Saeed Ebrahimijam Fall 2013-2014

1. DoğuAkdenizÜniversitesi Faculty of Business and Economics Department of Banking and Finance Markets Technical Analysisand Algorithmic TradingChapter 1: The philosophy of technical analysis SaeedEbrahimijam Fall 2013-2014 FINA417

2. Contents • Principal of Stock Market Investment • The Basic Principals • Technical analysis defined • Adaptability to Different Market and Investment Time Horizons • Dow Theory Fundamental of Technical Analysis and Algorithmic Trading

3. Introduction • price volatility in the all stock exchanges is common. • obtaining to the method with the least prediction error is one of the challenging issues of financial and investment markets analyzers. Fundamental of Technical Analysis and Algorithmic Trading

4. Introduction Generally there are two viewpoints of analyzing: • Fundamental: The stock market has no memory and prices are changed randomly according to economic and financial variables, reports and news. • Technical: The market has undergone a pseudo psychological mode and history is always repeatable. Like: RSI, MACD, %K, Fibonacci,… Fundamental analysts believe, “Technical analysis based on the weak principles”. Fundamental of Technical Analysis and Algorithmic Trading

5. The Differences Charts vs. Financial Statements At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. Fundamental of Technical Analysis and Algorithmic Trading

6. The affect of the news of iPhone5 announcement day on Apple stock price (12th SEP’12) Fundamental of Technical Analysis and Algorithmic Trading

7. 23 April 2013 'break news' “that explosions at White House have injured Obama“ Hackers' break into Associated Press' Twitter account-Sending DOW Jones plunging 100 points-The S&P 500 Index also fell about 1percent -Wiping out $136.5 billion (according to Reuters data.) The hack also briefly sent gold (-GC) as much as $5 higher. Crude oil (-CL) in New York fell in response. Both reverted to earlier price levels once the AP clarification came out. Fundamental of Technical Analysis and Algorithmic Trading

8. Large gap between Financial model and market price Fundamental of Technical Analysis and Algorithmic Trading

9. An old saying on wall street: • “Sell on good news.” Why ??? Because if the actual news is as expected, it is, of course, already discounted and reflected in the market price. Therefore, you would expect no further rise in price based on that news. A related paper: “Buy on bad news, sell on good news: How insider trading analysis can benefit from textual analysis of corporate disclosures,” Hagenau et all. http://www.krannert.purdue.edu/faculty/kkarthik/wise12/papers%5Cwise12_submission_36.pdf Fundamental of Technical Analysis and Algorithmic Trading

10. Three basic principals of technical analysis: 1. Everything (All economic factors dealing with stock price) are hidden is discounted and reflected in market prices. 2. Prices move in trends, and trends persist. 3. Market action is repetitive. Fundamental of Technical Analysis and Algorithmic Trading

11. Technical analyzers believes: • Technical analyzers believe that all the important information of company (lose/profit report, balance sheet,…), economical, political, psychological and… conditions are all reflects in the stock prices. Fundamental of Technical Analysis and Algorithmic Trading

12. As a rule, people will act the same way they have in the past. • The stock market is a reflection of the actions of people, technicians study it to determine how people will react under certain conditions and, thus, how security prices will move. Fundamental of Technical Analysis and Algorithmic Trading

13. Technicians believe in Demand -supply • The real value of a share of stock or other market instrument at any point is determined solely by supply and demand as reflected in trading activity. • Price movements and fluctuations are simply the reflection of changes in supply and demand. • The technician does not care what the underlying forces of a shift in supply and demand are. • The study of market prices is all that is necessary. Fundamental of Technical Analysis and Algorithmic Trading

14. The basic assumptions presented by Robert D. Edwards and John Magee in the classic book, Technical Analysis of Stock Trends: Consider: • Stock prices are determined solely by the interaction of demand and supply. • Stock prices tend to move in trends. • Shifts in demand and supply cause reversals in trends. • Shifts in demand and supply can be detected in charts. • Chart patterns tend to repeat themselves. Fundamental of Technical Analysis and Algorithmic Trading

15. WHAT IS A TREND? • From a technical analyst's perspective, a trend is a directional movement of prices that remains in effect long enough to be identified and still be playable. Anything less makes technical analysis useless. • If a trend is not identified until it is over, we cannot make money from it. • If it is unrecognizable until too late, we cannot make money from it. • In retrospect, looking at a graph of prices, for example, many trends can be identified of varying length and magnitude, but such observations are observations of history only. • A trend must be recognized early and be long enough for the technician to profit from it. Fundamental of Technical Analysis and Algorithmic Trading

16. A rising trend, or "uptrend," occurs when prices reach higher peaks and higher troughs. • A declining trend, or "downtrend," is the opposite—when prices reach lower troughs and lower peaks. Fundamental of Technical Analysis and Algorithmic Trading

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18. The old Wall Street adage, “The trend is your friend,” is true because, once begun, a trend is likely to continue. By following it, you increase your probability of making money. Fundamental of Technical Analysis and Algorithmic Trading

19. 2nd principal of technical analysis • The price changes are function of specific trends. The trends are always consistent and don’t change without any reasons. • Moving car on the road!!! Fundamental of Technical Analysis and Algorithmic Trading

20. Market prices move in a similar manner. • First, they begin in one direction, up or down, creating a trend. That trend persists until the price movement slows and gives warning before finally reversing and moving in the opposite direction. At that point a new trend is initiated. • As illustrated in Figure, trends can be easily spotted on charts. The chart patterns show the balance of supply and demand for a particular stock or other market instrument. Fundamental of Technical Analysis and Algorithmic Trading

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22. What is Technical Analysis? • In its basic form, technical analysis is the study of past market data, primarily price and volume data; this information is used to make trading or investing decisions. • Technical analysis is rooted in basic economic theory? Fundamental of Technical Analysis and Algorithmic Trading

23. TECHNICAL ANALYSIS DEFINED • Giving consideration to the principles discussed above, technical analysis can be defined as simply the study of individual securities and the overall market based on supply and demand. • Technicians record, usually in chart form, historical price and volume activity and deduce from that pictured history the probable future trend of prices. Fundamental of Technical Analysis and Algorithmic Trading

24. ADAPTABILITY TO DIFFERENT MARKETS AND INVESTMENT TIME HORIZONS • it can be applied effectively to virtually any trading medium and investment time horizon. • A technician can analyze stocks, bonds, options, mutual funds, commodities, and many other forms of investments(Gold, Oil, real states,…) for buy and sell opportunities. • one can do so by examining tic-by-tic, intraday, daily, weekly, monthly, or some other interval of time to use technical analysis for a wide range of time horizons—from very short-term to very long-term perspectives. Fundamental of Technical Analysis and Algorithmic Trading

25. Technical analysis is used in two major ways: • Predictive • Reactive Fundamental of Technical Analysis and Algorithmic Trading

26. Predictive • Those who use technical analysis for predictive purposes use the analysis to make predictions about future market moves. • Generally, these individuals make money by selling their predictions to others. Market letter writers in print or on the web and the technical market gurus who frequent the financial news fall into this category. • The predictive technical analysts include the more well-known names in the industry; these individuals like publicity because it helps market their services. Fundamental of Technical Analysis and Algorithmic Trading

27. Reactive • On the other hand, those who use technical analysis in a reactive mode are usually not well-known. • Traders and investors use techniques of technical analysis to react to particular market conditions to make their decisions. • For example, a trader may use a moving average crossover to signal when a long position should be taken. Fundamental of Technical Analysis and Algorithmic Trading

28. HOW DOES THE TECHNICAL ANALYST MAKE MONEY? • There are several requirements needed to convert pure technical analysis into money. • The first and most important, of course, is to determine when a trend is beginning or ending. The money is made by "jumping" on the trend as early as possible. Theoretically, this sounds simple, consistently is not so easy. • The indicators and measurements that technical analysts use to determine the trend are not crystal balls that perfectly predict the future. Under certain market conditions, these tools may not work. Also, a trend may suddenly change direction without warning. Thus, it is imperative that the technical investor be aware of risks and protect against such occurrences causing losses Fundamental of Technical Analysis and Algorithmic Trading

29. From a strategic standpoint, then, the technical investor must decide two things: - First, when to enter a position, - Second, when to exit a position. Choosing when to exit a position is composed of two decisions: 1- when to capture profit (take profit). 2- when to exit from position at a loss (stop loss) Fundamental of Technical Analysis and Algorithmic Trading

30. The wise investor is aware of the risk that the trend may differ from what she expected. • Making the decision of what price level to sell and cut losses before even entering into a position is a way in which the investor protects against large losses. Fundamental of Technical Analysis and Algorithmic Trading

31. Adam smith: “If you don’t know who you are, the stock market is an expensive place to find out” Fundamental of Technical Analysis and Algorithmic Trading

32. Technical analysis method should be different by characteristics of the person. Level of Stress, behaviors and wealth. • Complementary of person’s characteristics and investment philosophy. Fundamental of Technical Analysis and Algorithmic Trading

33. Obviously, those whose time, nerves, and capital are limited will want to pass up very short-term trading opportunities (such as intraday trading of stock index futures) and, perhaps, use longer-term technical analysis–derived buy and sell signals for stocks, exchange traded funds (ETFs), or mutual funds. Fundamental of Technical Analysis and Algorithmic Trading

34. In sum, the basic ways to make money using technical methods are • "The trend is your friend"—play the trend. • Don't lose—control risk. • Manage your money—avoid ruin. • when the analysis is wrong and the position must be closed. Fundamental of Technical Analysis and Algorithmic Trading

35. Joseph Kennedy: “ Waiting for the ceiling price to sell shares is what silly people do….” Fundamental of Technical Analysis and Algorithmic Trading

36. The Story of Joseph Kennedy Joseph Kennedy was a stock market investor in the late 1920's. One day, in the Summer of 1929, he overheard an elevator boy boasting about how much money he had made in the stock market. Joseph Kennedy reasoned that if totally-uneducated low-income employees have now been attracted to the stock market, then the prices must be at their all-time highest. So, he raced to the floor of the stock exchange and famously yelled: SELL! For months, his friends laughed at him as prices kept rising and rising and rising. Then, one day, October 29, 1929, the market crashed. Joseph Kennedy and his family were safe. They had no money whatsoever in the market.Joseph Kennedy waited. Prices fell. He waited. Prices fell. Then, one day, in 1932, a full three years later, he bought a chain of department stores at 5 on the dollar. He bought the real estate, the buildings, the inventory, the goodwill - everything at a 95% discount. He then parlayed that brilliant purchase into a fortune that spawned a political dynasty of famous and politically successful Kennedy's, including one President John Kennedy. His wealth and his influence will last for centuries - because he had the courage to go against the conventional wisdom. He played the INNER game instead of just reading the newspaper headlines.Joseph Kennedy SOLD when everyone was buying. Then, he BOUGHT when the Depression was at its very worst. He made a gigantic fortune BECAUSE of The Great Depression. We are not in a Depression now, but we are in a serious Recession. And, you can make your fortune right now - BECAUSE of the Recession. Fundamental of Technical Analysis and Algorithmic Trading

37. Dow Theory • Charles Dow never formalized the Dow Theory. • But his work has formed the basis for modern-day technical analysis. • Despite the many changes that have occurred in the securities markets over the past century, much of Dow's basic work and ideas remain pertinent today. • Although Dow might be surprised at the analysis that more advanced tools and computer power allow, his classic work provides the basic theory that these contemporary models build upon. Fundamental of Technical Analysis and Algorithmic Trading

38. Six basic tenets of Dow theory • The market has three movements: 1. “main movement” primary movement: may last from less than a year to several years 2. "medium swing", secondary reaction: may last from ten days to three months 3. "short swing" or minor movement varies with opinion from hours to a month or more • Market trends have three phases 1. accumulation phase 2. public participation (or absorption) phase, 3. distribution phase. • The stock market discounts all news • Stock market averages must confirm each other • Trends are confirmed by volume • Trends exist until definitive signals prove that they have ended http://en.wikipedia.org/wiki/Dow_theory Fundamental of Technical Analysis and Algorithmic Trading