TECHNICAL ANALYSIS EXPLAINED

FOUR EDITION, MARTIN J, PRING.

SUMMARY

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 INDEX
CHAPTER 2: FINANCIAL MARKET AND BUSINESS CYCLE ............. 5
The discounting mechanism of financial markets ................................ 5
Market movements and the business cycle ......................................... 5
Introducing the six stages .................................................................... 7
Longer cycles........................................................................................ 8
Summary............................................................................................... 8
CHAPTER 4: TYPICAL PARAMETERS FOR INTERMEDIATE
TRENDS .................................................................................................. 9
Some basic observations ..................................................................... 9
Intermediate cycles defined ................................................................. 9
Intermediate-term cycle ................................................................... 10
Causes of secondary reactions .......................................................... 11
Relationship between primary intermediate moves and
subsequences reactions..................................................................... 11
Using intermediate cycles to identify primary reversals .................... 11
Reversal from bull to bear market ...................................................... 11
Summary............................................................................................. 12
CHAPTER 12: INDIVIDUAL MOMENTUM INDICATORS II ................ 12
The know sure thing (KST) ................................................................ 12
The long-term KST .......................................................................... 12
Short-and intermediate term KST ................................................... 13
Using the KST with the market cycle model ................................... 14
The directional movement system ..................................................... 14
The concept ..................................................................................... 14
The two DIs ...................................................................................... 15
The parabolic indicator ....................................................................... 15
The concept ..................................................................................... 15
How does it work? ........................................................................... 16

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 Setting the parameters .................................................................... 16
A practical use ................................................................................. 16
Summary............................................................................................. 16
CHAPTER 16: THE CONCEPT OF RELATIVE STRENGTH .............. 17
The concept ........................................................................................ 17
Construction of an RS line............................................................... 17
RS interpretation ................................................................................. 18
Positive and negative RS divergences ........................................... 18
Trend-reversal techniques............................................................... 20
Spreads............................................................................................... 23
Summary............................................................................................. 23
CHAPTER 18: PRICE: THE MAJOR AVERAGES .............................. 23
Composite market index..................................................................... 24
The market average using MAs ......................................................... 25
The major averages and ROCs ......................................................... 25
The DOW Jones transportation average ........................................... 26
The DOW Jones utility average ......................................................... 26
The unweighted index ........................................................................ 27
The NASDAQ ..................................................................................... 28
General motors ................................................................................... 28
The Russel indexes ............................................................................ 28
Summary............................................................................................. 29
CHAPTER 20: TIME: LONGER-TERM CYCLES................................. 29
The importance of time....................................................................... 29
Some basic principles of cycle ........................................................... 30
The Long (Kondratieff) wave .............................................................. 31
The 18-year cycle ............................................................................... 32
The 9.2-year cycle .............................................................................. 32
The Decennial pattern ........................................................................ 32

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 Seasonal pattern ................................................................................ 32
CHAPTER 22: VOLUME: GENERAL PRINCIPLES ............................ 33
Advantage of volume analysis ........................................................... 33
Principles of volume interpretation ..................................................... 33
Examples ............................................................................................ 35
Summary............................................................................................. 41
CHPATER 26: SENTIMENT INDICATORS ......................................... 41
Some basic thoughts .......................................................................... 41
Momentum as a substitute for sentiment ........................................... 42
A few worlds on short selling.............................................................. 42
Specialist/public ratio .......................................................................... 42
Short-interest ratio .............................................................................. 43
Insider trading ..................................................................................... 43
Advisory service ................................................................................. 43
Market vane and bond market sentiment .......................................... 44
Combining sentiment and momentum ............................................... 44
Mutual funds ....................................................................................... 45
Cash/Assets ratio ............................................................................ 45
Margin debt ...................................................................................... 46
Put/Call ratio ....................................................................................... 47
Inverted yield momentum ................................................................... 47
The market´s reaction to news ........................................................... 48
Summary............................................................................................. 48

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CHAPTER 2: FINANCIAL MARKET AND BUSINESS CYCLE

The discounting mechanism of financial markets

• The trend of all financial markets is essentially determined by
investor´s expectations of movements in the economy
• A weak economy is bullish for bond price
• An expanding level of economy activity is usually favorable for
stock prices
• A tight economy is favorable for industrial commodity prices
• The point of equilibrium can be thought of as a period of zero
growth in which the economy is neither expanding or contracting

Market movements and the business cycle

• In the business cycle, after the peak is experienced, the economy
continues to grow, but at a declining rate, until the line crosses
below the equilibrium level and contraction in economic activity
takes place
• Periods of expansion generally last longer than periods of
contraction. It takes longer to build something up than to tear it
down. Something its true for commodities an interest rate but in
this case the magnitude and duration of primary trend depends on
the direction of the secular trend
• The bond markets are the first financial market to begin a bull
phase, this usually occur at the initial stages of the recession
o The sharper the economic contraction, the greater the
potential for a rise in bond price (that is, fall in interest rates)
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 o The stronger the period of expansion, the smaller the
amount of economic and financial slack, and the greater the
potential for a decline in bond prices (and a rise in interest
rates)
• Following the bear market low in bond prices, economic activity
begins to contract more sharply
• The longer the distance between the low in bond and the low of
stocks, the greater the potential for the stock market to rally
• When commodity prices begin to rally, it is that point where all
three financial markets are in a rising trend
• The stock market discounts trend in corporate profits, so it remains
in an uptrend until investors sense that economy is becoming
overheated and the potential for an improvement in profits is very
low. At this point, there is less reason to hold stock, and they in
turn enter a bear phase. Later, the rise in interest rates takes its
toll on the economy and commodity prices begin to fall. At this
point, all three markets begin to fall

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Introducing the six stages
• Since there are three markets and each had two turning points, it
follows that there are conceptually six turning points in a typical
cycle
• The six stages can be used as reference points for determine the
current phase of the business cycle

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Longer cycles
• Some expansions encompass much longer periods, and they
usually include at least one slowdown in the growth rat followed by
a second round of economic expansion. This has the effect of
splitting the overall expansion into two or three parts. This is called
a double cycle

Summary
• A typical business cycle embraces three individual cycle for
interest rates, stocks and commodities. All are influenced by the
same economic and financial forces, but each responds differently
• These markets undergo a chronological sequence, which repeats
in most cycle
• Some cycles experienced a slowdown in the growth rate and not
an actual recession
• The leads and lags vary from cycle to cycle have little forecasting
value
• The chronological sequence of peaks and bottoms in the various
financial markets can be used as a framework for identifying the
position of a specific market within its bull or bear market cycle

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CHAPTER 4: TYPICAL PARAMETERS FOR INTERMEDIATE
TRENDS

Some basic observations

• A successful analysis of intermediate trend for any market offers
the following advantage:
o Change in intermediate trend aid in the identification of
turning point in the primary trend
o Intermediate-term trading involves fewer transactions than
trading of minor price movement and therefore in lower
commission costs
o Intermediate-trend reversal points occur several times a year
and can, if properly interpreted, enable a relatively high and
quick return on capital
Intermediate cycles defined
• A primary trend typically consists of five intermediate trends, three
of which form part of the prevailing trend, while the remaining two
run counter to that trend.
• There are essentially two types of intermediate prices movement:
o The first, which goes in the direction of the primary trend,
may be called a primary intermediate price movement
o The second which retraces between one-third and two-thirds
of the preceding primary intermediate trend. This price
movement which runs counter the main trend, is called a
secondary movement or reaction.
• A secondary reaction does not have to be a decline in a bull market
or a rally in a bear market. It can also be a sideways movement or
consolidation

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Intermediate-term cycle
• Intermediate movements can either go with or against the main
trend, which means that there is an intermediate cycle, just as
there is a primary one
• An intermediate cycle consists of a primary intermediate price
movement and a secondary reaction. It is extended from the low
of one intermediate trend to the low of the other
• Technicians are alert to the possibility of a reversal in the primary
trend when a third intermediate cycle is nearing completion. This
does not mean that primary movements can never encompass
more or fewer than three primary intermediate price movements,
expect three as a normal event

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Causes of secondary reactions
• The primary tend f stocks prices is determined by the attitudes of
investor to the future flow of profits
• History shows that secondary reactions occurs because of
technical distortions, which arise in the market as a result of
overoptimism or excess pessimism
• A bear market rally for stocks generally takes place because of an
improved outlook for business conditions over what was
anticipated. A bear market rally develops under the opposite set of
condition
• Corrections in commodity and currency markets all have their
roots in a changed but incorrect perception of the underlying
(primary) economic trend
• The apparent motivating force for the correction need not
necessarily be directly linked to the outlook for business or interest
rates
Relationship between primary intermediate moves and subsequences
reactions
• The smaller in magnitude the primary intermediate-term
movement was, the lager the retracement tended to be, and vice
versa
Using intermediate cycles to identify primary reversals
• If only one intermediate cycle has been completed, the chances of
prices reaching higher levels (lower levels in a bear market) are
quite often
• When two intermediate cycles are completed, the technicians
should be alerted to the fact that a reversal of the primary trend
can occur
Reversal from bull to bear market
• The first intermediate up phase of a bull market is usually
accompanied by a substantial expansion in volume that is
significantly greater than those of previous intermediate up phase
• Another sign of a basic reversal occurs when prices retrace at least
80% of the previous decline. The greater the proportion of
retracement, the greater the odds of a reversal in the basic trend

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 • Since volume normally expands substantially on the intermediate
down phase during a bear market reaches a low, a shrinkage un
volume during an intermediate decline could well be a warning thar
the bear market has run its course
Summary
• The typical primary trend can be divided into two one-half primary
intermediate cycles, each successive up-move and a down-move.
In a bull market, each successive up-move should reach a new
cyclical high, and in a bear market, each successive down-move
of the intermediate cycle should reach new low. Breaking the
pattern of rising lows and falling peaks is an important warning of
a reversal in the primary trend
• A secondary movement or reaction is that part of an intermediate
cycle that runs counter to the main trend, a downward reaction in
a bull market or a rally in a bear market. Secondary intermediate
movements typically last from 4 weeks to 3 months and retraces
between one-third and two-thirds of the previous intermediate
price movements.
o Secondary price movement also take the form of a line or
horizontal trading pattern
• The character of intermediate cycles can be used to help identify
primary trend reversal
• The stronger an intermediate rally, the less the retracement is
likely to be, and vice versa for primary bear markets

CHAPTER 12: INDIVIDUAL MOMENTUM INDICATORS II

The know sure thing (KST)

The long-term KST
• The rate of change (ROC) measures the speed of an advance or
decline over a specific time span and is calculated by dividing the
price in the current period by the price N periods ago
o The longer the time span under consideration, the greater
the significance of the trend being measure

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 • The use of a ROC indicator helps to explain some of the cyclical
movements in markets, often giving advanced warning of a
reversal in the prevailing trend, but a specific time frame used in a
ROC calculation reflects only one cycle
• Price at any one time is determined by the interaction of many
different time cycles. An indicator that takes this into consideration
is likely to be timelier without losing too much in the way of
sensitivity
• In ROC, major turning points tend to occur when several cycles
are in agreement, speedy advances and declines develop when
more cycles are operating in the same direction
• In ROC, the function of longer time frames is to reflect the primary
swings, while the inclusion of the shorter ones helps to speed up
the turning points
• The KST turning points develop sooner than those of the ROC
• The KSR will work best when the security in question is
experiencing a primary up-and-down trend based on the business
cycle
• Periods of accumulation and distribution occur between the times
when the KST and MA change direction
• There are really three levels of signaling
o The first occurs when the indicator itself changes direction
o The second when KST crosses its MA
o The third when the MA also reverse direction
• In most cases, the MA crossover offers the best combination of
timely signals with a minimum whipsaw
• Changes in the direction of the 9-moth MA offer the most reliable
signals, but these usually develop well after turning points
• During periods of a secular or linear uptrend or downtrend have
many false signals
Short-and intermediate term KST
• The MA crossover are a classic way in which the KST is used.
Unfortunately, not all situations are as usable as this

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Using the KST with the market cycle model
• Three main trends:
o Short-term trends are usually monitored with daily prices
o Intermediate-term trends with weekly prices
o Long-term with monthly prices
• The construction a long-term KST is a useful starting point from
which to identify major market cycle junctures
• The best investments are made when the primary trend is in rising
mode an the intermediate-and short-term market movement are
bottoming out
• During a primary bear market, the best-selling opportunities occur
when intermediate-and short-term trends are peaking
• Combining the three trends:
o The best buying opportunities seem to occur either when the
long-term index is in the terminal phase of a decline or when
it is in an uptrend, but has not yet reached an over-extended
position
• EMA crossover should be interpreted as a buy or sell alert not on
a reversal in direction
The directional movement system
• Was designed by Welles Wilder
• Its objective is to determine whether a market is likely to
experience a trending or trading range environment
• A trending market will be better signaled by the adoption of trend-
following indicator, whereas a trading range is more suitable for
oscillators
The concept
• The directional movement indicator is plotted by calculating the
maximum range that the price has moved, either during the period
under consideration or from the previous period´s close to the
extreme point reached during the period
• The system tries to measure directional movement
• Since there are two directions in which prices can move, there are
two directional movements indicators called +DI and -DI
• The standard, or default time span is 14 days periods

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 • Crossovers of the DIs are used as buy and sell signals
• There is one other important indicator incorporated in this system
and that is the Average Directional Index (ADX)
o The ADX is simply an average of the +DIs and -DIs over a
specific period
• When the -DI is greater than +DI, the negative signs are ignored
• ADX only tells us whether the security is experiencing directional
movement or not. The normal default time span is 14 days
• The ADX is calculated in such a way that the plot is always
contained within the scale of 0 to 100
o High readings indicate that the security is in a trending mode
(it has a lot of directional movements)
o Low reading indicates a lack of directional movement and
are more indicative of trading range markets
• Unlike other oscillators, the ADX tells us nothing about the
direction in which a price is moving, only its trending or nontrending
characteristics
The two DIs
• Buy alerts are signaled when the +DI crosses above the -DI
• Sell alerts are signaled when the -DI crosses above the +DI
The parabolic indicator
The concept
• Th parabolic system, devised by Welles Wilder, is not a
momentum indicator
• Parabolic system is designed to resolve the lag between the
turning points and the trend-reversal signal of trend following
systems by increasing the speed of the trend
• Parabolic indicator is a stop-loss system and it is also a trailing
stop-loss system
• The expression parabolic arises from the shape of the curve of the
stops as it appears on the chart
• In a rising market, the stop is continually being raised, never
lowered
• In a declining market, the stop is continually being lowered, never
raised

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How does it work?
• The parabolic shows up on the chart as a parabolic-shaped curve
that is plotted above and below the price
o This curve is often referred to as the SAR, which stands for
stop and reversal system
• The parabolic is often used not only to stop a position, but actually
to reverse it
Setting the parameters
• Most charting packages enable the user to set two parameters
o Acceleration factor
o Maximum acceleration factor
• The acceleration factor is the amount the parabolic is increased
every time the price makes a new high in an uptrend and a new
low in a downtrend
• The maximum factor is a limit above which the acceleration factor
cannot go
• The lower the acceleration factor, the less timely the signal, and
the higher the acceleration factor, the more sensitive and timelier
are the signals but result in more whipsaws
• Setting levels for the acceleration factor is a trial-and-error process
A practical use
• One of the favorites ways in which the parabolic can be applies is
to enter a trade on an MA crossover an exit the trade on a reverse
crossover
Summary
• The KST can be constructed for any time frame, from intraday to
primary
• The KST is calculated from the smoothed ROC of four-time span,
each of which is weighted according to the length of time
• Long-term, short-term and intermediate KSTs can be combined on
one chart to reflect the market cycle model
• The +DIs and -DIs measure positive and negative short-term
direction
• When DIs cross, they trigger buy and sell signals
• The ADX measures the directional movement of a trend

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 o A rising ADX indicates an increase in directional movement
and vice versa
o When the ADX reverse direction from high reading, the
prevailing trend is likely to change
• The parabolic is a stop-loss system
• The parabolic is better used as an exit mechanism due to the
larger risk often associate with the initiation of a position based on
an initial parabolic stop

CHAPTER 16: THE CONCEPT OF RELATIVE STRENGTH

The concept
• Relative strength (RS) is a technical concept that measures the
relationship between two securities
• RS as discussed here is comparative RS where one security is
divided by another and the result is plotted as a continuous line
• RS can be used to compare one asset to another in order to decide
which one to buy or to better understand an intermarket
relationship
• In commodity trading, a spread is a form of RS. A spread involves
the relationship between one commodity and another.
Alternatively, a spread capture the relationship between a distant
contract and an herby one
• A currency is really a relative relationship
• The most common and important use of RS is to compare a stock
to a market average. When RS is used in this way, it becomes a
powerful concept for individual stock selection
Construction of an RS line
• An RS line is obtained by dividing the price of the item by another
o The numerator is usually a stock and the denominator is a
measurement of the market
• When the line is rising, it means that the stock is underperforming
the market

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 • When the RS line peaks out, it means that the stock is
underperforming the market
• A rising line does not mean that the stock is advancing in price,
only that is outperforming the market or rising relative to the market
index
• RS moves in trend, just like the price, this means that RS lend itself
to trend-reversal techniques such as price patterns, trendlines and
MA crossover

RS interpretation
• RS trends tend to experience more random noise that the absolute
price
Positive and negative RS divergences
• When the price and RS are rising, they said to be “in gears” and
an actual trend is likely to continue
• When RS line fails to confirm new highs, this situation indicates
that the odds favor the stock beginning a period of
underperformance against the market, it is not an absolute sell
signal but indicates that the price probably will go down
• A divergence represents an early warning which is later confirmed
by a trend-reversal signal in the price

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 Negative divergence

Positive divergence

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Trend-reversal techniques
• MA crossover: sometimes it´s a good idea to run an MA through
the price using the crossovers as legitimate signals of a change
in trend. It´s also possible to do the same thing for an RS line, but
because the RS line tend to be much more volatile, this
technique often proves unprofitable because of numerous
whipsaws that are generated
• Trendline violations: the concept is to construct a trendline for the
RS line and when that is violated to look around for a legitimate
trend-reversal signals in the price to act as confirmation
• Price patterns: price patterns can also be employed to analyze
trends in RS

RS AND MAs

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RS and up trendlines

RS and down trendlines

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 RS and price patterns

RS and price patterns

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Spreads
• RS I widely used in the futures market under the heading “spread
trading”
• Spreads are often calculated by subtracting the numerator from
the denominator rather than dividing
• The TED spread measures the relationship between (high-quality)
T-bills and (low-quality) Eurodollars, is a popular trading vehicle
Summary
• Comparative RS compares one security with another. The result
is plotted as a continuous line called the RS line
• The most common application is to compare a stock with a market
average. When the line is rising, it means that the stock is
outperforming the market and vice versa
• Divergence between the absolute price and RS warn of weakness
• RS moves in trend. Any trend-determining technique can be
applied to a relative strength line
• One of the most useful techniques for analyzing the primary trend
of relative action is the use of smoothed long-term oscillator,
specially the KST

CHAPTER 18: PRICE: THE MAJOR AVERAGES

• Price is the most logical starting point for any attempt to analyze
the strength of the overall market structure
• There are two methods for measuring the general level of stock
price:
o The first, known as an unweighted index, takes a mean
average of the prices of a wide base of stocks
o The second also takes an average of the prices of a number
of stocks, but in this case the prices are weighted by the
outstanding capitalization, that is the number and market
value of shares of each company
• The first method monitors the movement of the vast majority of
listed stocks, but since the second give a greater weight to larger

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 companies, movements in a market average constructed in this
way are more fairly represent the change in the value of the
nation´s portfolio
• Weighted averages are usually used as the best proxy for the
market
Composite market index
• The DJIA is the most widely followed stock market index in the
world
o It is constructed by totaling the prices of 30 stocks and
dividing the total by a divisor. The divisor is published
regularly in the Wall Street journal
o It is not a composite index, since it does not include such
industries as transportation and utilities
• One of the drawbacks pf the method used in the construction of
the DJIA is that if a stock increases in price and is not split, its
influence on the average will become substantially greater
• The Standard and Poor´s (S&P) composite, which comprises 500
stocks, represents well over 90% of the NYSE market value, is
another widely average
o It is calculated by multiplying the price of each share by the
number of shares outstanding, totaling the value of each
company, and reducing the answer to an index number
• Most of the time, the DJIA and S&P500 move in the same direction
but are times when they divergence
o The greater the divergence the more substantial the
subsequent move in the opposite direction
• The NASDAQ composite is a capitalization-weighted index
consisting of 500 stocks
o It´s very much a technology-drive index
• The NYSE compiles an all-encompassing index called the NYSE
composite. It represents the ideal index
o Its movements are similar to those of the DJIA and the
S&P500. Nevertheless, divergence between the trend of
these three averages offer additional confirmation of
changes in the overall technical structure

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 • The most comprehensive indicator of all is the Wilshire 5000 equity
index, a composite that represents the value-weighted total in
billions of dollars of most of the actively traded common stocks in
the United states
o Originally, it includes 5000 securities but at the turn of the
century this had grown to include over 6500 issues
o This is the indicator that should be used for monitoring trends
of the overall market
The market average using MAs
• When experimenting with an MA from the point of view of trend
determination it is necessary to first assess the type of cycle to be
considered
o The 4-year stock market cycle has corresponded to the U.S
business cycle for many decades. This year (or 41 month)
cycle is of great significance int trend determination
• The choice of an MA to detect such swings is limited to anything
less than the full period
• The crossovers between MAs and market index are taken as an
alert of sell or buy signals
o For intermediate swings, crossover of 13-and-10-week (50-
day) averages have proven to be useful benchmarks
o For even shorter swings, a 30-day (6 week) MA works well,
although some technicians prefer a 25-day average
The major averages and ROCs
• It seems that an excellent signal of an intermediate to primary
trend bottom develops when the ROC either recrosses above its
oversold line at -20% or touches the -20% level and then reverses.
Alternatively, a recrossing of the +20% level offers a reasonably
reliable intermediate peak or bear market signal
• In really strong or weak market, premature are triggered so it´s a
good idea to wait for confirmation from a 9-or-12-month MA
crossover
• Another technique is to construct a trendline. This is combined with
a 12-month ROC where a similar trendline is constructed or a price
pattern. When both lines are violated is usually a good sign that
the bull or bear move is over
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 • In cases where it is obvious that trendlines are going to be violated
after the turning point. It is usually best to disregard then and rely
on other evidence
The DOW Jones transportation average
• The transportation average is basically affected by two factors:
o Volume of business
o Changes in interest rates
• When a business recovery gets under way, transportation volume
picks up
• When sales start to fall, transportation volume then falls sharply
• Transport companies tend to be more heavily financed with debt
than industrials
• The transportation average quite often leads the industries
average at important juncture points
• The significance of the DOW theory rule requiring confirmation of
both the industrial and transport
• The use of relative strength (RS) is useful during periods of no
confirmation between the two averages, when RS can offer a
useful clue as to now the discrepancy will be resolved
The DOW Jones utility average
• The DOW Jones utility average composite is utility stocks from
electric utilities, gas pipelines, telephones companies, and so
forth.
• This average is one of the most reliable barometers of the
industrials
o This is because utility stocks are extremely sensitive to
change in interest rates and interest rates generally lend the
overall stock market
• Interest rate changes are important for utility stocks for two
reasons
o First, utilities companies require substantial amount of
capital because they are usually highly financed with debt
relative to equity. As interest rates rise, the cost of renewing
existing debt and raising additional money puts pressure on

26
 profits. When interest rates fall, these conditions are
reversed and profit rise
o Second, utility companies generally pay out their earing in
form of dividend, so that these equities are normally bought
just as much for their yield as for their potential capital gain.
When interest rates rise, bonds, which are also bought for
yields, fall in price and thus become relatively more attractive
than utilities. When interest rates fall, the money return once
to utility stocks, which then rise in price
• When the utility average flattens out after an advanced or moves
down while the industrials continue to advance, it is usually a sign
of an imminent change in trend for the industrials
• The relationship between the utilities and the industrials is often
overlooked because the usually given their loudest message when
other market activity is at its most exciting
o At market tops, the utility averages quietly decline while
investors, analysts and the media are exciting about huge
price advances ye to be seem
• Since changes in the trend of interest rates usually occur ahead of
the reverses in the stock market, the interest sensitive utility
average more often than not lead the DJIA at about market tops
and bottoms
The unweighted index
• An unweighted index is calculated by adding the prices of a
universe of stocks and dividing the total by that number. The
resulting averages is then weighted by price rather than
capitalization
o The most widely followed is the value line arithmetic
• Unweighted indexes are useful because they closely represent the
price of the average stock often found in individual portfolios
• Unweighted index is also helpful in gaining an understanding of
the market´s technical structure, since they tend to lead the market
(that is, the DJIA) at market tops.
o When a divergence occur between the DJIA and the value
line, it almost always results in the Dow being dragged down
as well

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 • A show of good relative by the unweighted indexes at a time of
sustained weakness in the major averages often signifies that an
important rally will follow when the decline is over
• Just as divergence in oscillators should be confirmed by price, so
these disagreements between average, whether they are positive
or negative in nature, must be confirmed before we can conclude
that the trend has reversed
The NASDAQ
• The technology boom of the 1990s brought the NASDAQ
composite
• This capitalization-weighted index is dominated by large
technology companies and has become a proxy for the technology
sector
• The NASDAQ has no leading characteristics, but it can be used
with relative strength analysis
General motors
• Most of the time GM tends to rise and fall in concern with the trend
of the DJIA or the S&P500
• GM usually leads the markets, so that a new high in the DJIA or
S&P500 that is unconfirmed by GM is a warning signal of a
reversal in trend
• GM is not as helpful at market bottom because it usually lags
• 4-month rules:
o If in a bull market GM fails to make a new high within 4
calendar months (for example, February 27 to June 27) of its
previous peak, the bullish trend of the market has reversal,
the same thing occurs during a market decline
The Russel indexes
• The Frank Russell organization publishes three important indexes:
1. The Russell 3000
2. The Russell 2000
3. The Russell 1000
• The Russell 1000 is a composite capitalization based on the 1000
largest stocks in the country

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 • The Russell 2000 represents the next 2000 issues based on
capitalization
• The Russell 300 is a composite index of the others and in 2001
represents approximately 98% of the investable U.S equity market
• Often, they are in gear but when they divergence, an alert arises
that the prevailing tend can change
• The relationship between the Russell 2000 (low cap) and Russell
1000 (blue chip/high cap) can also be helpful because it can
provide a clue as to which category investors should favor
• When several closely related securities are being lead by one of
the group and that leader fails to confirm a new high or new low,
this is usually a sing of exhaustion and is followed by a trend
reversal
Summary
• No prefect index or average exist that consistently and truly
represent “the market”
• There are basically two methods of calculating market averages,
those that use capitalization and those incorporating an
unweighted formula
• Most of the time, market index moves in gear with each other. It is
when discrepancies develop and are confirmed that reversals in
trend are signaled

CHAPTER 20: TIME: LONGER-TERM CYCLES

The importance of time

• Time is represented on the horizontal axis of most technical charts
• It is normally used in conjunction with price, volume, and breadth-
the other three dimension of psychology that are involved in
determining trends in the stock market are measurement on the
vertical axis
• Time is concerned with adjustment because the longer a trend
takes to complete, the greater its psychological acceptance and

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 the greater the necessity for prices to move in the opposite
direction and adjust accordingly
• The longer the period, the greater the magnitude and duration of
the next move are likely to be
• The idea of a reaction commensurate with the previous action is
known as the principle of proportionality
Some basic principles of cycle
• Prices move in periodic fluctuations known as cycle
• The most dominant of the longer cycle is the so-called 4-yaer
cycle, in which there is a nominal or average length between
thoughts of 41-months
o The length of the 4-year cycle can vary either way by 6
months
• Cycles are shown on a chart in the form of a sine wave
• These curves are usually based on a rate of change (ROC) or
trend-deviation calculation, which is then smoothed to eliminate
misleading fluctuations
• All stocks, index and markets go through a similar cycle, but the
timing of their peaks and their bottoms differ as does the size of
their price fluctuations
• The rising part of each cycle usually consists of three stages,
which correspond to the three phases described in the DOW
theory
• It is normal for prices to reach new high as each stage unfolds, but
sometimes this doesn´t happen. This is known as a “magnitude
failure” is a distinct sign of weakness
o A magnitude failure occurs because of very poor underlying
fundamentals
• The principle of commonality states that a cycle of similar duration
exists in the price action of all stocks, indexes and markets
• The greater the number of securities moving in the same duration,
the stronger the trend
• The principle of variation states that while stocks so through similar
cycles, the price magnitudes and durations of these cycles will be
different because of fundamentals and psychological
consideration

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 • In cases in which the cyclic turning points of a number of
components of a particular market converge, the magnitude of the
next move will be much greater
• There are four influences affecting a time series trend at any one
time:
o Secular
o Cyclical
o Seasonal
o Random
• The secular influence is very long term and embraced the 4-year
cycles
• The principle of summation occurs when several cycles are
combined in the calculation of a specific indicator
The Long (Kondratieff) wave
• The 54-year wave is named after a little-known Russian economist
who observed in 1926 that the United States had undergone three
long economic waves
• Kondratieff used a wholesale prices as the focal point of his
observation
• This cycle reflects the balance between long-term inflationary and
deflationary forces as they affect the financial market
• Kondratieff noted that each wave had three phases
o An up wave lasting about 20 years
o A transition or plateau period of 7 to 10 year
o A down wave of about 30 years
• He observed that each up wave was associated with rising prices,
the plateau with stable prices and the down wave with declining
prices
• The relatively stable plateau period has always been associated
with a very powerful bull market
• The Kondratieff wave should be used as a framework on which to
base a better understanding of the very long-term trends of
inflationary and deflationary forces, rather than a basis for
mechanistic prediction

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The 18-year cycle
• The amplitude of a cycle is a function of its duration, that is, the
longer the cycle, the larger the swing
• This cycle gains credibility because it operates in other areas, such
as real estate activity, loan and discounts, and financial panic
The 9.2-year cycle
• Is always a 4year lag in learning whether the 9.2-year cycle is still
operating
The Decennial pattern
• This pattern was first noted by Edgar Lawrence Smith
• 10-year pattern reproduced itself over that 58-year period
• The first cycle low of the decade has more of a tendency to fall
between the end of year 1 and the middle of year 2
• The final cycle low for the decade often comes at the tail end of
the seventh year rather than in the middle of the eighth
• The decennial cam ne a greater value if it is used to identify where
the strong and weak points usually occur, and then to see whether
other technical phenomena are consistent
Seasonal pattern
• There is a distinct seasonal patter of stock prices that tends to
repeat year after year
• Stocks seem to have a spring raise, a late second quarter decline,
a summer rally and a fall decline. The year end with a rally that
usually extends into January
• Stocks purchased in October have a high probability of
appreciating if held for 3-to 6-month period
• July and January are heavy months for dividend disbursement and
the retail trade the year-end period is the strongest of the year
• January barometer: if prices rise in January, they are likely to do
so for the whole year
• October is the weakest month
• The November-January period tends to be the best 3 month
holding period for the market as a whole
• The day preceding holidays is statistically a bullish period

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CHAPTER 22: VOLUME: GENERAL PRINCIPLES

Advantage of volume analysis

• There are three principles benefits from monitoring volume:
o First, when we look at indicator that measure both price and
volume momentum, it´s possible to see if they agree, if so,
the probabilities are in favor for an extension of the prevailing
trend
o Second, if they disagree, it tells us that the underlying trend
is not as strong as it might appear on the surface
o Finally, volume often throws up characteristics of its own that
literally show the message of an impending trend reversal
Principles of volume interpretation
1. The most important principle is that volume typically goes with the
trend
• It Is normal activity to expand in a rising market, and contract
in a declining one
2. One important aspect to consider is the fact that volume reflects
an exchange between buyer and sellers
3. If buyers get greedy, they will push up the bid until they obtain as
much quantity as they want. If seller react to bad news, they might
panic, pushing price down sharply, but at all times the amount of
a security being sold is always equal to that being purchased
4. Rising volume and rising prices are normal. This combination
indicates that the market is in “gear” and has no forecasting value
5. Volume normally lead price during a bull move. A new high in price
that Is not confirmed by volume should be regarded as a red flag,
warning that the prevailing trend may be about to reverse
• The greater the number of negative divergences, the weaker
the underlying technical picture
• The lower the peaks relative to each other, the less
enthusiasm that is generated and the more susceptible the
technical position becomes once buying dries up or selling
enthusiasm intensifies
6. Rising prices and falling volume are abnormal and indicate a weak
and suspect rally
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 • This type of activity is also associated with a primary bear
market environment and can be used as an indicator in this
respect
• Volume measure the relative enthusiasm of buyers and
sellers
• A market that rallies on a trend of lower volume indicator that
prices ae rising because of a lack of sellers rather than the
enthusiasm of buyers
7. Sometimes both prices and volume expand slowly, gradually
working into nan exponential rise with a final blowoff stage
• Following this development, both volume and price fall off
equally sharply
• The significance of the reversal will depend upon the extent
of the previous advance and the degree of volume
expansion
8. The opposite of a parabolic blowoff is a selling climax. A selling
climax occurs when prices fall for a considerable time at an
acceleration pace, accompanied by expanding volume
• A price rise from a selling climax is by definition
accompanied by declining volume. This is the only time
when contracting volume and a rising price may be regarded
as normal
9. When prices advance following a long decline and then react to a
level at slightly above, or marginally below the previous trough, it
is a bullish sing if the volume in the second trough is scientifically
lower than the volume on the first
10. A downside breakout from a price pattern, trendline, or
moving average (MA) that occurs on heavy volume is abnormal
and is a bearish sing, confirming the reversal trend
• When price decline, it usually because of lack of bids, so
volume contracts
• When volume expands on the downside, it is because sellers
are more motivated
11. When the market has been rising for many months, an
anemic price rise accompanied by high volume, indicates churning
action and is a bearish factor

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 12. Following a decline, heavy volume with little price change is
indicative of accumulation and is normally a bullish factor
13. Record volume coming off a major low is usually a very
reliable signal that a very significant bottom has been seen
because it indicates that an underlying change in psychology has
taken place
14. When volume and price expand at a sharp pace, short of a
parabolic blow off, and then contract slightly, this usually indicates
a change in trend
• Sometimes this is an actual reversal, and at other it is a
consolidation
15. When price experience a small rounding top and volume a
rounding bottom, this is a double abnormal situation since price is
rising and volume falling as the peak is reached. During the
decline, price declines and volume expands, which is also
abnormal and bearish
Examples

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38
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Summary
• It´s normal for volume to go with the trend
• In a rising market volume usually leads price
• When volume contracts as price rally, it is bearish; when volume
expand when prices fall, it also bearish
• Climactic volume, both on the upside and downside, usually
indicates exhaustion and the likehood that the prevailing trend will
reverse

CHPATER 26: SENTIMENT INDICATORS

Some basic thoughts

• During primary bull and bear markets, the psychology of all
investors moves from pessimism and fear to hope,
overconfidence, and greed
• The worse the problem, the more significant the bottom

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 • The better-informed market participants, tend to act in a manner
contrary to that of the majority by selling at markets tops and
buying at markets bottom
Momentum as a substitute for sentiment
• Individual stocks and many markets don’t have published
sentiment data from which indicators can be derived. In such
instances it is possible to substitute oscillators since there is a
close correlation between overbought conditions and those of
excessive bullishness and vice versa
• The movement of oscillators and sentimental indicators is closely
related
• Protrend short-term momentum extremes often fails to signal
significant contra-trend moves, the same is true of sentiment
indicator, for example: oversold condition in bear markets often fail
to signal rallies
• Oversold reading in bull market are far more powerful than
oversold reading in bear market and vice versa
• If sentiment indicators are noa viable, momentum series can
become useful substitutes
A few worlds on short selling
• Short severs make excellent candidates for indicators that monitor
market sentiment
Specialist/public ratio
• Specialist are individuals and firms on the New York Stock
Exchange who are charged with the responsibility of making
markets in individual stocks in both quiet and volatile environments
• When the specialists are short selling at a high level relative to the
public this is bullish and vice versa
• The ratio seems to work better in signaling an advance
• Sell signals are not so reliable

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Short-interest ratio
• The short interest is a figure published around the end of the month
that reports the number of shares that have been sold short on the
NYSE
• A large number of shares sold short indicates a predominantly
bearish attitude and vice versa
• The ratio of the short interest to the average daily volume of the
preceding month offers more reliable signals than the short
interest taken by itself
• A short-interest ratio of lees than 1 has normally reflected a very
bullish consensus and from a contrary aspect is considered
bearish
Insider trading
• The “insiders” are generally correct in their decision, tending to sell
proportionally more stocks as the market rides, and vice versa
• A rise above the 70% level and a subsequent reversal in the
direction of the index are often enough to signal a decline
• The indicator should be used as a background factor rather than a
precise timing device
• At major lows, a decline below the 60 level usually indicates that
the market has found a floor and is relatively immune to further
price erosion
• The reversals that take place from below the 40% level appear to
offer the best warning of an impending advance
Advisory service
• The evidence suggests that the advisory service in aggregate act
in a manner completely consistent with that of the majority and
therefore represent a good contrary indicator
• The advisory services follow the trend of equity prices by becoming
most bullish near market tops ad predominately pessimist around
market bottoms
• This index also gives a goo indication of how market psychology
can swing from outright passim to extreme overconfidence

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 • Whenever the advisory service sentiment indicator has moved
below the lower dashed line and then risen above it, important buy
signals have usually resulted
• The buy signals tend to develop fairly closely to the lows, whereas
the sell signals are less responsive
Market vane and bond market sentiment
• Sentiment indicator are also published for the futures market
o The results are published on the percentage of participants
that are bullish
• The theory is that when a significant number of traders are bullish
on a particular market, they are already positioned on the long side
and there is very little potential buying power left
o The implication is that the price has only one way to go, and
that is down
• If most participants are bearish, selling pressure has reached an
extreme, and therefore prices will reverse to the upside
• One problem with these statistics is that they are based on the
opinion of short-term traders
• Important signals often occur when the indicator crosses above
the 70% level and then recrosses it
• Reading that have fallen below 30% and then rises above it haven
often generated timely buy signal
• The main drawback in interpreting these data is that premature
buy and sell signals often appear when a persistent trend is under
way
Combining sentiment and momentum
• One useful approach for identifying early reversals in trend is to
combine sentiment and momentum into one series
• Buy and sell alerts occur when the bullish momentum index
crosses through the oversold and overbought zones and then
recrosses the zones on its way back to zero
• Sometimes important clues of a potential trend reversal occur as
the bond move to an extreme but are not confirmed by a similar
move in momentum

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Mutual funds
• Data on mutual funds are published monthly by the Investment
Company Institute
• The statistics are useful because they monitor the actions of both
the public and the institutions
• These data should be treated as a flow-of-founds indicator, but
they also reflect attitudes of various market participants
Cash/Assets ratio
• Mutual funs consistently hold a certain amount of their portfolios in
the form of liquid assets in order to accommodate investors
wishing to cash in or redeem their investments
• A useful indicator is derived when this cash position is expressed
as a percentage of the total value of mutual fund´s portfolio
• The index moves in the opposite to the stock market, because the
proportion of cash held by mutual funds rises s prices fall, and vice
versa
o There are three reasons for these characteristics:
▪ First, as the value of fund´s portfolio falls in a declining
market, the proportion of cash held will automatically
rise even though no new cash is raised
▪ Second, as prices decline; the founds become more
cautious in their buying policy, because they see fewer
opportunities for capital gains
▪ Third, the decisions are made to hold more cash
reserves as insurance against a rush of redemption by
the public
• In a rising market the opposite effect is felt, as
advancing prices automatically reduce the
proportion of cash, sales increase, and fund
managers are under tremendous pressure for
capitalize on the bull market by being fully
invested
• One of the functions of an indicator of this nature is to warn of
setbacks

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Margin debt
• Trends in margin debt are probably better classified as flow-of-
funds indicator
• Margin debt is money borrowed form brokers and bankers using
securities as collateral
o Th credit is normally used for the purchase of equities
• At the beginning of a typical stock market cycle, margin debt is
relatively low, it begins to rise very shortly after the final bottom in
equity prices. As prices rise, margin traders as a group become
more confident, taking on additional debt in order to leverage
larger stock position
• During a primary uptrend, margin debt is a valuable source of new
founds for the stock market
• The difference between stocks purchased for cash and stock
bought on margin is that margined stock must at some point be
sold in order to pay off the debt. In other hand, stock purchased
outright can theoretically be hold indefinitely
• During stock market declines, margin debt reverses its positive
role and becomes an important source of stock supply
o This occurs for four reasons:
▪ First, the sophistication of margin-oriented invertors is
relatively superior to that of other participants. When
this group realizes that the potential for capital gains
has greatly diminished, a trend of margin liquidation
begins
▪ Second, primary stocks market peaks are invariably
preceded by raising interest rates, which in turn
increase the carrying cost of margin debt, therefore
making it less attractive to maintain
▪ Third, since 1934 the Federal Reserve Board (The
Fed) has been empowered to set and vary margin
requirements, which specify the amount that can be
lent by a broker or bank to customers for the purpose
of holding securities
▪ Forth, the collateral value of the securities used as a
basis for the margin speculator is faced with the option

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 of putting up more money or selling stock in order to
pay off the debt
• The higher the level of margin, the greater the market´s
vulnerability when the numbers begin to contract
o A better way to express this statistic is to express the level
of debt as a percentage of outstanding market capitalization
• It is the trend of margin debt that is all-important, because trend
reversals signal whether traders are confident (willing to take on
more debt) or pessimistic (liquidating it). For this reason, margin
debt is a useful indicator when expressed in relation to its 12-
month EMA
o EMA crossovers offer confirmation of major reversal
Put/Call ratio
• A put gives an investor or traders a theoretical option to sell a
specific security at a predetermined price over a specified period
o In effect the purchaser of a put is betting that the price of the
underlying asset will go down
• A call is a bet that the underlying asset will raise in price
o It gives a purchaser the option to buy a security at a
predetermined price over specified period
• This indicator measures the swings in sentiment between the bulls
and bears
• The lower the ratio, the more bullish the crowd and the more likely
the marker is to decline, and vice versa
• A low ratio means that very few people are buying puts relative to
calls, whereas a high ratio indicates that a larger number of traders
that normal are betting that the market will go down
Inverted yield momentum
• The trend of any indicator is often as important as its level
• The idea is that the swings in the dividend yield form a bullish
extreme of around 3% to a bearish one of to 5 to 6% reflect change
in psychology
• When the opposite takes place, the indicator generally offers
timely buy signals
• The overbought and oversold levels are at +20% and -20%

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The market´s reaction to news
• The more convincing the news and the more muted the response,
beyond the initial few hours of trading after the news are published,
the greater the potential vulnerability, and vice versa
• If price do not respond to news in the expected way, it is probably
in the process of turning
Summary
• Sentiment indicator are useful supplement to the trend-
determining techniques. They should be used for the purpose of
assessing the consensus view from which a contrary position can
be taken
• Since many sentiment directions are subject to institutional
changes, it is mandatory to consider them as a group rather than
relying on one or two indicators alone

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