Technical Analysis of the Financial Markets
This book provides a comprehensive guide to technical analysis, a methodology used to study historical price movements and trading volume to predict future trends in financial markets. The book covers a wide range of topics, from the basic philosophy of technical analysis to advanced indicators and chart patterns.
1. The Philosophy of Technical Analysis
The book begins by defining technical analysis and its basic principles. It explains how technical analysis assumes that all relevant market information is already reflected in the asset's price. It also clarifies the difference between technical analysis and fundamental analysis, where the former focuses on market behavior itself, while the latter focuses on underlying economic and financial factors. This section also discusses the importance of timing in trading and the flexibility that technical analysis offers for its application to various financial instruments and timeframes. It also addresses some criticisms leveled against technical analysis, such as the random walk theory, and emphasizes the universal principles upon which technical analysis is based.
2. Dow Theory
The book dedicates a section to Dow Theory, which is considered the cornerstone of modern technical analysis. It explains the basic principles of Dow Theory, including the idea that the market moves in trends, that trends have three phases (accumulation, public participation, distribution), and that volume confirms the trend. The book also discusses the use of closing prices in Dow analysis, some criticisms of the theory, and its application to futures trading.
3. Chart Construction
This section reviews the different types of charts used in technical analysis, such as bar charts, Japanese candlestick charts, and Point and Figure charts. The book explains how to construct these charts, including the use of arithmetic and logarithmic scales, and how to incorporate volume and open interest into the analysis. It also provides an overview of weekly and monthly charts and their importance in analyzing long-term trends.
4. Basic Concepts of Trend
Understanding trend is crucial in technical analysis, and this section provides a comprehensive definition of trends, their types (uptrend, downtrend, sideways), and their classifications (major, intermediate, minor). The book discusses in detail the concepts of support and resistance, and how to draw trendlines and price channels. It also touches upon the Fan Principle, the importance of the number three in technical analysis, percentage retracements, speed resistance lines, Gann and Fibonacci fan lines, internal trendlines, reversal days, and price gaps.
5. Major Reversal Patterns
This section focuses on price patterns that indicate a potential reversal in trend. The book explains major reversal patterns such as the Head and Shoulders pattern (including the Inverse Head and Shoulders), and Triple and Double Tops and Bottoms. It clarifies how to identify these patterns, the importance of volume in confirming them, and how to determine potential price targets after the pattern is complete. It also addresses variations from ideal patterns and saucer and spike patterns.
6. Continuation Patterns
This section covers price patterns that indicate the continuation of the current trend. These include Triangle patterns (symmetrical, ascending, descending), Broadening Formations, Flags and Pennants, Wedge Formations, and Rectangle Formations. The book explains how to recognize these patterns and how to use them to predict the continuation of price movement. It also touches upon the concept of the Measured Move and the Continuation Head and Shoulders pattern, and the importance of confirmation and divergence.
7. Volume and Open Interest
Volume and open interest are important secondary indicators in technical analysis. This section explains how to interpret volume in all markets, and how to interpret open interest in futures. It also provides a summary of volume and open interest rules, discusses blowoffs and selling climaxes, the Commitments of Traders Report, the importance of monitoring commercial traders, net trader positions, open interest in options, Put/Call Ratios, and how to combine option sentiment with technicals.
8. Long-Term Charts
The book emphasizes the importance of using long-term charts to gain a broader perspective on market behavior. It explains how to construct continuation charts for futures, and how long-term trends refute the idea of randomness in markets. It also provides examples of long-term charts and clarifies that they are not intended for short-term trading purposes.
9. Moving Averages
The moving average is a fundamental tool for smoothing price data and identifying trends. This section explains the moving average as a smoothing device with a time lag, moving average envelopes, and Bollinger Bands and how to use them as targets. The book also covers moving averages tied to cycles, Fibonacci numbers used as moving averages, the application of moving averages to long-term charts, the Weekly Rule, and the issue of optimization.
10. Oscillators and Contrary Opinion
This section covers oscillators, which are tools used to measure momentum and identify overbought and oversold conditions. The book explains the use of oscillators in conjunction with trend, measuring momentum, and measuring the Rate of Change (ROC). It also discusses constructing an oscillator using two moving averages, the Commodity Channel Index (CCI), the Relative Strength Index (RSI) and how to use the 70 and 30 lines to generate signals, Stochastics, and Larry Williams %R. This section emphasizes the importance of trend and when oscillators are most useful. It also discusses the Moving Average Convergence/Divergence (MACD) and the MACD Histogram, and how to combine weekly and daily charts. Finally, it addresses the Principle of Contrary Opinion in futures, investor sentiment readings, and Investor Intelligence numbers.
11. Point and Figure Charting
This section introduces Point and Figure charts, a unique type of chart that focuses solely on price movement, disregarding time and volume. The book explains the difference between Point and Figure charts and bar charts, and how to construct a daily Point and Figure chart. It also covers the concept of the Horizontal Count and price patterns in Point and Figure charts.
12. Japanese Candlesticks
The book dedicates a detailed section to Japanese candlesticks, a popular method of price analysis. It provides an introduction to Japanese candlesticks, how to construct candlesticks, and basic candlestick patterns. It also covers reversal and continuation patterns that can be identified using Japanese candlesticks, and how to use them to make trading decisions.