Technical Analysis I

UP JFA

Investments Council

Supplemental Handout

Technical Analysis

Premise: The historical performance of security prices provide some indication of future

performance.

Assumptions: - The price reflects all necessary information available to the public. - There are historical patterns. - Prices have a tendency to trend.

NOTES

Technical Analysis I

A. Objects

I. Trendlines - A trend is the general direction in which prices are moving - Short-term, medium-term, and long-term trends - There can be a lack of any directional trend (a.k.a. sideways trend) - Two types of trends, which can be helpfully traced out with trend-lines - Trend-lines help visualise points of price support and resistance

(1) Uptrend: Higher highs, higher lows; trend-line drawn at lows of a trend

(2) Downtrend: Lower highs, lower lows; trend-line drawn at highs of a trend

- Special mention: Channels - Channels generally point out important points of support and resistance

Technical Analysis I

II. Supports and Resistance - Support and resistance points are certain price levels that a securitys price rarely breaches. - These levels are a result of the dynamics of market (trader) psychology and are generally met

with increased trading levels (volume) when breached. - A convincing breach of a support or resistance point, when accompanied by large trading

volume, signals heightened trader conviction on the side of the breach, and increases the

chances of the reversal being sustained. - Support and resistance points may regularly be tested and, when breached, reverse roles.

III. Fibonacci - Fibonacci objects infer potential entry, support, and resistance points using the golden ratio. - Traders often use fibonacci objects to aid them in positioning and setting up trades.

Technical Analysis I

- The most common types of fibonacci objects are: (1) Fibonacci Expansion

- The fibonacci expansion uses the golden ratio to forecast potential support and resistance points from an initial primary trend and subsequent counter move.

- Fibonacci expansions are primarily used in conjunction with other indicators and objects to set profit targets and smooth out returns on a trade-by-trade basis.

- Since expansions provide multiple potential profit targets, the object also helps traders in judging opportunities for scaling out of (or gradually taking profit from) open positions.

- Fibonacci patterns in a shorter time frame may also be part of larger fibonacci patterns over a longer time frame.

(2) Fibonacci Retracement - Fibonacci retracements infer potential support and resistance points within a set vertical

distance (usually with end points located at price extremes). - Retracements are used by traders to help identify potential entry and stop loss levels.

Technical Analysis I

(3) Fibonacci Arc - Fibonacci arcs use are similar to Fibonacci retracements, and provide traders with key entry

levels of potential support and resistance. - Fibonacci arcs are plotted by taking a security prices primary move, taking the 38.2%, 50%,

and 61.8% key levels of the primary move, and plotting three curves that intersect these

points.

(4) Fibonacci Fan - Fibonacci fans use a security prices primary move to infer potential points of support and

resistance, using the golden ratio to plot the 38.2%, 50%, and 61.8% key levels of the

primary move, and plotting three lines through the low of the primary move and each of the

three key levels.

Technical Analysis I

E. Indicators

I. Moving Average - When viewing visual price data, unpredictable (for all intents and purposes, random)

fluctuations in the price can make identifying trends troublesome. To deal with this, traders

often superimpose the security prices moving average (with a set time span) on the main

window. - Traders also often superimpose more than one moving average, setting one average at a low

time span and another at a higher time span, to capture information regarding trends in varying

time horizons. - If the price is above the moving average while both are rising, the security price is in an

uptrend, and vice versa. - Moving averages often act as supports and resistances, and a cross of the price and the moving

average is often taken as a buy/sell signal (if price crosses the moving average going up, its a

buy signal, and vice versa). - Three of the most common forms of the moving average are the:

(1) Simple Moving Average: Simple arithmetic mean - The SMA is the most commonly-used moving average, and reacts relatively slower to

heightened recent volatility.

(2) Linear-Weighted Moving Average: Weighted-average in periods (most recent is heaviest) - The LWMA is the least used form of the three, and generally attempts to adjust for time

lags by calculating the moving average using linearly-assigned weights according to the

price points relative distance from the current time.

(3) Exponential (-Weighted) Moving Average: Autoregression (more efficient form of LWMA) - The EWMA is the most commonly-used moving average for traders, as it has higher

robustness in the face of volatility spikes and non-normal distributions.

Technical Analysis I

II. Relative Strength Index (RSI) - The RSI is an oscillator (an indicator bounded within a certain range, in this case 0 to 100) of

momentum which measures the degree to which a security has been bought or sold in the past

(14 days by default). - Critical levels in the RSI are at 30 and 70. An RSI reading below 30 indicates the security is

notably oversold, and above 70 indicates the security is overbought. - The RSI is one of the most widely-used indicators, and when used in conjunction with other

indicators, aids many traders in identifying potential reversals.

Technical Analysis I

III. Moving Average Convergence-Divergence (MACD) - The MACD is another very popular indicator used by traders to follow trend momentum and

strength. - The MACD itself is simply the difference between the levels of two EWMAs. When the MACD is

above the 0 line, the short-term EWMA is above the long-term EWMA and suggests upward

momentum, while a negative MACD indicates downward momentum. - Plotted into the MACD window is a signal line, which is an EWMA of the MACD. When the

MACD crosses the signal line from below (from above), this provides a strong buy (sell) signal. - Divergence of price movements from the MACDs movements signals the end of the current

trend. - Some MACD charts (like the one below) also show a histogram superimposed, which measures

the difference between the MACD and the signal line. Generally, large differences (large bars)

indicate strong momentum for the direction of the bars.

Technical Analysis I

IV. Average Directional Index (ADX) - The ADX is an indicator that attempts to quantitatively assess a current trends momentum and

strength. - Commonly, the ADX (white line below) is plotted along with two other Directional Movement

Indicators (DMIs): the +DMI (blue) and the -DMI (red). - When the ADX is increasing and crossing/above the 20 level, the trend is suggested to be

gaining momentum and strength, while if it is falling and crossing/below the 40 level, the trend

is suggested to be exhausting and prone to reversals. - The +DMI and -DMI indicate momentum relative to each other: when the +DMI is above the -

DMI, it is interpreted as the price being in an uptrend, and vice versa.