Technical Analysis Notes

The price action in the financial markets is a reflection of human nature: Greed vs. Fear.

Technical analysis deals with probabilities. Smart traders only take high probability trades.

The goal is to identify price reversals as early as feasibly possible.

Prices move in trends.

There are three branches of technical analysis; sentiment, flow of funds, market structure indicators.

Sentiment moves from one extreme at a bear bottom to another at a bull top. When analysts get too exuberant, it's time to get out. When they are overly pessimistic, this is a good sign that you can reenter the market at its low point.

Keep an eye on how much money is sitting on the sidelines available for investment. This capital is what can drive the future price of the market higher.

At the end of market bull and bear cycles, the indicators will typically become divergent signaling and impending reversal.

Short term movements tend to be random in nature.

Changes in the market normally precede changes in the economy by 6-9 months. Markets move based on anticipation.

The longer the trend, the greater the reversal.

There are three trends followed by traders; primary (9 months to 2 years), intermediate (6 weeks to 9 months), and short term (2 to 4 weeks).

Bull markets usually last longer than bear markets and are more gradual in their movement.

A trend is presumed to be in tact until proven otherwise.

Prevailing trends will normally retrace 1/3 to 2/3 of the previous move.

Housing and transportation lead the economy.

The bond market is the first financial market to enter a bull market as interest rates move lower. Equities move up next, and finally, commodity prices.

80% of all stocks follow the prevailing trend.

Normally, volume goes up on rallies, and contracts when prices decline.

Historically, when the dividend yield on the market is below 3%, the market is approaching its top. When the yield exceeds 6%, it finds bottom.

A primary trend consists of five intermediate trends; three which move in the direction of the primary and two which oppose.

At all times, there are four influences on prices: psychological, technical, economic, and monetary.

Two signs that a bull run is at an end; higher prices without higher volume, higher volume without a rising price.

Reversal from bear to bull; retracement of 80% of the previous decline, shrinking volume on price dips.

The average intermediate advance takes 24 weeks and moves prices upward by 22%.

The average intermediate decline takes only 13 weeks and drops the price by 18%.

Technicians watch for transitional phases that interrupt trends or signal reversals. This is where the primary trend is interrupted and the equity moves into a horizontal price pattern for a period of time.

Wait for a 3% penetration of a trend line before giving it real credence.

Volume should move up and down with pricing.

As a pattern completes, volume dries up.

When resistance is broken, volume moves up dramatically.

Downside moves don't require heavy volume to be valid.

Head and shoulders is consider the most reliable of all chart patterns. It occurs at both tops and bottoms. Volume is heaviest during the formation of the left shoulder and again at the peak.

Once the neckline on a head and shoulders pattern is broken, the expected price movement is equal to the distance between the peak and the neckline.

A head and shoulders failure is normally followed by an explosive rally.

A double bottom signals a potential breakout to the upside if accompanied by heavy volume.

A symmetrical triangle does not indicate which way the price is likely to break. Rather, just that a price break is likely. A right triangle will normally have a price break above or below the horizontal line.

A flag is a price pause with quiet volume. The breakout is in the direction of the original trend. They can last from five days to five weeks. Flags seem to form at the halfway point in a move.

Pennants and wedges follow similar characteristics as flags. Be sure that the volume follows the price movement.

Breakaway gaps to the upside are very bullish provided they are accompanied by high volume. They happen at the beginning of a move.

Runaway gaps occur during a straight line advance or decline during the middle of the move.

Exhaustion gaps mark the end of a trend.

Gaps have the potential to become important support or resistance levels.

Outside price bars are a strong signal of exhaustion.

And inside bar represents balance between buyers and sellers following a sharp up or down move. It normally gives way to a trend in the opposite direction.

A two bar reversal is a classic signal of a trend change.

A key reversal bar comes at the end of a long rally or contraction.

Pinocchio bars can give a false sense of a breakout.

Trend lines are dynamic areas of support and resistance. They are best drawn after the market closes as it indicates who is willing to hold a position overnight.

A trend line connects troughs in a bull market and peaks in a bear market. The breaking of a trend line represents a trend reversal.

The significance of a trend line is a function of its length, the number of times its been touched, and the angle of ascent or decent.

Steeper trend lines are likely to rupture more quickly than those which are more gradual.

Changes in the price trend are identified by the price crossing its moving average. A bullish signal occurs when the price crosses above the moving average and a bearish signal occurs when it crosses below.

Moving averages act as areas of support and resistance. The more times it is touched, the greater its significance.

Moving averages should be thought of as a moving trend line who's significance is measured by its length, times touched and angle of accent or decent.

Simple moving averages generally outperform weighted or exponential averages.

A sharp price move is often preceded by a gradually narrowing trading range.

Moving averages of different time frames can be plotted together on the same chart. When the shorter term moving average is above the longer term, this is a bullish sign and vice versa.

When Bollinger bands narrow, there is a good chance for a dramatic price movement.

If the price moves above the upper band, higher prices are likely. If prices move below the lower band, the opposite is likely.

The use of momentum indicators can warn of latent strength or weakness in the price trend.

The rate of decline often slows ahead of the final low.

You must use momentum indicators in conjunction with some kind of trend reversal signal.

Various momentum indicators deal with the following; overbought and oversold conditions, divergences, identification of trend reversals.

Normally, a reversal in the momentum trend is used to confirm a reversal in price trend.

Buy and sell signals only come from a reversal of the price trend.

When a sharp price move takes place, oscillators have minimal value.

In a bull market, oscillators tend to move into an overbought condition and stay there for a long period of time.

An overbought condition will many times signal the top of a bear market rally.

It is only when a bull market is maturing or in a bear phases that overbought levels can be relied upon to signal that the rally is over.

An excellent buy and sell alert are generated when the momentum indicator enters an overbought or oversold territory and then crosses back through the boundary on its way back to zero.

When a security is mega-overbought, the correction is normally a sideways move.

Record volume after a major decline is usually a reliable signal that a new bull market is forming.

Maximum momentum normally comes ahead of peak prices.

Trend lines can be drawn on the oscillators themselves.

RSI measures the relative internal strength of a security against itself.

RSI measurement of under 20 indicates an oversold position, whereas, a measurement of over 80 indicates an overbought situation. But in any event, wait for the price reversal before buying or selling based on this indicator.

MACD compares two moving averages with the shorter being subtracted from the longer MA.

Crossovers of the signal line trigger buy and sell signals when used in conjunction with price trend and other indicators.

The theory behind stochastic is that prices close near the upper end of the trading range during an uptrend and near the bottom of their trading range when bearish.

When stochastic indicators slow down, there is a high probability that a reversal is about to take place.

Short term prices are usually monitored with daily prices, intermediate term trends with weekly prices, and long term trends with monthly prices.

Trending markets are best situated for trend following like moving averages whereas a trading range environment is more suitable for oscillators.

The ADX tells whether a security is trending or not. It does not indicate price direction. When the ADX reverses direction from a high reading, a change in trend is likely.

Candle charts provide a unique visual effect that emphasizes certain market characteristics not easily identifiable by bar or closing charts.

Candle patterns can be reversal or continuation in nature.

Western chart reading techniques can be used in conjunction with candles to produce superior results.

There is no known method of predicting the exact magnitude or duration of a price trend.

Support and resistance are points on a chart where the probabilities favor a halt or reversal in the prevailing trend.

When a support level is broken, you need to look for the next one down.

Many times, support and resistance levels are formed at round numbers, 10, 50, or 100. They represent psychological barriers.

A broken support line often times becomes a new resistance line. Likewise, a broken resistance line often times become the new support.

Trend lines and moving averages are dynamic levels of support and resistance.

The more times a zone has been able to reverse a price trend, the greater its significance.

The steeper the price movement preceding a given support or resistance zone, the greater its significance.

The greater the quantity of security that changes hands at a given support or resistance level, the greater its importance.

Perhaps the best known principle of proportion is the 50% rule. Many bear markets have seen prices cut 50% while bull runs normally up double from their low.

RS, as opposed to RSI, compares one security to another. The most common application is to compare a stock with a market average. When the line is rising, it means the stock is outperforming the market and vice versa.

Divergence between the price and RS warn of latent strength and weakness.

4 year stock market cycle has corresponded to the business cycle for many decades.

When a business recovery gets underway, inventories are low, and raw materials are needed to initiate production. Transportation volume usually picks up, driving up the price of the Dow Jones Transportation Averages, making it a leading indicator of the overall market trend.

Because utility stocks are so interest rate sensitive, and because big companies are typically leveraged, the direction of the Dow Jones Utility Average will lead the overall stock market. As the market tops, the Utility Average quietly declines.

The NASDAQ is a proxy for the technology sector.

It has been said that "what is good for GM, is good for America". It usually leads the markets up, and lags on the way down.

The Russell 2000 is a proxy for low cap stocks.

The stock market cycle experiences a distinct pattern of industry group rotation because of the chronological nature of the business cycle. Interest sensitive groups have a tendency to lead at peaks and troughs, whereas companies reliant on capital spending or commodity price inflation generally lag the overall markets.

Deflationary forces predominate during the early stages of a business cycle, whereas inflationary pressure come to the fore as the cycle matures.

Bond prices typically make their lows after the recession has been underway for some number of months. The stock market makes its lows 3 to 6 months before the low in economic activity. The commodity market comes to life several months after the recovery has begun.

Economic recoveries are led by consumer spending, spearheaded by the housing industry which is stimulated by low interest rates.

Housing and construction stocks are a leading market indicator, along with retail, restaurants, cosmetics, tobacco, and interest sensitive stocks like utilities and finance. The last to move are the groups associated with capital spending like steel, chemicals and mines.

Stocks with good fundamentals and high yields normally lead the charge out of a recession. Then stocks which are a bit more speculative will follow. Air transport is almost always one of the first groups to turn down before a peak.

Drug stocks present their best performance at the tail end of a bull market.

The longer a trend takes to complete, the greater its psychological relevance.

The overall market tends to follow the 41 month business cycle (referred to as the 4 year cycle) which moves from recovery, to peak, to economic stagnation, to recovery. This cycle has been observed since 1871.

There is a seasonal pattern to the stock market. It seems to generally rise in the spring, suffer a late second quarter decline, rally in the summer, and decline in the fall. The market normally goes back up toward the end of the year into January. Therefore, stocks purchased in October have a high probability of appreciating if held 3-6 months.

The last trading day of the month and the first three trading days of the next month are unusually profitable. These four trading days average .118 percent vs. .015 for all trading days. It is said that all he positive returns in the market come during these four days.

Monday is the only historically down day of the week for the stock market.

All days show an upward bias going into the last half hour of the trading day.

Volume is an independant variable from price.

It is normal for volume to increase during times of rising prices and contract during declines.

A new high in price that is not confirmed by volume should be regarded as a red flag.

Rising prices and falling volume are a sign of weakness.

Never short a dull market.

Following a decline, heavy volume with little price change is indicative of accumulation and is a bullish sign.

High volume coming off a major low is usually a very reliable signal of a market bottom.

When looking at a double bottom, if the second low is achieved with less volume than the first, this is a bullish sign.

Market strength is usually accompanied by prices closing in the upper half of their trading range with increasing volume.

Identify the direction of the main trend before doing any short term analysis.

Market breathe measures the degree to which the vast majority of stocks are moving in the same direction. The greater the number, the most significant the trend.

When breathe reverses its downtrend, this is a bullish signal.

The most widely used indicator of market breathe is the advance/decline line.

The market peak normally comes 6-9 months before a peak in the economy.

Blue chip stocks are normally the last group to be sold off by investors during a bull market.

Divergence between market prices and the advance/decline line show an impending reversal.

Interest rates are critical to the overall market. They impact the consumer's ability to borrow, the profitability of corporations, the relationship between stocks and competing instruments, and the interest brokers charge on margin accounts. In general, when interest rates are low, stocks will grow. When interest rates are high, stocks will die.

Utility stocks are particularly influenced by interest rates due to their lack of growth and relatively high dividend payout.

Bonds normally top out ahead of equities at market peaks.

High quality bonds will decline in price before higher yielding bonds (lower quality) in the face of rising interest rates.

Virtually every primary stock market peak in the last 100 years was preceded by a peak in bond values.

Rallies in the stock market are normally much stronger when combined with falling interest rates.

Since the incorporation of the Federal Reserve System, every major bull market peak in equities was preceded by a rise in the discount rate.

After three consecutive rate hikes by the Fed, the equity market is likely to tumble.

Optimism reaches its peak around the same point that the market is reaching its high. Next comes the day of reckoning.

Oversold readings in a bull market are far more powerful than oversold readings in a bear market.

Insiders are those who hold in excess of 5% of the total voting stock, or are corporate officers. They must report any of their purchases or sales within 10 days. Insiders have proven to be leading indicators of their stock's prices.

What how the price of a stock reacts to good or bad news. The the price moves contrary to the news, then a reversal is most likely in the offing.

When everyone holds the same bullish position, the market runs out of new buyers.

Indicators are most valuable when they register extreme overbought or oversold positions.

Peaks in bond yields are normally preceded by peaks in commodity prices which act to slow the economy.

Bond prices react unfavorably to good economic news.

Market Peaks

NYSE advance/decline line peaked several months earlier.

Old rules get thrown out.

Extreme technical benchmarks are exceeded.

Rising short term interest rates act to slow market momentum.

Recessionary pressures attack corporate profitability.

Dow Jones Utility Average peaks.

Oscillators show overbought conditions.

The Dow and S&P averages cross below their 200 day moving averages.

Good news fails to move the price of a stock upward.

3 month commercial paper yields cross above their 12 month moving average.

Market Bottoms

Short term interest rates start to head down.

Upward trend of early cycle leaders; utilities, financials, and consumer non-durables.

Positive divergence between NYSE advance/decline line and major stock market averages.

Record volume.

Bad news has little negative impact on market prices.

End of market peaks, bottoms.

Moving average crossovers work well in a trending market. Oscillators are best saved for range bound markets.

A strong buy signal is triggered when an oscillator is in a pre-determined oversold position and the price of the issue has moved above its moving average. The position should be liquidated when the issue moves below its moving average. If the oscillator moves to an overbought position, the position size should be reduced.

Good stocks to own are those which are breaking out of extended bases accompanied by expanding volume and improving RSI.

A bull market generally carries most stocks with it, but performance of individual issues can vary.

Once a favorable market environment has been established, the process of selecting stocks should begin with the isolation of promising industry groups with a positive long term technical position.

Once attractive groups have been isolated, it is important to look for stocks which are outperforming the industry group index.

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