ALDEMAR RODRIGUEZ

Technical Analysis of the FX Market

1. In connection with the methods and technical analysis assumptions:
a. Discuss each of the six principles of Dow Theory, giving your point of view about
the validity of each.
The six principles of Dow Theory are:
-The averages discount everything: Dow said that any factor influencing the supply and
demand will be reflected in the index. I dont know if this point could be true because
these factors cannot be predicted, however are considered by the market and reflected
in the behavior of the index.
-There are three types of trends in the market: Primary Trend (long term), Secondary
Trend (medium term) and Minor Trend (short term). In this case is necessary to know if I
m a long or short term investor. If Im a long term investor I should ignore the minor
trend because can be manipulated by big institutional player. However if Im a short
term trader always Im trying to exploit the minor trends to get the most profit from
volatility.
-Primary trends have three phases: the first one is Accumulation phase or institutional
purchase, the second one is Fundamental phase or general public purchase and finally
Distribution phase, speculative or institutional sales. This point is very important
because shows how the market moves. During the first phase the informed investors
begin to operate, then start the second phase when traders who make technical
analysis enter to the market. And the last phase, is characterized by high activity in the
market supported by the media and optimistic economic forecasts in the newspapers
and on TV.
- The averages must confirm each other: this principle is important to make a decision,
because if we want to make sure what the market trend is, we must confirm the signal
(through technical indicators or averages) in order for a valid change of trend to occur.
- The volume confirms the trend: volume is only used to confirm uncertain situations,
volume should increase in the direction of the primary trend. If the primary trend is
down, volume should increase during market declines. If the primary trend is up,
volume should increase during market advances.
- A trend remains intact until it shows signals directions changes: many analysts
believe that a bull market is always moving to new highs. However, the market may
experience extended oblique trend without rendering the primary trend change. If the
main signal passed, according to theory, is bullish, primary trend continues until we can
see a bear market signal.
b. How can the fractal geometry approach help to understand the financial
markets trends?
Fractals can be extremely powerful tools when used in conjunction with other indicators
and techniques, especially when used to confirm reversals. The most
common confirmation indicator used with fractals is the "Alligator indicator", a tool that
is created by using moving averages. The standard rule states that all buy rules are
only valid if below the "alligator's teeth" (the center average), and all sell rules are only
valid if above the alligator's teeth. When we use fractals we must consider few things:
They are lagging indicators, they are best used as confirmation indicators to help
confirm that a reversal did take place. It is best to plot fractals in multiple time frames
and use them in conjunction with one another. Always use fractals in conjunction with
other indicators or systems. They work best as decision support tools, not as indicators
on their own. In conclution fractals make excellent decision support tools for any
trading method.

c. What criticisms can you make to technical analysis approach as a mechanism to

forecast the future behavior of financial assets prices?
The principal criticism about the usefulness of technical analysis is the existence of
three variations in the Efficient Market Hypothesis:
- Future prices cannot be predicted from examining past data, and technical analysis is
ineffective. All the past prices and data are considered fully reflected in the current
price.
- All information that is available to the public is assumed fully reflected in the current
price, thus fundamental analysis is also useless. Its assumed that share prices adjust
immediately to any new information.
- All information, both public and private, is assumed to be reflected in the share prices,
and no one can earn any additional returns. Even insider information is useless.
Another criticism about technical analysis is that it is self-fulfilling, and has no real
basis. The argument is that because traders all see the same signals, they trade so that
the market moves in accordance with the overriding wisdom.
2. Contributions and conclusions of the following papers
a. The Obstinate Passion of Foreign Exchange Professionals Technical Analysis.
In this reading we can observe how technical analysis is important to take decisions in
the foreign exchange market and the use of technical analysis to provide high returns.
The contribution of this paper is the continued use of technical analysis, to explain the
idea was necessary to study some arguments: the first one is that the market may not
be fully rational, technical analysis may exploit the influence of official interventions,
that it may be an efficient form of information processing and that it may inform on
nonfundamental influences. These arguments allow concluding that, for major flexible
exchange rates and over longer time periods, the use of technical trading strategies
may be used to provide very high returns.
b.

Fibonacci Numbers as a Tool of Technical Analysis in the Forex Market The

Attempt of Application.
In forex trading, Fibonacci retracements can identify potential reversal, support and
resistance levels. All these are more useful during the trading day in order to define
potential entry points, market reversal points, and also the exit strategy. If it is not
main trading strategy that you are relying upon, with Fibonacci you could use the lines
to confirm your own entry or exit strategy. The contribution of Fibonacci for forex is a
strong tool that should be utilized by all fellow traders in order to help them take
trading decisions.
c.

Neural Networks as a Decision Maker for Stock Trading A Technical Analysis

Approach.
This paper discuss about how technical indicators can be improved by adopting neural
networks, to uncover the underlying nonlinear patterns of these technical indicators for
short-term stock trend prediction. In particular, neural networks can be used as a
decision maker that automatically helps investors perform stock trading when decisions
received from different indicators contradict each other. Also the the profitability
improvement is positively correlated to the predictability measure (SIGN) but higher
and lower SIGNs do not always guarantee higher and lower profitability. Potentially
higher investment return may be obtained from training the networks to correctly
predict the directions of stock movement only when significant profit opportunities
exist.

3. Based in "The Art of Japanese Candlestick Charting" available in Moodle, analyze five
candles patterns different to those discussed in class, and its use as a decision
criterion in technical analysis.
-The rising three methods: is a continuation
pattern that appears in an uptrend. The first
candlestick in this pattern is a light bullish
candlestick with a large real body. The following
few candlesticks should be smaller bearish
candlesticks that are dark in color. These
candlesticks should not exceed the range of the
first candlestick. The last candlestick that
completes the pattern should open higher than
the close of its preceding candlestick and should
close above the close of the first candlestick. This
pattern is more reliable if the first candlestick does
not have much upper and lower shadows.
-The falling three methods: appears in a downtrend. The first candlestick in this pattern
is a dark bearish candlestick with a large real body. The following few candlesticks
should be smaller rising candlesticks that are bullish and light in color. The last
candlestick that completes the pattern should below the close of its preceding
candlestick and should close lower that the close of the first candlestick.
-Piercing line: occurs when a bullish candle on day 2
closes above the middle of day 1's bearish candle.
The rejection of the gap up by the bulls is a major
bullish sign, and the fact that bulls were able to
press further up into the losses of the previous day
adds even more bullish sentiment. Bulls were
successful in holding prices higher, absorbing
excess supply and increasing the level of demand.

-Morning star: a bullish candle on day 2 is a

stronger sign of an impending reversal. But it is day
3 that holds the most significance. Day 3 begins
with a bullish gap up, and bulls are able to press
prices even further upward, often eliminating the
losses seen on day 1.

-Evening star pattern: On the first day, bulls are

definitely in charge, usually new highs were
made.The second day begins with a bullish gap up.
It is clear from the opening of Day 2 that bulls are in
control. However, bulls do not push prices much
higher. The candlestick on Day 2 is quite small and
can be bullish, bearish, or neutral

4. Technical Analysis Workshop Data

-Support and Resistance as straight lines

Is a straight line that connects two or more price points and then extends into the
future to act as a line of support or resistance. Trend lines should not be the final
arbiter, but should serve merely as a warning that a change in trend may be imminent.
By using trend line breaks for warnings, investors and traders can pay closer attention
to other confirming signals for a potential change in trend.
- Simple Moving Average:

Moving averages smooth the price data to form a trend following indicator. They do not
predict price direction, but rather define the current direction with a lag. Moving
averages lag because they are based on past prices..

-MACD:
60
40
20
0
-20
-40
MACD

SIG 9

A trend-following momentum indicator that shows the relationship between two moving
averages of prices. The MACD is calculated by subtracting the 26-day exponential
moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the
"signal line", is then plotted on top of the MACD, functioning as a trigger for buy and
sell signals.

-Bollinger Bands:
2200
2100
2000
1900
sma
1800

upper bollinger band

lower bollinger band

1700

The purpose of Bollinger

Bands is to provide a relative definition of high and low. By definition, prices are high at
the upper band and low at the lower band. When the bands lie close together, a period
of low volatility is indicated. Conversely, as the bands expand, an increase in price
market volatility is indicated. In particular, the use of oscillator-like Bollinger Bands will
often be coupled with a non-oscillator indicator-like chart patterns or a trendline. If
these indicators confirm the recommendation of the Bollinger Bands, the trader will
have greater conviction that the bands are predicting correct price action in relation to
market volatility.

-Japanese Candlestick:
It is a combination of a line-chart and a bar-chart, in that each bar represents the range
of price movement over a given time interval. Candlestick charts are a viforeign
exchange, commodity, and option trading. For example, when the bar is white and high
relative to other time periods, it means buyers are very bullish. The opposite is true for

a black bar
decision making in stock.

.sual

aid

for

-Full Stochastic Oscillator:

is a momentum indicator that shows the location of the close relative to the high-low
range
over
a
set
number
of
periods

%k

%D

. The oscillator's sensitivity to

market movements can be reduced by adjusting the time period or by taking a moving
average of the result

-Gann Angles:
Gann watched for important tops and bottoms to form on a daily, weekly, or monthly
chart and drew his angles from these changes in trend. When the trend is up and the
price stays in the space above an ascending angle without breaking below it, the
market is strong; when the trend is down and the price remains below a descending

angle

without

breaking

above

it,

the

market

is

weak