FIN 40500: International

Finance
Beyond the Fundamentals; Technical
Analysis

Fundamental analysis focuses on economic/financial theory and

various economic indicators to explain market movements

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Trade Balance Approach

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Price Level Approach

Interest Rate Approach

Monetary Approach

Technical analysis is not concerned with the causes of market

movements. Instead, technical analysis focuses on the movements
themselves. Is there information in past price movements that can be
used to predict future movements?

Chart Analysis
Quantitative Methods

The forecasting equation for a technical analysis would be

something like this

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$/Euro: Weekly data over 3 years

Chart analysis begins with a time series plot of an assets price

Charts can be hourly, daily,

weekly, etc.

Higher frequency data will be

more detailed, but noisier

A chartist looks for patterns in the to identify resistance (upper bounds)

and support levels (lower bounds)

Old Support
level

New Support
level

Connect two
consecutive highs to
get the upper
channel

A parallel line through

a recent low becomes
the lower support

A breakout indicates
a new pattern forming

Bullish channels
tend to have
upward breakouts

Find the trend by connecting at least two highs

Two lows complete

the triangle

Breakout occurs at the apex, usually with increasing volume

Ascending triangles
usually have
upward breakouts

The Run: A breakout from the lead in trend

The Bump:
Increase in trend
by more than 50%

Two lows identify the

lead in trend

The head is the first advance past the left shoulder

The left shoulder is the first high
above the current trend

The right shoulder is the first

high following the reversal

Two lows identify the lead in trend

The neckline connects the two shoulders and indicates lower support

What pattern do you see?

Run
Bump

Fibonacci, one of the greatest mathematicians of all time discovered

a sequence of numbers which are now used across many disciplines
Suppose that you begin with a pair of rabbits:

Rabbits take one month to mature.

Once mature, they can breed

offspring

Offspring come in pairs (one male and one female).

A pair of

offspring are born each month

The rabbits never die

Now

One Pair
(Y)

1 Month

2 Months

One Pair
(M)

Two Pair
(M, Y)

3 Months

Three Pairs
(M, M, Y)

Y = Young, M = Mature

Can you find the Pattern?

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89,
Each number in the Fibonacci sequence is the
sum of the previous two
1+ 1 = 2
1+2=3
2 + 3 = 5 .
These numbers seem to appear a lot in nature

One

Two

Three

White Calla Lily

Euphorbia

Trillium

Five

Eight

Thirteen

Bloodroot

Black-eyed Susan

Buttercups
(By far the most
common)

Ordinary field daisies have 34 petals a fact to

be remembered when playing she loves me,
she loves me not!
(with 34 petals, you will always finish with
she loves me not!)

Take a pineapplehmmmlook at the various spirals formed

Every human has 2 hands with 5 fingers on each. Each finger is made
of 3 segments connected by 2 jointsdont these numbers sound
familiar?

Each section of your index

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

Similar ratios are seen between

your hand and
forearmcoincidence?

Suppose that we divide each number into the following number

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89,
1/1 = 1
2/1 = 1
3/2 = 1.5
5/3 = 1.667

8/5 = 1.6
13/8 = 1.625
21/13 = 1.615
34/21 = 1.619

The ratios converge

to 1.618

Now, suppose that we divide each number into the previous number
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89,
1/1 = 1
1/2 = .5
2/3 = .667
3/5 = .6

5/8 = .625
8/13= .615
13/21 = .619
21/34 = .617

1 .618 1.618

The ratios converge

to .618

AND

1
1.618
.618

Suppose that
we begin with a
1X1 square

Put another 1X1

square next to it

Now, put a 2X2

underneath

Now, add a 3X3 square

Connect the corners of the squares and you get the golden
spirallook familiar??

Math is everywhere!!

Anyways, back to technical analysis. Many of the technical methods are

based on PHI (.618) and powers of .618
.618
.382 = .618*.618
First, draw a trend line
.236 = .618*.618*.618

Draw arcs
that
intersect the
trend at
61.8%, 50%,
and 38.2%
of the high
(these will
indicate
future
supports)

Draw an initial trend line between two extreme points

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

At the second extreme point, draw a vertical line

Once a reversal occurs, it tends to find support at

Fibonacci levels!

Large price swings tend to occur on Fibonacci times!

(times could be in days, months, years, etc)

Elliott Waves

Elliot wave theory relies on cycles within cycles

Grand Super cycle

Super cycle
Cycle

Each cycle consists of 5 moves with the trend (1,3,5

are impulse, 2,4 are corrective) and 3 that are
against the trend. A 5-3 wave

Elliott Waves consist of 5 moves

with the trend (1,3,5 are impulse, 2,4
are corrective) and 3 that are against
the trend. A 5-3 wave cycle

Beginning of the next

wave

Impulse

Correction

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

Impulse (1)

Correction (2)

Finally, the super-cycle oscillates around a grand super-cycle

Note that the grand super cycle has two movements, the super cycle
has 8 movements, the cycle has 34Fibonacci numbers!!

RSI (Relative Strength Indicator)

RSI 100
1

100
Total "Up" points
Total "down" points

If Up Points = 0, RSI = 0

If Down Points = 0, RSI = 100

RSI < 30 (Oversold)

RSI > 70 (Overbought)

RSI (Relative Strength Indicator)

RSI 100
1

100
Total "Up" points
Total "down" points

Chart Interval: 15 minutes

Period Length: 20 (300 minutes)
Total up points = 7
Total down points = 11

7
RS .636
11
100
RSI 100

1 RS
RSI 38.89

Fast Stochastic
Close(X) - Low(X)
FS
*100, X Period Length
High(X) - Low(X)
Signal Y Period Moving Average of FS
Period High: FS = 100

Period Low: FS = 0
Signal < 30 (Oversold)

Signal > 70 (Overbought)

A moving average takes out the volatility by averaging several

observations. For example, a MA(3) would average the current
observation with the previous 2 observations.
Data

May

June July

Aug.

Sept.

Oct. Nov.

Dec.

.6

.3

-.1

.1

.2

.6

.2

MA

May

June

July

Aug.

Sept.

Oct.

Nov.

Dec.

.6

.3

-.1

.1

.2

.6

.2

.2

.45

.1

.15

.4

.4

.2

.27

.10

.07

.3

.33

.33

.3

.17

.2

.275

.3

2
3
4

.2

Moving Average Convergence/Divergence

(MACD)

The MACD indicator calculates the difference

between moving averages of two different lengths
(usually, 12 periods and 26 periods)
The signal is typically a 9 period moving average of
the difference
A divergence means that something is happening
Positive to Negative = Sell Signal
Negative to Positive = Buy Signal

MACD

Suppose that the longer run moving

average has a length equal to the number of
observations the series average

MA
MA(10)

MA(N)

Time
- To + :
Buy point

+ To - :
Sell point

- To + :
Buy point

Punch line

Technical methods are useful for short run

prediction
Dont lose sight of the fundamentals!!!