Last Revised: 10/04/2023

Extras
Segments Page

Technical Analysis Introduction 2

The Trend 3

Dow Theory 6

Introduction to Charts - Part 1 9

Introduction to Charts - Part 2 10

The Basics 12

Trend Lines Applied to GM Video

Breakouts, Stops, and Retracements 18

About the VIX 24

M.M100518656.

This document should be used in conjunction with the corresponding segments for Extras as provided on
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1
 Last Revised: 10/04/2023

Technical Analysis Introduction

Ontology Epistemology
- what exists - how can we know about what exists
method 1
trends method 2
Observation
cycles
ontological method n
assumptions method 1
Inference
method 2
prediction
turning method n
points
N N

Validity of claim = 𝟏#𝐍

time time
𝛒(ont. assumption false) = 1 - validity non-replication
replication

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The Trend
Page 1/

Technical Analysis (TA) is based on one major assumption:

‘freely traded market prices, in general, travel in trends’
or - prices tend to show persistence

uptrend countertrend

trend

- the length of the trend of interest is

based on individual preferences/investment
objectives
- goal is to spot trends and countertrends as soon as possible
- TA is probabilistic, not deterministic
- goal is to combine indicators (including fundamentals)
to increase the probability
Fundamental - strategic
when TA and FA agree - lean in!
Technical - tactical

Page 2/
Fundamental - what to buy (time in the market)
Technical - when to buy (timing the market)
when to enter
take profit
+ when to exit
take loss - pure technical positions
are not concerned with ‘what’ to
buy - ∴ best to avoid left tail outcomes
Pure TA Rules/ (loss is predetermined, i.e. 2% or 5%)
the trend is your friend (until the end)
don’t lose control position size and max. loss
manage your money M.M100518656.

What is a Trend? downtrend

higher peaks horizontal peaks
lower peaks
and troughs
higher troughs

uptrend sideways
lower troughs

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A trend is a directional movement of prices that remains

in effect long enough to be identified and still be profitable

How are trends identified?

- time series of prices - DV, time - IV
b1 coefficient ➞ strength and direction
(requires min. 30 data points - 30 days) - may not be
resistance timely
- trendlines
support trend is in place
until the trendline
is broken
- trends form from the forces of supply and demand
(sellers) (buyers)
- information and motivations will show up in price action
TA believes it is futile to analyze the components of S/D except
through the prices they create

Page 4/

What trends are there?

1 week
- trend lengths are not uniform
daily
or even
intraday
1 month
1 yr.
shorter time periods
- the ability of trends to act similarly over different periods is
called their fractal nature
fractal patterns exist in nature (recursive patterns)
point is: the length of the trend is irrelevant since technical
principles are applicableM.M100518656.
to all of them
- the granularity of the trend followed is determined solely by
the trader’s/investor’s period of interest

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Primary trend (months/years) - investing
Secondary/intermediate trend (weeks/months)
hedging or swing trading
Short-term (days)
intraday (minutes/hours) - day trading, scalping

Other assumptions of TA:

1/ Prices are determined by the actions of supply and demand
based on expectations,
emotions, and biases
2/ Prices discount everything (including varying interpretations of info.)
3/ Prices are non-random
4/ History tends to repeat since humans will behave similarly to the
way they have in the past in similar circumstances
- this forms identifiable patterns
never identical ∴ open to interpretation

Page 6/

Other assumptions of TA:

5/ TA believes that patterns are also fractals
6/ Emotions are affected by earlier emotions through emotional feedback
i.e. rising prices are enough to cause rising prices (momentum, drift,
trend)
- positive feedback loops can cause bubbles and panics
high prices low prices can
can go even go even
higher lower

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Dow Theory
Page 1/

Charles Dow - founder and first editor of Wall Street Journal

- considered the father of TA
- first to create a stock index Railroad
Industrials
Alfred Cowles - performed the first formal test of Dow Theory (1934)
as articulated by Dow’s WSJ successor, William Hamilton
- conclusion - No! - Dow Theory results in returns that lag the market
- the ‘market’ was based on an index Cowles created
1998 - Journal of Finance - retested and adjusted for risk
- yielded high SRs and 𝛂 > 0 (1902 - 1929)
- out-of-sample 1930 - 1997 - still performed well
The Dow Theory (book, Rhea, 1932)
1/ The primary trend is inviolate - cannot be manipulated
2/ The averages discount everything - including expectations
3/ Dow Theory is not infallible - likely, not always

Page 2/

Dow Theory Theorems/

1/ Ideal market picture consists of an uptrend, top, downtrend
and bottom
top
a generalized
downtrend
uptrend model
bottom

2/ economic rationale should be used to explain stock market

action
Railroad Avg. - expect to turn up/down before Industrials
Industrial Avg. - turning up/down confirms Railroads
M.M100518656.

new highs/lows on both confirms a primary trend

3/ Prices trend
a) Primary trend - most important (bull/bear) - several yrs.
b) Secondary trend - against the primary trend - weeks to months
c) Minor trends - daily fluctuations

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Primary trend/ longest of the three (several years)

- represents the overall broad long-term movement of
security prices
- upward - primary bull
- downward - primary bear
3 phases 3 phases
1/ reviving confidence from the 1/ abandonment of hope upon
prior primary bear which stocks were purchased
2/ response to increased corporate 2/ selling due to decreased
earnings earnings
3/ speculation becomes dominant 3/ distress selling regardless of
and prices rise on hopes and value by those who believe
expectations the worst is yet to come or
who are forced to liquidate

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Secondary trend/ runs counter to the primary trend

- retraces 33% to 66% of the primary price change since
the last secondary trend
e.g./
20 13
9 3

Minor trend/ unimportant

- basically - prices become more random and unpredictable
as the time horizon shrinks
Concept of Confirmation/ - occurs when both Industrial and Railroad
M.M100518656.

averages reach new highs or lows together

on a closing basis
not confirmed

new low

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failure to reach new highs
- primary trend may be reversing
non-confirmation - if confirmed by the other average
then confirmation of a new
primary downtrend

- use of S&P 500

and Russell 2000

Page 6/

Importance of Volume/ used as a secondary confirmation of a trend

- lower volume on rallies

with higher volume on
declines usually suggest an
overbought market
(and vice versa)

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- volume confirms less buying conviction

price (called a divergence)

Criticisms/ - results in actions after bottoms/tops

- secondary trends can be mistaken for new primary trends

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Introduction to Charts - Part 1

Page 1/

Charts - main tool of TA (charts can be generated for any time frame)
- focus is on interpreting the information contained in the chart
- a chart is a price history, graphically presented
- they reflect market behavior and are subject to repetitive
patterns
- also shows periods of high and low price volatility
Line Chart: price and time ➞ each point is just one price (closing)
- shows a trend but does not display intraday volatility
high
Bar Charts: OHCL high - low = range
close
open
low
can be:
H
Candlestick Charts c o
wicks or shadows white/open shaded/black
- originated in rice real body green red
trading markets in c hollow closed
o
Japan L (bullish) (bearish)

[Link]
rce=rewardful&via=mark

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Introduction to Charts - Part 2

Page 1/

1/ Multi-line charts - several time series in one chart

2/ Multiple Y-axis - comparing 2 variables with very different
absolute values
- compare and contrast trends and relationships
- left vertical axis + right vertical axis
or/ multiple left or right axes
- evaluate if 2 series move together (co-integrated)
3/ Vertical Scale
a) arithmetic scale (linear) - y-axis has same price intervals
e.g. 10 - 20 same distance as 190 - 200 even though
they represent different returns (100% vs. 5.26%)
b) logarithmic scale - y-axis has same percent intervals
- chart displays price growth rate over time

Page 2/

3/ Vertical Scale
b) logarithmic scale 30 80
40
growth rate
20
10
price 20
10

- long term charts ( > 3-5 yrs.) should be logarithmic

Volume/ bottom of chart with its own scale

equivolume - rectangle for each day
useful for quickly spotting days with
height = range extremely heavy or light volume
- frame is coloured
M.M100518656.

width = volume green = up

∴ horizontal axis will not red = down
be evenly spaced for time - indicates level of volume for the day
but not on what time of day

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Volume/ Volume-scaled charts or Volume Bars
- each bar is a unit of volume rather than time progression
e.g. each bar = 100k shares, regardless of time

- better visualization of when during the day volume was

the heaviest/lightest

1M sh. each bar = 1M sh.

varying time periods

23 11 6

[Link]
rce=rewardful&via=mark

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Trends - The Basics

Page 1/

- trends occur - trend analysis is probabilistic at best and

open to interpretation
- question: can they be identified early enough by
examination of the chart alone to be profitable
Trend goals/
1/ determine, at the earliest point, when a trend has begun
2/ select an entry point and trade with the trend
3/ exit when the trend is ending
- combined with fundamentals + experience + skill
+
technicals time
knowledge

Terminology/ upward - rising

one trend line
downward - falling
sideways - range or neutral area - 2 trend lines
non-trending - no trend lines (e.g. forex)

Page 2/

- any particular trend is influenced by its next larger and

smaller trend
i.e. minor trends don’t influence the major trend
(small) (large)
- short-term trends influence the medium-term trend, which in
turn influence the long-term trend
- trending prices (up/down) indicate an imbalance of demand and supply
information - verifiable
trend is being drive by interpretation
subjective
emotions
sellers require higher prices
to add supply
M.M100518656.
the observation of an uptrend
can be enough to encourage
buyers must offer higher prices supply only at higher prices
- the observation of an uptrend can
be enough to induce more demand the longer this goes on, the
and at higher bids more the interpretation of info
leans in the same direction
(enter irrationality and emotion)

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Page 3/
- the trend is a direction
- easiest way to determine a trend is to look for peaks and troughs
peaks trend R
R trend line
S (upward) trend or channel lines
channel
troughs - also called a
S Point
line consolidation area,
congestion area, or
trend line
(downward)
rectangle
channel formation
resistance
line - typically forms
after a large
support non-trending trend move
Resistance - supply > demand - buyer fatigue
Support - demand > supply - seller unwillingness
- the more price points that touch a line (S, R), the stronger and
more important the line becomes
(S, R)

breakout Page 4/

R
R
S - previous resistance now becomes new support

S
each line touches a resistance or support point
sets up notion of resistance zone rather than a single
(or support) price line
belief price won’t go higher pull back to let buyers in
- previous buyer happy to - belief prices won’t go lower
breakeven

- Round numbers - careful about interpreting much around round numbers

- typically strike prices for options - as expiration nears, mm
M.M100518656.

becomes part of the supply/demand imbalance for no

technical or fundamental reason, no emotion, or interpretation
Reversal points: DeMark and Williams method
- use the # of bars on either side of a suspected
reversal point

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the more bars, the stronger the point

2 lower 2 higher lows
lows low point
Percentage method: - larger the %’age, the more important
but less common the reversal
2% - determined beforehand
2%
if next 2 days make lower lows
Gann 2-day swing:
than the high bar,
(previously 3-day) identify low or high point the point = resistance
if next 2 days make higher highs than the low
bar, then support
High Volume Method: - very large volume, typically associated with fundamental
(most useful) activity
- typically a good sign of a reversal
- candlestick: called an outside day
price - high probability this reversal continues
Note: very rare that all 4 methods
volume will give the same signals.

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Drawing support/resistance zones:

- draw a horizontal line through each trough/peak point
- lines may cluster at S and R - the more clustering, the
- zone = highest point - lowest point stronger the zone
- for consistency, use all intraday or all closing prices
- longer in the past they formed, the less important they are
- if prices move above res./below sup. - called a
breakout (↑) - old res. becomes sup.
breakdown (↓) - old sup. becomes res.
Range trading: ranges take some time to form
M.M100518656.

- range may be too narrow to play and ranges don’t typically hang around
if: close long positions or for long
- may be good
sell calls covered calls
places for strikes but
sell puts never
if short buy or sell puts

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Breakout Trading: wait until the breakout occurs

(all trend
- trade in the direction of the breakout discussion still
applies)
Donchain breakout method (four week breakout system)
buy when the highest high over past 4-weeks is broken
(sell) (lowest low)
- stay long (or short) until there is a sell (buy) signal
- uses SAR trades ➞ stop and reverse
Directional Trends/ channel trend line
the steeper the line, the
downtrend
uptrend more powerful the trend
channel but the more unsustainable
trend line
it becomes over time
- spotting uptrends: 1/ regression line with S.D. bands (+⁄− 1)
linear regression - charting feature
- outside S.D. bands = outlier - sign the trend may be
changing

Page 8/

- spotting uptrends:
2/ trend line - need at least 2 points (trough points for
downtrends)
- provides a signal of a change in trend
(a crossing of the line is the signal, line is indicator)
- typically arithmetic charts will do the job
-1.2 × 𝐏𝟎 × 1.2
- outside the range - use log charts
(and over longer (will work better)
40% range periods)
trend line = %∆P
trend line = $∆P
Accelerating Trend Lines/ Decelerating Trend Lines/
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unsustainable fan lines (each with less

- often a tight market negative slope)
or a short squeeze reversal

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general rules: the longer and more times the trend line is
touched by prices, the more significant when the line is broken
- the steeper the line, the sooner it will be broken
- Breaks ➞ end of a trend or anomaly (false break)
- no way to know but// break on high vol. + fundamental news = higher
probability
- assess breaks on a closing basis - should be minimized
since day traders must close positions by end of day
- closing prices represent a longer-term trader’s perspective
Channels/
steeper the breakout, the more it may be driven
TA requires X by emotion
action - an indication to go looking for
vs. information - found ➞ assess - may be a repricing event
requires - not found - consider next action
inquiry
T + 30
- covered call
at X

Page 10/

- any kind of acceleration is a potential (strong) sign of

pure emotionalism and thus a potential signal to action
Internal Trend Lines/ - drawn through the trend such that a large
number of minor reversals touch the line above and below.
(not very useful)
Other Types of Trendlines/ from the highest high (or lowest
Point and Figure charts/ low)
O
O x
O x
x resistance
Speed Lines/ - predicting future S/R lines 45o angles (by necessity of
construction)
M.M100518656.

𝟏# fast
𝟑
speed lines
50% - believed to be ‘natural’ levels of support
slow (Edson Gould)
𝟏#
𝟑

- no evidence this has value

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Andrew’s Pitchfork/ expectation is that the
(no value) 50%
price will move to the
middle resistance line

Gann Fan Lines/ WD Gann - believed prices and time had a

(no value) geometric pattern
4
- used 9 basic angles based on 1, 2, 3, 4 and 8
45%

angle angle angle

2
3 4 and 8
1
1 1 1
4 angle angle
1 1 4 and 8
2 3
trough point

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Breakouts, Stops, Retracements

Page 1/

Breakouts/ price breaks out through a previous support or

resistance level/zone
often signifies that a significant change in supply
or demand has occurred and a new price trend is beginning
in direction of previous trend ➞ trend still exists
breakout
in opposite direction of previous trend ➞ reversal
(close long, possibly short)
(short) (long)
- false breakouts are common
Confirmation/ penetration of a trend line, support or resistance zone
and that it is real (i.e. not false)
- for a zone, should breakout past the most extreme level
- closing price is critical - intra bar breakouts are not confirmed
- a close above res. or below sup. increases the probability
that the breakout is real

Page 2/

Confirmation/ more closes beyond res./sup. - the higher the

probability but more of the move will be missed
- using points or percent/
$ % ➞ 1-3% close beyond the res./sup. level on a
closing basis
- time/ penetration remains outside zone for a certain time
- usually 2 bars
1
2 - should penetrate even further than first bar
- shows follow-through (high volume adds to confirmation)
M.M100518656.

- volume/ heavier trading demonstrates that other traders were acting

- shows power to the move
- volatility/ more volatile stocks can trigger signals (points, percent)
falsely more often
∴ breakouts should consider volatility

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- volatility/ use a trendless volatility measure
- Beta - only useful for equities
e.g. 1% - 3% breakout @ 𝜷 = 1 requires 1.5% - 4.5% @ 𝜷 = 1.5
- removes the trend
standard deviation - value influenced by the trend (flawed)

- average true range (ATR) - average of each bar’s high-low range

over some time period
- true range of each bar is greatest of:
1/ difference between H and L
unts
acco 2/ abs. value of the difference between the prior bar’s close
for and the current bar’s high
price 3/ abs. value of the difference between the prior bar’s close
gaps
and the current bar’s low
- breakout will be some multiple of the ATR

Page 4/

- average true range (ATR) - the ATR will expand and contract
over time as price volatility changes

price
support
1 ATR below support

pivot point technique - used to determine likely sup./res. levels

- used by day traders to establish day price ranges
P (pivot point) ➞ previous day’s (H + L + C)/3
logic: most recent
R1 (first res.) ➞ 2 × P - prev. period low price action (previous
M.M100518656.
S1 (first sup.) ➞ 2 × P - prev. period high bar) is the best
R2 (second res.) ➞ P + prev. period H - L prediction of the
S2 (second sup.) ➞ P - prev. period H - L current bar’s action
(questionable)

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pivot point technique - for daily breakout, use previous weekly or
monthly action
- if R1/R2 or S1/S2 also match an actual res./sup. level,
breakouts have more confirmation (2 beliefs, larger crowd)
- other pivot point calculations - DeMark, Woodie’s, Camarilla, Fibonacci
- no one pivot calculation is consistent or accurate

- Can a breakout be anticipated? - increasing volume as price approaches

res./sup., decreasing volume as it retraces

Stops/ an order to buy/sell once a specific price has been hit

buy stop - buy above the current price once hit, market or
sell stop - sell below current price limit order

- used to enter or exit a position

Page 6/

Stops/ - above res. ➞ buy stop to enter (only on a breakout)

entry stop
below sup. ➞ sell stop to enter - short sale on breakout
or/ sell stop to exit existing long position
exit stop or protective stop
- stop levels can be set using the same rules used to confirm
breakouts
- stops too close to the current price will get triggered too often
when ready to exit a position, place a tighter sell stop
(lets the market decide)
- trailing stop e.g. 1%
price - stop trails price by a
stop
M.M100518656. set amount ($) or %

- hard stop - coded into an order - a rule that should be adhered to

- soft stop - no order, just an intention to enter/exit at a specific price

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Stops/ buy stops for short positions best placed with the
entry order
protective stops for long positions
- all stops should be set based on price action of the security and
the level at which a reversal in trend is likely
- generally set with trend lines, or res./sup. levels/zones
buy stop
trade in direction
R of trend
Stop price
S
- must keep raising the
2% - 3% sell stop
Stop on a breakout Stop in an uptrend
confirmation - progressive stops
represents reversal point of
major trend
e.g./ 32
buy @ 30 10% stop @ 27 - wrong
sell stop @ 24 - correct
25

Page 8/

Stops/ preservation of capital rule:

e.g./ no more than 1% cap. loss on any position
100k 1% = 1000
buy @ 30, stop @ 24 = 6 loss ➞ 𝟏𝟎𝟎𝟎$𝟔 = 166 shares
Chandelier exit: limited ATR trailing stop
e.g. stop at 2.5 - 4× ATR

$50 ATR = 2.50 stop = 3× ATR = 42.50

- stop will move up to 𝛒𝟎 - 3× ATR ➞ may be more useful
price when uptrend rises far
3 × ATR above trend line
support line
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Stop line

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Page 9/

Stops/ parabolic SAR (stop and reverse)

rising PSAR = prior PSAR + AF (Prior EP - Prior PSAR)

acceleration extreme point
factor
starts @ .02, ↑ .02 each time EP makes
a new high
% of gain e.g. 50% of gain
40%
as price rises higher
30%

time stop - exit stop after some period of time if the trade is
not profitable

money stops - set a stop after a certain gain/loss is reached

e.g. 5% stop loss, 20% take profit

Page 10/

Stops/ gaps - when a security opens and trades totally outside

the previous day’s range (typically on fundamental news)
- stops should be placed below the gap opening (above for
shorts)

stop

false breakouts - a.k.a. specialist breakouts

- upside (downside) buy (sell) stops to enter/exit
are triggered on breach but may have no follow
through
M.M100518656.

buy stop triggered buy stop triggered

sell stop exit
add sell stop here
sell stop entry (short)

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Retracements/ corrections to the principal trend
- retracements can happen within a trend or after a breakout
uptrend: beginning of a retracement sets a res. point
downtrend: sets a support point
- retracement back to a prior res./sup. after a breakout
is called a throwback/pullback (often short in both
time and distance)
- can be many retracements within a larger trend
- may be some information in the length and time of the retracement
- for a significant uptrend - retracement would be short and shallow
e.g. < 50% of the previous move up
> 50% - primary trend may be in jeopardy
- common %’ages 33⅓, 50%, 66⅓% or Fib. 38.2% , 61.8%
- no evidence that these have any regularity

Page 12/

Retracements/
50%
pullback
price objective
buy stop
𝐭𝐚𝐫𝐠𝐞𝐭 − 𝐞𝐧𝐭𝐫𝐲
R 𝐫𝐞𝐰𝐚𝐫𝐝) =
𝐫𝐢𝐬𝐤 𝐞𝐧𝐭𝐫𝐲 − 𝐬𝐭𝐨𝐩
sell stop
- should be a min. of 3:1
buy stop at 32
sell stop at 28 𝐫𝐢𝐬𝐤) 𝟒𝟓 − 𝟑𝟐 𝟏𝟑
𝐫𝐞𝐰𝐚𝐫𝐝 = 𝟑𝟐 − 𝟑𝟖 = )𝟒 = 𝟑. 𝟐𝟓
price objective 45

3:1 ➞ price objective = 32 + 3(4) = 44

- if 44 is not realistic/probable, may not
represent a good reward to risk ratio
M.M100518656.

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About the VIX Index

Page 1/

VIX - measures the implied volatility being priced into the

S&P500 index options (SPX)
- an indication of 30-day implied volatility
- performance of VIX is inversely related to the S&P500
- also: VVIX - volatility of VIX
VXN - imp. vol. of NASDAQ - 100 ➞ will have higher vol.
RVX - imp. vol. of Russell 2000 ➞ small-cap stocks
VXD - imp. vol. of DJIA ~ 8% of Russell 3000

- fairly new ~ mid 1990s

- original based on S&P100 options, used only 8 strikes
- 2003 changed to S&P500 - uses many more strikes
- uses mid-point of bid-ask for option price for ATM and OTM
- uses actively traded options - extends until there puts calls
are 2 consecutive strikes with no bid-ask posted

Page 2/
front next
month month standard expirations
removes the
end-of-contract volatility
that can occur min. 8 days - to the second (up to 9:30am 3rd Friday
of the month)
combined in such a way as to create
a synthetic ATM option that expires exactly 30 days
from the moment of calculation

Imp. Vol. of this option = VIX put-call

at r = 0, and constant IV at all X parity
1. $ATMP = ATMC IVP = IVC at strike = X
P IV
2. $(ATM - y)P = $(ATM + y)C but. X - y and X + y
M.M100518656.

IVP ≠ IVC
skew ↑
call
selling
IV
put skew
buying
OTMP ATM OTMC OTMP ATM OTMC

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Page 3/
IV
- on rallies, call buying on the index does not
occur to the same extent as put buying on
sell-offs
skew ∴ index typically has positive skew
-10% +10% - single names more commonly have
OTMP ATM OTMC a volatility smile
VIX is expressed as an annual volatility measure
𝛔2 ➞ variance, can be divided and multiplied
∴ scales linearly with time
i.e. daily 𝛔2 × 252 = annual 𝛔2 (it follows that daily 𝛔2 = annual 𝛔2
252)
𝛔 - standard deviation (volatility) scales with √𝐭

i.e.
𝛔𝟐 for variance, but 𝛔 for volatility
𝐭 √𝐭

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VIX = 32 ➞ implies a daily vol. of 𝟑𝟐# = 2.016%

√𝟐𝟓𝟐
(rule of 16 since
Interpretation: 𝛔 × √𝐭 √𝟐𝟓𝟐 ~ 16)
68% cone
16%
2% forward price using 𝐫𝐟
2% 16% = center of the
distribution

30-day move VIX

- a VIX of 32
t=0 t=1 t = 252
1% 3.46 means the options
2% 6.92
it does NOT mean
market is pricing in
3% 10.40 a 2% standard deviation
the market is pricing
4% 13.85
in a M.M100518656.
2% daily move of return per day
5% 17.32
6% 20.78 i.e. 68% of returns will be
7% 24.25 +⁄− 2% around the E(R)
8% 27.71
𝐏𝟎 given
9% 31.18
daily 𝛔
10% 34.64

25
 Last Revised: 10/04/2023
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32.90

21.49

M.M100518656.

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