Post by TradingForGod on Aug 12, 2004 13:30:22 GMT -5
Hi Everyone. Today begins a series of columns on the basics of technical analysis. When I say basics, I mean just that. For some of you this will probably be worth very little, but for others it will at least expose you to some of the key principles of this approach. Comments and suggestions are welcome.
The earliest technical analysis that I am aware of comes from the 1600s when Japanese rice traders graphed the daily price changes of “empty rice” (rice futures) using what we now call “candlestick charts”. This is similar to the “open, high, low, close” charts we usually see today, except that the range between the open and the close is expanded so that you can see it better. Look at the Microsoft chart below (we’ll be using this same chart to talk about the various technical indicators I look at). You can see that some of the bars are filled in and some are not. The filled bars represent days when the closing price is below the opening price (bearish). The empty bars represent days when the closing price is above the opening price (bullish). The extensions above and below the fat “real body” of the bar are called “shadows”. These extensions identify the high and low of the day. I actually like candlestick charts better that OHLC charts because the quickly give you a little more information. At a glance you can tell if it’s an up or a down day. But that’s just a matter of personal preference. There are tons of bar formations that the Japanese came up with to analyze the charts. Remember, there were no moving averages or other math based indicators back then. They only have visual references. These formations have names like doji stars, dark cloud cover, and hanging man. Some represent consolidations, some are bullish, and some are bearish. As we go on I may occasionally use one of these formation names. If so, I’ll briefly describe their meanings and interpretations. For now, just know that they represent the earliest attempt to make sense of market price action.
Until the turn of the 20th century, not much progress was made in technical market analysis. People had to graph charts by hand, which was very cumbersome, and there wasn’t a lot of need for analysis because there wasn’t a lot of trading. But as stock trading became more and more important, people began to use things like trendlines and very basic moving averages (MAs for short). Again, since there were no computers or calculators any math based analysis had to be done by hand, so it took a lot of effort. Almost all analysis at that time was still graphical. The MSFT chart shows a couple of basic trendlines. They are easy to draw. You just connect the lowest lows or the highest highs. They should act as support and resistance respectively. The more touch points on the trendline, the more significant it becomes. On this chart, notice the number of times the low of the day in mid-May was captured by the trendline. Also notice how this trendline has now been violated. That’s potentially pretty bearish. By convention, I use green line for support and red lines for resistance, but again that’s just a personal choice.
In the late 19th century, Charles Dow (of the Industrial Average fame) started doing work on repeating patterns he noticed on stock charts. In the 1930s, R.N. Elliott picked up where Dow left off. As I recall, he became very ill and was bed-ridden for a long time. So he started looking at charts of stocks, hundreds of them, and found the same kind of repeating pattern that Dow did. Over time he codified a set of “principles” that he thought governed price motions. He saw price action as a series of “waves”. His work became know as the Elliot Wave Principle. There are whole books written about this subject, but I will give you the bare bones overview here. He saw market action divided into a series of impulsive and corrective moves. If the market is in an uptrend, the impulsive moves are higher (duh!). If the market is in a downtrend, the reverse is true. Obviously, the corrective moves are counter to the main trend. He believed that all (actually, most) impulsive moves consist of five components, or waves. Three of them were in the direction of the main trend, and two were counter-trend. He labeled these segments 1 through 5. The corrective moves consist of three waves. Two are in the main direction of the correction, with the middle one going the opposite way. He labeled these segments A, B, and C. I know that may seem a bit confusing, but let’s look at it on the MSFT chart below.
Hopefully you can see the wave action here. There are some pretty hard and fast rules for interpreting the charts, BUT I think the main drawback of Elliott Wave is that there are always at least two ways of interpreting the data, bullish and bearish, and in some cases many more. There are some people who use EW almost exclusively. I am not one of them. I think it is very valuable in identifying the possibilities, but you need other analysis techniques to decide which of the possibilities is most likely.
Here are a few of the basic rules:
1) Impulsive moves consist of five waves. Corrective moves are three waves.
2) Waves can be sub-divided into progressively smaller waves within waves. In modern terms this means that market action has “fractal” characteristics…never mind what that means.
3) The “1” and “5” waves are usually, but not always, about the same length. The “3” wave usually extends beyond the “1” wave length by some ratio of the Fibonacci sequence. We’ll talk about what Fibonacci numbers are in the next column.
4) The “A” and “C” waves are usually about the same length.
5) The “2”, “4” and “B” waves correct a portion of the previous advance by some ratio of the Fibonacci sequence, usually either 38% of 62% of the prior move.
Whew, that’s a REALLY brief overview. For those who want a more detailed explanation of EW, there are plenty of online resources that you can look at. My purpose here was just to introduce the concept and terminology so that later on when I say, “This A-B-C correction has retraced 38% of the previous advance” you will know what I mean. Clear as mud?
Tomorrow I will talk about the Fibonacci number sequence. It is a fascinating subject, and truly shows the divine order threaded throughout the world we live in. It also shows up A LOT in trading patterns. Until then…<br>
God bless you all,
TradingForGod
The earliest technical analysis that I am aware of comes from the 1600s when Japanese rice traders graphed the daily price changes of “empty rice” (rice futures) using what we now call “candlestick charts”. This is similar to the “open, high, low, close” charts we usually see today, except that the range between the open and the close is expanded so that you can see it better. Look at the Microsoft chart below (we’ll be using this same chart to talk about the various technical indicators I look at). You can see that some of the bars are filled in and some are not. The filled bars represent days when the closing price is below the opening price (bearish). The empty bars represent days when the closing price is above the opening price (bullish). The extensions above and below the fat “real body” of the bar are called “shadows”. These extensions identify the high and low of the day. I actually like candlestick charts better that OHLC charts because the quickly give you a little more information. At a glance you can tell if it’s an up or a down day. But that’s just a matter of personal preference. There are tons of bar formations that the Japanese came up with to analyze the charts. Remember, there were no moving averages or other math based indicators back then. They only have visual references. These formations have names like doji stars, dark cloud cover, and hanging man. Some represent consolidations, some are bullish, and some are bearish. As we go on I may occasionally use one of these formation names. If so, I’ll briefly describe their meanings and interpretations. For now, just know that they represent the earliest attempt to make sense of market price action.
Until the turn of the 20th century, not much progress was made in technical market analysis. People had to graph charts by hand, which was very cumbersome, and there wasn’t a lot of need for analysis because there wasn’t a lot of trading. But as stock trading became more and more important, people began to use things like trendlines and very basic moving averages (MAs for short). Again, since there were no computers or calculators any math based analysis had to be done by hand, so it took a lot of effort. Almost all analysis at that time was still graphical. The MSFT chart shows a couple of basic trendlines. They are easy to draw. You just connect the lowest lows or the highest highs. They should act as support and resistance respectively. The more touch points on the trendline, the more significant it becomes. On this chart, notice the number of times the low of the day in mid-May was captured by the trendline. Also notice how this trendline has now been violated. That’s potentially pretty bearish. By convention, I use green line for support and red lines for resistance, but again that’s just a personal choice.
In the late 19th century, Charles Dow (of the Industrial Average fame) started doing work on repeating patterns he noticed on stock charts. In the 1930s, R.N. Elliott picked up where Dow left off. As I recall, he became very ill and was bed-ridden for a long time. So he started looking at charts of stocks, hundreds of them, and found the same kind of repeating pattern that Dow did. Over time he codified a set of “principles” that he thought governed price motions. He saw price action as a series of “waves”. His work became know as the Elliot Wave Principle. There are whole books written about this subject, but I will give you the bare bones overview here. He saw market action divided into a series of impulsive and corrective moves. If the market is in an uptrend, the impulsive moves are higher (duh!). If the market is in a downtrend, the reverse is true. Obviously, the corrective moves are counter to the main trend. He believed that all (actually, most) impulsive moves consist of five components, or waves. Three of them were in the direction of the main trend, and two were counter-trend. He labeled these segments 1 through 5. The corrective moves consist of three waves. Two are in the main direction of the correction, with the middle one going the opposite way. He labeled these segments A, B, and C. I know that may seem a bit confusing, but let’s look at it on the MSFT chart below.
Hopefully you can see the wave action here. There are some pretty hard and fast rules for interpreting the charts, BUT I think the main drawback of Elliott Wave is that there are always at least two ways of interpreting the data, bullish and bearish, and in some cases many more. There are some people who use EW almost exclusively. I am not one of them. I think it is very valuable in identifying the possibilities, but you need other analysis techniques to decide which of the possibilities is most likely.
Here are a few of the basic rules:
1) Impulsive moves consist of five waves. Corrective moves are three waves.
2) Waves can be sub-divided into progressively smaller waves within waves. In modern terms this means that market action has “fractal” characteristics…never mind what that means.
3) The “1” and “5” waves are usually, but not always, about the same length. The “3” wave usually extends beyond the “1” wave length by some ratio of the Fibonacci sequence. We’ll talk about what Fibonacci numbers are in the next column.
4) The “A” and “C” waves are usually about the same length.
5) The “2”, “4” and “B” waves correct a portion of the previous advance by some ratio of the Fibonacci sequence, usually either 38% of 62% of the prior move.
Whew, that’s a REALLY brief overview. For those who want a more detailed explanation of EW, there are plenty of online resources that you can look at. My purpose here was just to introduce the concept and terminology so that later on when I say, “This A-B-C correction has retraced 38% of the previous advance” you will know what I mean. Clear as mud?
Tomorrow I will talk about the Fibonacci number sequence. It is a fascinating subject, and truly shows the divine order threaded throughout the world we live in. It also shows up A LOT in trading patterns. Until then…<br>
God bless you all,
TradingForGod
