FIN 40500: International

Finance

Beyond the Fundamentals; Technical

Analysis
Fundamental analysis focuses on economic/financial theory and
various economic indicators to explain market movements

%et    NX t Trade Balance Approach


%et      t   t*  Price Level Approach


%et     i  i *  Interest Rate Approach

 
%et  E  %f t i  Monetary Approach
 i 1 
Technical analysis is not concerned with the causes of market
movements. Instead, technical analysis focuses on the movements
themselves. Is there information in past price movements that can be
used to predict future movements?

 Chart Analysis
 Quantitative Methods

The forecasting equation for a technical analysis would be

something like this

%et     i %et i
 $/Euro: Weekly data over 3 years

Chart analysis begins with a time series plot of an asset’s price

Charts can be hourly, daily,
weekly, etc.

Higher frequency data will be

more detailed, but noisier
A chartist looks for patterns in the to identify resistance (upper bounds)
and support levels (lower bounds)

Old Support
level

New Support
level
 Connect two
consecutive highs to
get the upper
channel

A parallel line through

a recent low becomes
the lower support
A “breakout” indicates
a new pattern forming
Bullish channels
tend to have
upward breakouts
 Find the trend by connecting at least two highs

Two lows complete

the triangle

“Breakout” occurs at the apex, usually with increasing volume

Ascending triangles
usually have
upward breakouts
 The “Run”: A breakout from the lead in trend

The “Bump”:
Increase in trend
by more than 50%

Two lows identify the

“lead in” trend
 The head is the first advance past the left shoulder

The left shoulder is the first high The right shoulder is the first
above the current trend high following the reversal

Two lows identify the “lead in” trend

The neckline connects the two shoulders and indicates lower support
What pattern do you see?

“Run”
“Bump”
Fibonacci, one of the greatest mathematicians of all time discovered
a sequence of numbers which are now used across many disciplines
Suppose that you begin with a pair of rabbits:
Rabbits take one month to mature. Once mature, they can breed
offspring
Offspring come in pairs (one male and one female). A pair of
offspring are born each month
The rabbits never die
Now 1 Month 2 Months 3 Months

One Pair Two Pair

One Pair
(M) (M, Y) Three Pairs
(Y)
(M, M, Y)

Y = Young, M = Mature
Can you find the Pattern?
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ……

Each number in the Fibonacci sequence is the

sum of the previous two
1+ 1 = 2
1+2=3
2 + 3 = 5 ….

These numbers seem to appear a lot in nature…

 One Two Three

White Calla Lily Euphorbia Trillium

Five Eight Thirteen

Buttercups Bloodroot Black-eyed Susan

(By far the most
common)
 Ordinary field daisies have 34 petals – a fact to
be remembered when playing “she loves me,
she loves me not”!

(with 34 petals, you will always finish with

“she loves me not!”)

Take a pineapple…hmmm…look at the various spirals formed

Every human has 2 hands with 5 fingers on each. Each finger is made
of 3 segments connected by 2 joints…don’t these numbers sound
familiar?

Each section of your index

finger, from the tip to the
base of the wrist, is larger
than the preceding - fitting
the Fibonacci numbers 2, 3, 5
and 8.
By this scale, your fingernail
is 1 unit in length.

Similar ratios are seen between

your hand and
forearm…coincidence?
Suppose that we divide each number into the following number
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ………

1/1 = 1 8/5 = 1.6

2/1 = 1 13/8 = 1.625 The ratios converge
3/2 = 1.5 21/13 = 1.615 to 1.618
5/3 = 1.667 34/21 = 1.619

Now, suppose that we divide each number into the previous number
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, ………

1/1 = 1 5/8 = .625

1/2 = .5 8/13= .615 The ratios converge
2/3 = .667 13/21 = .619 to .618
3/5 = .6 21/34 = .617

1
1  .618  1.618 AND
 1.618
.618
Suppose that Put another 1X1 Now, put a 2X2
we begin with a square next to it underneath
1X1 square

Now, add a 3X3 square

Connect the corners of the squares and you get the golden
spiral…look familiar??
Math is everywhere!!
Anyways, back to technical analysis. Many of the technical methods are
based on PHI (.618) and powers of .618
.618
.382 = .618*.618 First, draw a trend line
.236 = .618*.618*.618

Draw arcs
that
intersect the
trend at
61.8%, 50%,
and 38.2%
of the high
(these will
indicate
future
supports)
 Draw an initial trend line between two extreme points

Draw rays
that intersect
at 61.8%,
50%, and
38.2%

At the second extreme point, draw a vertical line

Once a reversal occurs, it tends to find support at
Fibonacci levels!
Large price swings tend to occur on “Fibonacci times”!
(times could be in days, months, years, etc)
Elliott Waves
 Elliot wave theory relies on cycles within cycles
 Grand Super cycle
 Super cycle
 Cycle
 Each cycle consists of 5 moves with the trend (1,3,5
are impulse, 2,4 are corrective) and 3 that are
against the trend. A “5-3” wave
Elliott Waves consist of 5 moves Beginning of the next
with the trend (1,3,5 are impulse, 2,4
are corrective) and 3 that are against wave
the trend. A “5-3” wave cycle

Impulse

Correction
The 5-3 wave cycles actually oscillate around a larger “super-cycle” The
super-cycle is also a 5-3 wave.

Impulse (1)

Correction (2)
 Finally, the super-cycle oscillates around a “grand super-cycle”

Note that the grand super cycle has two movements, the super cycle
has 8 movements, the cycle has 34……Fibonacci numbers!!
RSI (Relative Strength Indicator)

 100 

RSI  100  

1   Total "Up" points
Total "down" points 



If “Up Points” = 0, RSI = 0
If “Down Points” = 0, RSI = 100

RSI < 30 (Oversold)

RSI > 70 (Overbought)
RSI (Relative Strength Indicator)

 100 
RSI  100  
1   Total "Up" points
Total "down" points 


7
Chart Interval: 15 minutes RS     .636
Period Length: 20 (300 minutes)  11 
Total “up” points = 7
 100 
Total “down” points = 11 RSI  100   
1  RS 
RSI  38.89
Fast Stochastic
 Close(X) - Low(X) 
FS    *100, X  Period Length
 High(X) - Low(X) 
Signal  Y Period Moving Average of FS
Period High: FS = 100
Period Low: FS = 0

Signal < 30 (Oversold)

Signal > 70 (Overbought)
 A moving average takes out the volatility by averaging several
observations. For example, a MA(3) would average the current
observation with the previous 2 observations.
Data

May June July Aug. Sept. Oct. Nov. Dec.

.6 .3 -.1 .1 .2 .6 .2 .2

MA May June July Aug. Sept. Oct. Nov. Dec.

1 .6 .3 -.1 .1 .2 .6 .2 .2
2 .45 .1 0 .15 .4 .4 .2
3 .27 .10 .07 .3 .33 .33
4 .3 .17 .2 .275 .3
Moving Average Convergence/Divergence
(MACD)
 The MACD indicator calculates the difference
between moving averages of two different lengths
(usually, 12 periods and 26 periods)
 The signal is typically a 9 period moving average of
the difference
 A divergence means that “something is happening”
Positive to Negative = Sell Signal
Negative to Positive = Buy Signal
MACD Suppose that the longer run moving
average has a length equal to the number of
observations – the series average
MA
MA(10)

MA(N)

Time

- To + : + To - : - To + :
Buy point Sell point Buy point
Punch line
 Technical methods are useful for short run
prediction
 Don’t lose sight of the fundamentals!!!