 Personal Finance Powerpoint Presentation. Technical Analysis. Prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia. Technical Analysis, which you can find online. Take a look at the references, resources, continue your research from there. This by Adam Hayes, updated March 14th, 2022. In prior presentations, we've been looking at investment goals, investment strategies, investment tools, keeping in mind the two major categories of investments. That being fixed income, typically bonds, equity, typically stocks. We're focused here on the equity or stocks side of things. Quick recap on what stocks are. Corporations are a separate legal entity. The owners of the corporation are generally owning stocks which represent an equal unit of ownership for each individual stocks. Those corporations then could choose to be publicly traded on exchanges. And that's usually those publicly traded companies, what we are talking about when we're thinking about investing in stocks. Also, note that you might invest in stocks with multiple tools such as mutual funds and ETFs which make it easier for smaller units of dollars to be pooled together and allowing you to diversify which we've talked about in prior presentations. If you're investing in individual stocks, then of course you're gonna be wanting to do more research on those individual stocks as opposed to investing more broadly where you might be looking at research on the market as a whole and investing in say sectors. So now we're concentrating in more on like individual types of stocks and investing in them when asking the question of what is technical analysis. Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from traded activity such as price movement and volume. So note, if you're looking at individual stocks, you might try to analyze a company by looking one at their underlying financial statements and trying to see the health of the company through their financials and so on. Or you might just try to look at the trends and say what has been happening in the past, what's likely gonna happen in the future given like a cyclical nature it would be the theory, it would be the idea meaning past data could be used possibly to think about what's gonna happen into the future and if we can extrapolate out those trends then we can make our trades on that movement basically the price movement. So unlike fundamental analysis which attempts to evaluate a securities value based on business results such as sales and earnings, technical analysis focuses on the study of price and volume. So we're not really digging down here on the financial statements when we're focused on technical analysis although that's another great tool that you could use instead again we're looking at that kind of trend of what's happening with the trading over time. So understanding technical analysis. Technical analysis tools are used to scrutinize the way supply and demand for a security will affect changes in price, volume and implied volatility. It operates from the assumption that past trading activity and price changes of a security can be valuable indicators of the securities future price movement when paired with appropriate investing and trading rules. So we could say okay I've got an idea about how trends have happened over time. I think those trends can be applicable possibly and the future therefore the past trading data should be used to, could be used possibly to make predictions in the future. Now people will debate this all the time you'll find some people that say hey no I'm gonna look at the underlying financial statements and I'm gonna be investing based on value of the company and other people will argue we'll know the trend analysis you can see cycles on this and some will take both of those kind of analytical tools into consideration. A pessimist on this analysis might give an argument such as you know when you go to the to the to Vegas and you see the roulette wheel for example and you see how many times they'll actually tell you how many times it's landed on red and how many times it's landed on black and if it's landed on red a bunch of times you might think well then I should bet on black because it landed on red a bunch of times but statistically speaking in that instance the past data doesn't have any impact on the future data. So that would be a statistical kind of argument saying well maybe we're reading too much into it but at the same time obviously we know that there are cyclical natures in a business market so we think that there are trends so you would think that it could be more valuable so people will argue which method would be the best method to use and how much value there would be in and you can research and engage in those arguments. So it is often used to generate short-term trading signals from various charting tools but can also help improve the evaluation of a security's strength or weakness relative to the broader market or one of its sectors. So this information helps an analysts improve their overall valuation estimate. Technical analysis as we know it today was first introduced by Charles Dao and the Dao theory in the late 1800s. Several noteworthy researchers including William P. Hamilton, Robert Ria, Edson Gilt and John McGee further contributed to Dao theory concepts helping to form its basis. Nowadays technical analysis has evolved to include hundreds of patterns and signals developed through years of research. Using technical analysis, professional analysts often use technical analysis in conjunction with other forms of research. So you're gonna wanna be looking at if you could it would be great to be using these kind of tools in alignment with other kind of analytical type of tools as well. How much weight you put on the different tools and whatnot will be dependent upon the models that you're gonna be putting together and using. So retail traders may make decisions based solely on the price charts of a security and similar statistics but practicing equity analysts rarely limit their research to fundamental or technical analysis alone. Technical analysis can be applied to any security with historical trading data. This includes stocks, futures, commodities, fixed income, currencies and other securities. In fact, technical analysis is far more prevalent in commodities and forex markets where traders focus on short-term price movements. Technical analysis attempts to forecast the price movement of virtually any tradable instrument that is generally subject to forces of supply and demand including stocks, bonds, futures and currency pairs. In fact, some view technical analysis as simply the study of supply and demand forces as reflected in the market price movements of a security. Technical analysis most commonly applies to price changes but some analysts track numbers other than just price such as trading volume or open interest figures. Technical analysis indicators. Across the industry there are hundreds of patterns and signals that have been developed by researchers to support technical analysis trading. Technical analysis have also developed numerous types of trading systems to help them forecast and trade on price movements. So obviously once we start looking at the past data and try to extrapolate what we think is gonna happen into the future we can come up with a whole lot of different theories based on different assumptions about past data and what we think is gonna happen in the future which could be dependent in part on the current environment that we're in and the basically what the actual thing that we're trading in the industry for example the size of the business and so on and so forth. Some indicators are focused primarily on identifying the current market trend including support and resistance areas while others are focused on determining the strength of a trend and the likelihood of its continuation. Commonly used technical indicators and charting patterns include trend lines, channels, moving averages and momentum indicators. In general technical analysts look at the following broad areas of indicators. So we got the price trends, we got the chart patterns, volume and momentum indicators, all selectors. We got the moving averages, support and resistance levels. So underlying assumptions of technical analysis there are two primary methods used to analyze securities and make investment decisions. We've got the fundamental analysis and technical analysis. The fundamental analysis involves analyzing a company's financial statements to determine the fair value of the business while technical analysis assumes that a securities price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. So notice the assumptions that are basically being making here. If we're looking at the actual financial statements and trying to drill down and look at the price reflects what we think the value of the financial statements are, then we're assuming that we can determine what the value is possibly better by focusing more on it than the current market is. When we're looking at market trends, you might be looking at or making the assumption that we'll look at the market because it's a free market has already done that analysis. It's pricing in everything that needs to be kind of priced in and therefore we're gonna basically look at the trends that are rolling through. And so I don't think obviously both of those positions are kind of the extreme edges of the position which means that many people will most likely use both of these methods if you had a sophisticated type of model although many people will probably gravitate to one or the other as what they prefer depending on their theory of the market. So technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing a securities fundamental attributes. Charles Dow released a series of editorials discussing technical analysis theory. His writing includes two basic assumptions that have continued to form the framework for technical analysis trading. Number one, markets are efficient with values representing factors that influence a securities price. So the efficiency of the market, remember that's what a market is supposed to do. The fact that we're trading the stocks on a public market, the fact that we've made all the stocks the same in terms of value for one individual company so that we can value all the stocks and the fact that we've made the financial statements available and hopefully in a format that they can be compared would mean that there's enough information on both sides of the equation on the selling and the buying side of the stocks that they should reach an efficient equilibrium would be the idea. Number two, even random market price movements appear to move in identifiable patterns and trends that tend to repeat over time. So now you're gonna say, well, that would lead us to say, well, we're not gonna focus so much on looking, on trying to value it, the company better than the market does, but we're going to instead look at the trends and we've looked over time, we think that there's patterns. Even when it looks sporadic, we think there are patterns. We think it's not like when you're at the relic wheel and looking at a red and black. Some people might argue that, right? So that you're reading too much into the past pattern to try to predict the future. But if you think that there's a cyclical nature, then you're gonna be able to put stuff in there. Again, some people might argue against this. A lot of people might say, well, look, I think if I analyze like Buffett, for example, analyzes really well the underlying fundamentals of the company, then it's not always the case that possibly the market is being as efficient as it can at any one particular time. There might be kind of stickiness or some, for whatever trends happening that are happening that aren't reflecting underlying value of the stocks. So those people would say, well, I think the markets are efficient in the long run, but I think you could probably find stocks where the market is mispricing them, right? In some cases, and then make your bets based on the underlying value of the stock. Some might argue, and again, this argument about being able to find trends. If we human beings want to find trends and we will find trends, even when there are no trends there, and that's a danger of over trend finding, right? We can look at just a wall and start seeing faces in it just because we feel like the pattern looks like a face. It's just two dots that are there. So you gotta be a little bit careful and grounded with it and make sure that your analysis is grounded in good theory. So today, the field of technical analysis builds on Dow's work. Professional and analysts typically accept three general assumptions for the discipline. Number one, the market discounts everything. Technical analysts believe that everything from a company's fundamentals to a broad market factors to market psychology is already priced into the market. This point of view is congruent with the efficient market's hypothesis, the EMH, which assumes a similar conclusion about prices, meaning the market's works. The markets are being efficient. The price is reflecting what should be reflected in the price. So we're gonna rely on the price of being efficient, which to some degree you can kind of do, but you might kind of overdo that point because I'm not sure they're efficient perfectly at any one given time all the time. So the only thing remaining in the analysis of price movement, which technical analysts view as the product of supply and demand for a particular stock in the market. Number two, price moves and trends. Technical analysts expect that prices, even in random market movements, will exhibit trends regardless of the timeframe being observed. In other words, a stock price is more likely to continue a past trend than move erotically. So most technical trading strategies are based on this assumption, meaning if something's moving in one direction, it's kind of taking a physics type of assumption, right? It's moving one way. It's not gonna stop that movement that way unless some other force is applied to it or something like that, right? So number three, history tends to repeat itself. Technical analysts believe that history tends to repeat itself. The repetitive nature of price movement is often attributed to market psychology, which tends to be very predictable based on emotions like fear or excitement. Technical analysts use chart patterns to analyze these emotions and subsequent market movements to understand trends. So it's kind of interesting here that basically now we're looking at this idea that the markets are gonna be impacted by our emotion, which is gonna have these cyclical kind of trends, which is kind of interesting because you would think that if it moves by our emotions here, then you would think that we might not always be at this number one assumption where the markets are valued completely correctly because you would think that sometimes our emotions might drive us out of valuation because we're making picks based on something other than taking into account just all the factors in the market. But in any case, so while many forms of technical analysis have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns of price movement that often repeat themselves. Technical analysis versus fundamental analysis. Fundamental analysis and technical analysis, the major schools of thought when it comes to approaching the markets are opposite ends of the spectrum. Both methods are used for researching and forecasting future trends in stock prices and like any investment strategy or philosophy, both have their advantages and disadvantages. Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a security. Fundamental analysis study everything from the overall economy and industry conditions to the financial conditions management of companies. Earnings, expenses, assets and liabilities are all important characteristics of fundamental analysis. Technical analysis differs from fundamental analysis in that the stock's price and volumes are the only inputs. The core assumption is that all known fundamentals are factors into price. Thus, there is no need to pay close attention to them. Technical analysis do not attempt to measure securities intrinsic value, but instead you stock charts to identify patterns and trends that suggest what a stock will do in the future. Limitations of technical analysis. Some analysts and economic researchers expect that the EMH demonstrates why they shouldn't expect any actionable information to be contained in historical price and volume data. However, by the same reasoning, neither should business fundamentals provide any actionable information. These points of view are known as the weak form and semi-strong form of the EMH. Another criticism of technical analysis is that the history does not repeat itself exactly. So price pattern study is dubious importance and can be ignored. Prices seem to be better modeled by assuming a random walk. So in other words, this would be the argument that's closer to saying, hey, look, from a statistical point of view, if I look at the trend of heads or tails from flipping a coin in the past, that doesn't really tell me any information that's useful in the future because the future's gonna be basically different from the past. So you can look at trends and from a poetic standpoint, if you've heard people say, well, the future doesn't repeat the past, but it rhymes, right? Well, if it rhymes, can you tie a rhyme into the past and how could you use that data to make future predictions? So a third criticism of technical analysis is that it works in some cases but only because it constitutes a self-fulfilling prophecy. So now it's basically saying, well, you can see why this is working, but the reason it's working is because influencers are basically getting people on board with this kind of trend philosophy, which actually is the thing that's perpetuating us to be more cyclical, possibly, than it otherwise would be if we weren't locked into this ideology that this is the way it should be. So which is first, the chicken or, you know, what's driving the trend here? So for example, many technical traders will place a stop-loss order below the 200-day moving average of a certain company. If a large number of traders have done so and the stock reaches this price, there will be a large number of sell orders which will push the price stock down, confirming the movement traders anticipated. So they made the trade basically happen and then they're reading in that they read what was going to happen, right? That it's been reversed, the cause and effect. Then other traders will see the price decrease and also sell their positions, reinforcing the strengths of the trend. This short-term selling pressure can be considered self-fulfilling, but it will have little bearing on where the asset's price will be weeks or months from now. In sum, if enough people use the same signals, they could cause the movement foretold by the signal, but over the long run, this sole group of traders cannot drive the price. So in other words, if everybody's looking at the same kind of indicators, the fact that they're looking at those indicators is gonna be what's gonna drive the action. But you would think in the long run, they couldn't actually drive the action in the long run, which is kind of an argument for actually looking at the financial statements and trying to get your own fundamentals if you're on the long-term side of things. So charter market technician, CMT, among professional analysts, the CMT Association supports the largest collection of chartered or certified analysts using technical analysis professionally around the world. The Association's Chartered Market Technical Technician, CMT designation can be obtained after three levels of exams that cover both a broad and deep look at technical analysis tools. The Association now waves level one of the CMT exam for those who are certified financial analysts, that's a CFA charter holder. So this demonstrates how well the two disciplines reinforce each other. What assumptions do technical analysts make? Professional technical analysts typically accept three general assumptions for the discipline. The first is that similar to the efficient market hypothesis, the market discounts everything. Second, they expect the prices even in random market movements will exhibit trends, regardless of the timeframe being observed. Finally, they believe that history tends to repeat itself. The repetitive nature of price movements is often attributed to market psychology, which tends to be very predictable based on emotions like fear or excitement. So what is the difference between fundamental and technical analysis? Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a stock. The core assumption of technical analysis on the other hand is that all known fundamentals are factored into price. Thus, there is no need to pay close attention to them. Technical analysis does not attempt to measure a securities intrinsic value, but instead you stock charts to identify patterns and trends that might suggest what the security will do in the future. How can I learn technical analysis? There are a variety of ways to learn technical analysis. The first step is to learn the basics of investing, stocks, markets and financials. This can be done through books, online courses, online material and classes. Once the basics are understood from there, you can use the same type of materials, but those that focus specifically on technical analysis. Investopedia course on technical analysis is one specific option. We're not promoting anything at here. We're not affiliated in any way, but you can take a look at those resources if you so choose.