Compiling the weekly report
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As discussed in the article A Broader Approach, I utilise various inputs in the analytical process. These are combined to form an opinion on the outlook for various financial markets. And while I believe it is important for technical analysis to be viewed as more than "crystal ball gazing", I do not believe it is the "holy grail". It is a roadmap … not necessarily a prediction of future prices.
Over the years, when explaining how I pull the various aspects of technical analysis together, I have often defined a very simple approach that I believe combines the basic elements of technical analysis. In a nutshell, it can be broken down into four modules. Of course there are other things to monitor, as I will discuss later, but if we are just looking at the price action of a single stock or equity market, there are several questions that can be addressed. What is price doing? How is it doing it? What does it feel like? Where are we?
What is price doing?
Is it trending or ranging? Are there any identifiable chart patterns evident? Is it approaching significant levels of support or resistance? These are some of the first things I look at when reviewing a price chart, and I believe they will be immediately apparent as I look at the price action. In most cases if it isn't obvious, it isn't that significant.
How is it doing it?
This relates to such things as momentum indicators and volume patterns.
For instance, if price is moving higher but momentum is beginning to abate, and volume characteristics are deteriorating, then I would question the ability of the stock to move significantly higher.
There is still a large element of subjectivity in indicator analysis, and it is imperative to know the type of market you are analysing (trending or ranging). Broadly speaking, oscillators can be useless and misleading in trending markets, just as moving averages are of limited value in ranging markets.
Momentum indicators form a significant part of any analysis, and I have covered some of the ways I use these on the following pages.
What does it feel like?
This takes into account investor sentiment.
Most people would be familiar with the "cycle of market emotions" that traces the mood of the market from capitulation and despair, through to relief and hope, and then on to excitement and euphoria. This captures the full cycle and relates to the large swings in the markets - bull market peaks in 2000 and 2007, and bear market lows in 2002/03 and 2009 are great examples of this.
On a smaller scale, those indicators that monitor investor psychology are extremely helpful at different junctures in the cycle. The put/call ratio, the ARMS index, the VIX (Chicago Board Options Exchange Volatility Index), the amount of cash held by fund managers - all these are helpful in assessing the underlying psychology.
It is interesting to observe that certain chart patterns are characteristic of differing phases in the investment cycle. For example, "triangle" formations represent indecision on behalf of investors as they swing between periods of hope and caution, whereas "flag" patterns are typical of a strong market where sentiment is quite euphoric.
Where are we?
This takes into account cycles and seasonal factors.
The basic premise of cycle theory and indeed seasonality is that there are forces that cause market fluctuations to form approximate time patterns. They are not always exact and sometimes skip a beat, but they are a useful guideline in determining where we are in the cycle.