CMT TUTORIAL

LEVEL 1

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 Level 1 Examination
2

Exam length: Two (2) hours

Exam format: MULTIPLE CHOICE

Questions to be solved: 132

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3

 The CMT level 1 candidate is responsible for the material

on a definition level. The candidate must understand the
terminology used in these readings, be able to describe the
concepts discussed in these readings, and be able to
examine trends.

 The exam measures basic, entry-level competence.

 The candidate is expected to have a working knowledge of

the basic tools of the technician.
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 Basic points of study –
4

1. Terminology of technical analysis

2. Methods of charting
3. Determination of price trends/basics of pattern
recognition
4. Establishing price targets
5. Equity market analysis
6. Applying technical analysis to bonds, currencies, futures
and options

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 Content wise Weightage -
5

Content Areas Percentage Questions (+/-2)

1. Theory and History 10% 12
2. Markets 3% 3
3. Market Indicators 13% 16
4. Construction 15% 18
5. Trend Analysis 15% 18
6. Chart & Pattern Analysis 18% 22
7. Confirmation 10% 12
8. Cycles 4% 5
9. Selection and Decision 5% 6
10. System Testing & 4% 4
Money Management
11. Ethics 3% 4
------------------------------------------------------------------------------------------------------------------------------------------------------------
TOTAL 100% 120

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 Significant Topics from Recommended Readings
6

• Dow Theory
• Moving Averages & related studies
• Fibonacci
• Volume Analysis & confirmation
• Chart Types - Point & Figure
• New Market Profile
• Price Patterns
• Bar and Candle Patterns, Gaps

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 Significant Topics from Recommended Readings
(contd…)
7

• Sentiment Indicators & Breadth Analysis

• Statistics - Introductory level, order types, money
management
• Cycles and Group Rotation
• Ethics

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8 New Study Material
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 New Study Material
9

The Definitive Guide to Point and Figure by Jeremy du Plessis

1. Introduction

2. Characteristics and Construction

3. Understanding Point and Figure Charts

4. Projecting Price Targets

New Trading Systems and Methods by Perry Kaufman

1. Charting Systems and Techniques
2. Price Distribution Systems

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 Point and Figure
10

 Does not consider time or volume (new advances do)

 Is this good or bad?

 Uses a series of X’s and O’s to plot up and down movement

 A buy is signaled when an X column rises higher than a previous X
column
 A sell is signaled when an O column falls below a previous O column
 Patterns exist such as double tops, head and shoulders, triangles etc

 Box Size – the monetary/point valued assigned to each box

 Reversal Size – the number of boxes in the opposite direction that must
be filled to switch columns

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 Point and Figure
11

One Box Reversal Chart:

 Known to be more difficult than the three box reversal

One box P&F focuses on price consolidation areas like bar charts do
Patterns – not proven but respected
 Head and Shoulders
 Fulcrum
 Triangles

 Trend lines can be drawn at any angle just like on a bar chart

 Count (target) – count the number of squares horizontally that has the most
columns in the consolidation, including blank squares. Add or takeaway that many
boxes vertically from the consolidation row to estimate a target.

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 Point and Figure
12

Sample One Box Reversal Chart

17.00
16.50
16.00 X
15.50 X O
15.00 X O
14.50 X X O X
14.00 X O X O
13.50 X X O X X
13.00 X X X O O X O X X
12.50 X O O O X X X X O O X
12.00 X O O O X O O
11.50 X O X O
11.00 X O
10.50 X
10.00

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 Point and Figure
13

Three box reversal chart:

1. Stronger results when back tested
2. Trend lines can only be drawn at 45 degrees – drawn at highs and lows
3. Horizontal count = (3 * total width of boxes * box size) + lowest price or -
highest in formation
4. Vertical count = (3 * number of boxes in column * box size) + first box in
column
5. Patterns – buy when an X column exceeds the high of a previous X
column and sell when an O column falls lower than the previous O
column.
 Other patterns still apply…double tops, bottoms etc

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 Point and Figure
14

15.00     X X   X
 What is the box size?
14.50     X O X   X  What is the reversal size?
14.00     X O X   X  Is there any support or
13.50 X   X O X O X resistance?
13.00 X O X O X O X  Is there a potential pattern
12.50 X O X O   O   forming?
12.00 X O          
11.50 X            
11.00 X            

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Perry Kaufman - Charting Systems and Techniques

1. This chapter is about the automating of popular technical

tactics, and those that have been left out, over the years due
to the evolution of technology
Eg: there are many programs out there that have indicators to
perform Elliott Wave analysis, which is quite complex, but
those same programs lack a study to draw automated
trendlines.

2. Dunnigan and the Thurst Method-

A downswing is a decline in which the current days high and
low are both lower than the corresponding high and low of the
highest day of the prior upswing
Perry Kaufman - Charting Systems and Techniques
Perry Kaufman - Charting Systems and Techniques

Buy Signals
1. Test of the bottom - when price gets within a certain percent
of a prior low
2. Closing-price reversal – a new low for the swing followed by a
higher close than the prior day
3. Narrow Range – the current days range is less than half of the
largest range for the swing
4. Inside Range – both the high and low fall within the prior range
5. Penetration of the top by any amount
Perry Kaufman - Charting Systems and Techniques

Sell: Second bar has a

range less than half the
largest in upswing.

Buy: New low with

close greater than
yesterday
Perry Kaufman - Charting Systems and Techniques

1. Trap Forecasting – taking a quick or calculated profit

2. Continuous Forecasting – letting the trend (profits) run its
course until a sell signal is generated
3. Square Root Theory – a market trading at 81 (9 2) would
move to 64 (82) or 100 (102)
4. Nofri’s Congestion-Phase System
- Markets spend the greater part of their time in non-
trending motions.
- Basis of system is a three or four day reversal
-Should only be used in trading ranges.
Perry Kaufman - Charting Systems and Techniques

The outside day WITH and outside close is a successful reversal

pattern.
a.An outside day has the high and low outside the range of the
previous day. The high is higher and the low is lower. An outside
close is when the close of bar two is higher or lower than the high
or low of bar 1.
b.Buy (Sell) on the close of an outside day if the close is above the
prior high (low)
c.If buying (selling), place a stop-loss just below (above) the low
(high) of the outside day.
d.Close out position on the close three days after entry
Perry Kaufman - Charting Systems and Techniques
Perry Kaufman - Charting Systems and Techniques

• The Fibonacci Ratios – the comparison of one number to the next larger
number in the following sequence
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144…
• Key comparative ratios of explaining human behavior are 61.8% 38.2%
50% and 100%
• A 100% retracement means the prior move was on false information. A
61.8% retracement is deep and usually occurs earlier in the trend cycle.
Perry Kaufman - Charting Systems and Techniques

• Price pattern back-testing results

a. It is arguable that price patterns are formed by participants, not
by random events. (They testing a synthetic data series)
b. Nine of the ten price patterns were profitable three days after
signal. The triangular top was not.
c. When formations were conditioned on rising or declining
volume, the results changed for some of the patterns. Overall,
rising volume improved results.
Perry Kaufman - Price Distribution Systems

1. Standard deviation is the most commonly used measurement of price

distribution. In simple terms it represents the average distance of all
data points from the mean.
• +/- 1 standard deviation = 68% of the price movement
• +/- 2 standard deviations = 95% of the price movement
• +/- 3 standard deviations = 99% of the price movement
2. It is more likely for price to reach 1sd than it is 2sd then it is 3sd
3. The most frequent method of deploying such analysis is through the
Bollinger Band study.
• A typical period is 20 bars with 2sd.
• Per the book, signals from larger periods tend to be more reliable.
• Bollinger Bands also describe market volatility. Narrow equates low
volatility and wide high volatility.
Perry Kaufman - Price Distribution Systems
Perry Kaufman - Price Distribution Systems

4. Analysis of Zones
Zone analysis divides price into 20% sections over the last 3 years. It
works best in markets with abnormal distribution.

5. Long Term Price Distributions

6. Markets in physical commodities such as soybeans and coffee have a

cost of production that forms a practical lower bound to price
movement.
Perry Kaufman - Price Distribution Systems

6. Median – middle value of a data set

Mode – most common occurrence in data set
Kurtosis – the peakedness of the distribution (how high or flat)

7. Skew – the position of the mode.

8. Market Profile – the ultimate chart for distribution analysis

- Developed by J. Peter Steidlmayer

9. The shape of your distribution tells you the type of day that occurred.
28 Important Topics
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 Topics to Focus Upon
29

1. Types of Indices
2. Definition of Trends
3. Cycles & their Types
4. Inter-market Analysis
5. Bar / Candle chart construction
6. Reversal and continuation patterns
7. Axis Types
8. Technical Indicators
9. Elliott Wave
10. Fibonacci
11. Dow Theory
12. Breadth
13. Ethics

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 Types of Indices
30

1. Price Weighted Index

2. Capitalisation Weighted Index
3. Equal Dollar Weighted Index

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 Definition of Trends
31

1. Secular Trend is any period longer than the business cycle

2. Primary (Major) Trend is the long term trend and is measured

in months or years

3. Secondary (Intermediate) Trend is measured in weeks or

months, interrupts the Primary Trend

4. Short Term Trend is measured in days

5. Intraday Trend is measured in minutes or hours

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 Cycles
32

• Amplitude – Height of the cycle from base up to peak = price at peak

– price at base
• Period – Length of cycle measured from trough to trough ie: 20 days
• Phase – Difference between the troughs of different cycles ie: # of
days between the trough of cycle A and the trough of cycle B
• Inversions – when a peak occurs when we would expect a trough.
Look for the next larger cycle and see if that is peaking, if so then its
accepted because larger cycles dominate
• Translation – a term used to describe where the peak of a cycle falls
in regards to the midpoint
• Right translation – when a peak occurs after the halfway point of the
cycle
• Left translation – when a peak occurs before the halfway point of the
cycle

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 Cycles
33

• Principle of Harmonics – cycles tend to have lengths a multiple of two

or three longer or shorter than the next series of cycles.
• Principle of Nominality – cycles are rarely equal therefore an average
or ‘nominal’ period is calculated
• Principle of Commonality – securities of similar nature tend to have
similar cycles, ie: stocks tend to have similar cycles to indices
• Principle of Proportionality – periods of rising prices are followed
equally by periods of falling prices (or of even multiples)
• Principle of Variation – price magnitudes and duration of cycles will be
different because of fundamental and psychological considerations
• Principle of Summation – combining two cycles can produce peaks and
troughs

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 Cycles
34

Long Period Cycles -

1. Kondratieff Cycle

2. 34-year Historical Cycle

3. 18 year and 9.2 year cycle

4. Decennial Patterns

Short Period Cycles -

1. Four year (presidential cycle)

2. Seasonal Pattern

3. January Barometer / January Effect

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35 Inter Market Analysis
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 Inter Market Analysis
36

Four Asset Classes -

1. Currencies
2. Commodities
3. Bonds
4. Stocks

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 Relationships Between Various Asset Classes
37

USD and Commodities - Inverse Relationship

• USD ↓ Commodities ↑
•  Falling USD could be bearish for Bonds and Stocks ONLY IF
Commodities are rising
• Falling USD can co-exist with rising Bonds and Stocks as long as
Commodities are stable

Commodities and Bonds – Inverse Relationship

• Commodities ↑ Interest rate (yield) ↑ Bonds ↓
• Interest Rates ↑ Stocks ↓ Bonds ↓

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 Relationships Between Various Asset Classes
38

Bonds and Stocks – Direct Relationship

• Bonds ↑ Stocks ↑

• Exception – major turning points

• In deflation they decouple – bonds rise and stocks fall

Commodities and Stocks– Inverse Relationship

• Commodities ↑ Stocks ↓

• Depends on the position of economic cycle

• Stocks change direction before commodities

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 Relationships Between Various Asset Classes
39

USD and US Stocks/Bonds – Direct Relationship

Oil & Stocks – Inverse Relationship

• Crude Oil ↑ Stocks ↓

• Oil shares are a leading indicator of oil – they top and bottom

first

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 Relationships Between Various Asset Classes
40

Currencies:
 
USD ↓ Drug Stocks ↑ Multinational Stocks ↑
Since major revenue comes from global markets

USD ↑ Small Cap Stocks ↑

Since major revenue comes from domestic markets

Australian & Canadian dollars – commodity based currencies – directly

correlated to commodity prices

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 Commodities / Bond Ratio
41

Commodities / Bond ratio ↑ - Inflation ↑

Gold/energy/aluminum/copper/ paper & forest products ↑
 
Commodities / Bond ratio ↓ - Inflation ↓
Interest rate sensitive stocks/ consumer staples/financial &
utilities ↑ 

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 Global Interest Rates
42

Global Interest Rates always rise and fall together.

Stock sectors have a tendency to perform globally.

Eg- Auto sector ↑ in US - Auto sector ↑ in Japan

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 Inflation/Disinflation/Deflation
43

Inflation – prices of goods rise at a fast rate - Commodities are strongest

Disinflation - prices of goods rise at a slower rate – Stocks are strongest
Deflation - prices of goods fall – Bonds are strongest 

Inflation – Commodities – strong, Stocks & Bonds – weak

Disinflation - Commodities – weak, Stocks & Bonds – strong
Deflation - Commodities – weak, Stocks – weak, Bonds – strong

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 Inter Market Analysis
44

Normally Bonds and Stocks tend to move in same direction.

But in deflation they decouple. Bonds rise and stocks fall

(eg – as happened in the year 2000)

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 Asset Cycle
45

Bonds top out first Bonds bottom first

Then Stocks top out Then Stocks bottom
Commodities top last Commodities bottom last

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 Yield Curve
46

Steep yield curve – prerequisite for an early recovery

Flattening yield curve – sign of an economy that is in recovery
Inverted yield curve – sign of economic weakness
Inverted Yield Curve (IYC)
1. IYC is a situation where short term rates are higher than long term
rates
2. Stocks with high PE ratios become vulnerable (eg-dot com stocks in
2000)
3. IYC – positive for Bonds, negative for stocks
4. All recessions were preceded by IYCs
5. Ideal thing to do while an IYC develops – sit on cash

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 Real Estate Funds (REITs)
47

Affected by long term interest rates – rates ↑ REITs ↓

Are counter cyclical – move opposite to business cycle

REITs are an ideal investment in bear market because –

• High dividend yield
• Low correlation to stocks – provide diversification
• Negative correlation to tech stocks (like in 2000) 

Real estate & housing – both inflation as well as deflation sensitive

Real estate cycle – 18 years – called “The Long Cycle” –
combination of Kondratieff & business cycles.

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 Economic Cycle
48

3 stages of economic expansion

1. Early Expansion – Transportation
2. Middle Expansion – Technology / Service
3. Late Expansion – Energy

2 stages of economic contraction

1. Early Contraction – Consumer Staples
2. Late Contraction – Financials & consumer cyclicals

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 Trends
49

Secular Trend
One that lasts for many years or decades

Cyclical Trend
1. Is a short counter trend within a secular trend
2. Relatively shallow in nature
3. Causes no damage to secular trend

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 Efficient Frontier
50

1. A blend of portfolio with different asset classes.

2. Addition of commodities futures to a portfolio (max 30%)

increases the ratio – ie – lowers risk and increases returns.

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51 Candle Patterns
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 One Candle Patterns
Long Bullish/Bearish Doji Spinning Top

Long White/Black Session Open and close Small real body

are narrow or same

Hammer Inverted Hammer Shooting Star Hanging Man

Lower Shadow twice Upper Shadow twice SAME as Inverted Hammer SAME as Hammer
the length of Real Body the length of Real Body
which is at the top range which is at the bottom range TOP REVERSAL SIGNAL TOP REVERSALSIGNAL
 Two Candle Patterns

Engulfing Harami Piercing Line Dark Cloud Cover

Must be opposite colors Must be opposite colors White RB cls >50% into Black Black RB cls >50% into White

Large Real Body wraps Small Real Body contained Downtrend evident Uptrend evident
Around small Real Body inside Large Real Body Session opens < prior low Session opens > prior high
 Three Candle Patterns

Morning Star Evening Star

Downtrend is evident Uptrend is evident

Black candle followed by star White candle followed by star

White candle cls >50% into Black candle cls >50% into
Prior black candle
Three White Soldiers Three Black Crows

Downtrend is evident Uptrend evident

3 White RB’s, all similar size 3 Black RB’s, all similar size
Each session cls near high Each session cls near low
 Outside Days – strong reversal in sentiment
Top Reversal Day (Outside Bar) – the setting of a new high in an
uptrend followed by a lower close on the same day. The second
bars trading range should encompass all of the first bar.

Bottom Reversal Day (Outside Bar) – the setting of a new low in

a downtrend followed by a higher close on the same day. The
second bars trading range should encompass all of the first bar.
Stronger signals given when:

1.The wider the outside bar compared to the prior ones

More
2.The more bars encompassed the better the signal examples
and details
3.More volume to that bar compared to others is a better signal in Pring
4.The closer the close to the high/low of the day in which price page 115
may reversing the better
Inside Bars – reflects a balance between buyers and sellers
following a sharp up or down move.

Inside Bars – the setting of a new high in an uptrend followed by

a lower close on the same day. The second bar’s trading
range should be encompassed by the first bar.

Bottom Reversal Day (Outside Bar) – the setting of a new low in

a downtrend followed by a higher close on the same day. The
second bar’s trading range should be encompassed by the
first bar.
Stronger signals given when:
More examples
1. The wider the first bar compared to the second and details in
Pring page 118
2. The smaller the inside bar relative to the outside bar
3. More volume to that bar compared to others is a better signal
 Two Bar Reversals

Form after a prolonged advance or decline

First bar of the formation develops strongly in the direction of the prevailing trend.
The second is almost a mirror image of the first
Stronger signals given when:
1. Preceeded by a persistent trend – the shaper the better
2. Both bars should have exceptionally wide trading ranges
3. Open and closing prices should be close to the extremes
More examples
and details in
Pring page 122
 Other Patterns To Consider
1. Key Reversal Bars – Page 124

2. Exhaustion Bars – Page 128

3. Pinocchio Bars – Page 131

Summary:
One and two bar reversals reflect exhaustion and signal a
change, usually a reversal in trend
To be effective they must be preceded by a worthwhile move
Their trend reversal significance is only of short term duration
The more characteristics they contain the better the signal
59 Price Patterns
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 Reversal Patterns
60

Thumb Rules-
1. Topping Patterns (Reversals):
a. In order for a topping pattern to occur, price must break lower
b. In order for a top to occur, it must be preceded by an uptrend
c. Declining volume into new highs warns of a top (but not neces.)
d. Increase in volume when breaking down through support is signal of a reversal
2. Bottom Patterns (Reversals):
a. In order for a bottoming pattern to occur, price must break higher above some
level of resistance
b. In order for a bottom to occur, it must be preceded by a downtrend
c. Declining volume into new lows warns of a slow of down trend. Historically,
volume analysis is more important at tops than bottoms
d. Spike in volume when breaking up through resistance is a signal of a reversal

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 Reversal Price Patterns
61

1. Head and Shoulders – When pattern follows the direction of price, it is a reversal.
When it goes against trend, it is a continuation.
2. Triangle – also known as a rising wedge as a top or a falling wedge as a bottom
1. Price contacts two converging trend lines at least 4 times but not more than
six and then breaks out of pattern.
2. Ascending vs. Descending
3. Double Tops / Bottom – two tests of resistance / support and then break of prior
low (prior high) confirming reversal.
4. Triple Tops / Bottom - three tests of resistance / support and then break of prior
low (prior high) confirming reversal.
5. Rounded Tops / Bottoms
6. V Spike

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 Head & Shoulders Pattern
62

 A reversal head and shoulders occurs at the top or bottom of a trend. When it occurs at
the bottom it can also be referred to as an Inverse H&S
 A continuation H&S pattern occurs AGAINST the trend – seem to appear less than the
reversal patterns
Volume Considerations -
 Volume should rise into the top of the left shoulder and fall to the completion of the
shoulder because the trend is still in that direction.
 The volume to the head should be less than the volume to the top of the right shoulder
 As you approach the top of the head volume should decline
 As price begins trending down, the volume should be like what it was going to the top of
the head or greater showing opposite pressure
 Volume should be light to the top of the right shoulder
 Volume should be strong to the neckline especially when breaking it.
 If price tests the neckline after breaking it, it should do so on light volume.

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 Continuation Patterns
63

Thumb Rules-
1. These patterns occur most often against the prior trend direction
a. If price is rising, a continuation pattern will show at least a small
decline or pause in that rise
b. If price is falling, a continuation pattern will show at least a small rally
or pause in that decline
2. These patterns display a decline in volume in the ‘consolidation’ phase
when compared to the volume in the prior trend.
3. Using average volume levels helps determine this
4. They occur in a shorter time frame when compared to most reversal
patterns.
5. On a daily chart, a continuation pattern usually occurs in 1-3 weeks.
Anything longer begins to become suspect.

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 Continuation Price Patterns
64

1. Pennant – small triangle

2. Flag – rectangle sloping against the prevailing trend

3. Wedge – converging trend lines going against the prevailing trend

4. Rectangle – horizontal trading range representing a pause in trend, wait

for break out to determine direction

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65 Technical Indicators
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 Axis Types
66

Y-Axis Scales
Linear - Price change on y-axis is in dollar or point form with an equal
arithmetic difference between each level. Use linear when the range of
data presented on the axis is small (no exact percentage given).

Logarithmic – The scale and distance between markings on axis considers

the percent change that has occurred. Use when the range of data
presented on the axis is large.

Example: 25 to 50 (25 points) is 100% increase. 100 to 125 (also 25 points) is

a 25% increase. Using a linear scale distorts the price changes so that they
look equal – yet the latter is a much smaller percentage than the former.
Important, because in asset allocation and measurement decisions we
are often interested in relative values (e.g. rates of return)

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 Moving Averages
67

Simple Moving Average -

a.Add up all prices in a selected time range and divide by the number of days.
Rising MA is - upward trend, Falling MA - downward trend.
b.Long MAs are slower at picking up trends but have less whipsaws. Short MAs
can pick trends faster but increase the probability of whipsaws.
c.Multiple moving average occurs when two different time framed moving
averages cross. They can signal a support and resistance levels.

Weighted Moving average - weights the current data in a series more than the
older data.

Exponentially Smoothed Moving Average (EMA). When a SMA is updated, the

oldest data point is excluded from the average. This dropping off effect can
generate false trend signals. EMA helps to handle this effect. Wilder Method is
another type of EMA

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 Moving Averages
68

Triangular Moving Average - Is a MA of a MA. The result is a extremely smoothed

MA.

Determining a trend : Select time horizon, use MAs to identify support and resistance
levels, look for mean reversions, and look for MA crosses.

Buy signal is generated when

1.Price crosses above a moving average

2.A shorter term moving average crosses above a longer term moving average

Sell signal is generated when

Price crosses below a moving average
A shorter term moving average crosses below a longer term moving average.

Moving averages can also provide support and resistance in trends

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 Moving Average Convergence Divergence
69

MACD -

• MACD line (white) is the difference between the Exponential MAVG of two periods
(12- and 26-day).

• The Signal line (red) is a 9-day Exponential MAVG of the MACD line.

MACD1 = (26 day EMA of price – 12 day EMA of price)

Signal = (9 day EMA of the MACD1 line)

MACD2 = (MACD1 – Signal)

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Moving Average Convergence Divergence

Like simple moving averages, MACD attempts to tell you when a change in trend has
occurred.

BUY: MACD line crosses above Signal

SELL: MACD line crosses below Signal

Buy / Sell when both lines cross above/below the baseline

An Exponential average is one that weights the current price more in the formula
 Directional Movement Indicator
71

In an uptrend, a security will experience higher highs and higher lows. In a

downtrend, a security will experience lower lows and lower highs. DMI charts the
difference between highs (+DM, green) and lows (–DM, red). The white ADX line
measures the strength of a trend.

DMI Signals -

BUY: +DMI crosses above –DMI

SELL: +DMI crosses below –DMI

Rising ADX: trending market

Flat/Declining ADX: range market

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 Relative Strength Index
72

RSI is an oscillator created to map the momentum of price over time. It is a ratio of the
strength of up days versus the strength of down days.
During heavy periods of accumulation “buying” or distribution “selling”, a security can be
considered “overbought” or “oversold.” These levels are traditionally set at 70 for
overbought and 30 for oversold for equities.
RSI = 100 – ( 1 / ( 1 + RS)) RS = Average Gain / Average Loss

RSI Signals -
BUY: RSI becomes oversold, then crosses above oversold line
SELL: RSI becomes overbought, then cross below overbought line

People also look at trends in RSI vs. trends in price which is known as divergence.

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 Relative Strength
73

• RS shows if a security is outperforming or underperforming an index.

• It is a ratio of the price of one security to a benchmark.

Please do not confuse the Relative Strength Index and

Relative Strength

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 Bollinger Bands
74

•Created by John Bollinger, these bands indicate trading ranges and volatility.
Bollinger
bands are created by plotting a 20-day moving average, then 2 standard deviations
above and below the average.
•This assumes the security is 95% likely to trade between the upper and lower bands.
The bands will expand under periods of higher volatility, and contract during periods of
lower volatility.
•Analysts assume that price will hit resistance when it reaches the top bands, and
support upon reaching the lower band.
Band Signals -

BUY: Price breaks upwards through the upper Bollinger Band of a narrow bandwidth

SELL: Price breaks downwards through lower Bollinger Band of a narrow bandwidth

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 Fibonacci Ratios
75

• Sequence: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987…

• These ratios are mysteriously found all over the world.

• By identifying a prior down trend and drawing “Fibonacci Lines” from the absolute high to the absolute
low we can project future levels of support and resistance.

Application of Fibonacci:

1. Used to generate levels of support and resistance

2. Used to generate targets

• Identify two significant turning points of price, one top and one bottom.
• Subtract the high from the low and multiple that value by each Fibonacci number.
• Add them to the low to get your retracement levels& vice versa.

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 Dow Theory
76

Basic Tenets of Dow Theory:

 The Averages Discount Everything

 The Market has Three Trends:

Primary – represents the tide (if it keeps getting higher)- at least a year
Secondary – represents the waves that make up the tide
- 3 weeks to 3 months
- usually retrace 1-2 thirds of previous trend movement, or half the previous move
Minor – represent the ripples on the waves - less than 3 weeks

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 Dow Theory
77

 Major Trends have Three Phases

Accumulation Phase – represents informed buying by the most astute investors.
They believe all the bad news has been priced in.
Public Participation Phase – Where technical trend followers begin to participate,
a time of rapidly increasing prices and business news improves
Distribution Phase – begins when newspapers begin to print increasingly bullish
stories, when economic news is better than ever, and when speculative volume
and public participation increase. The “accumulation” investors begin to
distribute their positions

 The Averages must confirm each other

- The Dow Jones Industrial Average
- The Dow Jones Transportation Average (previously the Rail Avg)
No important bull or bear market could take place unless the averages confirmed
each other.

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 Dow Theory
78

Confirmation :
If one index makes a new high, so does the other. If one makes a
new low, so does the other. Otherwise there is a divergence in
the market place and the prior trend is still intact.

 Volume must confirm trend

- Volume should expand in the direction of the major trend.

 A trend is in effect until it gives definite signals that it has reversed

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 Breadth Indicators
79

Market Breadth measures the degree to which a market index is supported by a wide
range of its components. It is useful from two aspects:
It Indicates whether the environment for most items in a universe is positive or
1.

negative
Signal major turning points through divergences
2.

Breadth Indicators -
Advance Decline Lines
1.

McClellan Oscillator
2.

McClellan Summation Index

3.

New Highs and New Lows

4.

Put Call Ratio

5.

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 Breadth Indicators
80

Advance Decline Lines

 A cumulative total of the difference between the number of stocks on the
NYSE that advanced minus those who declined
 If the market is making new highs, this index should be too. If the index
does not, it is a sign of bearish divergence, or a potential top.
 Violations in Trendlines are significantly important, especially if the A/D
line leads.

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 Breadth Indicators
81

 McClellan Oscillator – a short term breadth momentum indicator that

measures the difference between the 19 and 39 day exponential moving
average of advancing minus declining issues.

 McClellan Summation Index – a cumulative total of all of the readings

from the Oscillator

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 Breadth Indicators
82

New Highs and New Lows

 The number of securities making new 52 week highs or 52 week lows
during the course of a day or week.
 When an index traces out a period of higher peaks and the number of
“New Highs” forms lower peaks, it means less stocks are supporting
the rally. This is a bearish indication.

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 Breadth Indicators
83

Put / Call Ratio

 Takes the sum of the number of puts trades for a security and the
number of calls and divides them.
 A high put call ratio is generally bullish 6/2 = 3
 A low put call ratio is generally bearish 2/6 = .3
 Since most option contracts expire worthless, traders use it as a
contrarian indicator. A higher put volume means general investors are
bearish so the overall market direction is actually higher.

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84 Statistics
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Statistics Objectives

• Difference between Inferential & Descriptive Statistics

• Common Measures of Central Tendency and Dispersion

• The Process of Regression

Descriptive vs Inferential Statistics

• Descriptive – describes or characterizes data / observations

• Inferential – uses observations as a basis for making estimates or

predictions, i.e. – inferences about a situation that has not yet been
observed
The Importance of Probability

• Did the observed outcome occur purely by chance?

• Are securities prices random or deterministic?

• The importance of Independence

– The outcome of the 1st event does not effect the probability of the
outcome for the second event

Technicians do not believe in independence,

Proponents of Random Walk Hypothesis do
The Importance of Sampling

• To determine the statistical properties of an observed outcome

one extracts a subset of the observations from the population.

• Subset must be selected randomly.

• Beware of sampling variability or sampling variation

– Sample may not be completely representative or an
exact duplicate of the population

• Overcome by taking many samples of large size.

Permutations vs. Combinations

•Permutation - The number of ways of selecting or arranging

things when duplication is not allowed and order is important :
n! / (n-x)!

• Combination - The number of ways of selecting or arranging

things when duplication is not allowed and order is not
important :
n! / [(n-x)! * x!]

More investment applications than permutations.

Measures of Central Tendency

• Mean – aka “the average”

– calculated by adding all observed values and dividing by the number of
observations
– More stable than median/mode across samples, gives a more reliable
estimate of central tendency
– skewed by extreme values
• Median – the value that splits the distribution of observations in half
– Often used when the distribution of outcomes is skewed by extreme
values, rather than being symmetric
– Must be used when size of some of the values in a distribution are
unknown
• Mode – the outcome that occurs with the highest frequency
– Most often used when data concerns categories, not quantity variables
• Geometric Mean – aka “the compound rate of return”
– Calculated by multiplying values together and taking the nth root, where n
is the number of observations. Used with a time series that is growing or
shrinking over time
– Always less than arithmetic mean except when all values are equal
Dispersion

• Dispersion – a very common measure of risk

“the greater the variability of an investment outcome, the greater the risk”

• Range – Difference between the maximum and minimum values of a sample.

Drawbacks:
– 2 values from the sample are used, the rest are ignored
– Does not say how close the observations are to the mean and the media

• Variance – σ2 – the average of the squared differences between each observation of a sample
and the mean of a sample
– Does not measure spread or dispersion, but dispersion about the mean

• Standard Deviation – σ – the positive square root of the variance

– Standardized measure from the mean

** Degrees of Freedom
– When using values from a sample, rather than a population, it is important to use n-1
in the denominator, not n. This is necessary to get an “unbiased estimate”.
Common Distributions

1. Chi-Square Distribution
2. Student’s T Distribution
3. F Distribution

All 3 use The Standard Normal Variable

Covariance & Correlation

Covariance: The 2 variable version of variance

• Answers the question “How similar are these prices or returns?”

• Cov(x1, x2) = 1/n * (x1 i - x1 avg) * (x2 i - x2 avg)

• r = Cov(x1, x2) / σx1 σx2 aka “correlation cofficient”

• When .50 < r ≤ 1 then a strong positive correlation

• When near zero, then not correlated (no relationship between the two)

• When -1 ≥ r > -.50 then a strong negative correlation

Linear Regression

 • Used to help predict the value of an uncertain (dependent) variable from some known
(independent) variable

• Plot the intersects of the observations in a scatter diagram

• Create a Regression Line using “least squares”
• Regression equation = y = a + bx
– a is the y-intercept
– b is the slope
• The slope of the straight line explains the relationship between daily price changes of the
S&P500 and US Two Year Yields
– Upward sloping = positive relationship
– Downward sloping = negative relationship

• r2 = coefficient of determination
– Value between 0 & 1
95 Ethics
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 Code of Ethics
96

• Do the Code of Ethics REALLY VERY WELL.

• Know them, memorize them, rehearse them. They are

guaranteed free points.

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 Code of Ethics
97

Shall
 Maintain the highest level of standards (ethics, laws,
compliance etc)

 Keep present and past client/employer info in confidence

 Leave adequate time for an employer/client to act on their

recommendation prior to doing so for ones self or family.

 Use the CMT designation when they can

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 Code of Ethics
98

Shall not:
 Publish or make statements they know or have reason to believe are
false
 Publish or make statements that are not supported by the
accumulated knowledge of TA
 Disparage others work
 Seek, give, or act on insider info
 Plagiarize, unless permission is granted by client
 Spam the MTA mailing list

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99 General Guidelines
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 Examination Guidelines
100

• Sleep well the previous night.

• Reach well before the scheduled time.
• Bring your ID to the Testing Centre.
• Watch the clock and leave time to review your test.
• Process of elimination on multiple choice  choose the “best” answer
• Allow yourself enough time to study and choose the right time to take
the test.
• Use the “Mark” button.
• Focus on challenging topics before the exam and during class.
• Read each question well before answering.
• Beware of tricky questions, they may appear to be easy.
• Think Positive

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GOOD LUCK!
Vishal B Malkan (MFM, CMT)
Meghana V Malkan (CS, LLB, CMT)

www.malkansview.com
9821618517, 9870093030