Monday, January 30, 2012

Charting a Course (3)


In the last blog, we talked about a stock's "price range", the band within which recent prices are trading.  If this band continues for a period of time, technical analysts refer to this as consolidation.  During a period of consolidation, buyers and sellers seem to be indecisive as to which way the stock is going to move in the future, either up or down, since the trend line is flat.  The stable price range might last for days, weeks or months.  During this period of neutrality, chartists look for indicators as to which way (up or down) the stock price might break out of the consolidation, which would signal the next trend.

If the trend is going to resume the past direction, technical analysts believe the chart will show a pattern which looks like either a flag or a pennant.  A flag forms a rectangle of prices, usually with a slope in the opposite direction from the previous rise or decline.  A pennant is a triangular band, starting with wide price swings and converging at a point of small price changes, with no apparent directional slope.  Each of these indicators tells the chartist that the stock is taking a break before continuing to resume the previous price direction.  This link to the website provides additional explanation and examples of flags and pennants.  If the flags and pennants persist over a long period of time, the chartist may view the flag as a rectangle and the pennant as a symmetrical triangle, two other indicators.

If the trend is going to reverse itself and head in the opposite direction (a point of inflection), the chart might show a price pattern over time which looks like, first, a left shoulder, then a head and, finally, a right shoulder: the head and shoulders pattern with alternating price rises and declines of varying heights and lengths.

A head and shoulders indicator, viewed in the normal pattern, is seen as a reversal from a trend of increasing prices to a trend of declining prices following the final movement of the right shoulder (downward).  This link to the website provides additional explanation and an example of the top (reversal) head and shoulders indicator.

 A reverse head and shoulders indicator, which looks the same, but upside down, is viewed as the reversal from a trend of declining prices to a trend of increasing prices, following, again, the final movement of the right shoulder (upward).  This link to the website provides additional explanation and an example of the bottom (reversal) head and shoulders indicator.

These are but a few of the more widely studied indicators used by chartists.  In the next blog, we will continue our study of charts and technical analysis.

As always, comments are welcome.

Monday, January 23, 2012

Charting a Course (2)


Assuming that the technical analyst has been studying his or her chart of choice for a period of time and patterns are beginning to reveal themselves, the question is what is being shown?  In his book, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback discusses chart patterns as follows:

Because there is a potentially infinite number of price patterns that a stock can trace, chartists have identified (devised) a virtually infinite number of chart patterns to correspond to them.  These patterns are known by such esoteric names as head and shoulders, reverse head and shoulders, single, double, and triple tops and bottoms, flags, pennants, spikes, saucers, triangles, rectangles, lines, breakouts, consolidations, blowoffs; in short a name for everything and everything with a name.* 

This blog is not intended to provide an in-depth study of charting.  Given the large number of patterns studied by technical analysts, I will discuss only a few of the more well known patterns or indicators.  A chart covering a long period of price movement for an individual stock will begin to show trends, up, down or sideways.  If the time period shown on the chart is short term, the movements can be quite jagged.  As the time period lengthens, the chartist can trace a trend line along the price increases or declines shown on the chart.  The trend line (starting from the left) over time is either pointing northeast (going up); southeast (going down); due east (staying the same) or reversing itself (inflection point).  These are the most basic messages a chart can provide.

Over time, relatively consistent highs and lows begin to show a stock's "price range" which is defined by what is called the Support Level on the bottom, the lowest point beyond which the price has not dropped in the applicable time period, and the Resistance Level on the top, the highest point beyond which the price has not risen in the same period.  This is the band within which the stock is traded.  The chartist believes that a price break out above or below the "price range" is very predictive of where the price might go in future trading.  In effect, the market may be in the process of setting new Support or Resistance Levels.  One of the basic principles of technical analysis is that a price break out either above the Resistance Level or below the Support Level or the occurrence of a sustained inflection point when the trend line reverses itself are all very important indicators.  Depending on the volume accompanying such moves, the chart could be  providing a strong indicator for the technical analyst to consider.

We should remember that the prices being charted show purchases and sales by people in the market.  The Support Level reflects the price at which buyers have consistently come into the market to purchase shares of the stock.  This would appear to be the price level at which the market considers the stock so cheap that it is a buy no matter what.  Conversely, Resistance Levels reflect the price above which no one is buying the stock, the price level at which the market considers the stock too expensive to buy no matter what.  Any changes in these levels could be seen as changes in investor/trader sentiment about a stock.  Technical analysts see this as a foreshadowing of what people in the market may do in upcoming days, which could give the chartist a trading advantage.

We will study some additional common patterns or indicators in the next blog.

* Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, pages 212-213

Comments are always welcome.

Monday, January 16, 2012

Charting A Course (1)


We have used the term, "chartist" in past blogs as another term for technical analyst.  There are as many types of charts as there are chartists.  The form of chart used is a personal decision which, I suspect, is dictated by the type of information the technical analyst believes is important and predictive.  The chartist wants the information presented in a fashion with which he or she  feels most comfortable.  There are two forms of chart used by many in the technical community: the bar chart and the point and figure chart.  First, we will learn about the bar chart ("BC").

The BC gives the analyst a picture of price movement over time.  The individual making this type of chart notes the price points along the vertical axis and the discrete time periods along the horizontal axis.  The vertical line or bar within the graph shows the price movement for the selected time - a day, a week, a month or any other time period the chartist wants to work with.  For our example, we'll use a daily bar.  The top of the bar is the highest price of the stock that day.  The bottom of the bar, conversely, is the lowest price of that day.  The closing price within that price spread is noted with a horizontal hash or tick line across the vertical barCreating a BC of daily prices takes time and patience because a few days of bars will not reveal much more than daily randomness, i.e., market noise, so to speak.

As we learned in the last blog, volume plays an important role in providing a complete picture.  Many BC graphs will also indicate the volume for the selected time period.  In our example, the daily volume (again as a vertical line) would be drawn at the bottom of the chart below the price bar for each day.  This is really a graph within a graph since the left side of the graph below the price axis must also show volume numbers.  If a stock trades several thousand shares a day, the volume points can be set in thousands.  If it trades only a few hundred shares daily, then the volume axis points can be set in hundreds.  The goal in our example is to show the ebb and flow of both the stock's price movement and trading volume for each day.

I must apologize for the rather tortured two paragraphs above.  It is very difficult to describe a graph in words.  This link to the website  will provide a short video about the BC, the most popular form of graphing.

The second most popular graph is the point and figure chart ("PF").  The main difference between the BC and the PF chart forms is the fact that time is not an element in PF charts.  The focus is solely on price movement, up or down.  A sheet of graph paper is a page of boxes.  The PF chartist designates a dollar value for each square on the graph: $1, $5, or any dollar amount the he or she decides to use.  The vertical axis on a PF chart lists prices.  The horizontal axis on a PF chart does not have a value measure.  So long as the price of a stock is advancing, the rise in price is indicated by X's (each X representing the designated dollar box value) added in the same column.  When the price goes into decline, the chartist moves to the next column to the right and notes the decline(s) with one or more O's starting at the first declining price point (again based on the dollar value of each box).  Additional O's are added in that same column, so long as the price continues to decline.  

Let me provide an example.  If the dollar value of each box is $3 and the price has risen $15, then the chartist marks 5 boxes in a column matched to the prices shown on the vertical axis of the graph.  Each time the price goes up another $3, another X is added to the same column, keeping pace with the prices noted on the left axis.  If the chartist has decided that a reversal will not be graphed unless it exceeds $6, then the X's continue to be added (at $3 per X) until the price reverses by $6 or more.  At that point, the chartist starts marking O's in the next column to the right (starting at the first declining price level) and continues to show price declines in that column (in $3 increments) until a reversal to the upside of $6 or more occurs.

Time does not play a role in the PF chart.  Price movement is the only thing that matters. The X's or O's continue to be added to the same column until the price reverses.  In order to avoid small  daily fluctuations, which would result in an unwieldy chart, the chartist may decide not to show a reversal unless the price has either risen or declined by a set amount, such as $6 or more as in my example above.  This number would be picked by the analyst based on the stock's average daily volatility.  I am not a chartist, but it seems to me that a second graph sheet supplementing the PF chart showing trading volume would be helpful.  I have no idea how such a chart would be set up, but since volume is considered such an important factor in technical analysis, you would think a PF chartist would want to keep track of it.

Again, I apologize for this rather dense text.  A clearer presentation, with an example, can be seen with this link to the website

We will continue exploring charts in the next blog.

Comments are always welcome.

Monday, January 9, 2012

Speaking Volumes


The Moving Averages and Advance/Decline Lines show price movement, which is only half of the story.  It is one thing to see which way prices are moving, but without knowing the volume of the movement (number of shares traded), the technical analyst does not have the full picture.  The price of a stock gives only the current value, but without the amount of stock traded, it is of little worth.  A hundred shares traded at $20 is one thing; ten thousand shares traded at that price is quite a different story.  The number of shares traded gives a much clearer picture of the supply (amount available from sellers) and the demand (amount wanted by buyers) for the stock.

We looked at Humphrey B. Neill's book, The Art of Contrary Thinking in an earlier blog.  Another of his books,Tape Reading & Market Tactics, first published in 1931, is still in print.  Neill had quite a bit to say about volume of trading as an indicator of supply and demand.  He explained the role of volume in technical analysis as follows:

For the sake of simplifying our problem, I shall here roughly define the three main types of volume-activity:

First:  Increasing volume during an advance, with the intervening pauses or setbacks occurring on light volume.  This is indicative of the underlying demand's being greater than the supply, and favors a resumption of the advance.

Second:  Increased volume at the top of a rally, or of an advance, lasting for some time, with no appreciable gain in prices - an active churning of stock transactions without progress.  This is indicative of a turning-point.

Third:  A "tired," or struggling , advance, when stocks creep upward on light volume or "die" at the top.  This indicates a lack of demand (few buying orders); and, whereas, selling-orders likewise are light, this action frequently marks a "rounding-over" turn, which may be followed by increased volume on the down side (when the sellers see that they cannot hope for much higher prices at the time).  These struggling trends are subject to sudden reversals, particularly when they have endured for several days.

These types of action are present, but reversed in sequence, in declining markets.*
Author's emphasis in bold.

Volume shows where the money is flowing.  Norman G. Fosback, in his work, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, discussed several volume indicators which he felt were important, including one he called On Balance Volume ("OBV").  He had this to say about the topic:

The common theme of OBV and each of these money flow methods is that the more volume used to produce any given price change, the greater, and more significant, is the reading.**
Author's emphasis in bold.

Mr. Fosback explained that OBV is based on the theory that volume trends lead to price trends.  In other words, the volume of trading in a stock over a period of time presages the price of the stock, which will follow the path of the volume, either up or down.

* Excerpt from Tape Reading & Market Tactics, Humphrey B. Neill, republished by BN Publishing, pages 43-44

** Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, page 222

Comments are always welcome.


Monday, January 2, 2012

Advances & Declines - Portrait of A Market


If looking at one or more individual stocks, the technical analyst creates a chart of moving averages for each stock.  If studying a market, the technical tool is the Advance/Decline Line ("A/D Line").  I made a mistake in the blog on moving averages when I defined the A/D Line as the ratio of the number of stocks in the market going up compared with the number of stocks going down over a prescribed period of time. That should more accurately be called the Advance/Decline Ratio.  The A/D Line is a little different.

The chartist using the A/D Line gets the number of stocks advancing in price and the number of stocks declining in price for a trading day from the financial press.  The next step is to net the advances against the declines to arrive at a number: positive if advances exceed declines and negative if the opposite occurs.  If there were 1,000 advances and 700 declines in a day (ignoring the number of unchanged stock prices) then the number to be added to the chart would be a positive 300.

Daily results alone are not looked upon as predictive since they will appear random.  Graphing longer periods will show the trend or the point of inflection, when the trend starts to reverse itself.  Just as with moving averages, the chartist can choose his or her preferred time period;  5,10, 30, 60, 200 or whatever other number of days seems appropriate to the individual.  As with moving averages, the oldest number in the A/D Line is dropped and the newest number is added as each day passes.

Al Frank discussed some market rules about advances and declines as follows:

A crude rule of thumb (pretty much unchanged over the past six years) is that when there are 2,000 or more advances than declines in a 10-day period "the market" (namely, the New York Stock Exchange) has become slightly overbought.  Likewise, 2,000 more declines than advances for 10 days indicates a slightly oversold market condition.  When considering 25 days, excesses amounting to 3,000 in one direction or the other indicate overbought or oversold conditions.  Obviously, the greater the net of advances or declines within each period, the greater the overbought or oversold condition.

The longer the period observed, the more long-term its implications.  Ten day excesses relate to short-term fluctuations, short term being considered a few days to a few weeks.  Twenty-five day excesses refer to intermediate-term potentials, or several weeks to several months duration.  Obviously, there can be all manner of crosscurrents in such indicators, which are sometimes mediated by other less-conflicted indicators, to be considered in due course.

Mr. Frank's last sentence sums up the difficulties faced by a chartist.  It would seem that there is rarely, if ever, a clear signal as to what the market is going to do.  No matter how many graphs the technical analyst creates, the ultimate decision as to what they indicate must be made by the individual.  The interpretation of value by a fundamental analyst and the interpretation of indicators by a technical analyst are, essentially, different techniques which arrive at the same end.  Regardless of the investment strategy employed, the individual must ultimately decide for himself or herself what to do with the information presented.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

Comments are always welcome.