Introduction to Technical Analysis

1. Technical analysis is a tool to gain insight into market price behaviour and so enable you to more profitably judge investment entry and exit points.


2. In essence Technical Analysis, correctly used, will motivate investment action that brings a higher probability of success than decisions made through the mechanism of pure random choice.


3. Dow Theory and Elliott Wave Theory, when fully comprehended, demonstrate that the market is not random.


4. Both these theories have proven themselves over 100 years.


5. These hypotheses work because price action is a result of human decisions.


6. Historical observation indicates that price conditions may change but human nature does not.


7. Thus Technical Analysis is basically a form of behavioural (social) science.


8. Such study cannot predict the future, else there would be no market as it is a “zero sum game”, but it can be a guide.


9. In my experience too much use of “Technicals” leads to “Paralysis by Analysis”. Thus I advise the use of some technical indicators but not too many.


10. My favourite analysis indicators are:


1. Moving Averages
2. MACD
3. Stochastics
4. Price Candlestick Format)
5. The A/D line

1. Moving Averages:

10 Day Line
20 Day Line
50 Day Line
100 Day Line
200 Day Line

2. MACD:

Moving Average Convergence/Divergence
Use the histogram format 12 – 26 – 9
MACD turns two trend following moving averages into a momentum oscillator by subtracting the longer moving average from the shorter. Thus it merges trend with momentum into one indicator.

3. Stochastics:

Fast: 14 - 3 - 3
Slow: 28 - 7 - 7

The stochastic oscillator is a momentum indicator that shows the price close relative to the high – low price range over a set number of periods. Thus it follows the momentum of price. As a rule momentum changes before price. It can be used to show oversold and overbought price conditions.

4. Price: Candlestick Format

Japanese Candlestick charts are one of the oldest types of charts used for price prediction. They date back to the 1700’s when they were used for predicting rive prices.

The Candlestick format shows the full range of price movement i.e. high, low, open and close. Thus we get a sense of the market sentiment behind price changes. This cannot be observed through looking at the standard line format which simply records closing prices.

Candle Format Example:



Candle Format Example:



Candle Format Example:



Candle Format Example:



Candle Format Example:



Candle Format Example:



 

5. The A/D Line:

The Advance Decline Line is a breath indicator based on Net Advances, which is the number of advancing stocks less the number of declining stocks.

The AD Line is a cumulative measure of Net Advances. It rises when Net Advances is positive and falls when Net Advances is negative.

www.wealthbuilder.ie May 2011