The last issue of the Market Technician went to press in the midst of

unprecedented financial turmoil. Old and respected institutions

were disappearing from the financial landscape at such an alarming
rate that some questioned whether we might not be witnessing a
systematic collapse of the international financial order as we know
it. But governments around the world stepped in to underpin the
banks. However, no sooner had they had shored up the financial
sector when the real economy started to buckle. The authorities are
now competing with each other to bring in the largest fiscal
packages in order to try and ward off an economic depression.
It was encouraging to see a good delegation of STA members at
the IFTA conference in Paris in November. A criticism of previous
IFTA gatherings has been that they have tended to invite the same
speakers. But this years hosts, Afate, made a big effort to ring the
changes. The theme was research and analysis of financial markets
which brought together academics and market practitioners. And,
perhaps not surprisingly, this gave rise to some spirited
discussions. In fairness to the academics presenting papers at this
conference, they all accepted that market behaviour is totally
inconsistent with random-walk theory. But some traders found the
academics statistical analysis of historical data completely
divorced from the realities of the market and revealed a lack of
understanding about the underlying rationale of technical
analysis. For example, a central bank had apparently sent out a
questionnaire asking technical analysts to come up with an end-
year forecast without realising that technical analysis is essentially
a dynamic process rather than a static modelling system. For their
part, academics were frustrated by the lack of standardisation of
technical analysis. For example, patterns such as head and
shoulders can be interpreted completely differently by different
analysts. As scientists, academics are looking for ways to formalise
the subject so that they can measure its results but the lack of
standardisation makes it difficult for them to do this in
conventional academic terms. Looking ahead, academics are trying
to develop genetic algorithms that evolve patterns or rules that are
not currently used by technical analysts.
Tony Plummer gave an excellent talk on The logic of non-rational
behaviour in financial markets in which he examined how the
market works as a system. As well as looking at what drives group
behaviour, he put the recent turbulence within an historical
perspective. The chart below shows how 1-day percentage changes
tend to cluster around a centre of gravity of relatively small moves in
the middle of the diagram. Over the past 62 years two main events
have been outside this inner core October 1987 and October 2008.
In other words, if looked at from sufficiently wide perspective,
seemingly random movements assume an order or pattern. As a
corollary, it is clearly possible to identify unusual events.
Overall, the Paris conference provided a forum for some very
interesting discussions and was a useful step in developing a
better understanding of how academics and market practitioners
can work together.
The education committee under John Camerons direction have
just completed another foundation course. The course for the
diploma will begin this month. The autumn Diploma exam resulted
in one Distinction, 19 passes and 9 fails.
IN THIS ISSUE
2 STA diploma results
3 Obituaries
4 Market forecasts for 2009 J. Nebenzahl
6 Charting the rise of technical analysis K. Edgeley
8 2009 Market perspectives T. Parker
10 Perpectives on technical analysis J. Hanahodzid
FOR YOUR DIARY
10th February How to use the lesser known Tom De Mark
Oscillators
Speaker: Trevor Neil
10th March Technical analysis art or science
Speaker: Tim Parker
15th April Speaker: Julien Nebanzahl
N.B. Unless otherwise stated, the monthly meetings will take
place at the British Bankers Association, Pinners Hall, 105 -108 Old
Broad Street, London EC2N 1EX at 6.00 p.m.
JANUARY 2009 www.sta-uk.org
MARKET TECHNICIAN
No. 63
THE JOURNAL OF THE STA
COPY DEADLINE FOR THE NEXT ISSUE MARCH 2009 PUBLICATION OF THE NEXT ISSUE APRIL 2009
DJ Industrial Average: Jan 1946 to Nov 2008
1-day percentage changes
Issue 63 January 2009 MARKET TECHNICIAN 2
CHAIRMAN
Deborah Owen: editorial@irc100.com
TREASURER
Simon Warren: warrens@bupa.com
PROGRAMME ORGANISATION
Mark Tennyson-d'Eyncourt: mdeyncourt@csv.org.uk
Axel Rudolph: axel.rudolph@dowjones.com
LIBRARY AND LIAISON
Michael Feeny: michaelfeeny@yahoo.co.uk
The Barbican library contains our collection. Michael buys new books for it
where appropriate. Any suggestions for new books should be made to him.
EDUCATION
John Cameron: jrlcameronta@tiscali.co.uk
Adam Sorab: adam.sorab@cqsm.com
IFTA
Robin Griffiths: robin.griffiths@cazenovecapital.com
MARKETING
Clive Lambert: clive@futurestechs.co.uk
Simon Warren: warrens@bupa.com
Karen Jones: karen.jones@ commerzbank.com
MEMBERSHIP
Simon Warren: warrens@bupa.com
REGIONAL CHAPTERS
Alasdair McKinnon: AMcKinnon@sit.co.uk
SECRETARY
Mark Tennyson dEyncourt: mdeyncourt@csv.org.uk
STA JOURNAL
Editor, Deborah Owen: editorial@irc100.com
WEBSITE
David Watts: DWattsUK@aol.com
Simon Warren: warrens@bupa.com
Deborah Owen: editorial@irc100.com
Please keep the articles coming in the success of the Journal depends on
its authors, and we would like to thank all those who have supported us
with their high standard of work. The aim is to make the Journal a valuable
showcase for members research as well as to inform and entertain
readers.
The Society is not responsible for any material published in The Market
Technician and publication of any material or expression of opinions does
not necessarily imply that the Society agrees with them. The Society is not
authorised to conduct investment business and does not provide
investment advice or recommendations.
Articles are published without responsibility on the part of the Society, the
editor or authors for loss occasioned by any person acting or refraining
from action as a result of any view expressed therein.
Distinction
C. Bain
Pass
A Al Haddad
N Al-Rantisi
T Babooa
D Binnington
C Chevalier
P Colas
D Grover
M Harniman
J Hawbrook
N Holt
S Kelly
C Manian
C Matthews
A Myers
H Rashdan
J Remington-Hobbs
N Suiffet
C Viketos
D Williams
Networking
WHO TO CONTACT ON YOUR COMMITTEE
STA diploma results
AUTUMN 2008
STA Diploma Course 2009
The STA is again holding its Diploma course in Technical
Analysis at the London School of Economics in Aldwych.
All teaching is by STA members.
The course runs from: 14 January 2 April 2009
It prepares students for the Diploma examination in April 2009.
The Course consists of 11 Wednesday evenings and is followed
by a full Exam Preparation Day (including Report writing), on
Thursday 2 April 2009. The sessions are from 6.00pm to 9.00pm
and the Exam Preparation Day, which includes lunch, runs from
9.30am to 5.00pm. The Exam itself lasts three hours and will be
held Wednesday 22nd April 2009.
It is possible to attend individual lectures.
If you would like further information
please contact Katie Abberton on
0845 003 9549
MARKET TECHNICIAN Issue 63 January 2009
3
Obituaries
Franoise Skelley 1963 2008
On rare occasions in our personal and professional lives, we meet
certain people who are unique, who make a lasting impression. It
may be because of their fierce intelligence, their strength of
character, passion for life, loyalty, or their complete sense of fun.
Franoise Skelley was such a person, and she had all of these
qualities in abundance.
Fran started her career in technical analysis in the late 1980s, when
she and her husband Steven were running a TA consultancy.
However, it wasnt until she joined Credit Suisse in 1992 that she
really came to international prominence. Here she built a world
renowned team and created many innovative technical products.
Full of energy and never afraid to state her views, Fran was
passionate about technical analysis and always looking to learn
new techniques. She was, though, equally focused on the correct
and disciplined application of the core basics, and her approach to
market analysis was rigorous and thorough, professionalism at its
peak. But her real joy was in calling market tops and bottoms,
which she did on a regular basis.
Fran had a close association with the STA, where she was a member
of the forward planning and grandfathering committees, and was
an active and enthusiastic supporter of the annual dinners and
conferences, where she became a recognised speaker. She also felt
strongly about IFTA, attending many of its conferences and was
herself a speaker at the London IFTA conference in 2002. She was
also a member of the American Association of Professional
Technical Analysts. Fran was made a Fellow of the UK Society of
Technical Analysts in 2005.
When speaking to friends and colleagues, words and phrases that
repeatedly cropped up when describing Fran were: wonderful,
intelligent, fun, loyal, independent, strong, passionate, force
of nature, didnt suffer fools, unafraid of anyone or anything. She
had that rare ability to light up and enliven any event, whether a
professional business meeting or a social gathering. For those that
worked with her, she was an inspirational colleague and a loyal and
trusted friend.
Fran was diagnosed with cancer in early 2007 and passed away in
August 2008, after a brave fight, at the tragically young age of 45.
Her strength of character, practicality and lack of self-pity during
this period was incredible to behold, not just to family and friends,
but also to the doctors and nurses. We extend our thoughts,
sympathies and prayers to her family, with whom we share great
sadness at this loss.
David Sneddon and Anne Whitby
Ian S. Notley 1936-2008
Ian passed away in May of 2008 after a bout with cancer. I first met
Ian in the 1970s when he spoke in New York City. One could only be
impressed with his knowledge of the subject under discussion and
his erudite manner of presentation. I became a dedicated follower
and learned much from Ian over the years.
He did a great service to the industry by presenting his cyclical
material with style and confidence. His delivery did as much to
convince audiences as did the integrity of his data and his
thorough knowledge of past market cycles. Ian always stuck to his
guns, and his resolve was based upon history, market and political
history. I recall his presentation in Canada in 1989 during which he
said that the economy and the markets were about to turn up.
Many were very dubious, citing the fundamental problems of the
day. Ian remained resolute and his forecast proved to be accurate. I
am certain that we all have similar stories to tell.
He had moved from Australia to Canada in the early 1970s, working
with several firms in Toronto. In 1987, he moved to Connecticut and
formed Yelton Fiscal, his own advisory group. He supported our
craft during his entire career, being one of the founders of the
Canadian Society of Technical Analysts (CSTA) and of the
International Federation of Technical Analysts (IFTA). We all
remember the Walkabout, Ians introductory session at IFTA
conferences. In 1993, he was awarded a Fellowship of the Society of
Technical Analysts and was given an award for Cycle Wave Analysis
by the MTA in New York in 1997. In 2002, he was presented with the
A.J Frost award by the CSTA. In 2006, the MTA honoured him again
with an annual award in recognition of innovative work.
Ian said that A man lives on through his protgs and Ian
certainly developed a following of dedicated and knowledgeable
professionals who remain students of the markets. His work and
his service is continuing under the guidance of Jonathan Arter who
spent nearly twenty years working with Ian and who recently
conducted the always well received Walkabout at the IFTA
conference in Paris.
Ian personally altered my life when he introduced me to an Arab
who subsequently hired me. This led to my marriage and 14 years
in the Gulf. My wife and I always looked forward to his visits to our
villa and our discussions of history and culture. Surya and I and Ians
many Arab friends miss him, as well as all of those who knew him
worldwide.
Bill Sarubbi
Issue 63 January 2009 MARKET TECHNICIAN 4
This presentation will examine the 2009 outlook for the foreign
exchange, bond and commodity markets together with the major
stock indices.
FOREX 2009
Chart 1 shows the monthly Euro/dollar cross rate. The analysis
displays a double top at $1.6, which is also the top of a long term
channel. The logical correction is very violent and seems to be
cyclical. The first quote of the Euro/dollar (January 1999) is $1.17;
which is also the pivot of the 1999-2008 downside and upside
swings. The most favoured scenario is, therefore, a fall of the
Euro/dollar during 2009 with $1.17 the major target. Any brief rally
below $1.4910 will confirm this forecast (selling area) but a break
up above this threshold level would trigger a new wave of buying,
probably take the rate to a high of around $1.64 (alternative
scenario). Once the $1.17 level is reached, the Euro/dollar should
resume its secular uptrend (2010-2012).
BONDS 2009
The Eurozone bond contract, the Bund, has been moving broadly
sideways since establishing a major top at 124.60. The market seems
to be tracing out a flat and somewhat complex correction which is
likely to continue over the coming months until the 118.50 level is
breached. This technical signal will trigger a huge rally toward new
highs, above 124.60 and could occur within the next three to six
months.
COMMODITIES 2009
Oil (shown on Chart 3) is about to reach the 38.2% fibonacci ratio
of $52. This level could trigger an intermediate bounce but the fall
from $150 has been so strong that 50% is a more likely retracement
target. Oil should bounce from the $35/37.50 area, probably
helped by momentum supports (such as the 52-wk displayed
here). This reversal will nevertheless take some time as bottoms in
commodity markets are commonly rounded (whereas tops are V-
Top patterns as seen at the $150 peak). From this support area, oil
should rally back up to $100 in the course of 2009 and probably
higher in 2010, with the potential to make new all-time highs.
Gold (chart 4) has been the strongest commodity during the
financial turmoil. A 38.2% ratio should complete the correction of
the previous bullish Elliott cycle and, from here, some rebound
should occur. But the current complex correction (ABC/X) allows
for a longer base formation than that of oil. Under this central
scenario, gold should move sideways during 2009, possibly
bottoming at $635, the 50% ratio. The two boundaries ($725 and
$635) are clearly long term entry prices for the on-going secular
bullish movement.
EQUITY INDICES 2009
Chart 5 shows the S&P500 implied volatility. Markets have clearly
entered a new highly-volatile territory. This should last another two
to three years with the lows unlikely to fall below 30. In the short
term, it is very difficult to evaluate the possible paths of a crash
given the high volatility.
Market forecasts for 2009
The article is a summary of a presentation given at the November 2008 IFTA conference.
By Julien Nebenzahl
Chart 1
Chart 3
Chart 2
MARKET TECHNICIAN Issue 63 January 2009
5
With a 50% fall in global equities in less than 18 months, it is
common sense to say that we are closer to the end of the
correction process than the beginning.
In cyclical terms, the most important event is the failure of the US
presidential cycle to trace out its usual pattern in 2006, as was the
case in 1986 and the subsequent consequences of that episode are
well known (see chart 6 of the STOXX600). Despite this major
interruption in the four-year cyle, one can assume that the cycles
will soon re-synchonize, as they have done in previous years -
especially if we understand the credit bubble as the main cause of
this cycle disturbance. The four-year cycle points to a low in 2010;
the 10-year (or business cycle) is expected to occur in 2012.
We can, therefore, have an intermediate rally before the 2010 and
2012 cyclical bottoms (given that both of them may or may not
create new lows). The monthly chart of the STOXX600 (Chart 7)
shows a bullish channel broken this autumn. This indicates that the
trend is over but it leaves room for some recovery before a new
correction gets underway. Once the current bottom is in place -
and this could be either October 2008 or February 2009 (for the
reasons discussed above, it is very difficult to evaluate the exact
timing) - the favoured scenario is a fast rally toward 38.2% or even
50%, therefore a +33/50% rise from the lows.
Update on December 23rd:
FOREX 2009
The sharp correction in December has not challenged the
Euro/dollar bearish scenario of $1.17 in 2009 because the
$1.491/1.5 level has not been broken. However, volatility should
decrease in the first quarter.
BONDS 2009
The outlook for bonds has changed dramatically: the upper
threshold of the Bund has been realised much sooner than
expected. Bond markets will remain strong in early 2009 and then
peak before the end of the year. This correction couldbe an issue for
financial markets.
COMMODITIES 2009
Oil is now on the support (50% ratio) and gold is still in the ABC/X
complex correction.
EQUITY INDICES 2009
Markets are in the process of forming a base but no strong signal
has appeared so far. It seems that the beginning of the year will still
create anxiety before hope.
Julien Nebenzahl is the founder and President of DayByDay, the leading
independent European technical analysis research house. He was
chairman of the French society of Technical Analysis (AFATE) from 2004
to 2007 and is co-author of L'analyse technique, theories et methodes.
Chart 4
Chart 7
Chart 6
Chart 5
Issue 63 January 2009 MARKET TECHNICIAN 6
Technical analysis along with behavioural finance (with which it
shares many beliefs) is gaining more popular acceptance. Volatility
in asset prices since the 2000 stock market peak commends a more
active investment stance over a buy-and-hold strategy. Technical
analysis is well placed to provide guidance in these troubled times.
The random-walk theorist and the technical analyst have been
prickly adversaries for more than 30 years. Burton Malkiels best
selling bookA Random Walk Down Wall Street was first published in
1973 after a 20-year bull market; a golden age of growth, low
inflation and minimal unemployment. The book suggests that
markets fluctuate with no set pattern around an intrinsic fair value. If
the theory holds, prices will reflect all available information and any
residual excess return will be random; the best strategy in the stock
market in such an environment is one of buy-and-hold. The book
suggests no excess return can be generated by the use of technical
or fundamental analysis. Certainly, in the years preceding 1973, buy-
and-hold seemed to be the best course of action for equities, but in
the 10 years thereafter it was significantly less profitable.
The crowd drives the trend
The rational investor, Homo Economicus, beloved in the ivory
towers of academia, bases his decisions on the maximisation of
wealth and utility. However, he is an elusive creature once he steps
on to Wall Street and his progress is far from random. The advances
and recognition of behavioural finance, with its basis in cognitive
and emotional biases, do not explicitly commend technical
analysis, but the technical and behavioural approaches share many
beliefs. Traditional economics proposes that the rational investor
will learn from past mistakes, but a psychological approach would
argue against this. Psychologists and technical analysts suggest
that past behaviour is the best predictor of future behaviour;
cognitive biases cause sentiment to fluctuate cyclically from
extreme optimism to extreme pessimism.
Kondratieff, Schumpeter and Kitchin, among others, have
identified repetitive cyclical rhythms in economic activity. It is the
interaction of cycles of different length that give the appearance of
randomness but, in reality, this interaction is far more predictable.
The cyclical rotation out of stocks and into commodities in the
1970s may be before the memory of many currently in the market
place, but again, after a 20-year bull run in equities, we have seen a
similar rotation since the 2000 stock market peak. Politicians may
make claims to reduce boom and bust, but attempts to smooth out
economic activity are often in vain, as we are now discovering.
The argument of what drives asset returns is one of the logical
against the psychological. The rational investor may exist in
isolation, but when he enters the market place he becomes one of
the crowd and is governed by the group mentality. This herding
behaviour is often driven by expectations based on prior price
action; in this respect the individual can become influenced by the
sentiment of the crowd. The market reaction to a news release is
based on how the outcome differs from the pre-announcement
consensus forecast. Crowds can sometimes reflect better the sum of
the individual members knowledge but can also behave irrationally
when trends extend; hence the old Wall Street adage right during
trends, but wrong at both ends. As Charles Dow said the market
reduces to a bloodless verdict all knowledge bearing on finance. In
this respect, technical analysis agrees with Famas Efficient Market
Hypothesis in that prices discount everything, reflecting shifts in
supply and demand; where it differs is in emphasizing the potential
for crowd psychology to drive trend activity.
The trends are in the distribution tails
Biases prevail in almost all market behaviour; these can range from
overconfidence in a price forecast to the rejection of data or
analysis that contradicts ones current trading position. An
expectations bias can develop when relying on a past correlation
between two securities to continue indefinitely. Optimism and
confidence dominate decision making and investors tend to
overestimate their knowledge, underestimate risk and exaggerate
their ability to control their emotions.
A key argument against the random walk theory is extreme price
movement. Prices do find a long-run equilibrium, albeit a rising
one in stocks linked to economic growth, but there are also periods
of serial correlation. How often do moves of three, four or more
standard deviations from the mean occur? Certainly more than a
normal distribution would allow. Market returns do not follow a
normal path, the distribution being more leptokurtic, with fatter
tails at the distribution extremes reflecting the trend activity that a
technical analyst looks for.
Technical tools
The ability to identify clearly the prevailing phase of the market is
critical to successful analysis. A range-bound market of price
fluctuations around a stationary mean provides trading
opportunities if one can identify when prices will revert to the
mean. By using a bounded oscillator such as the Relative Strength
Index, it is possible to time entry and exit points to trade the range.
Charting the rise of technical analysis
By Kevin Edgeley, CFA, MFTA
Figure 1: Inflation adjusted S&P (source: Haver Analytics)
MARKET TECHNICIAN Issue 63 January 2009
7
A trending market provides quicker returns, but oscillators are often
a poor tool in such an environment; they will gravitate to the upper,
or overbought, area in a bull trend and the lower or oversold area in
a down trend. The more traditional tool for trading a trend is a
moving average system which will maintain directional positions as
the trend develops, but the problem remains - which is the best
moving average? The significance of a break above or below a
moving average is often over-emphasized. Contrary to popular
opinion, the optimal average length varies across time and across
asset class. The identification and measurement of trend strength is
the key determinant in investment selection; an indicator such as
Wilders Average Directional Movement Index (ADX) can be used to
measure the relative trend performance of different assets but note
that this indicator measures the strength of a trend, not its direction.
Many funds and managed programs use variations on these
themes for price direction and market timing purposes.
Complementary analysis
The technical and fundamental approaches are not necessarily
contradictory. Fundamental analysis looks at the cause of
economic change supply and demand, productivity, industrial
development technical analysis looks at the effect. These
fundamental drivers impact on the market consensus and thereby
on price. Price can and does vary from a fundamental fair value.
The difference can often be one of value against momentum. In
fundamental terms, a stock may look cheap and worthy of a buy
recommendation but technically, the momentum of a price trend
may make the stock cheaper still as the move enters the fat tail of
the distribution. The net result may be a buy at the same level as a
fundamental strategy buys against the trend on the way down,
while a technical strategy buys with the trend on the way back up.
Technical analysts have often been accused, probably rightly in
many cases, of a lack of rigour in testing their beliefs. There have
been a number of empirical tests on the validity of chart patterns,
with varying results as these subjective patterns are difficult to
quantify. Others have found persistent serial correlation in prices -
the so-called momentum effect. Many academics, however, remain
sceptical of technical analysis due to its inconsistency with
traditional financial theory. Blind adherence to a moving average
breakout or a particular chart pattern as a signal for a price move
does not endear technicians to the broader market. However, in
the same way a fundamental analyst would not rely purely on a
low P/E ratio for recommending a stock purchase, sound technical
analysis relies on a mix of different indicators to generate a trade
recommendation. Technicians make no claims to get the market
right every time, but more and more empirical research on
behavioural principles reinforces the case for technical analysis to
play a more prominent part in the investment process.
Professional fundamental analysts vastly outnumber those using a
technical approach, but the technical contingent is growing and is
supported by regional societies in the same way as the CFA. Many
regional chapters run an education syllabus; in the UK this leads to
the STA Diploma, and on further study to the IFTA Master of
Financial Technical Analysis. This education process aims to
provide more rigorous support for technical methods.
The current market environment is supportive of further growth in
the use of technical methods. In the 1970s, the US stock market
changed phase from trend to range and, although there were
periods of serial correlation within this range, these trends were
short term and fluctuated around a fairly stationary long term
mean. This period led to a number of innovations in the technical
world and it is likely that the current market conditions will
engender further expansion in the use of technical analysis.
This article first appeared in Professional Investor (Autumn 2008)
Figure 2: FTSE 100 and Trend Strength (source: Updata)
Issue 63 January 2009 MARKET TECHNICIAN 8
2009 market perspectives
The article is a summary of a presentation given at the November 2008 IFTA conference.
By Tim Parker
This article is a re-run of a short presentation I made to the
International Federation of Technical Analysts in Paris in early
November, when the world seemed to be falling apart. The analysis
I used was based on mainstream Dow Theory, using many longer
term charts for perspective while making some important inter-
market observations.
By November 2008 returns in global equity markets had posted
their worst year since the 1970s. The US equity markets fell 43% in
1931, and in 2008 to date were already down 40%, and appeared to
be heading for their second worst year after 1931 in 140 years. In
addition, volatility was exploding (7 days in October saw falls of 4%
or more), hedge funds and others were deleveraging fast, and
forced selling was beginning to emerge everywhere; downgrades
to corporate profits had hardly even begun, credit spreads were
rapidly widening, and so on...
The charts, however, were more encouraging:
1. S&P 500 Index: On the monthly bar chart the coincidence of
support from the 1982 uptrend and the 2002 low (a 100%
retracement of the 2002-07 rally) were too significant to ignore.
Also the long term RSI was becoming extravagantly oversold. A
reaction at just below 750 was to be expected.
2. The VIX: blew out to historic highs by end October. The key use of
this measure is to look for a lower high on the indicator coincident
with a new low on the S&P 500. This was to be seen in late
November.
3. The TED Spread (the spread between 3-month interbank rates
and the 3-month US Treasury Bill yield). This market is at the core of
the global financial crisis (rather than equities), so must be
watched. By 3rd November it had fallen 38% from the highs.
4. Spot Gold (in US$): On 6th November this chart was telling us
that a supposed key beneficiary of de-leveraging was not working
that well, despite US$ strength.
5. Japanese Yen Trade-Weighted Index: This de-leveraging beneficiary,
on the other hand, worked well... but was already 11% off its highs,
suggesting a cooling off in the panic to unwind the carry trade.
MARKET TECHNICIAN Issue 63 January 2009
9
6. US 10-Year Treasury Note Yield: I pointed out that a one-year
basing process may have been underway... in fact this was never
completed and, instead, yields collapsed to record lows. Again, this
is not necessarily bearish for equities in comparative yield terms.
7. US$ High Yield Corporate Bond Index: at extended levels, and
may also have been topping out.
8. Asian Equities: steepened downtrends were just broken. Was this
the first sign of imminent basing?
9. Taiwan TAIEX index monthly chart. The long term chart of this
equity market showed a reaction at significant 18-year uptrend
support.
10. China: back to basics... the Shanghai Composite index had
retraced 100% of the bubble and was now approaching lots of
support at the prior 8-year range.
11. DJ EuroStoxx 600 Pan European index: this was showing a long
term oversold condition at the 20-year uptrend...
12. Defensive sectors were testing the top of multi-year relative
ranges: such as the ratio of the Food & Bevs sector against the DJ
EuroStoxx 50 index.
13. Another defensive sector at 10-year relative highs was Health Care.
Conclusion
All was looking bleak in early November, and by Christmas it is still
a very fraught environment. However, the longer term charts are
not all that bad, and we wouldnt be surprised to see a better 2009
in markets than generally anticipated.
Tim Parker is Managing Director of PH Partners Ltd
www.phanalysis.com
Issue 63 January 2009 MARKET TECHNICIAN 10
Introduction
Ever since the emergence of modern finance theory, the followers
of technical analysis have found themselves marginalized by the
financial establishment and held at bay by fortress walls built on
misunderstanding and contempt; misunderstanding, since the
technical jargon of head-and-shoulders, wedges, and pennants
does not resonate with minds steeped in physics and statistics;
contempt, for the fervent adherents of modern finance reject the
mere possibility of patterns in market prices. Such a segregative
state of affairs hints at the striking dichotomy which permeates the
financial world. On the one hand, academics tend to embrace the
efficient markets hypothesis which, roughly speaking, stipulates
that markets are unpredictable, in the sense that there is no way to
forecast future prices based on previous ones and thereby make a
profit. The efficient markets hypothesis was shaped in the writings
of Eugene Fama and Paul Samuelson in the 1960s, and despite the
recent proposals of alternative hypotheses, it remains deeply
ingrained in the culture of academic finance.
This stands in sharp contrast with technical analysis, which
attempts to divine markets direction based on past prices. Often
and quite controversially this is done by searching with the naked
eye for certain patterns in price histories that are believed to
embody the prime mover of all market action: crowd psychology.
For example, a sequence of successively higher highs and lower
lows which traces the so-called triangle bottom pattern in the
price data is usually interpreted by technicians as a manifestation
of strengthening confidence punctuated by subsiding terror, and
hence as the presage of an uptrend. Perhaps surprisingly,
technicians in some cases do appear to make consistent profits
that cannot be attributed to chance alone.
In the light of this dichotomy, the rift between academics and
technicians is not quick to heal, but may require the two
communities to take a careful look at the other. In this article we
present our insights from one exploration of technical analysis,
spanning past, present, and future. First, to place technical analysis
in context, we conduct a historical study of its evolution through
time and across cultures. Second, we deal with the current lack of
formalisation of technical analysis: there is no complete agreement
on what technical analysis is, with many texts only partially
overlapping on the methodologies to be employed. Consequently,
our second main endeavour is to understand fully what present-
day technical analysis consists of, and to this end we conduct
interviews with its current leading practitioners. Finally, we
consider the future of technical analysis, which in our view will
move away from ambiguous heuristics towards formally defined
indicators and dynamic strategies, capturing the ever-changing
nature of financial markets. In the rest of this article we discuss
these three perspectives in turn, each the subject of a forthcoming
book co-authored with Andrew Lo.
The historical context of technical analysis
That human nature will never change and technical analysis
therefore never become obsolete is often heard from seasoned
technicians. But if fear and greed have always been the main
drivers of supply and demand in the markets, then technical
analysis that measures supply/demand imbalances should have
spread its web of roots deep in the realms of history and widely
across civilizations. Historical evidence suggests that this indeed is
the case. Arguably as old as the markets themselves, technical
analysis dates back to at least the ancient Babylon of the 7th century
B.C. This evidence comes from a set of price diaries that survived
until our time,
1
where the prices of the same six commodities such
as barley, dates, sesame, and wool were carefully charted,
continuously through centuries, with the purpose of predicting
them. In fact, just like contemporary technical analysts do, the
diary keepers would adjust the frequency at which they recorded
the market quotations according to the level of market volatility.
More recently, technical analysis was used in the 17th century at the
Amsterdam Exchange where business was conducted in a way that
is remarkably similar to that of current exchanges. In Confusin de
Confusiones (1688), one of the oldest books ever written on stock
exchange business, Joseph de la Vega provides a vivid account of
the dynamics of this Exchange and observes that on this point we
are all alike when the prices rise, we think they will run away from
us, suggesting that people at that time were naturally inclined to
make inferences about future prices based on past ones.
From the 18th century, the evidence that technical analysis was
used in Japan comes from the writings of the legendary trader
Munehisa Homma, who in his book The Fountain of Gold describes
how market psychology can help predict prices; for example,
when all are bearish, he suggests that there is a cause for prices
to rise.
2
Homma also documents the candlesticks charting
technique, which is used to this day, especially in Japan.
Skipping one century ahead, to late imperial China, the similarities
between Chinese merchant manuals and present-day technical
analysis texts manifest themselves in the emphasis of both on the
cyclicality of markets and the role it plays in market timing. The
statement from Essential Business, one such manual, that when
goods become extremely expensive, then they must become
inexpensive again
3
is as fully understandable now in the context
of trend reversals as it was then.
The foundations of the present-day technical analysis were laid
down in the early 1900s by Charles Dow. In the January 4th, 1902
edition of The Wall Street Journal, Dow proposed his famous
definition of a trend as a sequence of successive highs and lows by
saying that it is a bull period as long as the average of one high
point exceeds that of previous high points. However, even this
most recent form of technical analysis has never been formalised,
but continues now as always to flourish on the fringes of the
establishment and pass from one generation to the next through
odd apprenticeships and confabulations, remaining to this day a
most colorful part of the financial folklore.
Perspectives on technical analysis
By Jasmina Hasanhodzic
MARKET TECHNICIAN Issue 63 January 2009
11
Insights from the interviews with leading technicians
Given the lack of standardisation of technical analysis, learning
about it from books is a daunting task: the contradictory advice
and loose and frequent use of qualifiers such as often and
probably throws the uninitiated into ambivalence and confusion.
Learning about technical analysis from its leading practitioners is
more inviting; after all, that is how this intricate craft survived till
our time not through books, but through the word of mouth.
If a single word could summarise the interviews we conducted, it
would be diverse, as it captures both the intriguing beauty of this
craft and the troubles that plague it. Spanning a striking variety of
styles in their practice of technical analysis, our interviewees range
from short-term traders (Raschke, Weinstein) to educators (Murphy,
Acampora), long-term investors (Desmond, Deemer), artist
technicians (McAvity), highly eclectic technicians (Dudack), historians
(Shaw), long-term market theme writers (Farrell), and those who insist
on being labelled market rather than technical analysts (Birinyi).
Diverse, too, are their interpretations of technical analysis, a telling
illustration of which is provided by their responses to the question
does the lack of hard and fast rules in technical analysis ever
bother you, which varied from thats exactly what bothers me to
but there are hard and fast rules in technical analysis. The
interviewees do agree however on one point, and that is the
significance of the role intuition plays in their decision making. As
Murphy puts it, Im not sure I could explain to you how I do what I
do. I look at many things in a short interval of time and come to a
conclusion. That elusive skill may explain why these practitioners
do not have a problem with sharing their knowledge, the tools
they develop, or the strategies they pioneer. There is no single right
way to put it all together. Everyone does it in slightly and
sometimes widely different ways. Some technicians operate best in
complete isolation from the outside world Linda Raschke, who
does not watch TV or read The Wall Street Journal, is a prime
example others prefer to complement their technical per -
spectives with fundamental, economic, and political ones.
The palpable heterogeneity among leading technicians that
emerges from our interviews yields a potential explanation for the
lack of impact that technical analysis has had on the broader
financial community. Without a unified, standardised, and broadly
recognised body of knowledge in which every practicing
technician must be conversant, it is difficult to see how technical
analysis can spread. The advent of the Chartered Market
Technician program by the Market Technicians Association is a step
in the right direction but, as our interviews underscore, there is still
a considerable amount of art and subjectivity in the practice of
technical analysis.
Towards a science of technical analysis
For too long languishing in the murky waters of part art-part
science, technical analysis is finally starting to develop a more
rigorous approach. Big strides, indeed, have been made towards
the standardisation of technical analysis in recent years, such as by
Aronson (2007) and Kirkpatrick and Dahlquist (2006). The impetus
for statistically evaluating technical analysis naturally comes from
academia, with studies yielding evidence of its validity in wide-
ranging areas, such as moving averages (Brock, Lakonishok, and
LeBaron, 1992), genetic algorithms to discover optimal trading
rules (Neely, Weller, and Dittmar, 1997), and the Dow Theory (Brown,
Goetzmann, and Kumar, 1998), to name a few.
In their quest to quantify technical analysis, academics have
turned, too, to the most controversial of its techniques: patterns.
Finding patterns in price charts is a subjective endeavour that
relies on the natural smoothing filter of the human eye; a main
challenge therefore in quantifying the patterns lies in modelling
the way in which eyes smooth the data they view. The pioneering
works by Chang and Osler (1994, 1999) and Lo, Mamaysky, and
Wang (2000), as well as the recent extension of the latter by the
author (Hasanhodzic, 2007), take on this challenge by smoothing
the data using statistical filtering techniques, such as kernel
regression and neural networks. They then develop algorithms to
identify automatically technical patterns in that data, and finally
evaluate the information content of the patterns thus found.
4
These works, too, find proof of the validity of technical analysis.
The observation that human nature never changes, and that
consequently technical indicators designed to measure the
reflection of human nature in market prices never change either, is
a notable argument in favour of technical analysis, but one that at
the same time underscores its main shortcoming: technical analysis
has not kept up with technological advances. Of course, charting
and data collecting have become automated, but most popular
patterns and heuristics of today were developed in the pre-
computing age when calculating a simple moving average was a
formidable task. For example, a 10-day moving average became
popular because it was easy to compute one could divide by ten
simply by moving the decimal place to the left not because it was
statistically optimal, and it remains commonly used to this day.
Suboptimal parametrisation is only a symptom of a chronic disease
afflicting technical analysis: its static nature cannot account for the
ever-changing character of financial markets. In the past, when
execution was manual and costly, and financial systems far less
connected and complex, static used to be a prerequisite for
implementability, now it is a condition for failure. As markets
evolve and trading strategies become more sophisticated, the
need for new, dynamic indicators becomes apparent. Never has
this need been more urgent than now, when in the light of the
events of last years August, one can no longer deny that hedge
funds have become a paramount force: it is not the feeling of the
crowd but the action of a single gigantic hedge fund that
precipitated the crisis continuing to this day. This is echoed by
many of our interviewees, including Walter Deemer who finds
ingenious ways of tracing the hedge-fund activity indirectly, via
certain mutual funds: I am convinced that these 6 or 7 billion
dollars of assets in Rydex funds reflect the general hedge-fund
trading activity which is the driving force in the market, he notes.
Directly tracking hedge-fund activity is of course what one would
want, but this is problematic if not infeasible for, shrouded in
secrecy, hedge funds are notorious for their inaccessibility and
infrequent reporting. A possible way to circumvent this problem is
jointly proposed by the author (Hasanhodzic and Lo, 2007), and
consists of replicating hedge funds in a transparent and publically
available format. Starting from the empirical observation that a
large portion of hedge-fund returns can be obtained by passive
exposure to certain common risk factors such as those captured
by stocks, bonds, currency, commodity, and credit markets we
show how hedge-fund returns can be expressed in terms of
returns realized in those markets, via a linear regression model.
Based on this idea, a number of prominent asset-management
firms have recently launched mutual funds that aim to replicate
12 Issue 63 January 2009 MARKET TECHNICIAN
hedge-fund factor exposures. Unlike hedge-fund returns, the
returns of these funds are public and updated daily, and can be
used as an indicator of the aggregate performance of the hedge-
fund sector. Moreover, assets flowing in and out of these mutual
funds are publically available, which raises the possibility of using
them to gauge the investors sentiment shifts.
Conclusion
In this article we presented some of our perspectives on technical
analysis spanning past, present, and future. Our historical
exploration reveals that technical analysis was a force throughout
centuries and across cultures. Our interviews with the present-day
masters of technical analysis help us understand what technical
analysis is, and armed with that understanding we can move
towards the future, which in our view consists of standardisation and
development of new indicators to measure fast-changing market
environments. Although the fortress walls separating technicians
from the adherents of modern finance still stand tall, they are not
insurmountable, and we hope that the growing volume of in-depth
examinations of technical analysis will awaken the sceptics and open
the door for the dialogue between the two communities to begin.
1
As documented by Slotsky (1997).
2
As quoted by Nison (1994).
3
As quoted by Lufrano (1997).
4
It is important here to distinguish between evaluating
profitability of technical trading rules and evaluating the
information content of technical analysis; the former necessitates
the modelling of the trading implementation and risk
management, whereas the latter detects supply/demand
imbalances regardless of whether or not one can profitably act on
that information.
References
Aaronson, D., 2007, Evidence-Based Technical Analysis. Hoboken, NJ:
John Wiley & Sons.
Brock, W., Lakonishok, J. and B. LeBaron, 1992, Simple Technical
Trading Rules and the Stochastic Properties of Stock Returns,
Journal of Finance 47, 1731-1764.
Brown, S., Goetzmann, W. and A. Kumar, 1998, The Dow Theory:
William Peter Hamiltons Track Record Re-Considered, Journal of
Finance 53, 1311-1333.
Chang, K. and C. Osler, 1994, Evaluating Chart-Based Technical
Analysis: The Head-and-Shoulders Pattern in Foreign Exchange
Markets, working paper, Federal Reserve Bank of New York.
Chang, K. and C. Osler, 1999, Methodical Madness: Technical
Analysis and the Irrationality of Exchange-Rate Forecasts,
Economic Journal 109, 636-661.
De la Vega, J., 1957, Confusin de Confusiones. Cambridge, MA:
Harvard University Printing Office.
Hasanhodzic, J., 2007, Investments Unwrapped: Demystifying
Technical Analysis and Hedge-Fund Strategies, Ph.D. thesis,
Massachusetts Institute of Technology.
Hasanhodzic, J. and A. Lo, 2007, Can Hedge-Fund Returns Be
Replicated?: The Linear Case, Journal of Investment Management
5, 5-45.
Kirkpatrick, C. and J. Dahlquist, 2006, Technical Analysis: The
Complete Resource for Financial Market Technicians. Upper
Saddle River, NJ: FT Press.
Lo, A. and J. Hasanhodzic, 2009, The Heretics of Finance:
Conversations with Leading Practitioners of Technical Analysis.
New York, NY: Bloomberg Press.
Lo, A. and J. Hasanhodzic, forthcoming, Tales of Future Past: The
Fascinating Story of Technical Analysis. New York, NY: Bloomberg
Press.
Lo, A. and J. Hasanhodzic, forthcoming, A Quantitative Approach to
Technical Analysis. New York, NY: Bloomberg Press.
Lo, A., Mamaysky, H. and J. Wang, 2000, Foundations of Technical
Analysis: Computational Algorithms, Statistical Inference, and
Empirical Implementation, Journal of Finance 55, 1705-1765.
Lufrano, R., 1997, Honorable Merchants: Commerce and Self-
Cultivation in Late Imperial China. Honolulu, HI: University of
Hawaii Press.
Nison, S., 1994, Beyond Candlesticks: New Japanese Charting
Techniques Revealed. New York, NY: John Wiley & Sons.
Neely, C., Weber, P. and R. Dittmar, 1997, Is Technical Analysis in the
Foreign Exchange Market Profitable? A Genetic Programming
Approach, Journal of Financial and Quantitative Analysis 32,
405-426.
Slotsky, A., 1997, The Bourse of Babylon. Bethesda, MD: CDL Press.
Jasmina Hasanhodzic, Ph.D. is a research scientist at AlphaSimplex
Group, LLC. The views and opinions expressed in this article are those
of the author only, and do not necessarily represent the views and
opinions of AlphaSimplex Group, MIT, or any of their affiliates and
employees. The author makes no representations or warranty, either
expressed or implied, as to the accuracy or completeness of the
information contained in this article, nor does she recommend that
this article serve as the basis for any investment decision this article
is for information purposes only. The research summarized in this
article was supported by the MIT Presidential Fellowship and the MIT
Lab for Financial Engineering.
ANY QUERIES
For any queries about joining the Society,
attending one of the STA courses on technical
analysis or taking the
diploma examination, please contact:
STA Administration Services
(Katie Abberton)
Dean House
Vernham Dean
Hampshire SP11 0LA
Tel: 0845 003 9549 Fax: 07000 710208
www.sta-uk.org
For information about advertising in the journal,
please contact:
Deborah Owen
PO Box 37389, London N1 0WE
Tel: 020 7278 4605