong
downtrend it is usually taken as a
warning signal.
Prices on RG/RTA are displayed according to the
following order. For example:
750 760 740 745
Open High Low Close
Market closed
at 745
Bar charts
High
Low
Closeor Last
Open
High
Low
High
Low
Closeor Last
TheLast pricemoves up and
down thebar as its price
changes. At theend of the
period thefinal Last price
becomes theCloseprice.
When used in charting futures theOpen bar
is often drawn shorter in length than that
used for theClose.
Chart types
Section 2
35
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Bar charts
A dailybar chart for LME Copper
3 month forward contract prices
This shows a magnified
view of thearea in the
chart you can seethe
bars moreclearly
A dailybar chart for theStandard &
Poor 500 Index prices
This shows a magnified
view of thearea in the
chart you can seethe
bars moreclearly
Section 2
Chart types
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36
A candlestick chart plots instrument data activity as a series of two
dimensional candles and their wicks, each of which covers a specific
period. The candle body indicates the Open/ Close or Last prices
and the wick is used to indicate the High/ Lowprices similar to the
vertical bar used in bar charts.
I n addition a candlestick provides a visual indication of the relative
price movement of the instrument for the period.
O I f the Close or Last is lower than the Open price then the
candle body is coloured black
O I f the Close or Last is higher than the Open price then the
candle body is coloured white or red as used originally
?
?
Although candlestick charts are a relatively recent introduction into
western technical analysis, Japanese rice traders used these charts
centuries ago. Many exponents of candlestick charts believe that
patterns produced even by 2 3 days trading can give important
signals for short-term trading markets such as futures.
Drawing a candlestick
Candlesticks are drawn as follows:
1. Draw a vertical line between the High and Lowprices which is
known as the wick or shadow.
2. Overlay on this wick a candle or body for which its top and
bottom limits are given by its Open and Close/ Last prices. I f the
Close is lower than the Open price, then colour the candle black.
I f the Close is higher than the Open, then leave the candle
hollowor white.
Candlestick charts use what may seem a bewildering
number of names for candles and their patterns.
Below are just a few explanations of candles and
patterns:
This shows that
market players
arebuying
This shows that
market players
areselling
Candlestick charts
Spinning top
High
Low
Close
Open
High
Low
Open
Close
Upper shadow
Lower shadow
Doji Open/
Closearethesame
Bearish
engulfing
Bullish
engulfing
Engulfing patterns
Star formation
Bearish
Evening Star Morning Star
Black or
whitebody
Gap between
bodies
Chart types
Section 2
37
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Candlestick charts
Bearish engulfing this
is also virtuallyan
Evening Star formation
Bullish
engulfing
Evening Star
A weeklycandlestick chart of last trade
values for theNikkei 225 index
Morning Star
Section 2
Chart types
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38
Point and figure charting is a simple technique for plotting stock
and commodity prices which only charts significant changes in
order to identify trends. The charts are simple and easy to construct,
involve no timescale and only involve price changes of a user
determined amount.
?
?
Prior to the introduction of computerised techniques this was
probably one of the most popular techniques due to its simplicity
it is still a tool used in futures pits. The convention is to plot a chart
in vertical columns where the vertical axis consists of boxes and the
scale is known as the box size. For example, a user may decide that
each box represents one point in some circumstances and three
points in another. Xs and Os are used to chart price movements. As
prices rise an X is placed on the chart for each price rise equal to
the chosen box size. An O is used for each price decline equal to the
chosen box size. A second parameter used is the number of boxes
that constitute a reversal. A key feature of these charts over other
charts is that the horizontal axis (X-axis) is not time dependent. For
this reason changes in day are often marked by the day number or
by a colour change.
Choosing the box size
A small box size and small box reversal number will tend to give a
large number of X and O columns. The chart can be made coarser
by either raising the box size itself or the number of boxes that
constitute a reversal. I t is more common to increase the box size
than the box reversal number a three box reversal is ver y
common.
Depending upon the box size and reversal number, a point and
figure chart could cover a days trading or trading over several
months.
Starting the chart
The chart is started by placing a dot in the first box corresponding
to the instrument price. Ever ytime the price rises (or falls) by the
selected box size an X (or O) is placed in the same column. Xs (or
Os) are marked in boxes to the value of the move.
Xs and Os
0
0
0
0
0
X
X
X
X
X
Start dot
Xs marked to the
valueof the
pricerise
A single
box
Start dot
Os marked to the
valueof theprice
fall
If thebox sizeis 5 pips and a threebox
reversal is chosen, then therising market X
column would havea new column of three
Os introduced alongsideit if thepricefell
by15 pips. Thefirst O would beplaced
immediatelybelow thehighest X of the
previous column.
Point and figure charts
X
X
X
X
X
0
0
0
X
X
X
X
X
X
X
Chart types
Section 2
39
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Charting
Xs (or Os) are placed in the boxes until there is a price reversal and
the price falls (or rises) by the selected box size. The chart now
moves to the next column.
I f the price falls, thus moving from X = O, then the O is placed one
box across and down from the last X.
I f the price rises, thus moving from O = X, then the X is placed one
box across and up from the last O.
The horizontal axis is therefore a series of columns showing up and
down price movements. Price movements of less than the point size
selected are filtered out.
Uses
Point and figure charts are used to indicate buy/sell signals and to
identify the following:
X
X
X
X
X
0
0
0
0
0
X
X
X
X
X
0
0
0
0
0
0
Pricefall
Moveonecolumn to right
Movedown a box for first O
Mark as manyOs as necessary
for thepricefall
Pricerise
Moveonecolumn to right
Moveup a box for first X
Mark as manyXs as necessary
for thepricerise
Market behaviour
Demand exceeding supply
Supply exceeding demand
Supply and demand in balance
X
X
X
X
X
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X X
X
X
Point and figure chart
Long up columns Xs
Long down columns Os
Short up and down columns
moving sideways
This combination
is a buysignal
This combination
is a sell signal
Point and figure charts
Section 2
Chart types
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An example
The following is a list of prices which are to be plotted on a point
and figure chart. A chart using a box size of one and a three box
reversal is required.
Prices
15 25 10 15 10 15 5 15 12 15
I n all cases the price changes are greater than 3 so Xs and Os are
required for ever y price movement. A chart with a box range 5 to 25
will be sufficient for the plot.
The chart is started by placing a dot in box 15 and then placing Xs
in the first column up to 25.
At this point the price reverses by more than 3 points it goes down
to 10. Therefore an O is placed in the next column, one box down
and Os continued down to 10.
The price reverses again to 15. Now an X is placed in the next
column, one box up and Xs continued to 15.
You have probably got the idea by now. Why not check the rest of
the chart?
I t is worth remembering that if the price does not rise or fall by the
selected box size, then no entr y is required. A point and figure chart
only records price movement it is not dependent on time.
X
X
X
X
X
X
X
X
X
X
5
10
15
20
25
X
X
X
X
X
X
X
X
X
X
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
5
10
15
20
25
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
5
10
15
20
25
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
5
10
15
20
25
Start dot
Xs up to 25
Os in next
column
down to 10
Xs in next
column up
to 15
Point and figure charts
Chart types
Section 2
41
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Point and figure charts
A point and figurechart of oneminutebid
prices for spot Deutschemark using a box
sizeof 0.0002 and a 3 box reversal
A point and figurechart of last tradetick
prices for CBOT US T-Bonds using a box
sizeof 0.3125 (
1
/ 32 ) and a 3 box reversal
Section 2
Chart types
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42
Exercise 3
Plot the Reuters data as a point and figure chart.
Use a box size of 2 and a three box reversal.
You can check your answer on page48.
Day Price Day Price
1 5 . 6 6 7 6 2 7 9 7
2 0 7 7 7 2 4 8 7
3 9 6 7 8 2 9 8 7
4 8 5 7 9 2 9 8 7
5 1 5 7 0 3 9 7 7
6 9 4 7 1 3 8 7 7
7 5 . 3 5 7 2 3 0 7 7
8 7 7 7 3 3 5 6 7
9 4 9 7 4 3 5 6 7
0 1 2 8 7 5 3 6 5 7
1 1 4 6 7 6 3 5 . 0 5 7
2 1 1 7 7 7 3 7 4 7
3 1 3 7 7 8 3 5 5 7
4 1 3 7 7 9 3 5 . 1 5 7
5 1 1 6 7 0 4 6 5 7
6 1 2 5 7 1 4 6 4 7
7 1 8 5 7 2 4 6 4 7
8 1 0 5 7 3 4 6 5 7
9 1 3 4 7 4 4 2 6 7
0 2 5 4 7 5 4 7 7 7
1 2 7 4 7 6 4 1 8 7
2 2 4 6 7 7 4 7 7 7
3 2 9 8 7 8 4 7 6 7
4 2 0 8 7 9 4 7 6 7
5 2 2 9 7 0 5 5 . 0 6 7
Chart types
Section 2
43
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740
750
760
770
780
790
800
Section 2
Chart types
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44
Volume represents the total trading activity in a specific period for a
commodity or financial instrument. For example, overall volume is
the total number of contracts traded during the day of all contract
months of the LI FFE FTSE-100 futures contract; also, it is the total
number of Reuter ordinar y shares that are bought and sold during
the day on the London Stock Exchange. Usually the volume is
recorded as a vertical bar at the bottom of a line or bar chart, so that
the price and volume data correspond. The greater the volume the
higher the vertical bar.
?
?
Volume charts give a measure of the amount of buying and selling
that is taking place in a market. There is a saying in the markets
which many analysts subscribe to:
Volume confirms price action
The Dow Theor y places some emphasis on volume as a method of
confirming market signals and trends. Volume is also a useful
measure of the strength of price movements. High volume acts as a
confirmation of price direction. Low volume tends to be a warning
of lack of market interest at that price level and hence a risk that the
price direction may change.
When using volume charts to confirm price directions it is useful to
remember that market volumes can be light immediately before
market holidays or before the release of major market statistics.
Drawing a volume chart
The most common way of drawing a volume chart is as a sub-plot on
the same chart as that used to plot the data for a line, bar chart etc.
for prices. The volume data is usually plotted at the bottom of the
price chart using the same horizontal time axis. The vertical axis (Y-
axis) is usually an arithmetic scale that fits beneath the main chart.
If prices arein uptrend and volumes
high, then this is taken as confirming
thedirection of thetrend
If prices arein uptrend but volumes are
low, then this mayindicatethat buyers are
losing interest and a trend changeis on the
way
Price
Volume
Uptrend
Price
Volume
Uptrend
High
Low
Volume is seldom used by itself but in conjunction with chart
patterns and indicators which are described later in the
relevant sections. The following chart summarises the basic
market signals that can be gauged from price/volume charts:
Price

Volume

Market
Strong
Warning sign
Weak
Warning sign
Volume charts
Warning sign indicates that the price
trend may change.
Chart types
Section 2
45
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Volume charts
A dailyprice/ volumechart for CBOT
T-Bond prices
This continuation futures chart shows
thevolumedata for thefront month
contracts which arejoined together
A dailylast tradepricebar chart and a
volumesub-chart for Reuters shares
Section 2
Chart types
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46
Open interest is the total number of contracts which are still
outstanding in a futures market for a specified futures contract. A
futures contract is formed when a buyer and a seller take opposite
positions in a transaction. This means that the buyer goes long and
the seller goes short. Open interest is calculated by looking at either
the total number of outstanding long or short positions not both.
Open interest is therefore a measure of contracts that have not been
matched and closed out. The number of open long contracts must
equal exactly the number of open short contracts. I t is worth
remembering that the reason a player holds an open futures
position may be for hedging rather than speculative purposes. The
following chart summarises how changes in open interest may result.
?
?
Drawing an open interest chart
Open interest data are usually plotted, together with volume data, at
the bottom of a price chart. Actual open interest data is drawn as a
solid line. However, open interest for certain commodity contracts,
for example, Orange juice, can have seasonal tendencies which
should be taken into account. This is done by plotting the average
open interest as a dotted line. I t is the difference between actual and
seasonal open interest lines that gives significance to any changes in
open interest.
Thesolid lineis moving above
thedotted linewhich confirms
theuptrend
Thesolid lineis moving below
thedotted linewhich confirms
thedowntrend
Volume
Uptrend
Averageopen interest
dotted line
Actual open interest
solid line
Price
Open
interest
Volume
Downtrend
Averageopen interest
dotted line
Actual open interest
solid line
Price
Open
interest
Price

Open interest

Market
Strong
Warning sign
Weak
Warning sign
This chart summarises
thebasic market signals
that can begauged from
price/ open interest charts.
Warning sign indicates
that theOpen interest is
not supporting theprice
direction.
Open interest charts
Open interest acts as a confidence measure between bulls and bears
in a market. A decline in open interest signals that either bulls or
bears are closing their open positions which are not being matched
by fresh positions being opened by new bulls or bears. An increase
in open interest marks increased market participation by bulls or
bears and is normally seen as a validation of any existing price trend.
Action
New buyer (long) and new seller (short)trade
to form a new contract
Existing buyer sells and existing seller buys
the old contract is closed
New buyer buys from existing buyer. The
existing buyer closes his position by selling to
new buyer
Existing seller buys from new seller. The
existing seller closes his position by buying
from new seller
Resultingopen interest
Rise
Fall
No change there is no
increase in long
contracts being held
No change there is no
increase in short
contracts being held
Chart types
Section 2
47
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Open interest charts
Dailypricebar chart and open interest
sub-chart for theCOMEX High Grade
Copper futures contract September
1996
Dailylast tradepricebar chart and
open interest sub-chart for theCME
IMM Eurodollar futures contract
March 1997
Open interest charts are
onlyapplicablefor futures
contracts
Section 2
Chart types
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48
X
X
X X
X
X
X
X
X
X X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0 0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0 0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
740
750
760
770
780
790
800
Exercise3
Your chart
should have
looked
something
like this.
R
Chart types
Section 2
49
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Chart exercise1
Open Reuters 3000 and in a new workspace type in
CBRY.L@BAR to display a daily bar chart for
Cadbury shares. The system will default a 6 month
histor y. You should see a screen similar to this.
Now click on the X-axis
button in the
bottom toolbar and
change the data to
be viewed to 2 years.
Finally click the Daily,
Weekly, Monthy Page tab
to display all three charts
for the 2 year period. You
should now see a screen
similar to this.
RT
Charting exercises
I f you have access to Reuters Graphics and/or
Reuters 3000 you may like to have a look at the
following exercises which have been designed to
help you understand more fully the various chart
types described in this section.
Section 2
Chart types
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50
Chart exercise2
Open Reuters Graphics (v3.1) and enter USc1 to
display a 2 year daily bar chart for US T-bonds.
The screen should look something like this.
Open a new window and using
the Chart menu, open an Open
Interest chart for USc1 in the
new window. The windows
should look something like those
shown here.
Now delete your charts for USc1 and create a bar
chart for CBRY.L. Click on the PV button in
the toolbar to generate a Price/Volume
chart.
This chart should look something like this.
RG
Chart types
Section 2
51
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Summary
You have now finished the second section of the workbook and you
should have a clear understanding of the following charts:
Line
Bar
Candlestick
Point and figure
Volume
Open interest
As a check on your understanding of this section you should tr y the
Quick quiz questions. You may also find the section Over view a
useful revision aid.
Quick quiz questions
1. For each of the following diagrams indicate the location of the
High/Low/Open/Close prices.
2. Match the following statements concerning Point and Figure
charts.
A. Demand exceeding
supply
B. Supply exceeding
demand
C. Supply and demand
in balance
1. Long down columns Os
2. Short up and down columns
moving sideways
3. Long up columns Xs
A & B & C &
3. Which of the following statements are true and which are false
concerning volume and open interest charts?
a) Price up and volume up indicate a
weak market
b) Price up and volume down are a
warning sign
c) Price up and open interest up indicate
a strong market
d) Price down and open interest up indicate
a weak market
True False
You can check your answers on page54.
Section 2
Chart types
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52
Overview
Line charts
O Typically joins a series of , Bid, Ask, High, Low or
Close prices
O Vertical axis Y-axis can be an Arithmetic or
Logarithmic scale
O Horizontal axis X-axis can be tick, hour, day,
week, month etc
Point and figure charts
O Plot of stock or commodity prices which charts
significant changes using a vertical axis of boxes
and a scale known as the box size
O Price rise indicated by an X when the movement
equals the box size
O Price fall indicated by an O when the movement
equals the box
size
O Typical charts
use a three box
reversal
Open interest charts
O Line plot of total number of contracts still
outstanding in a futures market for a specified
contract month
O Open interest is
calculated by either
looking at the total
number of outstanding
long or short positions
not both
Bar charts
O I nstrument prices plotted as a series of vertical
bars
O Bar can indicate Open/High/Low/Close or Last
prices
Volume charts
O Vertical bars representing the total trading activity
in a specific period for a commodity or financial
instrument the greater
the volume the higher
the vertical bar
O Measure of the amount
of buying and selling
Candlestick charts
O Prices plotted as candles and wicks. Candle body
indicates Open/ Close or
Last prices; wick
indicates High/ Lowprices.
O I f Close or Last price is
lower than Open price,
then the candle is black
O I f Close or Last price is
higher than Open price,
then the candle is white or red
High
Low
Close
Open
High
Low
Open
Close
Chart types
High
Low
Closeor Last
Open
Price

Open interest

Market
Strong
Warning sign
Weak
Warning sign
Price

Volume

Market
Strong
Warning sign
Weak
Warning sign
Marketbehaviour
Demand exceeding supply
Supply exceeding demand
Supply and demand in balance
Pointand figurechart
Long up columns Xs
Long down columns Os
Short up and down columns
moving sideways
Chart types
Section 2
53
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Further resources
Books
Japanese Candlestick Charting Techniques
Steve Nison, New York I nstitute of Finance, 1991
I SBN 0 1393 1650 7
Candlestick Charting Explained
Gregor y Morris, Probus Publishing Co., 1995
I SBN 1 55738 891 1
Study Help for Point & Figure Techniques
Alexander Wheelan, Fraser Publishing, 1990
I SBN 0 8703 4091 3
Technical Analysis of Stocks and Commodities
Technical analysis of volume by H.K. Waxenberg
Vol. 4:2 (65-68), 1986
Point and Figure Charting by G. van Powell
Vol. 11:1 (30-33), 1993
Candlesticks and Intraday Market Analysis by G.S. Wagner & B.L
Matheny
Vol. 11:4 (169-173), 1993
Section 2
Chart types
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54
Quick quiz answers Your notes
1. For each of thefollowing diagrams indicatethelocation of the
High/ Low/ Open/ Closeprices.
High
Low
Close
Open
High
Low
Close
Open
High
Low
Open
Close
2. Match thefollowing statements concerning Point and Figurecharts.
A. Demand exceeding
supply
B. Supply exceeding
demand
C. Supply and demand
in balance
1. Long down columns Os
2. Short up and down columns
moving sideways
3. Long up columns Xs
A & 3 B & 1 C & 2
3. Which of thefollowing statements aretrueand which arefalse
concerning volumeand open interest charts?
a) Priceup and volumeup indicatea
weak market
b) Priceup and volumedown area
warning sign
c) Priceup and open interest up indicate
a strong market
d) Pricedown and open interest up indicate
a weak market
True False
v
v
v
v
Patterns
Section 3
55
C
o
n
t
e
n
t
s
57
60
62
66
72
76
80
82
85
87
87
88
89
90
12
3
6
9
1
2
4
5 7
8
11
10
This section of the module should take about 2
hours of study time. You may not take as long as
this or it may take a little longer remember
your learning is individual to you.
Introduction
Trendlines
Continuation/consolidation patterns
Reversal patterns
Support and resistance lines
Moving averages
Relative performance
Gaps
Charting exercises
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Section 3
Patterns
56
The longer a trendline is in effect and the more data points that
are used to establish the line, the greater the significance is.
Significant penetration of the trendline usually indicates a reversal
or a slowing of the trend.
On Trendlines, Money Flow Index and theElliott Waveby Brian D.Green
Technical Analysis of Stocks and Commodities , Vol. 12:8 (321-324), 1994
Patterns
Section 3
57
Introduction
Charting the market behaviour of any particular financial
instrument may be considered to be the result of a battle between
buyers bulls and sellers bears. Market prices do not move in a
straight line but zig-zag as prices rise and fall depending on who is
winning the buyer/seller battle. I n order to help market players
decide if they should buy or sell they need tools to help decide their
trading strategy. One such tool is the market trend and is simply
defined as:
Thedirection of themarket theway themarket is moving.
There are two basic trend directions and the situation when a
market is within a sideways consolidation to consider:
Uptrend This is considered to be the time to buy
or go long. A major uptrend is also
known as a Bull market. Market players
have the opportunity to profit by being
bullish buying and staying with the
uptrend.
Downtrend This is considered to be the time to sell
or go short. A major downtrend is also
known as a Bear market. Market players
have the opportunity to profit by being
bearish selling with a view to buying
later. I n equity markets it is not always
possible for normal
investors to be short they
are either in or out of the
market.
Sideways market This situation arises when there is no
strong conviction by either bulls or
bears. As a result market prices rise and
fall in a more congested space hence
the term congestion or consolidation is
sometimes used. This type of pattern is
generally considered to be a signal to
stay out of the market. However, some
traders use congestion patterns as an
opportunity for range trading selling
on the high side of the congestion and
buying back and reversing long at the
low side.
Within the zig-zag trend patterns you may also see temporar y
corrections in price movements these are known as pullbacks.
You have already been introduced to market sayings such as
and as long as the trend is intact the situation is stable.
The trend is your friend
Go with the trend
The markets
The markets
Sideways patterns eventually result in a breakout and reversal or
continuation of the original trend. Reversals and continuations have
characteristic patterns which the chartist uses to make trading
decisions. However, these patterns are not always easy to recognise!
Range
Section 3
Patterns
58
Both of the lines bounding a channel can be viewed as retaining
walls against which prices keep hitting and bouncing off. I n an
uptrending channel if the lower channel line is broken then this
may warn of a possible reversal of the uptrend. I f the upper channel
line is broken then this suggests an acceleration and strengthening
of the uptrend. I n the case of a downtrend it is breach of the upper
channel line that warns that the existing trend may be ending.
What is actually happening during these ups and downs in the zig-
zag patterns? The patterns are caused by the constant battle between
bulls and bears in the market place. At market peaks the bears gain
ascendancy and take control, whilst in the troughs the situation is
reversed and the bulls gain ascendancy. I f market players move to
stop a price fall, then they buy and provide support to the market. I f
they move to stop a price rise, then they sell and resistance to the
rise is the outcome.
Obser ving how markets react to support and resistance is a good
barometer of the measure of an underlying trend.
I n any market there will be short, medium and long -term trends. I n
some cases all these trends work in the same direction resulting in a
strongly trending market. I n other cases the different trends conflict
with each other which results in a much more subdued market price
action. The essence of using trends for both long term investors and
short term traders is to be able to assess when trends are likely to
change.
Chartists are looking for a trendline to be broken a breakout. This
is a signal to examine charts and market events closely. What do the
signals mean?
O Has the trendline/channel been broken?
O Are prices just fluctuating in their channel?
O Are there any pullbacks?
O Are prices moving sideways?
O Are there any continuation/reversal patterns?
So far the approach taken in considering patterns has only
concerned trends. What would Dow have had to say about such an
approach?
Lower
channel line
Upper
channel line
Resistance
Support
Whilst the situation is stable if you look carefully at the zig-zag
pattern of a trend you may notice that it is possible to draw two
more or less parallel lines one joining the high points of the peaks
and the other the lower points. These lines bound what is known as
a trend channel.
Uptrend
channel
Downtrend
channel
Patterns
Section 3
59
Although Dow Theor y concentrates on trends in the market, any
movement has to be confirmed Dow used his stock indices and
volume of trading for this purpose.
More modern techniques of pattern confirmation used by chartists
include moving averages which are a variation on trendlines. An
average is calculated for a number of prices by summing the prices
and dividing the result by the number involved. I n moving averages,
although the number of prices remains constant, the actual prices
used change on a period-by-period basis as the period moves on
one the oldest price in the sequence is dropped and replaced by the
current one.
Within moving average charts it is also possible to see price action
moving within a channel with walls a certain percentage above and
below the moving average. Conventional price channel analysis has
the upper/lower bands as a fixed percentage above/below the
underlying moving average. However, John Bollinger, the US
chartist, has further developed this technique by introducing a
volatilty measure such that the bands broaden in a volatile market
and constrict in a market where trading is subdued. These bands are
known as Bollinger bands.
Another type of chart which is used to confirm trends is based on
relative performance. This is a measure of how well a particular
instrument is performing relative to the rest of the market as
gauged by comparing it with a broad market measure or another
instrument. For example, if you have shares in Reuters Ltd you may
want to see how well your shares are performing relative to the FT-
Actuaries All-Share I ndex. A rising relative performance means that
the share is outperforming the market whilst a falling value means
the share is underperforming. I n the equity market this
performance measure is referred to as relative strength which
should not be confused with the Relative Strength I ndex, which is
an indicator described in the next section.
Careful inspection of daily charts may also indicate the presence of
gaps or blank spaces in the price chart. For example, in an
uptrending market, if the highest price for any one day is lower than
the lowest price for the following day, then a gap will appear in the
chart. True gaps are an indication of a bull/bear market conviction
which is so strong that a given price range has been completely
ignored. Gaps are often seen in futures markets and to a lesser
extent in equity markets. Gaps are rarely seen in 24-hour markets
such as the spot FX majors for USD/DEM etc.
I n order to help you identify the basic patterns that have been
discussed here, and to give an over view of how chartists use them,
information is given on the following:
O Trendlines/channels
O Continuation/consolidation patterns
O Reversal patterns
O Support and resistance
O Moving averages
O Relative performance/strength
O Gaps
The format for each section follows the same as adopted for the
previous section.
I t is important to remember that this workbook is not an exhaustive
treatment of chart patterns it only provides an over view to the
subject. I f you want to find out more then you can have a look at
some of the materials given in Further resources.
20
21
24
23
(20 +21+24) 3 = 21.67
20
21
24
23
25
(21 +24+23) 3 = 22.67
Price 3 day moving
average
20 21.67
21 22.67
24 24.00
23 23.67
25 22.67
23
20
Section 3
Patterns
60
A trendline is a line connecting consecutive high or low data points
in order to identify the direction of a market. The longer an
unbroken trendline can be drawn the more significant the trend.
?
?
Trendlines are used to identify the following characteristics in
market trends:
O Direction of the trend
O Reversal of a trend
O Continuation of a trend
O Support and resistance
Once a trend line is broken it is an early signal of a trend change
and sideways movement in prices it is not necessarily a signal to
immediately buy or sell.
Uptrend
This is a line drawn joining lowdata points. I t is drawn under the
low points and connects at least three consecutive rising lowpoints.
Classically the line does not cross any other data points but recent
research shows this is permissible under certain conditions.
Downtrend
This is a line drawn joining high data points. I t is drawn above the
high points and connects at least three consecutive falling high
points. Classically the line does not cross any other data points but
recent research shows this is permissible under certain conditions.
Reversal
This is when the validity of the current trend ends and the trendline
is broken. I mmediately following a reversal it is quite common for
the market to move sideways. However, there are instances where
the end of a trend is followed by a violent and strongly trending
market in an opposite direction to the original trend.
Continuation/consolidation
Prices often fluctuate back and forth towards the trendline giving
rise to a number of patterns such as pennants and triangles. The
sideways trend produced is generally an indication of a temporar y
pause in the prevailing trend.
For an uptrend thelineis
drawn below thedata points.
Consecutivelow points must be
higher than theprevious point,
for example, 2 is higher than 1.
1
2
3
Uptrend
For a downtrend thelineis
drawn abovethedata points.
Consecutivehigh points must be
lower than theprevious point,
for example, 2 is lower than 1.
1
2
3
Downtrend
Head
Left
shoulder
Right
shoulder
A common reversal showing a
head and shoulders pattern
A flat top triangle
continuation pattern
Trendlines
Traditionally, in uptrends and
downtrends thelinedoes not cross
anyother data points. However,
new research is introducing
concepts on trendlines and
channels that permit this.
Patterns
Section 3
61
Trendlines
A linechart of dailyclosing prices for
Reuter Holdings shares
A linechart of dailybid prices for the
Italian Lira against theUS Dollar
Uptrend line themoretimes thechart
hits thelineand thelonger thelinethe
morereliablethetrend
Downtrend line themoretimes the
chart hits thelineand thelonger the
linethemorereliablethetrend
Section 3
Patterns
62
Continuation patterns occur during periods of consolidation when
prices are moving sideways following an up or down trend. The
patterns are not always easy to recognise and do not always have the
regular shapes described below! Continuation patterns have names
based on geometric shapes:
O Triangles
O Rectangles
O Flags and pennants
Continuation patterns last for var ying periods of time flags and
pennants only last a few days, rectangles can last up to a year.
?
?
Market players use continuation patterns to determine a target price
for their trading strategy. This target price is the level they expect
the market to reach following breakout of the consolidation and
resumption of the continuation trend.
Triangles
These occur in both up and down trends and represent a battle
between buyers and sellers. Triangles can have flat tops, flat bottoms
or sloping sides as with an equilateral triangle. For example, in this
triangle the flat top indicates that the
sellers think that the price is the full value,
whereas the buyers are putting in orders
for higher and higher prices. Eventually
one side will win and a breakout will occur.
I t is interesting that the closer the price
gets to the apex of the triangle the less
reliable the pattern becomes.
I t is common to see that the breakout of a triangle following an
uptrend gives rise to a short, sharp rise before a price fall occurs.
Such breakouts are referred to as Bull traps and quite often mark
major bull market tops. I n a downtrending market the inverse
situation is called a Bear trap which often marks a major bear
market bottom.
Ideally, as a minimum, there
should bethreepoints of contact
on each sideof thetriangle.
Flat top
triangle
Thetarget pricefor each triangle
is taken when theprice
differencefor x =y. Market
players then decidetheir strategy.
Long terminvestors mayjust
usethepattern to confirma
trend whilst short termtraders
maydecideto buy/ sell at this
signal.
Flat bottom
triangle
Equilateral
triangle
x
x
x
y
y
y
Sellers think this is
full value
Buyers prices
going higher
Apex
A Bull trap
A Bear trap
Continuation/consolidation patterns
Patterns
Section 3
63
Rectangles
These represent a straight for ward battle of support and resistance
between buyers and sellers. Rectangles may build up over a period
of months and last up to a year. I f the breakout follows the direction
of the trend then prices will continue to rise but if the breakout is in
the opposite direction then this should be considered a major
reversal pattern. Sometimes after a breakout there is a small
correction before a new trend direction is established. This
correction, or pullback, retests the old resistance level which has
now become support before the original trend direction is resumed.
Flag
Thetarget pricefor a flag or
pennant is taken when theprice
differencefor theflagpole, x , is
reached in thedirection of the
trend following thebreakout
and trend continuation.
x
Flags and pennants
These are short term patterns usually lasting no more than a few
days and occur in fast moving markets involving steep rises. They
usually mark the half way point in a continuing price movement.
Flags are shaped like downward sloping parallelograms whilst
pennants are downward sloping and have a triangle like shape. The
shapes are often difficult to identify but usually involve the following
conditions:
O They occur after a sharp up or down price move
O The volume should decline for the duration of the pattern
O Prices should breakout of the pattern within a few weeks
other wise it is unlikely that it is a flag or pennant
Flagpole
Pullback
Pennant
x
Rectangle
Thetarget pricefor a rectangle
is taken when theprice
differencefor x =yas in thecase
for a triangle.
x
y
Continuation/consolidation patterns
Section 3
Patterns
64
Continuation/consolidation patterns
Bar chart of dailylast tradeprices for CBOT US T-Bond futures, December
1996
Equilateral
triangle
Bar chart of dailyprices for Nikkei 225 Index
Equilateral triangle
Bar chart of dailyprices for GBP against USD Linechart of dailycloseShenzen 3 month Copper futures prices
Flag
Rectangle
Patterns
Section 3
65
Continuation/consolidation patterns
A candlestick chart of dailybid prices for
DEM/ JPY cross rate
Periods of continuation areindicated by
priceaction between thelines shown in red
on thecharts
A weeklybar chart of last tradevalues
for theDAX Index
Section 3
Patterns
66
A reversal pattern, as the name implies, indicates a top or bottom in
market prices usually accompanied by a trend reversal. Some of the
patterns are relatively easy to identify and reliable in their
interpretation others are more complex. Reversal patterns are only
important if they occur in a strong and marked current up or down
trend. A pattern obser ved in a downtrend is the inverse, or mirror
image, of that seen in an uptrend although it is not always as
prominent. The most common patterns which indicate market
reversal are:
O Head and shoulders
O Double and triple tops/bottoms
O Wedges
O Rounding or saucer top/bottom also known as scalloped
?
?
Market players use reversal patterns to identify top and bottom price
structures and select target prices for subsequent breakouts and
reversals in market trends. To help establish a target price a chartist
will draw a neckline which, in a head and shoulders pattern, is a line
joining certain specified low points of the pattern.
Head and shoulders
This pattern is made up of three peaks. The centre peak is higher
then the outer two which are approximately the same height the
shape is supposed to resemble someone shrugging. The pattern
usually occurs at the end of a long uptrend and is one of the most
common and reliable of patterns. The left shoulder and head
represent the struggle between buyers and
sellers and high volumes are traded. On
the appearance of the right shoulder the
volume declines and if the support line
the neckline is broken, then this is a
strong indication that prices will continue
in that direction. I nterestingly an inverse
head and shoulders, in an equity market, is
often less pronounced and flatter than
seen in an uptrend.
Thenecklinecan behorizontal or slant up
or down. Moresignificanceis attached to
an upward sloping necklinein an uptrend
than a downsloping one.
Onceprices breakthrough theneckline
thetarget pricefor market players to take
profit on positions taken at thebreakout
can bedetermined using theprice
differencex =y. This techniqueassumes
that thepricemoved at least yprior to
theemergenceof thepattern.
Head and shoulders
Inverse head and shoulders
y
x
x
y
Neckline
Left
shoulder
Right
shoulder
Head
Head
Left
shoulder
Right
shoulder
Reversal patterns
x
y
Patterns
Section 3
67
Double and triple tops/bottoms
Double and triple tops and bottoms are successive peaks and
troughs, of approximately the same height and depth, which
represent the continuing struggle of buyers and sellers to dominate
the market. The patterns usually signal intermediate or long term
changes in the trend. Eventually buyers or sellers win and the trend
is reversed.
A double top looks like the letter M a double bottom a W. Triple
tops and bottoms resemble a head and shoulders but do not have
such a pronounced head.
Double and triple tops/bottoms can be distinguished from head
and shoulders patterns by looking at volumes, for example, the
number of shares being traded. I n double and triple tops/bottoms
the volumes usually decrease for each peak whereas in a head and
shoulders pattern the volume of right shoulder normally changes
dramatically.
For a double top a neckline is drawn through the mid-point of the
M as the support level.
Care is needed in using double and triple
tops/bottoms as you need to be confident that
the previous trend has been reversed. For
example, two double top formations following
each other could form part of a rectangular
continuation pattern. I t is worth noting that
double and triple tops/bottoms need not have
exactly equidistant peaks and troughs. Also the
peaks and troughs can be deep or shallow, though major tops and
bottoms are usually assciated with a deep consolidation area.
I n general double tops/bottoms occur more often than head and
shoulders or triple tops/bottoms. However, the likelihood of a full
reversal is greater with head and shoulders and triple tops/bottoms.
Thenecklinecan behorizontal or slant up
or down slightly.
Onceprices breakthrough thenecklinethetarget
level for thereversal can bedetermined taking
thepricedifferencex =y.
Double top
Double bottom
Triple top
Triple bottom
y
x
y
x
x
y
x
y
M shape
W shape
Reversal patterns
Section 3
Patterns
68
Wedges
Triangles and wedges define converging prices before a reversal and
can take several weeks or months to develop. These patterns are
taken as signals as an opportunity to profit.
Wedges have boundaries that gently slope
towards each other. Wedges can rise or fall
slope up or down. Just as with triangles, a
wedge breakout should occur before the apex
of the wedge is reached.
Rounding or saucer tops/bottoms
These are not common types of reversal patterns. They tend to form
slowly over a period of months indicating a protracted struggle
between buyers and sellers with neither really gaining ascendancy.
A rounding top is roughly shaped like an umbrella canopy whereas a
rounding bottom has a saucer shape. These patterns offer no clear-
cut buy or sell signals but when considered in conjunction with
fundamental analysis, chartists can use them to predict long term
investment opportunities.
Rounding
top
Rounding
bottom or
scalloped
Umbrella canopy
Saucer
Wedge
Ascending
wedge
Reversal patterns
Patterns
Section 3
69
Reversal patterns
A bar chart of last tradeweeklyNikkei 225
Index values
Double top
Inverse head and
shoulders
Left
shoulder
Right
shoulder
Sloping
neckline
Head
A bar chart of daily
GBP/ USD prices
Section 3
Patterns
70
Reversal patterns
Bar chart of dailyprices for DAX Index
Ascending wedge
Bar chart of dailyprices for USD/ DKK
Bar chart of dailylast tradeprices for CBOT US T-Bond futures for
December 1996
Double bottom
Double top
Bar chart of dailylast tradeprices for Microsoft shares
Rounding or
saucer
bottom
Patterns
Section 3
71
Reversal patterns
A bar chart of dailybid GBP/ DEM
cross rateprices
Double top
Inverse head and
shoulders
Inverse head and
shoulders
Double top
Double top
A bar chart of last tradeLIFFE
3-month Swiss Franc interest
ratefutures for December 1996
Sometimes thepatterns arenot quite
classical in appearance
Section 3
Patterns
72
Support and resistance lines are one of the basic components of
charting and are important in the understanding of trends and their
associated patterns such as continuations and reversals.
Support level
This is the level that supports market price action for a period of
time. I t is the level where buying interest is strong enough to
overcome selling pressure. The result is that the market does not fall
below that level.
Resistance level
This is the opposite of support and is the level that resists market
price action for a period of time. I t is the level where selling interest
is strong enough to overcome buying pressure so the market does
not exceed that level.
?
?
Support and resistance lines are used by traders involved with both
short and long-term timescales, for example, futures traders and
traders in the equities markets. The performance of price action
when support and resistance levels are approached is investigated
closely by analysts for signals of continuation or a reversal of the
previous trend.
I f prices have been in an uptrend and then fall, breaking an
important support level in the process, then this is taken as a
warning of a trend reversal.
I f a resistance level has been tested and not broken, then this is
usually taken as an early warning of a possible trend change.
Selling
overcomes
buying
Support and resistance levels
Buying
overcomes
selling
Resistance level
Support level
Prices in an uptrend
Support level
Prices break the
support level
Resistancelevel
If theresistancelevel is not
broken theprevious support
maybechallenged which may
result in a trend change
Support and resistance lines
Patterns
Section 3
73
Support/resistance reversal
When a support level is broken then the level takes on the new role
of resistance and when a resistance level is penetrated it takes on the
new role of support.
Open interest Future markets
There is a relationship between support and resistance levels in an
uptrend/downtrend. As a market moves away from support/
resistance, that is, new buyers/sellers are entering the market then
the open interest should increase. However, if such an increase is
not obser ved, then this is taken as a warning signal.
Resistance
Resistancelevel
penetrated so line
becomes support
Support
Support level
broken so line
becomes
resistance
Buying hereis not
wiseas prices are
falling
Buying hereis good
as prices arerising
Example of support/resistance reversal
A gold trader buys at $350 at A and sells his position
at $400 the resistance level, B. The market slides
back to C, the support level at $360, and then rises
quickly to D at $425. When should the trader buy?
A popular price to buy back is at the $400 level the
previous resistance level which has now reversed to
become the new support level. However, a sensible
trader would have a stop loss level beneath the $400
level in case the expected support level failed to halt
the downtrend in prices.
A
$350
C
$360
$400
B
D $425
Resistance
level New support level
ideal placeto buy
Support level
Support and resistance lines
Section 3
Patterns
74
Retracement
As a market reacts or rallies following a strongly trending move, part
of that price move is retraced this is known as retracement. I f the
amount of retracement can be predicted then trading levels can be
set to a traders advantage. Chartists use percentage retracements to
determine support and resistance levels. Quite often a correction in
a trending market will retrace to approximately half or 50% of the
previous move and so this figure is favoured by many traders. Other
common retracements in a bull trend are approximately 33% and
66%.
As you will see in the later section on Waves, numbers and cycles Gann
charts and Elliott Wave Theor y pay particular attention to
retracements. Gann lines are often drawn in eighths or tenths and
Elliott Wave Theor y predicts retracement levels at 0.382 (about
33%) and 0.618 (about 66%) which are based on the reciprocals of
the Fibonacci numbers 2.618 and 1.618 respectively.
Percentage retracements
On meeting
resistancetheprice
moves back
retraces towards
theprevious
support level
Percentage
retracements
Resistancelevel
Support level
33%
50%
66%
100%
Support and resistance lines
Patterns
Section 3
75
Support and resistance lines
A bar chart of weeklyLaserscope
shareprices
50% retracement
A bar chart of dailybid
USD/ FRF prices
61.8%
100%
Retracements
This is a good exampleof a Head
and Shoulders pattern with a
sloping neckline
61.8%
50%
0%
0%
0%
100%
100%
Section 3
Patterns
76
A moving average is usually created by adding a series of closing
prices and then averaging the data on a period-by-period basis. As
the period moves on, the oldest price in the sequence is dropped
and replaced by the current price in the period.
A moving average is a lagging indicator that provides a way of
smoothing out data and which is used to confirm price trends. The
period chosen for a moving average depends on the type of
instrument being charted the most common periods used are
9/10, 18/20, 40/50, 100 and 200 periods. Futures markets tend to
use shorter-term moving averages, for example, 9 and 18 periods,
whereas for long-term investment instruments, such as equities, 50/
100/200 are more popular periods. Assuming that the instrument
being charted has a cyclical trading pattern, research has shown that
the most successful moving average is associated with the cycle
period for the instrument. There are three types of moving average
used widely, all having benefits and drawbacks, which are:
O Simple Moving Average (SMA)
O Weighted Moving Average (WMA)
O Exponential Moving Average (EMA)
?
?
I n general all three types of moving average are used for the
following:
O To detect trend directions
O To determine buy/sell signals
When using moving averages it is important to remember that you
need to examine the relationship between the actual price and the
moving average. This means that the plot for a moving average must
appear on the price chart using the same X-axis as the instrument
being analysed.
Theposition of themoving average
plot can beused to indicatethe
trend direction of a market
Trend directions
Prices above
moving
average
Moving
averageline
Prices below
moving
average
Moving
averageline
Bullish
Bearish
Moving averages
Market signal
Bullish
Bearish
Price/ moving average relationship
Prices above moving average and
moving average moving up
Prices belowmoving average and
moving average moving down
What is the next moving
average in this sequence?
You can check your answer
on page 59.
Price 3 day moving
average
20 21.67
21 21.67
24 24.00
23 23.67
25
23
20
?
Patterns
Section 3
77
Using classical charting techniques for a single moving average, the
signal for buying is taken as the moving average turning up with
price action above the moving average. However, trading using such
a strategy can result in severe losses if the market prices oscillate
violently known as whipsawing. I n an attempt to avoid losses,
analysts use a two moving average crossover technique to indicate
buy/sell signals. The two moving averages typically comprise a short-
term 5-10 period and a longer-term 15-35 period 9/10 short-term
and 10/20 long-term periods are particularly popular with analysts.
The lines are usually distinguished using different colours in
charting applications although solid and dotted lines may be used
for publications.
Buy and sell signals are indicated as follows:
I f the short-term moving average comes from belowand crosses
above the long-term moving average, then this is a buy signal if
the price action is above the moving average cross-over point.
I f the short-term moving average comes from above and crosses
belowthe long-term moving average, then this is a sell signal if
the price action is belowthe moving average cross-over point.
The crossover is considered to be much more significant if both
averages are moving in the same direction.
I f both averages are moving up, then it is known as a Golden Cross.
I f both averages are moving down, then it is known as a Death Cross.
Short-termmoving
average
Long-term
moving average
Sell
Buy
Sell
Buy/sell signals
Simple Moving Averages
This is the type of moving average which has already been described.
I t is simply the arithmetic average of the number of data points in
the selected period.
A SMA inherently lags behind the market price action and
therefore any signals produced will inevitably lag behind the trend
change that caused the moving average(s) to reverse direction.
Though SMAs provide a simple analytical technique they are still
used widely by chartists.
Simple Moving Average formula
SMA =
P
1
+ P
2
+ P
3
+.......P
n
n
P = Price or value
n = Number of days in period
Moving averages
Section 3
Patterns
78
Short-term SMAs are more responsive and more whippy to price
action than those for long-term averages. So what period should be
used for moving averages? As has been mentioned already the
trading cycle period for a particular market is often used as too is
the half cycle period. For example, in a 50-day futures market
trading cycle the average period used is 25-days.
A SMA also assigns an equal weight to all the prices used to calculate
the average. This approach disregards the importance and relevance
of the most recent data as compared with the earlier data of the
time series used to calculate the moving average. Something
important may have happened ver y recently to affect the market
which is not given sufficient weight. I n order to take into account
some of the criticisms of SMAs two different moving averages can be
used:
O Weighted Moving Average (WMA)
O Exponential Moving Average (EMA)
Both these averages are used in the same way as SMAs but differ in
the way the average is calculated.
Weighted Moving Average
This technique uses a mathematical algorithm which assigns a
greater weight or importance to the most recent data.
The example for a five day period illustrates the process. The price
for each day is multiplied by its day number and added together.
This total is divided by the sum of the day multipliers to determine
the WMA. The older the day in the period the smaller the multiplier
used.
Exponential Moving Average
This is similar to a WMA in that the average also assigns a greater
weight to the most recent data. However, in this case, instead of
using a fixed number of data points (the periodicity), the EMA uses
all the data that is available. Each price entr y becomes less
significant but is still included in the calculation which uses a
complicated formula.
Example of a Weighted Moving Average calculation
P = Price or value
WMA =
5 x (P
1
)+ 4 x (P
2
) + 3 x (P
3
) + 2 x (P
4
) + 1 x (P
5
)
(5 + 4 + 3 + 2 + 1) = 15
Moving averages
Patterns
Section 3
79
Moving averages
Bar chart of dailycloseprices for Bass PLC shares
SMA
100 day period
Bar chart of dailycloseprices for Bass PLC shares
Bar chart of dailycloseprices for Bass PLC shares Bar chart of dailycloseprices for Bass PLC shares
SMA
14 day period
WMA
14 day period
Short term SMA
10 day period
Long term SMA
50 day period
WMA
14 day period
EMA
Section 3
Patterns
80
Relative performance is a measure of how well an individual stock
or stock market group of companies are performing relative to the
market as a whole or relative to another stock, over a specified
period.
I f the relative performance is positive and rising, then the stock is
outperforming the index. I f the relative performance is falling, then
this indicates underperformance.
?
?
As relative performance is a comparison, it is normal to plot the
data at the bottom of a price chart as a sub-plot. The relative
performance plots produced are used as indicators to detect and
confirm market trends.
A change in trend of the relative performance chart may be a
warning signal that something is changing in the share price itself. A
move in a share price accompanied by a similar move in relative
performance is taken as a reliable signal and confirmation to buy or
sell.
Calculating relative strength
The formula to calculate Relative strength for the closing prices of a
share against a Stock index is as follows:
Relative
performance
A1 = Latest closing price for share
B1 = Latest closing price for Stock index
A2 = Reference (start) closing price for share
B2 = Reference (start) closing price for Stock index
Thefalling relativeperformance
lineindicates thestock market
outperforming theshare
Shareprice
Relativeperformance
line
Therising relative
performanceline
shows uptrending sign
of strong share
Shareprice
Relativeperfromance
line
Relative performance
A2
B2
A1
B1
A1
B1

=
Patterns
Section 3
81
Relative performance
A linechart of dailyclosing prices for
Bass PLC shares
Relativeperformanceof Bass PLC shares
compared with theFT-SE 100 Index over
thesameperiod
This shows a linechart for dailylast
tradevalues for theNikkei 225 Index
and a bar chart for dailylast trade
S&P 500 Index values
TheRelativeperformancesub-chart
shows that theS&P 500 starts to
performconsistentlybetter than the
Nikkei fromthemiddleof July
Section 3
Patterns
82
I f price action evolves such that no trading occurs between, for
example, the close of one price and where it next opens, then a gap
or hole is produced in a price chart. However, subsequent trading
within the new period may succeed in filling this gap. A true gap
means that there is no trading price overlap because the prices have
skipped a price area. A gap occurs when the majority of market
players simultaneously decide that prices should be adjusted swiftly.
Thus a gap may be defined as follows:
The lowprice of a period is higher than the high price of the
preceeding period or conversely the high of the period is lower
than the preceding low.
Gaps are commonly seen in futures markets, much less so in equity
markets and rarely in spot FX currency markets.
?
?
Gaps are patterns which are used to determine and confirm price
moves. There are four basic types of gap which have different uses:
O Common
O Breakaway
O Runaway
O Exhaustion
Common gap
This type is seen in a sideways or congestion trading area and usually
indicates a market lack of interest in the price of an instrument.
This type of gap is also found typically with low volume trading
where there are few active market participants.
Breakaway gap
This type of gap occurs usually at the end of a consolidation such as
an ascending triangle and signals the start of a significant market
move. This type also usually occurs on a heavy volume of trading
and is associated with a volume increase at the time of the gap.
Gap
Common gap
Gap
Breakaway gap
Gaps
Low
High
Low
High
Low
High
Low
High
Previous
period
Previous
period
Gap
Patterns
Section 3
83
Runaway or measuring gap
This occurs typically in the middle of price move and is used to
estimate the size of a move it is taken as signal of a continuing
trend. The volume may not increase at the gap but if it does, then it
usually indicates a strong trend.
As the gap usually occurs in the middle of a price move the final
price move is easily calculated using the price difference from the
beginning of the move to the gap.
Exhaustion gap
This type signals the end of a price move and can be confused with a
runaway gap. Typically an exhaustion gap occurs ver y near to the
last day of a price trend which then reverses. The difference
between an exhaustion and a runaway gap is that the former
involves a ver y high volume of trading.
Gap
50% of move
Final pricemove
estimate
Runaway gap
Exhaustion gap
Gap
Thepeak in prices is
accompanied bya
peak in volume
Gaps
Section 3
Patterns
84
Gaps
A bar chart of dailylast tradeprices for
3 month forward contracts for Nickel on the
LME
A bar chart of dailylast tradeprices for
CoffeeC futures on theNew York CoffeeSugar
and Cocoa Exchangefor March 1997
Someof themoreobvious gaps are
within thehighlighted areas
Patterns
Section 3
85
Chart exercise1
Open Reuters 3000 and in a new workspace type in
CBRY.L for Cadbury shares. Make sure the
Technicals tab is to the front and click on the
Relative Performance page tab. You should now
see Relative Performance charts of Cadbury shares
relative to the FT All Share index and to the FTFM
index the appropriate FT market sector for Food
Processing.
RT
Charting exercises
I f you have access to Reuters Graphics and/or
Reuters 3000 you may like to have a look at the
following exercises which have been designed to
help you understand more fully the various
patterns described in this section.
Section 3
Patterns
86
Chart exercise2
Open Reuters Graphics (v3.1) and enter CBRY.L
to display a 2 year daily bar chart for Cadbur y
shares. From the Study menu first select the
Moving Average simple option and display a chart
with an average period of 100 days. You should see
a chart like this.
Now add a 14 day Weighted Moving Average and
an Exponential Moving Average to the chart and
you can investigate the moving averages. You will
need to alter the X-axis to view different time
periods.
RG
Patterns
Section 3
87
Quick quiz questions Summary
You have now finished the third section of the workbook and you
should have a clear understanding of the following patterns:
Trendlines
Continuation/consolidation patterns
Reversal patterns
Support and resistance
Moving averages
Relative performance
Gaps
As a check on your understanding of this section you should tr y the
Quick quiz questions. You may also find the section Over view a
useful revision aid.
1. This chart has a number of patterns. I ndicate and name as
many as you can.
2. This chart has a wedge pattern. I ndicate its position.
You can check your answers on page90.
Section 3
Patterns
88
Overview
Patterns
Trendlines
O Line connecting consecutive high or low data
points in order to identify the direction of a
market
O Uptrend is a line connecting at least 3
consecutive rising low points and is drawn under
the points
O Downtrend is a line connecting at least 3
consecutive falling high points and is drawn
above the points
Reversal patterns
O I ndicate an impending top or bottom in market
prices coupled with a trend reversal
O Patterns in downtrend are inverse of those in
uptrend
O Most common reversal patterns are:
Head and Shoulders
Double and Triple tops/ bottoms
Wedges
Rounding or saucer top/ bottom
Continuation/consolidation patterns
O Occur during consolidation where prices are
moving sideways rather than in an up or down
trend
O Most common continuation patterns are:
Triangles
Rectangles
Flags and pennants
Support and resistance lines
O Support line level that
supports market price action
for a period of time
O Resistance line level that
resists market price action for
a period of time
O Retracement as a market
reacts back following a
strongly trending move part of
the price move is retraced
Relative performance
O Measure of how well an individual stock or group
of stocks are performing relative to the market as
a whole, or relative to another stock, over a
specified period
Moving averages
O Moving averages are produced by adding a series of closing
prices, then averaging the data on a period-by-period basis. As
the period moves on, the oldest price is dropped and replaced
with current price in the period.
O Simple Moving Average (SMA) is a simple arithmetic average in
the selected period
O Weighted Moving Average (WMA) assigns a greater weight to
more recent prices
O Exponential Moving Average (EMA) assigns a greater weight to
more recent prices but uses all the prices the oldest price is
not dropped off
Gaps
O A gap in prices occurs when there is no trading
price overlap because the prices have skipped an
area
O There are four types:
Common
Breakaway
Runaway or measuring
Exhaustion
Patterns
Section 3
89
Further resources
Books
Technical Analysis of the Futures Markets
John J. Murphy, New York I nstitute of Finance, 1986
I SBN 0 13 898008 X
Technical Analysis Explained
Martin Pring, McGraw-Hill, 1991
I SBN 0 0705 1042 3
The NewCommodity Trading Systems and Methods
Perr y Kaufman, J. Wiley & Sons, 1987
I SBN 0 4718 7879 0
Technical Analysis from A X
Steven Achelis, Probus Publishing Co., 1995
I SBN 1 55738 816 4
Technical Analysis of Stocks and Commodities
Reversal Patterns by M.F. Bowman
Vol. 8:10 (371-376), 1990
Consolidation Patterns by M.F. Bowman and T. Hartle
Vol. 8:11 (405-409), 1990
Gaps by T. Hartle and M.F. Bowman
Vol. 8:12 (453-455), 1990
Calculating Relative Strength of Stocks by R. L. Hand
Vol. 10:5 (235-237), 1992
Support and Resistance Levels by J.J. Kosar
Vol. 11:1 (17-19), 1993
Trade with Moving Averages by C. Alexander
Vol. 11:6 (257-260), 1993
Section 3
Patterns
90
Quick quiz answers Your notes
1. This chart has a number of patterns. Indicateand nameas many as
you can.
Inversehead
and shoulders
Doubletop
Doubletop
2. This chart has a wedgepattern. Indicateits position.
Wedge
Indicators
91
Section 4
C
o
n
t
e
n
t
s
93
96
98
102
106
109
109
110
111
112
12
3
6
9
1
2
4
5 7
8
11
10
This section of the module should take about 60
minutes of study time. You may not take as long
as this or it may take a little longer remember
your learning is individual to you.
Introduction
Relative Strength Index
Stochastic oscillators
Moving Average Convergence Divergence
Charting exercises
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Section 4
Indicators
92
In 1954, I was fortunate to join Investment Educators as a gopher.
I carried luggage, ran the projector, made charts and took
attendance for the owner, Ralph Dystant, and for the technical
guru, Roy Larson.
Lanes Stochastics by GeorgeC. LaneMD
Technical Analysis of Stocks and Commodities , Vol. 2:3 (87-90), 1984
Indicators
93
Section 4
Introduction
The construction of charts is relatively straightfor ward but as you
have seen the process of identifying patterns is much more
complicated. The patterns seen in charts are seldom exact text-book
versions of ones you are seeking. The result is that predictions based
on price movement charts exclusively are never completely reliable.
I n most cases indicators are themselves plotted on sub-charts using
the vertical axis for the indicator and the horizontal axis for time.
These indicator plots are usually placed beneath the price
movement plot so that both plots use the same time axis. The chart
below shows a typical combination of price movement and volume
charts for an equity.
Confirmation when:
Increasing volumeon
uptrend highs and
decreasing volumeon
uptrend lows
oppositefor downtrend
Volume
data
Market players use a variety of indicators to confirm or reinforce
their trading strategies which they have derived from charting. Many
indicators are now in use, some are easy to use and others involve
complex mathematical calculations which have been developed by
market practitioners. I t is important to recognise that different
indicators can be more suited to different types of market
instruments, for example, equities and spot FX currencies.
Successful analysts use a cocktail of indicators to derive a trading
strategy it would be a mistake to use a single indicator in isolation.
I ndicators which are used in fast moving commodities futures
markets will not necessarily be so successful in the more long term
equities markets or those used for stock indices. I t is also worth
noting that as the power of computing techniques is constantly
being improved and as markets are expanded so to are the numbers
of indicators either new or adaptations of existing techniques.
What can market players do to
improve the reliability of their
predictions of future market trends?
What kind of tools and techniques
are available? You will probably
remember that even Dow recognised
that he needed confirmation of a
trend before implementing any
particular trading strategy. Dow used
volume as one of his indicators.
Types of indicators
There are two basic types of indicators you will encounter:
O Confirmation or divergence indicators
As their name implies, confirmation indicators confirm
underlying trends. Divergence is when the indicator line
moves away from the price line in an opposite direction.
I n effect divergence is non-confirmation which is seen as a
warning signal.
O Momentum indicators or oscillators
These indicators measure the rate of change, or velocity,
of price movements as opposed to the actual price levels
and are used to help determine a trading strategy.
Divergence is also a ver y important factor in utilising these
indicators.
Section 4
Indicators
94
Confirmation or divergence indicators
These indicators are based on, or associated with, the primar y price
movement chart. You have already been introduced to most of these
indicators either in the Chart types or Patterns sections and they
include:
O Volume
O Open interest
O Relative performance
O Moving averages
Volume This is one of the oldest indicators
orginally used by Dow. The values are
obtained from separate data associated
with the instrument prices. Generally
volume is used to confirm price
movement divergence is taken as a
warning signal.
Open interest This is similar to volume in use. The
values are also obtained from separate
data associated with the instrument
prices. Futures traders use this
indicator a strong up trend should be
confirmed by rising open interest.
Relative performance Relative performance measures the
relationship between a particular
instrument and the overall
performance of the market or market
sector. Any rises or falls must be put in
context for example, a share price
rise of 15% is not impressive if the
average market sector rise is 25%. A
change in the relative performance
trend can indicate an impending
change in the underlying price trend.
Moving average Moving averages are used to smooth
price information in order to confirm
trends and support and resistance
levels. They are also useful in deciding
on a trading strategy particularly in
futures trading or a market with a
strong up or down trend.
For simple moving averages the price is
averaged over a number of days. On
each successive day the oldest price
drops out of the average and is
replaced by the current price hence
the average moves daily. Exponential
and weighted moving averages use the
same technique but weight the figures
least weight to the oldest price, most to
the current price.
Momentum indicators or oscillators
These indicators measure the rate of change, or velocity, of
directional price movement and are used to give warning of short
term turning points.
When prices move up rapidly they are said to be overbought and this
is taken as a signal not to buy. When prices move down rapidly they
are said to be oversold and the signal is not to sell. A heavily
overbought/oversold situation is generally taken as an indication
that a market reaction or possibly even a reversal is imminent. The
reaction to a heavily overbought market can be a period of sideways
consolidation. Oscillators include:
O Relative Strength I ndex (RSI )
O Stochastic oscillator
O Moving Average Convergence Divergence (MACD)
Indicators
95
Section 4
Volume, Open interest, Relative performance and Moving average
as chart types or patterns have already been discussed but examples
of their use as indicators are covered in this section.
Momentum indicators are described using the same format as used
in previous sections and cover:
O Relative Strength I ndex (RSI )
O Stochastic oscillator
O Moving Average Convergence Divergence (MACD)
I t is important to remember that this workbook is not an exhaustive
treatment of indicators it only provides an over view to the subject.
I f you want to find out more then you might like to have a look at
some of the materials given in Further resources.
Stochastic oscillator
This is used to indicate overbought/oversold conditions on a
scale 0 100%. The indicator is based on the obser vation that in
a strongly trending uptrend market, closing prices for periods
tend to concentrate in the higher part of the periods range.
Conversely as prices fall in a strongly trending downtrend market,
close prices tend to be near to the extreme low of the period
range.
Stochastic calculations produce two lines, %K and %D which are
used to indicate overbought/oversold areas on a chart.
Divergence between the stochastic lines and the price action of
the underlying analysis gives a powerful trading signal.
Moving Average Convergence Divergence (MACD)
This indicator was devised by Gerald Appel and involves plotting
two momentum lines. The MACD line is the difference between
two exponentially moving averages and the signal or trigger line
which is an exponentially smoothed moving average. I f the
MACD and trigger lines cross, then this is taken as a signal that a
change in trend is likely.
Relative Strength Index (RSI)
This index was created by the US analyst J. Welles Wilder and is a
popular indicator which is applied to FX, commodity and equity
markets. The indicator compares an instrument only with its own
past performance.
The RSI measures the ratio of up-moves to down-moves and
normalises the calculation so that the index is expressed in a
range 0 100. I f the RSI is 70 or greater then the instrument is
seen as overbought a situation whereby prices have risen more
than market expectations. An RSI of 30 or less is taken as a signal
that the instrument may be oversold a situation whereby prices
have fallen more than market expectations. Many analysts prefer
to use overbought/oversold levels of 80/20 rather than 70/30.
Section 4
Indicators
96
Relative Strength Index
J. Welles Wilder originally developed the Relative Strength Index
indicator for use with price bar charts of individual stocks,
commodities or stock indices. However, the RSI is now used in all
markets. The indicator compares an instrument only with its own
past performance. I t is not a comparison with other instruments or
the market in general this is Relative performance.
?
?
The RSI should be used in conjunction with price movement charts
but not together with other indicators of the same type, for
example, stochastics. RSI values lie in the range 0 100 which may
be used to indicate the following:
O Overbought/ oversold conditions
A line is drawn at 70/80 above which the instrument is
said conventionally to be overbought and is a signal to
exercise caution in buying at that level. Below a line at
30/20 the instrument is said to be oversold and it is a
signal to think carefully before selling.
O Tops and bottoms
A top may be signified when a RSI peak is seen through
the 80/70 level followed by a down-turn; similarly a
bottom may be signified by a RSI trough through the 30/
20 level followed by an up-turn. The RSI analysis provides
only part of the evidence needed for market confidence
that a top/bottom has been formed.
O Patterns
Typical patterns such as head and shoulders, tops/bottoms
and pennants may be more obvious in the RSI chart than
in the price chart.
O Divergence
Divergence between price action and RSI is often taken as
a strong indication of a market turning point. Thus in an
uptrend, price action makes new highs compared with the
previous peak but the RSI indicator fails to reach and
surpass its equivalent previous high point.
Calculating the index
The RSI measures the ratio of average prices and
normalises the calculations so the index values lie
between 0 and 100. The index may be calculated
using the following formula although others are
used:
Onetechniqueis to varythelevel of theoverbought/
oversold lines according to whether themarket is in up or
down trend. For example, in an uptrending chart the
lines maybedrawn at 80 and 40, whereas in a
downtrending chart theymaybedrawn at 60 and 20.
100
1 + RS
RSI = 100
Where:
Up close is the price change between consecutive
periods where the close has moved higher
Down close is the price change between consecutive
periods where the close has moved lower
Wilder originally used n = 14 but other periods in
common use are 9 and 21 days.
Overbought area
Oversold area
RSI lines
70
30
0
100
RS = Sum of the up closes in n days
Sum of the down closes in the same n days
Indicators
97
Section 4
Relative Strength Index
A bar chart of dailyprices for Reuter
Holdings shares
TheRSI chart is based on a 14 day
period
Theupper lineis drawn at 70% and
thelower at 30%
A bar chart of dailylast tradeprices for
OrangeJuicefutures on theNew York
Cotton Exchange
TheRSI chart is based on a 9 day
period
Theupper lineis drawn at 80% and
thelower at 20%
Divergencebetween price
action and RSI
Section 4
Indicators
98
Stochastic oscillators originated as an engineering analytical
technique and were adopted by the US analyst George C. Lane as a
way of indicating overbought/oversold conditions using a simple %
scale. A key use of the indicator is to look for divergence between
the stochastic lines and that of the instrument price itself. This
information can be used to reinforce buy/sell trading decisions.
Stochastics are based on obser vations of instrument prices:
O As prices decrease in a trending market the closes tend to
be nearer the extreme lows of the period price range
O As prices increase in a trending market the closes tend to
be nearer the extreme highs of the period price range
The stochastic analysis is available in two forms fast and slow.
Fast stochastics use two oscillating lines which are shown as different
colours in charting applications or as solid or broken lines in
publications. The rawvalue or %K line (solid line) is shown on a
chart scale 0 100. The other line, shown on the same chart, is a
simple moving average of %K and is called the %D line (broken
line).
Slowstochastics use the %D line of fast stochastics together with a
simple moving average of this line usually called the SlowD. Fast
stochastics give a strongly oscillating chart and it is for this reason
that many analysts prefer now to use slow stochastics.
?
?
As for the RSI indicator, Stochastics are used to identify potentially
overbought/oversold situations. Divergence between the stochastics
performance and that of the underlying price action is ver y
important.
Overbought conditions are generally taken as occurring when the
lines move over 70/ 80%; oversold is taken when the lines move
below30/ 20%.
Stochastic oscillators
%K line solid
%D line dotted
100%
80%
20%
0%
Overbought region
Oversold region
Indicators
99
Section 4
Calculations
%D = SMA(%Kn
2
)
Stochastic oscillators
Bearish divergence
Higher tops
in prices
Lower tops
in %D
Bullish divergence
Lower
bottoms in
prices
Higher troughs in %D
Bearish divergence
This is indicated when %D forms two peaks, the second lower than
the first, in the overbought region, while the underlying prices are
rising. Confirmation to sell comes when, for Slow stochastics, the
%D line comes from above and crosses belowthe Slow D line.
Bullish divergence
This is indicated when %D forms two troughs, the second higher
than the first, in the oversold region, while the underlying prices are
falling. Confirmation to buy comes when for Slow stochastics, the
%D line comes from belowand crosses above the Slow D line.
Slow D = SMA(%Dn
3
)
%K = 100 x
Current close Lowest low over n
1
periods
Highest high Lowest low over n
1
periods
By far the commonest value used for n
2
is 3. Thus for fast stochastics,
%D, is the 3 period simple moving average of %K. For slow
stochastics, almost without exception, the value for n
3
is 3. Thus
Slow D is the 3 period simple moving average of %D.
The fact that a market is indicated as overbought should not be seen
necessarily as a sell signal or indication of an imminent trend
reversal. I n any strongly trending market, overbought/oversold
conditions can exist for a considerable perod of time. One of the
most powerful signals that stochastics can deliver is that of
divergence. However, the key to the successful use of stochastics is to
use them in association with other indicators/analyses to indicate
when a market is grossly overbought/oversold.
Section 4
Indicators
100
Stochastic oscillators
A bar chart of dailylast
tradeprices for Reuter
Holdings shares
Themiddlesection shows
theFast stochastic %D
(9,3) and %K (9) lines,
which areshown in
different colours onscreen
theoverbought and oversold
lines areshown at 80%
and 20% respectively
Thelower section shows
theSlow stochastic %D
Slow (9,3,3) and %D
(9,3) lines, which are
shown in different colours
onscreen theoverbought
and oversold lines are
shown at 80% and 20%
respectively
%K
%D
%D
%D Slow
You mayseethe%D linereferred to as the%K
Slow lineas in Reuters 3000
Thefirst of thefigures
shown in brackets relating
to %D and %Kindicate
thelength of period used.
Thesecond and third
figures represent the
moving averagefor the
number of periods used.
Indicators
101
Section 4
Stochastic oscillators
A bar chart of dailylast
tradeprices for Microsoft
shares
Themiddlesection shows
theSlow stochastic %D
Slow (9,3,3) and %D
(9,3) lines, which are
shown in different colours
onscreen theoverbought
and oversold lines are
shown at 80% and 20%
respectively
Thelower section shows
theSlow stochastic %D
Slow (21,3,3) and %D
(21,3) lines, which are
shown in different colours
onscreen theoverbought
and oversold lines are
shown at 80% and 20%
respectively
Thefirst of thefigures
shown in brackets relating
to %D and %K indicate
thelength of period used.
Thesecond and third
figures represent the
moving averagefor the
number of periods used.
Section 4
Indicators
102
The Moving Average Convergence Divergence (MACD) oscillator
indicator was devised by Gerald Appel as a technique to signal trend
changes and indicate trend direction. I t was originally designed to
obser ve the stock markets 26 and 13 week cycles. The procedure
uses two exponential moving average lines to indicate overbought/
oversold signals that oscillate above and below a zero line. There are
no upper or lower boundaries, for example 0 - 100, as used in
stochastics or the RSI .
First line
This is usually displayed as a solid line and is called the Fast MACD
line or plot. This line is the difference between a short and long
moving average of the price usually with smoothing factors
equivalent to 12/13 and 26 period EMAs being used.
Second line
This is often displayed as a dotted line, or a line of different colour
in charting applications, and is called the SlowMACD or signal line.
This line is an exponential moving average of the Fast MACD line. I t
is usual to see a smoothing factor equivalent to 9 periods used in the
EMA. Gerald Appel recommended 9, 12 and 26 as the periods which
should be used for the MACD lines.
?
?
I n common with moving averages, MACD is used to determine buy/
sell signals and to detect trend changes.
Sell signal
This is indicated when the Fast MACD line crosses from above to
belowthe signal line when both have positive values. The higher
above the zero line this crossover occurs, the stronger the signal is
said to be. Crossovers which occur with negative values should be
ignored.
Buy signal
This is indicated when the Fast MACD line crosses from belowto
above the signal line when both have negative values. The further
belowthe zero line this crossover occurs, the stronger the signal is
said to be.
Sell signal
Fast MACD linecrosses
fromaboveto below the
slow line
Fast MACD
Slow MACD
Zero line
Buy signal
Fast MACD linecrosses
frombelow to abovethe
slow line
Fast MACD
Slow MACD
Zero line
Moving Average Convergence Divergence
Both lines have
positivevalues
Both lines have
negativevalues
Indicators
103
Section 4
Fast MACD line
Traditionally this is produced by subtracting a 26 equivalent period
EMA from that for the 13 equivalent period EMA.
Slow MACD line
This is formed by smoothing the fast line with a 9 equivalent period
EMA.
Trends
Successive highest highs (or lowest lows) of market prices are
compared with highest highs (or lowest lows) of MACD when
plotted in forest graph form. I f there is a divergence in trend
between price action of the instrument and that of the MACD forest
graph then this is taken as a good indicator of a possible trend
reversal.
The criticisms of the MACD indicator are the same as those applied
to moving averages in general the most significant being that they
lag the market.
Buy/sell signals
Moving Average Convergence Divergence
Fast MACD
Slow MACD
Zero line
Buy
Sell
Prices trend up
MACD lines
trend down
Rather than plotting the analysis as two lines, a further technique is
to plot the difference between the lines as a forest graph. This
technique is ver y important as it is used to look for any divergence
which may occur between the price action for the instrument and
the MACD forest graph.
Smoothing factors
There is a simple formula which gives a good approximation
between smoothing factor used in the EMA algorithm and the
equivalent number of periods (n):
Smoothing factor =
2
n + 1
Divergence
Smoothing
factor
0.20
0.15
0.075
n
9
12
26
Section 4
Indicators
104
Moving Average Convergence Divergence
A candlestick chart of daily
bid prices for DEM/ FRF
cross rates
TheFast MACD and Slow
MACD signal lines are
shown in different colours
onscreen
A forest graph showing the
differencebetween thetwo
MACD lines
Signal line
Zero line
Indicators
105
Section 4
Moving Average Convergence Divergence
A bar chart of dailylast
tradeprices for Eurodollar
futures for March 1997
on theCME
TheFast MACD and
Slow MACD signal lines
areshown in different
colours onscreen
A forest graph showing
thedifferencebetween the
two MACD lines
Signal line
Zero line
Section 4
Indicators
106
Charting exercises
I f you have access to Reuters Graphics and/or
Reuters 3000 you may like to have a look at the
following exercises which have been designed to
help you understand more fully the various
indicators described in this section.
Chart exercise1
Open Reuters 3000 and in a new workspace type in
BAY.L@RSI to display a daily bar chart for British
Airways shares together with the Relative Strength
I ndex indicator sub-chart based on a 14-day
period. The system will default a 6 month histor y.
Now click on the X-
axis button in the
bottom toolbar and
change the data to
be viewed to 2 years.
You should now see a
screen similar to this. I f
you are unsure of what the
charts mean then
tr y using Help. You
will find a lot of
useful information
such as shown here.
RT
Indicators
107
Section 4
Chart exercise2
Open Reuters 3000 and in a new workspace type in
RTR.L@BAR to display a daily bar chart for
Reuters shares. Change the X-axis to view 2 years
of data.
Click the Stochastics Page tab to display sub-charts
for both Fast and Slowstochastics. I f you
need further explanation on the sub-charts
then use the Help facility.
RT
Section 4
Indicators
108
Chart exercise3
Open Reuters Graphics (v3.1) and enter CBRY.L
to display a 2 year daily bar chart for Cadbury
shares. Now open a new chart and from the Study
menu select the MACD option and display a sub-
chart.
The fast MACD line is the red line with the MACD
W (Weighted) legend the slowor signal MACD
line is the blue line with the MACD legend.
RG
Indicators
109
Section 4
Summary
You have now finished the fourth section of the workbook and you
should have a clear understanding of the following indicators:
Relative Strength I ndex (RSI )
Stochastic oscillator
Moving Average Convergence Divergence (MACD)
As a check on your understanding of this section you should tr y the
Quick quiz questions. You may also find the section Over view a
useful revision aid.
Quick quiz questions
1. Which of the following statements are true and which are false
concerning the Relative Strength I ndex indicator?
a) The indicator compares an instrument with
another instruments past performance
b) I f the RSI chart line is over a line drawn at
80, the instrument is said to be overbought
c) Divergence between price action and RSI is
often an indication of a market turning point
d) Patterns such as head and shoulders are not
ver y obvious in an RSI chart
True False
2. The following diagram shows two sections, A & B, of a
Stochastic %D line sub-chart. A & B are examples of Bullish
and Bearish divergence, but which is which?
A
B
80%
20%
A =
B =
3. Complete the missing words in the following statement.
When using the MACD indicator a selling signal is indicated
when the Fast MACD line crosses from above to below the
signal line when both have positive values. The further above
the zero line this crossover occurs, the stronger the signal is
said to be.
You can check your answers on page112.
Section 4
Indicators
110
Overview
Indicators
Relative Strength Index (RSI)
O Developed by Welles Wilder, this indicator is
applied to FX, commodity and equity markets
O Compares an instrument only with its own past
performance
O RSI values lie in the range 0 100:
Overbought line is usually set at 70/ 80
Oversold line is usually set at 30/ 20
Stochastic oscillator
O Adopted by Lane as a way of indicating
overbought/ oversold conditions using a simple
% scale
O Provides a way of signalling divergence between
a stochastic line and instrument price
O Two types of stochastic analysis Fast and Slow
O Fast stochastics uses two oscillating lines the
rawvalue or %K line and a simple moving
average of %K line called the %D line
O Slowstochastics uses the %D line together with
a simple moving average of this line called the
SlowD line
O Overbought conditions are usually over 70/ 80%
O Oversold conditions are usually under 30/ 20%
Moving Average Convergence Divergence
(MACD)
O Devised by Appel this oscillator signals trend
changes and indicates trend directions
O Fast MACD line is difference between a short
and long moving average of the price
O SlowMACD or signal line is an exponential
moving average of the Fast MACD line
O Sell signal when the Fast MACD line crosses
from above to belowthe signal line when both
have positive values
O Buy signal when the Fast MACD line crosses
from belowto above the signal line when both
have negative values
Indicators
111
Section 4
Further resources
Books
Technical Analysis of the Futures Markets
John J. Murphy, New York I nstitute of Finance, 1986
I SBN 0 13 898008 X
Technical Analysis Explained
Martin Pring, McGraw-Hill, 1991
I SBN 0 0705 1042 3
The NewCommodity Trading Systems and Methods
Perr y Kaufman, J. Wiley & Sons, 1987
I SBN 0 4718 7879 0
Technical Analysis from A X
Steven Achelis, Probus Publishing Co., 1995
I SBN 1 55738 816 4
Technical Analysis of Stocks and Commodities
Lanes Stochastics by G.C. Lane
Vol. 2:3 (87-90), 1984
Stochastic oscillator by M. Takano
Vol. 7:3 (86-86), 1989
Stochastic Oscillator: Sidebar
Vol. 8:2 (469-472), 1990
Stochastics by T. Hartle
Vol. 9:3 (103-103), 1991
Stochastics Indicators and Trading by D. Lundgren
Vol. 11:3 (144-146), 1993
RSI Variations by B. Star
Vol. 11:7 (292-297), 1993
The MACD Momentum Oscillator by B. Star
Vol. 12:2 (81-85), 1994
Using Indicators in Trading Ranges and Trends by B.C. Kramer
Vol. 12:4 (153-157), 1994
Section 4
Indicators
112
Quick quiz answers Your notes
1. Which of thefollowing statements aretrueand which arefalse
concerning theRelativeStrength Index indicator?
a) Theindicator compares an instrument with
another instruments past performance
b) If theRSI chart lineis over a linedrawn at
80, theinstrument is said to beoverbought
c) Divergencebetween priceaction and RSI is
often an indication of a market turning point
d) Patterns such as head and shoulders arenot
very obvious in an RSI chart
True False
v
v
v
v
2. Thefollowing diagramshows two sections, A & B, of a Stochastic
%D linesub-chart. A & B areexamples of Bullish and Bearish
divergence, but which is which?
A
B
80%
20%
A =Bearish
B =Bullish
3. Completethemissing words in thefollowing statement.
When using the MACD indicator a selling signal is indicated
when the Fast MACD line crosses from above to below the
signal line when both have positive values. The further above
the zero line this crossover occurs, the stronger the signal is
said to be.
Overbought
Oversold
Waves, numbers and cycles
Section 5
113
1, 1, 2, 3, 5, 8, 13, ?
C
o
n
t
e
n
t
s
115
120
124
128
129
129
131
132
133
12
3
6
9
1
2
4
5 7
8
11
10
This section of the module should take about 60
minutes of study time. You may not take as long
as this or it may take a little longer remember
your learning is individual to you.
Introduction
Elliott Wave Theory and Fibonacci
numbers
Gann charts
Charting exercise
Summary
Quick quiz questions
Overview
Further resources
Quick quiz answers
Section 5
Waves, numbers and cycles
114
1, 1, 2, 3, 5, 8, 13, ?
Betting on a horse, thats gambling; betting you can make three
spades, thats entertainment; betting that cotton will go up three
points, thats business. See the difference?
Gann Lines and Angles by Robert Pardo
Technical Analysis of Stocks and Commodities , Vol. 3:5 (177-183), 1985
Waves, numbers and cycles
Section 5
115
1, 1, 2, 3, 5, 8, 13, ?
Introduction
So far you have seen that trendlines combined with pattern
recognition and a variety of indicators can be used to predict future
prices and help determine trading strategies. You have also seen the
importance of using different techniques for different instruments
and market situations.
Elliott noticed that within cycles the same pattern was apparent an
advancing phase with peaks at 1,3 and 5 which he called impulse
waves and troughs at 2 and 4 which he called corrective waves.
Once the five wave movement was complete the market moved into
a three wave corrective movement a,b and c.
Elliotts Wave Theory has been applied to many markets now and
has three important aspects.
O Patterns
The most important element of the theor y is that wave
patterns exist which are repeated in cycles.
O Time
Time relationships are used to confirm wave patterns.
Elliott identified a number of time periods for cycles the
grand supercycle lasted 150 - 200 years whereas the sub-
minuette lasted less than a day.
O Ratio
Elliott noticed that there were 8 waves in some complete
cycles; others had 34 and 144 waves. He also discovered
there were mathematical relationships between the
proportions of different waves.
Whilst recovering after an illness in 1927 a retired accountant, Ralph
Nelson Elliott, spent time in analysing the events in numerous Dow
major trends. Like Dow, Elliott was interested in an overall
perspective of market movements rather than how individual stocks
performed.
I n 1938 Elliott published his Wave Theory which was devised to help
explain why and where certain chart patterns develop and what they
signalled. Elliott took Dows original three phases of a bullish trend
but considered the pattern to be closer to a repetitive rhythm of five
waves advancing (bullish) and three waves declining (bearish). This
rhythmic pattern was repeated over a wide range of time periods
and was called a cycle.
Dow identified trends in the market and thought of the various
types as major the tide, intermediate waves, and minor ripples.
Major trend
Intermediate
trend
Minor
trend
Bullish Bearish
Cycle 0
1
3
5
2
4
a
b
c
Section 5
Waves, numbers and cycles
116
1, 1, 2, 3, 5, 8, 13, ?
What were these relationships and what was the significance of the
ratios Elliott found? I n measuring the proportions of peaks and
troughs Elliott discovered that the ratio of wave height to the next
higher wave was often,
approximately 0.618 and
the ratio to the previous
lowwave was
approximately 1.618. The
ratio between alternate
wave numbers was also
consistently, approximately
2.618. The reciprocal value
of 1.618 is 0.618 and the
reciprocal value of 2.618 is
0.382 which is another important number in Elliott Wave Theor y.
What, if anything, did all these numbers mean? I n the natural world
there is a well established sequence of numbers governing events
and phenomena such as plant leaf arrangements and the numbers
of rabbits that can breed from a single pair. This sequence was first
identified by an I talian mathematician in the thirteenth centur y
Leonardo Pisano or Fibonacci. Fibonacci identified the sequence as:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144,...
The sequence is often referred to as Fibonacci numbers and is easily
calculated as each number in the sequence is obtained by summing
the previous two digits. I f you test these numbers, the further you
move down the series, the truer the following statements:
O The ratio of any number to its higher number is 0.618
O The ratio of any number to its lower number is 1.618
O The ratio of alternate numbers is 2.618
Why not prove these statements to yourself?
34
55
=
55
34
=
144
55
=
The ratios of 0.618 and 1.618 were also known to ancient Greek and
Eygptian scholars, artists and builders. The Golden Ratio, Section or
Mean proportions were used in constructions such as the Great
Pyramid of Giza and the Parthenon.
You will probably have noticed by now
the striking similarity in the numbers
associated with Elliott waves
and wave ratios with Fibonacci numbers.
3, 5, 8, 34, 144
Declining waves
Ascending waves
Wavepatterns
0
1
3
5
x
y
z
x
y
=0.618
y
x
=1.618
z
x
=2.618
TheGolden section
for each rectanglethe
sides havethe
proportions 1: 1.618
Waves, numbers and cycles
Section 5
117
1, 1, 2, 3, 5, 8, 13, ?
During his career Gann also produced many other tools and
techniques such as trading rules to help chartists and traders.
Most of the charts you have seen so far involve relatively short time
periods. However, an investigation of price movements and market
behaviour over much longer periods reveals some interesting cycles
in stock market performance and individual price movements.
Edward R. Dewey noted that 18.2, 9.2 and 4 year cycle periods are
important in stock markets he also found that international battles
follow a 22.2 year cycle!
I n the 1920s a Russian economist Nickolai D Kondratieff studied
commodity prices, interest rates, wage levels and production indices
in the US, UK, France and Germany. He concluded that there was a
cycle of market behaviour repeating itself approximately ever y 54
years quite close to the Fibonacci number 55.
A different use of numbers and geometr y was devised by William D.
Gann who was a stock and commodity trader working in the first
half of this centur y. Gann noticed that for particular stocks price
movements of 25%, 50% and 100% were quite common price
moves of 33.33% and 66.67% ocurred but less frequently. So price
rises and falls tended to follow ratios of 1,
2
/
3,
1
/
2,
1
/
3,
and

1
/
4.
Gann also noted that there was a relationship between the extent of
a price movement and the time the price took to reach its new level.
I f a share price moves one unit of price per one unit of time this
results in a trendline of 45. Gann described this as a 1 x 1
relationship or squaring of price and time.
Not all charts usethesame
scales for prices and timeso
a 1 x 1 linewill not
necessarilybedrawn at
45.
Thefirst number indicates
timeunits thesecond
priceunits. So 2 x 1
means a linefor two units
of time/ 1 priceunit and 1
x 2 represents oneunit of
time/ 2 priceunits.
Gann reasoned that if the price breaks through the trendline the
new trendline will have a mathematical relationship with the
original one. For example, it could be 2x, 3x or 4x the price or it
could be
1
/
2,
1
/
3,
or

1
/
4
of the original.
A Gann chart uses a series of parallel horizontal lines which act as
price targets together with a series of trendlines which fan out at the
various Gann ratios from the start of a trend.
Fan lines slopeup for
uptrends and down for
downtrends.
1 x 1
2 x 1
1 x 2
Time =
P
r
i
c
e

=
1 x 1
2 x 1
3 x 1
4 x 1
8 x 1
Time =
P
r
i
c
e

=
Section 5
Waves, numbers and cycles
118
1, 1, 2, 3, 5, 8, 13, ?
The Kondratieff wave
1800 1820 1840 1860 1880 1900 1920 1940 1960 1980
Peaks occur approximatelyevery54 years
1814 1864 1920 1973 Idealised peaks
First decade = Recover y
Second decade = Boom
Third decade = Peak
Fourth decade = Collapse
Fifth decade = Trough
Pattern of events
approximately every
50 years
Recovery
Boom
Collapse
Trough
Waves, numbers and cycles
Section 5
119
1, 1, 2, 3, 5, 8, 13, ?
The wave and pattern theories that have been described so far are
all based on linear dynamics the patterns are based on orderly,
recognisable and rhythmic patterns. However, as you may already
know market behaviour is not always so predictable and dramatic
deviations from patterns occur the stock market crash of 1987 is a
good example.
More recently some mathematicians have shown that there is a
correlation between price behaviour in the market place and the
new science of non-linear dynamic sometimes termed Chaos
Theory. Non-linearity is simply explained as the effect is not
proportional to the cause, as is the case in linear dynamics. A classic
and well known saying describing the situation is I t is the last straw
that breaks the camels back. I n a linear system if you throw a ball
into the air with a certain force and at a certain trajector y you would
be able to predict, accurately where the ball would land. I n non-
linear dynamics, although you know the ball will travel in a cur ve
shape this time when you throw the ball you would not be able to
predict accurately its trajector y or where it would land.
and then looking closely at the twigs on one of the branches. The
fractal nature of a freely trading market can be demonstrated
through the obser vation that a weekly chart looks ver y much the
same as those of daily, hourly, 5-minute etc charts. A fractal object is
one that occupies a non-whole number set of dimensions. What
does this mean? A flat piece of paper is two-dimensional but
crumple it into a ball and it is now neither solid three-dimensional
nor flat but somewhere in between. Mathematicians have shown
that in some markets prices can be shown to be performing as
fractals and thus Chaos Theor y can be applied potentially in
explaining market behaviour. But how can Chaos Theor y help the
trader if it cannot predict the future?
I t is not necessar y to be able to predict the future precisely in order
to be able to make a trading profit. What is important is the ability
to be able to predict shapes, patterns, trends in trading Chaos
Theor y recognises shapes but not their precise size and movement.
Neither wave, cycle nor chaos theories completely explain all events
in all markets. You have the choice now of selecting the tools and
techniques you want to use to help determine your trading strategy
for the markets you are involved with. I t is well recognised that a
successful strategy is made up of different techniques, for example, a
combination of bar charts together with trend analysis and Bollinger
bands.
You could toss a coin to decide whether to buy or sell in the market
place but then there is no guarantee that you would get an accurate
answer the coin could be double-headed or someone else could
grab the coin in mid-air or it may land on its rim and roll off the
table and be lost...Even if your coin does land properly then, at best,
over a period of time you will break-even using this technique.
However, experience shows you will probably be a net loser! One of
the greatest problems facing a trader is to learn when to take profits
from a successful trade and when to exit a trade which is going
wrong.
Waves, numbers and cycles are described using the same format as
used in previous sections and cover:
O Elliott Wave Theor y and Fibonacci numbers
O Gann Charts
Linear dynamic
system
Non-linear
dynamic system
Non-linear systems require the massive computational power of a
computer to produce a solution as to the relationship between cause
and effect with any speed. Currently only those relationships that
are slightly non-linear can be solved and be of use for forecasting
markets highly non-linear systems still lie outside the reach of
present computing power.
One of the foundations of Chaos Theor y is fractal geometry
objects that are fractals are similarly shaped however closely you
examine them. There are many good examples of fractal patterns in
nature, for instance, looking at the branches of a tree at a distance
Section 5
Waves, numbers and cycles
120
1, 1, 2, 3, 5, 8, 13, ?
The Elliott Wave Theory was devised by Ralph N. Elliott and has as
its underlying principle the assumption that markets move in a five
wave pattern in the direction of the trend, followed by a three wave
pattern in the counter direction.
?
?
Elliott based his orginal work on stock market indices where it is still
used successfully to classify and forecast market movements. Using
Elliott wave techniques does not work well for individual stocks. The
techniques are used successfully for heavily traded instruments in a
liquid market place, for example, spot FX, gold and actively traded
futures. The techniques are not so successful for thinly traded
instruments.
Patterns
These refer to the basic wave shapes which are repeated in cycles.
Depending on the magnitude of the cycle, each complete set of
waves can be expanded or subdivided into further sets of 5 and 3
waves. The number of waves resulting always follows the Fibonacci
sequence. The diagram opposite shows the various subdivided wave
patterns and the numbers of waves involved where:
However, market wave patterns do not always follow their
theoretical shape and extensions of an impulse wave can occur. I t
is ver y unusual to see an extension in the first wave they are
commonly seen in the third and fifth waves, especially in the third
waves.
0
1
2
3
4
5
a
b
c
Waves 1,3,5
areimpulse
Waves 2 and 4 are
corrective
Basic wave pattern
Subdivided waves
1
2
3
4
5
1
a
b
c
2
1
2
3
4
5
a
b
c
1
2
3
4
5
a
b
c
3
5
4
A
B
C
Bull extension
1
3
5
Extension between
waves 3 and 5
Bear extension
1
3
5
Extension between
waves 3 and 5
Elliott Wave Theory and Fibonacci numbers
Pattern Number of waves Total
x 5+3 8
y 3 + 5 + 5 13
z 5 + 3 + 5 + 3 + 5 21
w y + z 34
x
y
z
w
Waves, numbers and cycles
Section 5
121
1, 1, 2, 3, 5, 8, 13, ?
Patterns
Correction waves a,b,c can also exhibit patterns which are
identified as follows:
O Zig-zags 5,3,5
O Flats 3,3,5
O Triangles ascending, descending, contracting and
expanding. I n Elliott Wave Theor y, triangles
are always made up of 5 bars a to e.
O Complex Double, triple or multiple threes. I n complex
corrections these threes can be made up of
combinations of zig-zags, flats and triangles.
These corrective patterns can become ver y complicated and
difficult to recognise!
Ratio
Ratio analysis is used to determine where prices should move a
retracement is a movement in the opposite direction to the previous
trend. Typically the Fibonacci ratios of 0.382, 0.618, 1.618 and 2.618
are used to predict price targets for retracements and combinations.
Time
I t is not quite so easy to predict cycles based on time using Elliott
Wave Theor y. Although cycles exist it is more difficult to predict or
identify significant peaks and troughs corresponding to Fibonacci
numbers.
Bear zig-zag
Flat
Double three
Triangles
Ascending Flat top,
bottomsloping up
Contracting or symmetrical Top
sloping down, bottomsloping up
1
2
3
4
5
A
a
b
c
B
1
2
4
3
5
C
A
a
b
c
B
1
2
4
3
5
C
a
b
c
A
B
C
A
B
C
X
Elliott Wave Theory and Fibonacci numbers
a
c
e
b
d
Section 5
Waves, numbers and cycles
122
1, 1, 2, 3, 5, 8, 13, ?
Elliott Wave Theory
Summary
O The underlying principle is that market prices are cyclic
and can be identified according to patterns, ratios and
time
O A complete cycle is made up of 8 waves. I n a bull market 5
waves up are followed by 3 down and vice versa in a bear
market
O Waves can be expanded into longer waves and subdivided
in shorter waves. Thus a completed 5 bar wave can itself be
seen as a single wave in what is known as a wave of one
higher degree. Alternatively the third wave of a completed
5 wave structure can be sub-divided into 5 waves.
O Impulse waves may have extensions. Normally the third
wave, less often the fifth and rarely the first wave.
O Corrective waves a, b, c are made up of patterns
including:
Zig-zags
Flats
Triangles
Double, triple and multiple threes
O The Fibonacci sequence and numbers are an integral part
of the theor y the numbers of waves, ratios of one wave to
another, retracements of impulse waves and price targets
for both impulse and corrective moves
Elliott Wave Theory and Fibonacci numbers
Waves, numbers and cycles
Section 5
123
1, 1, 2, 3, 5, 8, 13, ?
a
Elliott Wave Theory and Fibonacci numbers
I
I I
I I I
I V
V
'
^

b
c
A
B
C
'
^

(ii)
(iii)
(iv)
(v)
=
=
=
=
=
A bar chart of last tradedailyFTSE -100 index
values
Elliott Waveanalysis is verycomplicated and different
technical analysts mayinterpret thesamechart in
different ways. Thevarious counts herearesuggested
Elliott wavepatterns only you mayinterpret thechart
differently!
(i)
Section 5
Waves, numbers and cycles
124
1, 1, 2, 3, 5, 8, 13, ?
W.D Gann was a stock and commodity trader working in the first
half of this centur y who reputedly made over $50 million in the
markets. He made his fortune using techniques and methods which
he developed based on the relationships between price movement
and time for instruments known as the time/ price equivalents.
There is no easy explanation for Ganns methods but in essence he
used lines and angles in charts to determine support and resistance
areas and predict the times of future trend changes.
?
?
Gann noticed that the majority of price movements followed a
simple ratio typically they were
1
/
4,
1
/
2
, 1 x, or 2 x the price at a
particular starting point. This starting point was termed the pivot
point. Sometimes the price movement was
1
/
3
or
2
/
3
the price from
the pivot point. Gann also noticed that there was an important
relationship between these price movements and time in
particular it was quite common to see a unit price movement take
place in unit time. This Gann called squaring the price which lies at
45 from the pivot point providing the scales on both chart axes are
the same.
Gann used a number of other lines to indicate future support and
resistance areas for different price/time ratios using Gann Angles.
These are expressed as Time x Price. For example, a 2 x 1 Gann
Angle line is drawn such that for ever y two time units there is an
increase in one price unit; a 1 x 2 line means that for ever y time unit
increase the price increases twice.
Pivot point
This is a particular point in a time and price chart when the trend
direction changes. Depending on the instrument being charted,
pivot points can be seen on a tick, hourly, daily, weekly etc. basis.
Squaring
the price
Pivot points
High pivot point
Low pivot point
1 x 1
Time =
P
r
i
c
e

=
Time =
P
r
i
c
e

=
Fan lines slopeup for
uptrends and down for
downtrends
1 x 1
2 x 1
3 x 1
4 x 1
8 x 1
Time =
P
r
i
c
e

=
Gann charts
Waves, numbers and cycles
Section 5
125
1, 1, 2, 3, 5, 8, 13, ?
Gann charts
Gann lines
These are lines which can be drawn to predict the future levels of
support and resistance calculated from a high and low pivot point.
All that is required is to divide the height of the price movement by
the number of divisions required typically 8 or 10. These lines
then provide the for ward support/resistance levels. Gann
emphasised the importance of the 50% retracement level line.
Gann angles
These are ascending/descending lines drawn from a high or low
pivot point, each having a specific angle known as the Gann angle.
The lines, projecting into the future, represent different rates of
price movement/change with time.
The lines for Gann angles also provide an indication for support
and resistance levels. As a price reaches and intersects a Gann angle
you should see either support or resistance for this price.
Gann lines
Gann angles
Gann charts
Gann lines, with their associated Gann angles, provide an enhanced
indication of future support and resistance levels.
Thepricedifference
between thehigh and
low pivot points has
been divided into 10
Time =
P
r
i
c
e

=
Time =
P
r
i
c
e

=
Time x Price
1 x 8
1 x 4
1 x 3
1 x 2
1 x 1
Line angle
82.50
75.00
71.25
63.75
45.00
Time x Price
2 x 1
3 x 1
4 x 1
8 x 1
Line angle
26.25
18.75
15.00
7.50
1x1
1x8
1x4
1x2
1x3
2x1
3x1
4x1
8x1
Section 5
Waves, numbers and cycles
126
1, 1, 2, 3, 5, 8, 13, ?
Gann charts
1 x 4
1 x 8
1 x 1
1 x 1
1 x 8
A bar chart of weeklylast tradeDAX index
values. TheTimePriceEquivalent is one
priceunit per interval for both Gann fans.
1 x 1
A bar chart of weekly prices for
Iomega Corporation shares. TheTime
PriceEquivalent is onepriceunit per
interval for theGann fan.
2 x 1
1 x 2
1 x 3
1 x 4
Waves, numbers and cycles
Section 5
127
1, 1, 2, 3, 5, 8, 13, ?
Gann charts
2 x 1
3 x 1
A bar chart of weeklylast tradeBritish
Gas shares. TheTimePriceEquivalent is
5
/ 8 units per interval for both Gann fans.
1 x 1
4 x 1
8 x 1
1 x 1
2 x 1
3 x 1
4 x 1
8 x 1
Section 5
Waves, numbers and cycles
128
1, 1, 2, 3, 5, 8, 13, ?
Charting exercise
Although Gann Fans are available on the new
version of Reuters Graphics, Elliott Wave
software charting packages are only available for
the specialist market. The following exercise
allows you to tr y and find the Elliott Wave
patterns in a chart.
Chart exercise
Using the bar chart for weekly bid USD/DEM prices indicate
any Elliott Wave patterns you think are present. As this is quite a
complicated task the start and finish points are indicated as I
and V. Check your chart with that on page 130.
I
=
V
=
Waves, numbers and cycles
Section 5
129
1, 1, 2, 3, 5, 8, 13, ?
Summary
You have now finished the fifth section of the workbook and you
should have a clear understanding of the following waves, numbers
and cycles:
Elliott Wave Theor y
Fibonacci numbers
Gann charts
As a check on your understanding of this section you should tr y the
Quick quiz questions. You may also find the section Over view a
useful revision aid.
Quick quiz questions
1. What are the four most important Fibonacci ratios and
reciprocals of ratios? You should be able to quote the values to
three decimal places.
2. I n Elliott Wave Theor y corrective waves a, b, c are made up
of patterns.Name at least three of these patterns:
i)
ii)
iii)
iv)
3. Which of the following statements are true and which are false
concerning Gann charts?
a) The start position for Gann lines is termed
the pilot point
b) Gann Lines predict the future levels of
support and resistance from a particular
high or low start position
c) A 1 x 8 Time/Price line means that for
ever y 8 time units there is an increase of
one price unit
d) The 1 x 1 Time/Price line is known as
squaring the price
True False
You can check your answers on page133.
Section 5
Waves, numbers and cycles
130
1, 1, 2, 3, 5, 8, 13, ?
Chart exercise Answer
Remember that Elliott Wave analysis is ver y complicated and
different technical analysts may interpret the same chart in
different ways. The various counts here are suggested Elliott
wave patterns only you may have interpreted the chart
differently!
I I
I
=
=
'
^

I
c
a

b
c
a
b
a
b
c
d
e
I I I
=
I V
=

a
b
c

V I
=
'
^
Waves, numbers and cycles
Section 5
131
1, 1, 2, 3, 5, 8, 13, ?
Overview
Waves, numbers and
cycles
Elliott Wave Theory
O Elliott Wave Theor y is applied to many markets and has three
aspects Pattern, Time and Ratio
O Devised by Elliott with the
underlying principle that
markets move in a five wave
pattern in the direction of the
trend, followed by a three wave
pattern in the counter direction
O Patterns of waves follow the
Fibonacci sequence of numbers
O Fibonacci ratios of 0.382, 0.618, 1.618 and 2.618 are used to
predict price targets for retracements and continuations
O Most common pattern shapes for correctional waves as opposed to
impulse waves are:
Zig-zags
Flats
Triangles
Complex Double, triple and multiple threes
Fibonacci numbers
O Leonardo Pisano or Fibonacci identified a
mathematical sequence of numbers in the
thirteenth centur y:
0,1,1,2,3,5,8,13,21,34,55,89,144...
O Each number in the sequence is the sum of the
previous two digits
O Ratio of any number to its higher number is 0.618
O Ratio of any number to its lower number is 1.618
O Ratio of alternate numbers is 2.618
O Reciprocal value of 1.618 is 0.618
O Reciprocal value of 2.618 is 0.382
Gann charts
O Gann developed charting techniques based on the relationship
between price movement and time for instruments known as
time/ price equivalents
O Gann Lines are used in charts to predict future levels of
Support/Resistance calculated from a high and low pivot point
O Support/Resistance lines for different time/price ratios are
expressed as Time x Price lines. For example, 2 x 1 means one
price unit increase for ever y 2 time units.
O Ascending/descending lines drawn from a high or low pivot
point, each have a specific angle known as the Gann angle.
O Unit price movement in unit time is called squaring the price
Time x Price
1 x 8
1 x 4
1 x 3
1 x 2
1 x 1
Line angle
82.50
75.00
71.25
63.75
45.00
Time x Price
2 x 1
3 x 1
4 x 1
8 x 1
Line angle
26.25
18.75
15.00
7.50
1
3
5
2
4
a
b
c
Section 5
Waves, numbers and cycles
132
1, 1, 2, 3, 5, 8, 13, ?
Further resources
Books
Elliott Wave Principle applied to the Foreign Exchange Markets
Robert Balan, Financial Publications, 1989
I SBN None
Elliott Wave Principle
Robert Prechter and Alfred Frost, Probus Publishing Co., 1990
I SBN 0 9327 5017 6
Mastering Elliott Wave
Glenn Neely, Probus Publishing Co., 1990
I SBN 0 9302 3344 1
Gann made easy: Howto trade using the methods of W.D. Gann
W. McLaren
The W.D.Gann Method of Trading
Gerald Marisch
I SBN 0 9302 3342 5
Technical Analysis of Stocks and Commodities
Gann by C. Arnold
Vol. 1:3 (48-51), 1982/3
Gann Lines and Angles by R. Pardo
Vol. 3:5 (177-183), 1985
What K-wave? by J. Walker
Vol. 7:7 (227-229), 1989
Trading with Gann lines by D. Lamarr
Vol. 8:4 (142-144), 1990
The Elliott Wave: Sidebar
Vol. 12:3 (106-111), 1994
Waves, numbers and cycles
Section 5
133
1, 1, 2, 3, 5, 8, 13, ?
Quick quiz answers Your notes
0.382 0.618
1. What arethefour most important Fibonacci ratios and reciprocals of
ratios? You should beableto quotethevalues to threedecimal places.
1.618 2.618
2. In Elliott WaveTheory corrective waves a, b, c aremadeup of
patterns. Nameat least threeof thesepatterns:
i) Zig-zags
ii) Flats
iii) Triangles
iv) Double, triple and multiple threes
3. Which of thefollowing statements aretrueand which arefalse
concerning Gann charts?
a) Thestart position for Gann lines is termed
thepilot point
b) Gann Lines predict thefuturelevels of
support and resistancefroma particular
high or low start position
c) A 1 x 8 Time/ Pricelinemeans that for
every 8 timeunits thereis an increaseof
onepriceunit
d) The1 x 1 Time/ Pricelineis known as
squaring theprice
True False
v
v
v
v
Section 5
Waves, numbers and cycles
134
1, 1, 2, 3, 5, 8, 13, ?
Your notes
A day in the life of a technical analyst
Section 6
135
C
o
n
t
e
n
t
s
137
139
144
148
148
12
3
6
9
1
2
4
5 7
8
11
10
This section of the module should take about 45
minutes of study time. You may not take as long
as this or it may take a little longer remember
your learning is individual to you.
Introduction
Its what people say...
An early start...
Summary
Whats next?
Section 6
A day in the life of a technical analyst
136
You cannot get something good for nothing. You must pay with
time, money or knowledge for success W. D. Gann
TheGann Method by John J. Blasic
Technical Analysis of Stocks and Commodities , Vol. 10:6 (268-271), 1992
Asking the market what is happening is always a better approach
than telling the market what to do
Using Bollinger Bands by John Bollinger
Technical Analysis of Stocks and Commodities , Vol. 10:2 (47-51), 1992
A day in the life of a technical analyst
Section 6
137
Introduction
This final section in the workbook is concerned with the day-to-day
activities of a few Technical Analysts which has been included to give
you a flavour of what they do. But why are there Technical
Analysts? The following brief summar y of technical analysis may
help to put the role of the practitioners and the techniques used in
perspective.
The birth of Technical Analysis is widely agreed as
occurring in Japan during the eighteenth centur y. This
was the first time that prices were recorded with a view to
predicting future events. Rice was the key commodity at
that time, and the ver y first Futures Exchange came into
being around 1700 to trade Rice futures, or empty baskets
as they were known. A successful merchant and
moneylender from the Honma family named
Munehisha, together with his nephew
Mitsuoka, are popularly recorded as having
invented the Candlestick method of plotting
price action. This method was little known outside of Japan until
about 1989/90 when Steve Nison, an American analyst, succeeded in
introducing and massively popularising the technique into Western
markets.
Charles Dow, famed for the Dow-Jones Index and the
DowTheory, is the person who comes most readily to
mind when talking of the modern histor y of charting/
technical analysis. Also the founder of TheWall Street
Journal, what is not so well known is that Charles Dow
was the originator of the Point and Figure method of
charting. Dows work up to his death in 1902 was principally
concerned with stockmarkets.
W.D.Gann is another famous American whose work on commodities
and stockmarkets spanned 50 years to 1950. A complete and unique
branch of theor y is named after him Gann Theor y. Between the
years of 1940-1955, Ralph Nelson Elliott, another American
formulated his theor y Elliott Wave Theory again essentially a
complete Technical Analysis branch in itself.
The beginning of the 1960s was a particularly difficult period for
technical analysts as this was the time that the Efficient Market
Theory held sway. This theor y, held by fundamentalists in particular,
suggested that price action in the market is random and cannot be
predicted. I t is also worth noting that up to this point all chart
construction was accomplished by hand, both a time intensive and
laborious process. But all this was about to change particularly by
events in the Foreign Exchange (FX) market.
Up to 1970 the FX market was a comparatively calm
place compared with the frantic arena that it is today.
Almost all trading took place between 9am and 5pm
London time with participants reluctant to quote
outside these hours. This was especially so in the USA
where prices were then quoted inversely, for example,
USD/DEM. I ndeed in London ver y often the first price quoted at
around 9am would be virtually identical to that last quoted before
5pm the previous afternoon. Spot Yen was a minor currency for the
dealing room junior to handle, along with the likes of Singapore
Dollar and Saudi Riyal. But by late 1971 this situation was to change
dramatically.
The reasons for the changes in 1971 have their origins in the
Bretton Woods conference, held in 1944 in the USA. This was when
the framework for the post-World War I I economic order was
discussed. From this meeting came the World Bank (I nternational
Bank for Reconstruction and Development)
and the I nternational Monetar y Fund
(I MF). Crucially all the mainline currencies
were pegged to the US Dollar. As economic
performances between nations diverged and
with the reluctance of governments to revalue their currencies, it
was clear that the Bretton Woods exchange parity agreement was in
jeopardy. Temporar y measures such as exchange controls and trade
barriers failed and in the autumn of 1971 the USA suspended the
Gold Standard.
Section 6
A day in the life of a technical analyst
138
The Bretton Woods exchange parity agreement was replaced with a
new era of floating exchange rates.
The result of floating exchange rates was volatility which was of an
intensity that had not been seen before. This introduced profound
new risk into the commercial world. Where previously companies
had accepted exchange exposure with equanimity, they realised now
that to hedge and lock in their exposure was a wise move. However,
markets moving with no defined limits also offered the opportunity
for speculative gain and the probability of loss for the foolish and
unwar y.
Thus there was the need to attempt to understand why
prices moved in the way they did. Could prices be
predicted? I n 1974 the I nternational Monetar y Market
(I MM) was established as a subsidiar y of the Chicago
Mercantile Exchange (CME). The I MM was set up to
deal in financial futures and began with contracts for
the mainline currencies against the dollar, plus an (unsuccessful)
Certificate of Deposit contract. Chicagos fame grew from its
expertise in trading commodity futures, it was the young traders
from the commodity pits who moved across into the newly instituted
I MM, bringing with them one of their principal tools technical
analysis.
To begin with the I MM turnover was small and had little impact on
the main FX market. However, as their market grew so did the
confidence of the traders within it and before long their activities
started to impact on the massive Spot market. Who are these crazy
people at the I MM? was an increasingly common question to be
heard in London in the mid-seventies. And what is this technique
called Technical Analysis that they are all using?
1976 is a notable year in that it saw the
introduction of the first commercial PC in the UK
- the Commodore Pet. Seen as something of a
novelty at the time it was not until I BM
introduced their own machine in 1981, and set
the standard for ever yone else to follow, that the PC market took
off. Computers can store vast quantities of data and then utilise this
data in performing large numbers of complex mathematical
calculations at astonishing speed. Here then was the final piece of
the jigsaw that lit the blue touchpaper and sent the Technical
Analysis Rocket into orbit.
The need to understand price action in the marketplace was ever
greater due to increasing volatility. Somehow certain chartists/
technical analysts seemed to have a ver y discernible edge over other
market participants they made consistently, accurate calls. The
techniques they used and research into new techniques were ideally
suited to the personal computer. I t is probably true to say that if it
was the wheel that revolutionised transport, then it was the PC that
revolutionised technical analysis.
Today the power and speed of desktop PCs are
constantly improving and what was considered to
be a state of the art machine a year ago is now out
of date! Testing technical analysis ideas requiring
massive computational power is now possible
which was but a pipe-dream until recently. Right
at the cutting edge we have now a merging
between traditional technical analysis and the new technologies of
Neural Networks, Expert Systems, Fuzzy Logic etc. Astonishing
advances have been made since the mid-1980s in analysing market
behaviour, but this may only be the beginning?
To give you an idea of the real world of technical analysis there are
two brief diaries taken from the activities of analysts. I f you want to
know more then read on...
A day in the life of a technical analyst
Section 6
139
You know I sometimes wonder why I do
this job! Why didnt I go into
accountancy after leaving school like my
mother suggested a regular nine-to-five
job, good prospects, and little stress.
Sorr y!, should have said I m a technical
analyst working for a medium sized Bank advising the dealers on the
technical perspective for the various markets the Banks trading and
investing in. This covers the spot FX desk, the guys trading Futures
on LI FFE, CME, and CBOT, and oh yes weve got a big Funds
Management division upstairs that I have to keep briefed on just
about ever y Equity market you can think of! You couldnt think of a
less routine job ever y days different! I t sure isnt 9-to-5, 7-to-7
might be more accurate when the markets are hectic. But in truth I
love it! Let me tell you about a crazy day thats just passed.
News is the fuel that
drives the markets. Thats
why dealers are always
hanging on the latest
headlines from premier
news providers such as
Reuters. Guess theres
two types of news, the
scheduled normally
concerning prime
economic data releases
from the G7 countries ...
and then theres the bolt from the blue variety. Fashions change,
but for several years the key monthly economic indicators for the
global markets have been the US employment figures issued at
1:30pm London time on the first Friday of each month. To be more
specific its the Non-farm Payroll component which 10 years ago no
dealer had ever heard of! I ts a strange world, time and again the
two hours following the release of Non-farms sees the most active
and volatile trading in the whole month. The November figures
were due on Friday the 6th Dec, and I d gone home on the
Thursday night thinking of the virtually certain hectic day ahead
plus prospects for my own trading position short of Dec FTSE
futures on LI FFE. But more of that later.
There I was relaxing watching one of the kids James Bond movies
when the mobile rang. My Treasurer on the line telling me that
Greenspan had made comments in a late NY speech regarding
inflated asset values and euphoric markets. Now if theres one guy
on the planet that can send the world markets into a tail-spin with
one sentence its Alan Greenspan, the chairman of the mighty US
Federal Reser ve effectively the US Central Bank. And here we had
it, the dreaded bolt from the blue news shock, and to cap it all the
night before the US employment figures! I t was going to be a ver y
early start in the morning the boss had moved the morning
strategy meeting to 7:30.
At my desk just after 6:00am and work like a mad thing preparing to
brief the section heads at the 7:30 meeting. Far East equity markets
have taken a dive, it looks like gloom and doom for Europe on
equities and interest rates. Suddenly I m the most popular person in
the Bank, ever ybody, but ever ybody, wants to know what I think. Is
this thestart of thecrash everyones feared? Wherearethedownsidetargets?
Isnt it overdone, shouldnt it bouncefromhere? etc etc. At least my own
position short of FTSE is looking good, and for that I offer up
thanks to Alan Greenspan last month I was cursing him!
I t would take for ever to cover all the markets we looked at in that
meeting, so I ll just pick one US T-Bond futures on Chicagos
CBOT and then show you what I got up to in my own trading.
I ve been into Candlesticks since reading Steve Nisons book and
like combining them with trendlines, slow stochastics, and Bollinger
bands a volatility envelope analysis. Ever y analyst has his own pet
analyses and the ways he/she interprets them. Successful technical
analysis is about using a cocktail of different techniques that
complement each other rather than using one single analysis in
isolation and I m no different.
Its what people say...
Section 6
A day in the life of a technical analyst
140
This is the daily candlestick chart of the
December T-Bond on the CBOT.
0 Bit of backtracking (OK, boasting
really). I d thought that the sideways
structure that formed during October
was shaping up like a triangle breakout
should resume the uptrend. So fingers
crossed and gave the bond desk a buy
signal should 111
20
/32 be broken on the
strong uptrending market developing
during the 29th Candle A. All rather
excited when it went like a rocket and
closed at 112
19
/32 virtually a big figure
in but getting right-side of the market
is just half of the stor y, once youre in
you have to decide when to get out!
O OK the Close on the 29th was outside
the Bollinger volatility envelope, but the
key thing was the envelope was
expanding top line going up, bottom
going down volatility therefore rising.
I t was a big breakout of a major
horizontal resistance at 111
28
/32 so we
thought this might be one to ride. Next
few days saw some topsy-tur vy conditions but no doubts the bulls
had control. Come late evening on the 12th Nov got called at home
by our late shift. T-Bonds about to close outside the Bollingers with
the top and bottom Bollinger lines in synch (both moving
together) Candle B. Now one of the golden rules of the game is
Bulls makemoney, Bears makemoney, but greedy Pigs just makelosses! So
prudence rules, put some money in the till, and we close half of the
long position at 114
28
/32. Two days later and weve got pretty well
the same situation but this time weve run slap bang into what we
see as the outer channel line. So close out the remaining 25 long
position at 115
9
/32 just before the close, thank you ver y much
indeed and good night nurse!
O However, in the trading world you cant rest on your laurels for
long, question What do wedo next? The guys on the Bond desk were
split as to what strategic position to run, if any. The older heads were
saying thetrend is your friend so lets get back long, the younger burn
emup brigade that it had gone too far and was bound to reverse
soon DANGEROUS!
Me? I preferred sitting on the fence!
A
B
C
D
E
Old gap
Major resistance
at 111
28
/ 32
Stochastic
divergence 1
Stochastic
divergence 2
A day in the life of a technical analyst
Section 6
141
This is the daily candlestick chart of the
December T-Bond on the CBOT.
O Close of Friday 22nd Nov saw a
classic Stochastic Divergence (Stoch
Diverge 1). The T-Bond desk were
mumbling that I d lost my ner ve (dont
they ever have any of their own trading
ideas?) and so I told them Sell the
Opening on the 25th. What looked
good at the off, 115
5
/
32
, had a nasty
smell about it near the close, 115
15
/
32
,
so swallowed hard and told the late
shift to cut it. Just 10 pips loss but I sure
was popular with the bond jockeys next
morning - short memories, what about
the 3 big figures I d recently made
them!
O 4th December and I m getting
interested in the bonds again. As a
down day develops its possible we
could be left with another confirmed
stochastic divergence (Stoch Diverge 2)
plus a nice long black candle would
give us a pattern with strong
characteristics of an Evening Star a
potent bull market reversal signal. So its agree what well do with
the bond desk if we get the right set-up near the close, make the call
to the brokers and sell at 115
22
/32 on the death Candle C. Next
day we get an acceleration on the downside Candle D and I m
the blue-eyed boy again! However, tomorrows the dreaded Non-
farm payrolls so the boss says he wants the profit on half the position
come what may and we leave a profit take at the expected
resistance level of 114
18
/32 which happily gets executed. Shortly
after wards Bang! and Mr Greenspan pulls the trigger!
O Next morning as I said all markets are in turmoil and we havent
even heard the Non-farms yet! Boss must be thinking of his bonus
as he says he wants the profit and to be flat before the figures. So
ever ybody looks at me and says where? Thanks! Well we know its
going to open loads lower and will be trading for 10 minutes before
the figures. Theres an old gap formed between the 4th and 5th
November, 113
3
/
32
to 113
10
/
32
. Old gaps act as support/resistance
and the market adage is to look to see this halfway between the gap.
So fingers and legs crossed we put in an order on the off to buy at
113
7
/
32
and bingo we get filled! A few minutes later out come the
Non-farms significantly better than expected and its all change for
a bull rally! How lucky can you be! Boss was walking round like a
Cheshire cat!
A
B
C
D
E
Old gap
Major resistance
at 111
28
/
32
Stochastic
divergence 1
Stochastic
divergence 2
Section 6
A day in the life of a technical analyst
142
But what about my own trading in this
mayhem I do like to tr y and keep my
hand in with a bit of live action besides
advising people all day long. My normal
patch for trading is the S&P 500 futures
contract on the CME and the FTSE future
on LI FFE main reason for trading these
contracts is to stay on the ball for Equity
markets given that I get so many Whats
going to happen? calls from the fund boys
upstairs. Of late I d been flying the Union
Jack and just concentrating on the FTSE.
As said I was short of the Dec. FTSE
futures going home on Thursday night.
For short term trading I like half hourly
charts, and round about midday on the
5th wed developed a nice set-up.
0 The ringed area that shows a long white
candle followed by two Dojis (a Doji is a
small candle where the Open and Close
are about the same looks like a cross and
is a sign of weakness in a trending
market). The next candle was a long black
that enveloped the bodies of the previous
three candles. As it was also a confirmed stochastic divergence I sold
just before the close of the half hour at 4078. I t all developed ver y
nicely on the downside going into the daily close,so I decided to
hold the position overnight. My hope was we might challenge the B
line of the A/ B channel that had dictated trading for the previous
two days.
O Well overnight Uncle Greenspan came and did me a big favour
and we opened gap down, not only under B but also beneath the
one channel down line at C. I have this theor y about parallel
channels, that when they break the market moves one and then two
channels down as the energy released is dissipated. So I was looking
for a rendezvous with the second channel down at D which we duly
got just before 10:30. Nearly took the whole position out as I could
hardly think given all the phone calls I was getting plus all the
shouting and shrieking going on around the room! However, I
cashed in for half the position at 3967 and decided to give the rest a
bit more rope.
A
B
X
1
2
3
Y
4
5
6
C
D
50.0%
38.2%
61.8%
A day in the life of a technical analyst
Section 6
143
O Good (lucky?) decision as the bears
came in as we approached midday and
gave the market a right seeing to! Just
before 12:00 I d got one of my classic
scenarios a truly wicked long black
candle 3 closing outside the volatility
envelope with upper and lower bands
moving in synch. Sit on the fence time,
dont be greedy! So out we come to go flat
at 3888 not bad result for whats not
even a days trading!
O Always a dangerous time after a big
profit. I ts so easy to let euphoria and I m
the greatest swamp rational analysis, and
before you know whats happened youve
done something really stupid and handed
a large part of the profits back! So having
learnt this painful message in the past
several times, I keep telling myself to calm
down and concentrate. Next candle 4
looks ver y much like a Hammer a classic
bear market candlestick reversal pattern.
However, with the Non-farms only an
hour away I havent got the guts maybe
I m being sensible for once. Normally I d
go like a shot to get long at the end of the period marked by candle
5 but Non-farms were but seconds away. Out they come and with
screams of Buy,buy... echoing around the room I manage to get
some on board and go long at 3926.
O Well not a lot of chance to do much more as throughout the
afternoon it seemed the whole world wanted to speak to me. But
for my running position the eternal problem where to come out?
Havent said, but I m also a bit of a Fibonacci fan that centuries
old I talian was one clever bloke! I particularly like the fibonacci
retracements for pullbacks from big moves 38.2%, 50%, 61.8%.
The overall move spawned by the Greenspan shambles was X to Y as
marked on the chart together with the fib retracement levels based
off this X Y move. You know sometimes one just has days where
ever ything goes right, and this was one of them! 50% was 3968 and
just before 5:30pm we manage to nick in and close out during the
APT (late electronic trading as opposed to pit open outcr y) session.
What a day, you dont get too many like that thank goodness!
Feeling shattered as I ve been at the desk for 12 hours without a
break. You can tell that its been a great day for the dealing room
from all the excited buzz, and I think theres a bit of a party mood
afoot. Yep, the Boss says all down the local wine bar and the
champagnes on him!
A
B
X
1
2
3
Y
4
5
6
C
D
50.0%
38.2%
61.8%
Section 6
A day in the life of a technical analyst
144
Pete is a technical analyst working for ABC who specialise in
providing live technical analysis on the various markets over Reuters.
Two of Petes main clients are Danny and Hans.
Danny is a speculator running a small fund. He trades in various
markets, usually holding positions for no longer than a few days.
Hans is a corporate dealer at XYZ Bank in Frankfurt. His client is an
importer of I talian shoes who requires a favourable exchange rate to
purchase foreign currency.
Pete advises both Danny and Hans on timing the market.
I ts 6.45 am in London, on 9th October. Pete is at his desk. He
checks the overnight movements on the currency and US T-Bond
markets to get an indication of how the European markets will open.
Between 7.00 8.00 am when most LI FFE Markets open Pete
analyses the markets he will be covering today. He writes a technical
commentar y on the markets providing trading recommendations
for the day ahead.
He reads the Reuter Insight Debt News Analysis, BXNB, on his RT to
see if any important economic data is due today. The US Gross
Domestic Product (GDP) figure is out at 1.30pm Pete envisages an
active afternoon!
The next few hours are quiet which allows Pete time to prepare his
Elliott Wave outlook of the US Stock Market for a client in New
York...
An early start ...
A day in the life of a technical analyst
Section 6
145
Pete: Hello.
Danny: Hi, its Danny. What
do you think of DEM/ ITL?
Pete: Ill takea look and
call you back in 5.
I ts 11.30 Petes phone rings.
Pete calls up a weekly bar chart of
DEM/I TL using Reuter Technical
Analysis. This allows Pete to get an
overall picture of the medium-term
trend. Pete examines over 3 years of
price action and has the following
obser vations:
1. A major bull market ended at
1275.00 in March 1995. The market
has been a bear since. The
impulsive moves are down whereas
the corrective moves are up.
2. The 15 and 30 week moving
averages are bearishly aligned, with
recent rally attempts thwarted by
these.
3. I mportant supports are at 945.00
and 897.00. Resistances are at
1036.70. 1099.50 and 1171.00.
Impulsive moves are the sharp moves
which go to make up the overall
trend. Corrective moves are
temporar y reactions against the
trend as profit-taking ensues.
The short-term average is under the
long-term average. Both are pointing
down.
DEMITL= HiLoCl Bar (Weekly)
Amount
30 - week
Moving Average
15 - week
Moving Average
1275
(March 1995)
Resistance1171
Resistance
1099.50
Resistance1036.70
Support 945.00
Support 897.00
Section 6
A day in the life of a technical analyst
146
Having ascertained the medium-term
trend, Pete now calls up a daily bar
chart of DEM/I TL using Reuter
Technical Analysis. Pete examines daily
sometimes intra-day charts to time
entr y into the medium-term trend. Pete
obser ves the following:
1. The market failed to hold under
3rd October low of 989.40,
rebounding back above 990.00
level.
2. 9-day RSI basing in oversold
territor y having shown a bull
divergence.
Petes conclusions:
The medium-term bear trend looks
over extended in the short-term. A
correction of between 38.2 and 61.8%
of the impulsive decline from 1036.70
looks due over the next few weeks.
Once the correction is complete, the
medium-term bear trend should
resume towards support at 945.00 and
897.00 as the next impulsive phase gets
under way.
Breach of the 61.8% retracement at
1018.00 will warn that the bear trend is
in the process of reversing.
Once Pete has decided what DEM/I TL
will do over the next few weeks he rings
Danny...
Signs of waning bear momentum are
noted when the market cannot
sustain a push into new lows.
Another sign of fading bear
momentum
Corrective moves usually retrace 38.2
to 61.8% of the preceding impulsive
move. These retracement values are
based on Fibonacci numbers.
DEMITL= HiLoCl Bar (Daily)
Amount
1036.70
61.8%
1018
38.2%
1007
3rd Oct low
989.40
Failed to
follow through
988.85 7th Oct
Oversold
New pricelow,
but higher RSI
level
A day in the life of a technical analyst
Section 6
147
Pete: Hi, Danny. DEM/ ITL looks good for a rally to
1007/ 1012 over thenext few weeks. Play thelong
sidewith a stop-loss under 988.85.
Danny: Thanks Pete Ill call my broker.
A stop-loss level is a pre-defined point at which a losing trade is
exited. Stops are used to minimise market risk.
Pete pops out for lunch and on his return about 1.20 pm starts to
monitor US T-Bond futures ahead of the US GDP data. The figure is
out at 1.30 pm and is weaker than expectations. The Bond markets
rise initially but swiftly reverse early gains. Five minutes later Petes
phone rings again...
Hans: PeteI want to buy someLire.
When should I get in?
Pete: Id wait a week or two. The
markets duefor a correction
towards 1007/ 1012 beforethe
next leg down to 945/ 897. Give
mea call then and well discuss
short-termtiming.
Danny: Pete, haveyou seen theBTPs?
Pete: Yeah, I hopeyoureshort!
Danny: Looks likeI should be with T-Bonds
struggling and DEM/ ITL going to 1007 - 12!
The Bond markets sell off and the DEM rallies
throughout the afternoon. About 3.30 pm Hans
phones Pete...
Finally, about 4.20 pm, Pete writes closing comments on his markets
which include a review of the day and an outline of anticipated
action for tomorrow.
Buoni del Tesoro Poliennali (BTP) are I talian fixed rate Treasur y
bonds with var ying maturities from 5, 10 and 30 years the most
liquid market being for 10 year bonds.
Section 6
A day in the life of a technical analyst
148
Summary
You have now finished the final section of the workbook and you
should now have some understanding and knowledge of the
following:
The development of technical analysis
The basic tools and techniques used by technical analysts
covering
Chart types
Patterns
I ndicators
Waves, numbers and cycles
The ways in which technical analysts use the various tools
and techniques
I f you decide you wish to study more about the ways traders and
analysts use Technical Analysis then the final Further resources
section may be of use.
What next?
I f you work in a sales, client training or customer support role
and you need a more detailed picture of a particular market or
markets, then you may find the Level 2 and 3 workbooks in the
Know your Customer series useful. The following sets of workbooks
are available:
O The Debt Markets
O The Securities Markets
O Foreign Exchange and Money Markets
O Commodity, Energy and Shipping Markets
You may also find the Level 1 workbooks Introduction to theCity;
Volume1: History & Structureand Volume2: Institutions & Trading
may be of interest. Alternatively you may want to study further for
whatever reasons. The choice is yours... if your decision means
you would like to study more workbooks, then contact your
training department for the titles you require.
Good luck!
A day in the life of a technical analyst
Section 6
149
Further resources
Books
Market Wizards: Interviews with Top Traders
J. Schwager, Harper Business, 1989
I SBN 0 8873 0601 1
Intermarket Technical Analysis
John Murphy, J. Wiley & Sons, 1991
I SBN 0 4715 2433 6
The Psychology of Technical Analysis
Tony Plummer, Probus Publishing Co., 1993
I SBN 1 55738 543 2
Steidlmayer on Markets
J. Peter Steidlmayer, J. Wiley & Sons, 1989
I SBN 0 4716 2115 3
Mind over Markets
J.F. Dalton, E.T. Jones and R.B. Dalton, Probus Publishing Co., 1993
I SBN 1 55738 489 4
Technical Analysis of Stocks and Commodities
The publishers of this monthly journal can be contacted at the
following address:
Technical Analysis I nc.
4757 California Avenue, SW
Seattle
WA 98116
USA
Reprints of the articles mentioned in the Further resources sections of
this workbook can be obtained from Technical Analysis I nc.
together with a CD-ROM of all the monthly journals, 1982 1994.
Section 6
A day in the life of a technical analyst
150
Your notes