Table Of Content

FT Press Fl NA NCIAI. TIM F.S In an increasingly competitive world, it is quality of thinking that gives an edge—an idea that opens new doors, a technique that solves a problem, or an insight that simply helps make sense of it all. We work with leading authors in the various arenas of business and finance to bring cutting-edge thinking and best-learning practices to a global market. It is our goal to create world-class print publications and electronic products that give readers knowledge and understanding that can then be applied, whether studying or at work. To find out more about our business products, you can visit us at www.ftpress.com. TECHNICAL ANALYSIS THE COMPLETE RESOURCE FOR FINANCIAL MARKET TECHNICIANS Charles D. Kirkpatrick II, CMT Julie R. Dahlquist, Ph.D. FT Press FINANCIAL TIMES Vice President, Editor-in-Chief: Tim Moore Executive Editor: Jim Boyd Editorial Assistant: Susie Abraham Development Editor: Russ Hall Associate Editor-in-Chief and Director of Marketing: Amy Neidlinger Cover Designer: Sandra Schroeder Managing Editor: Gina Kanouse Project Editor: Christy Hackerd Copy Editor: Water Crest Publishing Proofreader: Karen A. Gill Senior Indexer: Cheryl Lenser Compositor: ContentWorks Manufacturing Buyer: Dan Uhrig © 2007 by Pearson Education, Inc. Press Publishing as FT Press I^^H FINANCIAL TIMES Upper Saddle River, New Jersey 07458 FT Press offers excellent discounts on this book when ordered in quantity for bulk purchases or special sales. For more information, please contact U.S. Corporate and Government Sales, 1-800-382-3419, [email protected]. For sales outside the U.S., please contact International Sales at [email protected]. Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners. All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher. Printed in the United States of America Second Printing, August 2007 ISBN 0-13-153113-1 Pearson Education LTD. Pearson Education Australia PTY, Limited. Pearson Education Singapore, Pte. Ltd. Pearson Education North Asia, Ltd. Pearson Educati6n Canada, Ltd. Pearson Educatin de Mexico, S.A. de C.V. Pearson Education—Japan Pearson Education Malaysia, Pte. Ltd. library of Congress Cataloging-in-Publication Data Kirkpatrick, Charles D. Technical analysis: the complete resource for financial market technicians / Charles D. Kirkpatrick and Julie R. Dahlquist. p. cm. Includes bibliographical references and index. ISBN 0-13-153113-1 (hardback: alk. paper) 1. Investment analysis. I. Dahlquist, Julie R., 1962- II. Title. HG4529.K564 2007 332.63'2042—dc22 2006011756 This book is sold with the understanding that neither the authors nor the publisher is engaged in render ing legal, accounting, investment, or other professional services or advice by publishing this book. Each individual situation is unique.'Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The authors and the publisher disclaim any liability, loss or risk resulting, directly or indirectly, from the use or application of any of the contents of this book. CONTENTS Acknowledgments xxv About the Authors xxvii PART I: INTRODUCTION 1 1 INTRODUCTION TO TECHNICAL ANALYSIS 3 2 THE BASIC PRINCIPLE OF TECHNICAL ANALYSIS— THE TREND 9 How Does the Technical Analyst Make Money? 10 What Is a Trend? 11 How Are Trends Identified? 12 Why Do Markets Trend? 13 What Trends Are There? 15 What Other Assumptions Do Technical Analysts Make? 17 Conclusion 19 Review Questions 19 Contents 3 HISTORY OF TECHNICAL ANALYSIS 21 Early Financial Markets and Exchanges 21 Modern Technical Analysis 23 Current Advances in Technical Analysis 28 4 THE TECHNICAL ANALYSIS CONTROVERSY 31 Do Markets Follow a Random Walk? 33 Fat Tails 33 Drawdowns 35 Proportions of Scale 37 Can Past Patterns Be Used to Predict the Future? 39 What About Market Efficiency? 39 New Information 41 Are Investors Rational? 45 Will Arbitrage Keep Prices in Equilibrium? 46 Behavioral Finance and Technical Analysis 49 Pragmatic Criticisms of Technical Analysis 49 What Is the Empirical Support for Technical Analysis? 50 Conclusion 51 Review Questions 51 PART II: MARKETS AND MARKET INDICATORS 53 5 AN OVERVIEW OF MARKETS 55 In What Types of Markets Can Technical Analysis Be Used? 56 Types of Contracts 57 Cash Market 58 Futures Markets 60 Options Markets 63 How Does a Market Work? 63 Who Are the Market Players? 66 How Is the Market Measured? 67 Price-Weighted Average 67 Market Capitalization Weighted Average 68 Equally Weighted (or Geometric) Average 69 Conclusion 70 Review Questions 70 6 Dow THEORY 73 Dow Theory Theorems 76 The Primary Trend 78 The Secondary Trend 79 The Minor Trend 79 Concept of Confirmation 80 Importance of Volume 82 Criticisms of the Dow Theory 83 Conclusion 83 Review Questions 84 7 SENTIMENT 85 What Is Sentiment? 86 Market Players and Sentiment 87 How Does Human Bias Affect Decision Making? 88 Crowd Behavior and the Concept of Contrary Opinion 90 How Is Sentiment of Uninformed Players Measured? 92 The Concept of Sentiment Indicators 92 Sentiment Indicators Based on Options and Volatility 92 Polls 98 Other Measures of Contrary Opinion 103 Unquantifiable Contrary Indicators 112 Historical Indicators 113 How Is the Sentiment of Informed Players Measured? 114 Insiders 114 xii Contents Sentiment in Other Markets 120 Treasury Bond COT Data 120 Treasury Bond Primary Dealer Positions 121 Bond Market Fear Index 122 T-Bill Rate Expectations by Money Market Fund Managers 122 Conclusion 123 Review Questions 123 8 MEASURING MARKET STRENGTH 125 Market Breadth 127 The Breadth Line or Advance-Decline Line 128 The Advance-Decline Line Moving Average 132 One-Day Change in the Advance-Decline Line 133 Breadth Differences 135 Breadth Ratios 138 Breadth Thrust 142 Summary of Breadth Indicators 142 Up and Down Volume Indicators 142 The Arms Index 143 Ninety Percent Downside Days (NPDD) 145 Net New Highs and Net New Lows 146 New Highs Versus New Lows 147 High Low Logic Index 148 Hindenburg Omen 148 Number of Stocks Above Their 30-Week Moving Average 148 Very Short-Term Indicators 150 Breadth and New Highs to New Lows 150 Arms Index 151 Net Ticks 152 Conclusion 152 Review Questions 154 9 TEMPORAL PATTERNS AND CYCLES 155 Periods Longer than Four Years 156 Kondratieff Waves, orK-Waves 156 Contents xiii 34-Year Historical Cycles 159 Decennial Pattern 160 Periods of Four Years or Less 161 Four- Year or Presidential Cycle 161 Election Year Pattern 163 Seasonal Patterns 164 January Signals 165 January Barometer 165 January Effect 165 Events 165 Conclusion 166 Review Questions 166 10 FLOW OF FUNDS 169 Funds in the Marketplace 170 Money Market Funds 170 Margin Debt 171 Public Offerings 172 Funds Outside the Security Market 173 Household Financial Assets 173 Money Supply 174 Bank Loans 176 The Cost of Funds 177 Short-Term Interest Rates 177 Misery Index 178 Boucher's T-Bill Rate of Change Rule 179 Zweig's Prime Rate Indicator 180 Fed Policy 180 Predicting Federal Reserve Policy Changes 181 Zweig's Fed Indicator 182 Three Steps and a Stumble 183 Two Tumbles and a Jump 183 Long-Term Interest Rates (or Inversely, the Bond Market) 184 Yield Curve 185 Conclusion 186 Review Questions 186