Portfolio Management II
Reading 56. Technical Analysis
Learning Outcome Statements
b. describe the construction of different types of technical analysis charts and interpret them;
CFA Curriculum, 2020, Volume 1
Why should I choose AnalystNotes?
Simply put: AnalystNotes offers the best value and the best product available to help you pass your exams.
Subject 2. Charts
A line chart is a simple graphic display of price trends over time. It can give a broad overview of investor sentiment.
A bar chart has four prices per data point entry: the high price, the low price, and the opening and closing prices.
It can give an analyst a sense of the nature of that day's trading (price movement during the day).
A candlestick chart is similar to a bar chart as it provides the same four bits of data in each entry. The hollow or filled portion of the candlestick is called the "body." The long thin lines above and below the body represent the high/low range and are called "shadows" (also referred to as "wicks" and "tails").
- If the stock closes higher than its opening price, a hollow candlestick is drawn, with the bottom of the body representing the opening price and the top of the body representing the closing price.
- If the stock closes lower than its opening price, a filled candlestick is drawn, with the top of the body representing the opening price and the bottom of the body representing the closing price.
A big difference between a bar chart and a candlestick chart is the relationship between opening and closing prices. The price movements are much more visible in a candlestick chart.
Point and Figure Chart
Both axis of P&F charts' are dependent on price, rather than one being based on price and the other on date. The key unit in a P&F chart is the point, or unit of price.
The Xs represent upward price trends and the Os represent downward price trends. Each box on the chart represents the price scale, which adjusts depending on the price of the stock; the higher the stock's price, the more each box represents. On most charts where the price is between $20 and $100, a box represents $1, or 1 point for the stock.
The other critical point of a P&F chart is the reversal criteria. This is usually set at three but it can also be set according to the technician's discretion. The reversal criteria set how much the price has to move away from the high or low in the price trend to create a new trend or, in other words, how much the price has to move in order for a column of Xs to become a column of Os (or vice versa). When the price trend has moved from one trend to another, it shifts to the right, signaling a trend change.
The "noise," or insignificant price movements, is removed from the chart.
Scale - A linear scale is appropriate if the data range is narrow. A logarithmic scale can be useful when the data covers a large range of values; the logarithm reduces this to a more manageable range.
Volume - The higher the volume, the more active the security. To determine the movement of the volume (up or down), chartists look at the volume bars that can usually be found at the bottom of any chart. Volume is extremely important because it is used to confirm trends and chart patterns.
Time Intervals - Technicians use different time intervals for different purposes.
Relative strength analysis or ratio analysis, is used to compare the price of one financial instrument (e.g., a stock) to a market average (e.g., a stock index). It is another useful visual method for comparing various assets' performances, and is especially useful when an analyst is trying to narrow down a list of assets.