Category: Your Money

Technical Analysis of the Financial Markets: Ch 4

Last part of the review of the 4th chapter of John J. Murphy’s Technical Analysis of the Financial Markets.

Reversal Days

imageA reversal day happens either at the top of an uptrend (top reversal day) or at the bottom of a downtrend (bottom reversal day). A top reversal day is the setting of an intraday high for the uptrend followed by a close below the previous day’s close. A bottom reversal day is the setting of an intraday low for the downtrend followed by a close above the previous day’s close. The wider the intraday range, the higher the probability of a near term trend reversal.

A reversal pattern can form on monthly and weekly charts and usually bears greater significance compared a reversal day.

Price Gaps

Price gaps are areas in the chart where no trading has taken place. There are three types of gaps:

  1. Breakaway: the penetration of a resistance level usually occurs through a Breakaway Gap and signifies a major move. It occurs on heavy volume and upside gaps usually act as support levels. Its important that prices do not fall below these gaps during an uptrend.
  2. Runaway: formed after a trend is in play for a while (usually the halfway point), these are prices leaping upward on moderate volume. If these gaps are filled, then its usually a sign of weakness.
  3. Exhaustion: as the name suggests, it usually occurs at the end of a trend. After the identification of both the Breakaway and Runaway gaps, one should start expecting the Exhaustion gap. The filling of this gap during an uptrend is a bearish signal.

The Island Reversal Patternimage

Sometimes, after an upward exhaustion gap, prices trade within a narrow range before gapping to the downside. This leaves the few days of price action looking like an “island” and indicates a trend reversal that needs to be confirmed with the overall trend structure.

 

Up Next: Chapter 5: Reversal Patterns

Technical Analysis of the Financial Markets: Ch 4

Continuation of the review of the 4th chapter of John J. Murphy’s Technical Analysis of the Financial Markets (prev.)

The Fan Principle

imageSometimes, after an uptrend breaks down, prices will go down a bit before rallying up to the bottom of the old up trendline (now a resistance). A 2nd & 3rd trendine can now be drawn. If the 3rd trendline doesn’t hold, it shows that prices are headed much lower.

 

Most important up trendlines usually have a slope of about 45*. If the trendline is too steep, then it usually indicates that the prices are rising too rapidly and may not sustain; too flat, then it should not be trusted.image

Sometimes, based on prices movements, trendlines need to be redrawn. Here’s an example of a steep uptrend becoming a flatter one:

Trendlines are drawn and redrawn based on both the market as well as the trader’s time horizon.

image

 

Here, you have the major trend (1), a bunch of medium-term trends (2, 3, 4) and a short term trend (5).

The important thing to note is that in all of these cases, there is always retracement. These countertrend moves typically happen in either 50%, 1/3rd and 2/3rd moves before it goes back to following the trend. If you are looking for a buying area under the market, you can compute a 33-50% zone under the chart and use it a reference for putting on longs.

Note that if the prior trend has to be maintained, the correction must stop at 2/3rd (66%). If the prices move beyond this point, then the chances of a trend reversal are higher.

Speedlines

Speedlines measure the rate of ascent or descent of a trend (its speed). These lines act as support during market corrections. To construct a speedline for an uptrend:image

  1. Find the highest point in the uptrend
  2. From the highest point, drop a vertical line to the bottom of the chart from where the trend began
  3. Divide the vertical line into thirds and draw a line from the beginning of the trend through these points.

Speedlines need to be redrawn every time a new high (during an uptrend) or a new low (during a downtrend) is set. And these might go right through the price action.

Up Next: Reversals and Price Gaps

Its all about the EU now

Various Euro bills.

Image via Wikipedia

It appears that the market cannot hold more than one thought in its head at a time. At first, it was all about the US debt ceiling, and now its about the EU. Least we forget, there are sprinklings of a ‘hard-landing’ in China and a ticking time-bomb that is Japan. And what does it mean for India? The Nifty is down 7% since the beginning of this month and the banks are down close to 12%. So much for decoupling.

For those who have snoozed through the better part of last month, here’s the EU saga in short: There are 23 countries using the Euro common currency. All of these countries have different economies, cultures and entitlement programs (link pensions, healthcare, education, etc…) Germany and France are by far the biggest economies within the Euro. If all of these countries were to have individual currencies, then the German Mark (Deutsche Mark) would have appreciated vs. every other currency in Europe. As their currency would’ve appreciated, their exports would not have been as competitive, allowing other countries to have a semblance of a domestic industry. However, thanks to the Euro, the German export machine never faced a pause. To add to this, according to the EU banking laws, a sovereign default can never happen. So basically, it meant that the weaker countries could borrow at the same rate as the strong Germany and the banks need not set aside any capital for buying that debt either. And, as they say, all good things come to an end.

And what a spectacular end! If Greece, for example, had their own currency, then they could have just done a ‘soft’ default: print more currency, repay the debut with useless Drachmas, hyper-inflate for a couple of years, issue a mea culpa, and life goes on an usual. Just ask Argentina and Russia.

But the Germans wouldn’t have any money printing under their watch! No! No! No! So the PIIGS are now caught in a vortex where they have to endure years of depression and cut back on their entitlement programs. So basically, they have this big cement block call the Euro tied to their ankles as they are trying to keep their heads above the water. At some point, it would just make sense to just say good-bye to the Euro, devalue/default and focus on the future. And this is what we are seeing being played out in the markets.

Here’s a pretty nice infographic that the BBC put out on the interconnectedness of euro debt.

On the shit that Portugal is facing: Portugal Heading for ‘Shock’ Year

Is Germany immune to the crisis? definitiv nicht

Is it going to end soon? Nope. Brace yourself for a train-wreck in slow motion.

Is India going to be spared? Unlikely.

Keep your eyes open for daily deals on the bluest of the blue chips.

Follow me on twitter: @SunderStockViz

Sunder’s List

And if you lose a client because you’re not a gunslinger or because you’re not being aggressive enough in a market melt-up, then guess what – that client is eventually going to find the guy who will blow him up properly, just the way he wants it. (WSJ)

Whenever the market dives, the bears grow wings:

Europe’s debt crisis is a “more serious” situation than the housing bubble – GM CEO: (Bloomberg)

At least a 10%-15% decline in the S&P 500 from current levels (WSJ)

Looks like the S&P500 fell through the technical support discussed here.

One a side note:

Have PhD but no job? Go East (young) man! (Vivek Wadhwa)

Follow me on twitter: @SunderStockViz