CHAPTER EIGHT
BEYOND FUNDAMENTAL ANALYSIS
© 2001 South-Western College Publishing
Outline

Charting
The Underlying Logic
 Types of Charts
 Other Chart Annotations


Technical Indicators
Indicators with Economic Justification
 Indicators of the Witchcraft Variety

2
Outline

Old Puzzles and New Developments
Fibonacci Numbers
 Dow Theory
 Kondratev Wave Theory
 Chaos Theory
 Neural Networks


The Future of Technical Analysis
3
Charting: The Underlying Logic

The technical analyst believes
that charts can be used to
predict changes in supply and
demand and investor behavior.

Market participants seldom wait
for things to completely unfold.
They try to anticipate events
rather than merely react to
them.
4
Stock Price
Charting: Types of Charts
Time
Linear Scale Line Chart
5
Stock Price
Charting: Types of Charts
Time
Logarithmic Y-Axis Line Chart
6
Stock Price
Charting: Types of Charts
Time
Bar Chart
7
Stock Price
Charting: Types of Charts
Irregular Time Intervals
Point and Figure Chart
8
Charting: Types of Charts
Stock Price
open
close
close
open
Time
Candlestick Chart
9
Charting: Other Chart Annotations

support level

resistance level

congestion area

breakout
Chartists believe investors remember missed
opportunities and look for them to return.
10
Charting: Other Chart Annotations
Stock Price
Potential
Supply
B
D
C
A
Potential
Demand
Time
Potential Supply and Demand
11
Technical Indicators

These statistics, either calculated or directly
observed, are alleged to have a relationship
with the future direction of the overall stock
market or with an individual security.

Indicators with economic justification are
based on economic activities that are
measurable and observable.

Indicators of the witchcraft variety have no
logical connections between the
measurements and what the
measurements purport to show.
12
Indicators with Economic Justification

The higher the short interest figure, the larger
is the potential demand for the shares.

Increased margin buying has historically been
associated with rising markets.

Cash held by mutual funds represents
potential demand for stock.

When the confidence index gets closer to 1.0,
investors are more likely to be bullish about
the economy, and therefore about corporate
earnings.
13
Indicators with Economic Justification

An advance-decline line is a graphical
representation of the net advances over a
period of time.

A high relative strength ratio, such as a high
relative PE, means that investors are willing
to pay more for the past earnings of a
company than average.

Advocates of moving averages in stock
selection believe that changes in the slope of
the line are important.
14
Indicators of the Witchcraft Variety

The super bowl indicator states that the stock
market will advance the following year if the
super bowl football game is won by a team
from the original National Football League.

Increased sunspot activity every eleven years
leads to better weather for an improved
harvest, leading in turn to a stronger
economy, and finally to higher stock prices.

Hemline indicator : As shorter dresses for
women become the fashion, the market
advances, and vice versa.
15
Old Puzzles and New Developments
Fibonacci Numbers
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, ...

Fibonacci numbers occur frequently and
inexplicably in nature.

1.618, the golden mean of the numbers,
is used to calculate the Fibonacci ratios.

Many Fibonacci advocates in the investment
business use the first two ratios, 0.382 and
0.618, to “compute the retracement
levels of a previous move.”
16
Old Puzzles and New Developments
Dow Jones Industrial Average
Dow Theory
Meaningless
Daily
Fluctuations
(ripples)
Secondary
Trend
(waves)
Primary Trend
(tides)
Time
17
Old Puzzles and New Developments

Kondratiev wave theory states there is a 50-60
year business cycle.

Chaos theory sees systematic behavior
amidst apparent randomness.

A neural network is a trading system in which
a forecasting model is trained to find a
desired output from past trading data.
18
The Future of Technical Analysis

Technical analysis has persisted for more
than 100 years, and it is not likely to
disappear from the investment scene anytime
soon.

Improved quantitative methods coupled with
improved behavioral research will continue to
generate ideas for analysts to test.
19
Review

Charting
The Underlying Logic
 Types of Charts
 Other Chart Annotations


Technical Indicators
Indicators with Economic Justification
 Indicators of the Witchcraft Variety

20
Review

Old Puzzles and New Developments
Fibonacci Numbers
 Dow Theory
 Kondratev Wave Theory
 Chaos Theory
 Neural Networks


The Future of Technical Analysis
21