IFTA_CFTe_Syllabus

Certified Financial Technician (CFTe) I & II Syllabus & Reading Material (For exams taken from 1 October, 2014 onward)

Last updated: 22.08.14 11:22 AM Page 1 of 124

Certified Financial Technician (CFTe)

Syllabus for CFTe Level I & Level II

Document Change History

Revision Date Summary of Changes 22 August 2014 Page 17. Corrected the chapter numbers (3-5) on reading material for V. Jeremy Du Plessis:

The Definitive Guide to Point and Figure 25 June 2014 Page 87. Added Appendix D: Point and Figure Techniques (IFTA Required CFTe I Reading

Material)

29 May 2014 Page 17. Updated #3: Required additional IFTA reading material (see Appendices) Page 18. Added to XI. Charles D. Kirkpatrick, Julie R. Dahlquist: Technical Analysis: The Complete Resource for Financial Markets Technicians: Chapter 9. Temporal Patterns and Cycles and Chapter 19. Cycles.

20 May 2014 Page 10. Updated Outline of Topics Item 21.

Page 17. Added VI. Yukitoshi Higashino, MFTA: Primer on ICHIMOKU (Appendix E) (IFTA Required CFTe II Reading Material)

Page 17./ Page 18. Moved XII. David Linton: Cloud Charts: Trading Success with the Ichimoku Technique [Hardcover] from IFTA Required CFTe II Readiing Material (Page 17) to IFTA Recommended (Additional) CFTe II Reading Material (Page 18)

Page 95. Added Appendix E: VI. Yukitoshi Higashino, MFTA: Primer on ICHIMOKU ) (IFTA Required CFTe II Reading Material)

11 March 2014 Page 46: Added: Appendix B: Breadth Analysis (IFTA Required CFTe I Reading Material) Page 20. Added: Appendix A: The Elliott Wave Principle (EWP) (IFTA Required CFTe I Reading Material)



Outline of Topics

1 HISTORY OF TECHNICAL ANALYSIS.............................................................................................................3

2 PHILOSOPHY OF TECHNICAL ANALYSIS AND MARKETS ...........................................................................3

3 CHART CONSTRUCTION ...............................................................................................................................3

4 DOW THEORY................................................................................................................................................3

5 CONCEPTS OF TREND ...................................................................................................................................4

6 CLASSICAL BAR CHART PATTERNS..............................................................................................................4

7 SHORT TERM PRICE PATTERNS ...................................................................................................................5

8 POINT AND FIGURES CHARTING..................................................................................................................5

9 CANDLE STICK CHARTING ............................................................................................................................6

10 ICHIMOKU CHARTS.......................................................................................................................................6

11 OTHER CHARTING METHODS ......................................................................................................................6

12 MARKET PROFILE..........................................................................................................................................6

13 ELLIOTT WAVE THEORY ...............................................................................................................................7

14 BASIC ELEMENTS OF GANN THEORY ..........................................................................................................7

15 BASIC QUANTITATIVE TECHNIQUES............................................................................................................7

16 MOVING AVERAGES......................................................................................................................................8

17 OSCILLATORS AND CONTRARY OPINION ...................................................................................................8

18 RELATIVE STRENGTH....................................................................................................................................8

19 TIME CYCLES .................................................................................................................................................9

20 VOLUME AND STOCK MARKET INDICATORS..............................................................................................9

21 OTHER TECHNICAL IDEAS .......................................................................................................................... 10

22 TECHNICAL SYSTEMS ................................................................................................................................. 10

23 ACADEMIC FINDINGS ON TA...................................................................................................................... 10

24 SENTIMENT AND CONTRARY OPINION..................................................................................................... 10

25 BEHAVIORAL FINANCE & INVESTMENT PSYCHOLOGY............................................................................. 11

26 ETHICS .......................................................................................................................................................... 11



Outline of Topics (continued)

1 History of Technical Analysis Early days: Dow, Schabaker, Wykoff

Major Publications

2 Philosophy of Technical Analysis and Markets Technical versus Fundamental Forecasting

Technical Approach to Trading and Investing

What is a trend and how are they identified?

Supply and Demand

Assumptions of Technical Analysis

Random Walk Theory, Fat Tails, Proportion of Scale

Market Efficiency, Prediction of the Future

Criticism of Technical Analysis

Financial Markets and the Business Cycles

3 Chart Construction Types of Charts: Line, Bar, Candle, Point and Figures

Construction of Charts

Arithmetic or Logarithmic Scale

Volume, Open Interest

Time Frame

4 Dow Theory Basic Ideas

Closing Prices and Lines

Primary Trend, Secondary Trend, Minor Trend

Concept of Confirmation

Importance of Volume

The Dow Theorys Defects




5 Concepts of Trend Definition of Trend

Directions of Trend

Support and Resistance

Trendlines and Channels

Major Trendlines

Fan Principles

Strength of a trend

Percentage Retracements

Consolidations and Corrections

Breakouts

Speed Lines

Unconventional Trendlines

Internal Trendlines

Regression

How does psychology impact trends

6 Classical Bar Chart Patterns Basics

Psychology and Patterns

Reversal and Continuation Patterns

Patterns and Volume

Patterns and Price Objectives / measured moves

Head and Shoulder Patterns (normal and reversed)

Double Tops and Bottoms

Triple Tops and Bottoms

Rounding tops and bottoms

Saucers and Spikes

Triangles (symmetrical, ascending, descending)

Diamond Tops




Broadening Formation

Flags and Pennants

Wedge Formation

Rectangle Formation

Gaps

7 Short Term Price Patterns Basics and Pattern construction

Gaps

Spike (wide range bar, low range bar)

Dead cat bounce

Island reversal

Reversal Days Run Days

Thrust Days

Two-bar or three-bar patterns

8 Point and Figures Charting Basics

Chart Construction: Time and Volume Omitted

Box Count

Box Size and Reversal Filter

Price Patterns: Breakouts, Double Tops, Triple Tops

Support and Resistance

Trendlines

Measuring Techniques and Price Objectives

Point and Figures and Relative Strength

Point and Figures and other Technical Indicators




9 Candle Stick Charting Basics

Chart Construction

Bullish Reversal Patterns (i.e. Hammer, Engulfing Patterns, Harami ...)

Bearish Reversal Patterns (i.e. Hanging Man, Engulfing Pattern, Dark Cloud pattern ...)

Bullish Continuation Patters (i.e. separating Lines, upside Tasuki gap, ...)

Bearish Continuation Patterns (i.e. separating line, three line strike ...)

Candle Patterns and Filters

10 Ichimoku Charts Basics

Chart and Cloud Construction

Turning Line

Standard Line

Span 1

Span 2

Lagging Line

Interpretation of clouds

11 Other Charting Methods (Kagai Charts, Renko Charts and Three Line Break Charts are included in the CFTe Level II reading material section. The rest of the reading material in this section will be added later.)

Equivolume

Swing charts

Kagi Charts

Renko Charts

Three Line Break Charts

Heikin Ashi Charts

Drummond Geometry

12 Market Profile Basics, Construction and graphics

Market Profile organizing Principles




Range Development and Profile Patterns: Normal day, Trend day, neutral day, non trend day, double distribution day

TPO

Point of Control

Value Area

13 Elliott Wave Theory Basics and History

Principles of Wave Counting

Corrective Waves

Rule of Alternation

Channelling

Wave 4

Fibonacci Numbers, Ratios and Retracements

Fibonacci Time Targets

14 Basic Elements of Gann Theory (reading material to be added later) Basics and History

Gann Fan Lines

Fibonacci numbers and Gann lines

Gann Two-Day Swing Method

15 Basic Quantitative Techniques (reading material to be added later) Mean, Variance, Skewness

Frequency and Probability

Basic Time Series Concepts

Random Walk Theory

Yield Math Concepts

Time Value of Money / Present Value Concept

Compounding




Performance Measurement

Test procedures

16 Moving Averages Different Types of Moving Averages (Simple, Weighted, Exponential, Geometric, Triangular ...)

Moving Average Envelopes

Moving Average crossovers

Bollinger Bands

Bollinger Bands and Bandwidth

Moving Averages and Cycles

Estimating the Length of a Moving Average

Adaptive Moving Average

17 Oscillators and Contrary Opinion Principles of Oscillation

Oscillator usage and Trend

Measuring Momentum

Rate of Change

Double Moving Averages

Commodity Channel Index

Relative Strength Index

Stochastics

Williams %R

Directional Movement Indicator

Parabolics

Moving Average Convergence/Divergence (indicator and histogram)

18 Relative Strength Basics

Ratios, Spreads, Rankings,

Relative Strength Levy




Comparative Relative Strength

Relative Performance

How to Interpret Relative Strength Charts

19 Time Cycles Basics

Cycle Concept

Amplitude, Length, Phase, Harmonicity, Synchronicity

Detrending

Dominant Cycles

Cycles and Trends

Left and Right Translation

How to Estimate Cycles

Seasonalities

Stock Market Cycles

Fourier Analysis

Maximum Entrophy Spectral Analysis

20 Volume and Stock Market Indicators Measuring Volume and Open Interest

Volume and Chart Patterns

Volume Signals

On Balance Volume

Volume Accumulator

Measuring Market Breadth

Comparing Market Averages

Advance-Decline Line and Divergence

Different Time frames

McClellan Oscillator

New Highs Versus New Lows

Upside versus Downside Volume




Arms Index

TRIN and TICK

Equivolume Charting

21 Other technical Ideas (*reading material to be added later) CoT Data Filtering*

Trend indicators

Volatility Indicators

Range / Momentum Indicators

Cyclical Indicators

Hurst Exponent*

DeMark Indicators = fixed Pattern systems

22 Technical Systems Construction

Typical elements

Proper testing

Evaluation

Optimisation

Typical systems

23 Academic findings on TA Testing procedures

Testing objectives

Efficient Market Hypotheses

24 Sentiment and Contrary Opinion Principle of contrarian Opinion

Crowd Behaviour and the Concept of Contrary Opinion

Investor Sentiment readings

Investor Intelligence Numbers




Commitments of Trades Report

Net Traders Positions

Open Interest in Options

Put/Call Ratios

Polls

Insiders

Investors Psychology Individual and Group

25 Behavioural Finance & Investment psychology (reading material to be added later) Prospect Theory

Typical Behavioural Effects

Single Investors Behaviour

26 Ethic (reading material to be added later)



CFTe Level I Reading Material

CORE READING MATERIAL:

I. Edwards, Robert D. and Magee, John, Technical Analysis of Stock Trends, 9th (or current) Edition (2001-2008), John Magee Inc., Chicago Illinois 2001, ISBN 1-57444-292-9

Chapters: 1. The Technical Approach to Trading and Investing 2. Charts 3. The Dow Theory 4. The Dow Theory in Practice 5. The Dow Theorys Defects 6. Important Reversal Patterns 7. Important Reversal Patterns Continued 8. Important Reversal Patterns The Triangles 9. Important Reversal Patterns Continued 10. Other Reversal Phenomena 11. Consolidation Formations 12. Gaps 13. Support and Resistance 14. Trendlines and Channels 15. Major Trendlines 16. Technical Analysis of Commodity Charts 17. A Summary of Some Concluding Comments 17.2 Advancements in Investment Technology 18. The Tactical Problem 18.1 Strategies and Tactics for the Long-Term Investor 20. The Kind of Stocks we Want: The Speculators View Point 20.1 The Kind of Stocks we Want: The Long-Term Investors View Point 23. Choosing and Managing High-Risk Stocks: Tulip Stocks, Internet Sector and Speculative Frenzies 24. The Probable Moves of Your Stocks 25. Two Touchy Questions 27. Stop Orders 28. What is a Bottom - What is a Top? 29. Trendlines in Action 30. Use of Support and Resistance



CFTe Level I (Continued) Reading Material

33. Tactical Review of Chart Action 34. A Quick Summation of Tactical Methods 36. Automated Trendlines: The Moving Average 38. Balanced and Diversified 39. Trial and Error 40. How Much Capital to Use in Trading 41. Application of Capital in Practice 42. Portfolio Risk Management 43. Stick to Your Guns

II. Murphy, John J.: Technical Analysis of the Financial Markets, New York Institute of Finance, New York, NY, 1999, ISBN 0-7352-0066-1 Chapters: 1. Philosophy of Technical Analysis 2. Dow Theory 3. Chart Construction 4. Basic Concepts of Trend 7. Volume and Open Interest 14. Time Cycles

III. Pring, Martin J.: Technical Analysis Explained, 4th (or current) Edition, McGraw Hill Book Company, New York, NY, 2001, ISBN 0-07-138193-7

Chapters: 2. Financial Markets and the Business Cycle 4. Typical Parameters for Intermediate Trends 12. Individual Momentum Indicators II 16. The Concept of Relative Strength 18. Price: The Major Averages 20. Time: Longer-Term Cycles 22. General Principles 26. Sentiment Indicators



CFTe Level I (Continued)

Reading Material IV. Le Beau Charles, Lucas David: Technical Traders Guide to Computer Analysis of the Futures Market Chapters: 1. System Building 2. Technical Studies 4. Day Trading V. Nison Steve: Candlestick Charting Techniques, Second Edition Chapters: 1. Introduction 2. A historical background 3. Constructing the candlestick lines 4. Reversal patterns 5. Stars 6. More Reversal Patterns 7. Continuation Patterns 8. The Magic Doji 9. Putting it all Together VI. Du Plessis Jeremy: The Definitive Guide to Point and Figure Chapters: 1. Introduction to Point and Figure Charts 2. Characteristics and Construction 3. Understanding Point and Figure Charts 4. Projecting Price Targets 5. Analysing Point and Figure Charts



CFTe Level I (Continued) Reading Material

Required additional IFTA reading material (see Appendices): 1. Elliott Wave Theory (Appendix A) 2. Breadth Indicators (Appendix B) 3. Time Cycles Analysis (Appendix C: additional reading material to be added. Note: The questions on the

exam for this topic will be pulled from Murphy, John J. recommended reading listed above. ) 4. Point and Figure Techniques (Appendix D) RECOMMEDED (ADDITIONAL) READING: VII: Elder, Alexander Dr.: Trading for a Living, Psychology, Trading Tactics, Money Management Chapters: 1. Individual Psychology 2. Mass Psychology 3. Classical Chart Analysis 4. Computerized Technical Analysis 5. The Neglected Essentials 6. Stock Market Indicators 7. Psychological Indicators 10. Risk Management



CFTe Level II Reading Material

Core Readings I. Edwards, Robert and Magee, John, Technical Analysis of Stock Trends, 9th Edition

II. Martin J. Pring: Technical Analysis Explained Chapters:

1. The Market Cycle model 2. Financial Markets and the Business Cycle 16. The concept of Relative Strength 18. Price: The Major Averages 19 Price: Group Rotation 20. Time: Longer-Term Cycles III. Le Beau Charles, Lucas David: Technical Traders Guide to Computer Analysis of the Futures Market Chapters: 1. System Building 2. Technical Studies 4. Day Trading IV. Steve Nison: Beyond Candlesticks: New Japanese Charting Techniques Revealed (Wiley Finance, Nov 10, 1994)

Chapters: 2. The Basics 3. Patterns 4. Candles and the Overall Technical Picture 5. How the Japanese use Moving Averages 6. Three-Line Break Charts 7. Renko Charts 8. Kagi Charts



CFTe Level II (Continued)

Reading Material V. Jeremy Du Plessis: The Definitive Guide to Point and Figure Chapters: 1. Introduction to Point and Figure Charts 2. Characteristics and Construction 3. Understanding Point and Figure Charts 4. Projecting Price Targets 5. Analysing Point and Figure Charts VI. Yukitoshi Higashino, MFTA: Primer on ICHIMOKU (Appendix E) VII. J. Peter Steidlmayer and Steven B. Hawkins: SteidlMayer On Markets. Trading with Market Profile. Second Editon Chapters: 6. Understanding Market Profile 7. Liquidity Data Bank, On Floor information, and Volume @ Time 8. The Steidlmayer Theory of Markets 9. The Steidlmayer Distribution 10. The You 11. Anatomy of a trade 12. Profile of a Successful Trader 13. Trading, Technology, and the Future VIII. Howard B. Bandy: Quantitative Trading Systems, Practical Methods for Design, Testing, and Validation IX. Brian Millard: Future Trends from Past Cycles Chapters: 3. How Prices Move (I) 4. How Prices Move (II) 6. Cycles and the Market 8. Properties of Moving Averages 9. Averages as Proxies for Trends 10. Trend Turning Points (I) 11. Trend Turning Points (II)




Reading Material 12. Trend Turning Points (III) 13. Cycles and Sum of Cycles 14. Bringing it all Together

X. A.J. Frost, Robert R. Prechter: Elliott Wave Principle: Key To Market Behavior Chapters: 1. The Broad Concept 2. Guidelines of the Wave Formation 3. Historical and Mathematical Background of the Wave Principle 4. Ratio Analysis and Fibonacci Time Sequence. XI. Charles D. Kirkpatrick, Julie R. Dahlquist: Technical Analysis: The Complete Resource for Financial Markets Technicians Chapters: 3. History of Technical Analysis 4. The Technical Analysis Controversy 5. An overview of Markets 7. Sentiment 8. Measuring Market Strength 9. Temporal Patterns and Cycles 10. Flow of Funds 13. Breakouts, Stops, and Retracements 18. Confirmation 19. Cycles 21. Selection of Markets and Issues: Trading and Investing 22. System Testing and Management




Reading Material RECOMMEDED (ADDITIONAL) READING: XII. David Linton: Cloud Charts: Trading Success with the Ichimoku Technique [Hardcover]

Chapters: 8 . Cloud Chart Construction 9. Interpreting Cloud Charts 10. Multiple Time Frame Analysis 11. Japanese Patterns Techniques 12. Clouds Charts with other techniques 13. Ichimoku indicator techniques 14. Back-testing and Cloud Trading Strategies 15. Cloud Market Breadth analysis 16. Conclusion Notice to CFTe II Candidates: IFTA will supply additional reading material for the CFTe II on: Quantitative Analysis, and Behavioral Finance. This material, along with reading material highlighted above (if applicable), will be posted in the Appendices by 30 June 2014.



Appendix A

The Elliott Wave Principle (EWP)

(IFTA Required CFTe I Reading Material)

Mohamed ElSaiid, CFTe, MFTA Egyptian Society of Technical Analysts (ESTA)

Introduction

In this chapter, the Elliott Wave Principle is introduced to the candidate. The general form and essential concepts of the Elliott Wave structureand role, as well as the psychology and characteristics underlying the theory. Additionally, the chapter explains the relationship of the Elliott Wave Principle with the Dow Theory and classical approach in technical analysis. The chapter is partially designed in study guide format, offering various visual organizers, in an effort to help the reader connect the related concepts offered in the material and ultimately increasing comprehension of the basic principles of the EWP.

Part One: The Elliott Wave Principle; historical background and basic tenants

The Elliott Wave Principle (EWP) or Elliott Wave Theory (EWT) is a technical analysis approach developed by Ralph Nelson Elliott (R.N. Elliott) in the early 1900s that was primarily intended to describe or explain the action of the market index, namely; the Dow Jones Index (DJI). Prior to his works and findings on the EWP, R. N. Elliott was an accountant working for railways and a restaurant. During the early 1930sand while recuperating from a severe illness, he became interested in the Dow Theory. The various development of market phases as viewed via Dow Theory piqued his interest. Specifically, he became interested in categorizing the time-frames of the observed market trends. Through his meticulous research, R. N. Elliott measured the movements in the DJI and identified specific relationships between these movements later termed as waves. The relations between these waves varied from a size and time-related one, to a structure and role-related one. With respect to wave-role, R. N. Elliott contended that there were two types of waves; waves that move in the main trend direction, and waves that move against the main trend direction. R. N. Elliott organized his observations and findings and developed the EWP. R.N. Elliott initially introduced the EWP through a publication titled The Wave Principle in 1938. This was followed by a more detailed book; Natures Laws: The Secret of the Universe in 1946, just before his death in 1948. Over the years since his death, several followers and pioneering practitioners of the EWP continued to promote the wave principle by offering publications and newsletters to the investors and the financial community. Of those followers were, Charles Collins, publisher of the book "Wave Principle", Hamilton Bolton, who was accredited for introducing the EWP to a wide readership in the mid 1900s, and finally A.J. Frost and Robert R. Prechter who co-authored Elliott Wave Principle in 1978; a book which is regarded by many EW practitioners to be the best available description and validation of the EWP to date.



The general form and basic tenants of the Elliott Wave Principle

The Five Wave Pattern

Elliott Wave patterns take the form of five waves of a specific pattern. Three of these waves (labeled 1, 3 and 5), cause the development of the overall directional movement of prices. They are separated by two interruptions against the trend direction (labeled 2 and 4) which, in turn, cause the fluctuation that is naturally observed in the price action. In other words, waves 1, 3 and 5 describe the main direction of the move, while waves two and four are seen as pauses. Each of these five waves play a critical role in the construction of the waves and the overall description of the movement.

Figure 1: the basic five wave EW Pattern sequence



The Complete EW Cycle

The EWP contends that the progression of the five-wave pattern completes a single wave of a larger degree which ultimately builds the directional move. Following this progression, a three wave pattern develops to partially counteract this directional move. These three waves act as an interruption to the progression and complete the formation of a single EW cycle, consisting of eight waves.

This idealized complete EW cycle, consists of two fundamentally distinct structures or modes. These two modes are referred to as the motive mode and the corrective mode. In this idealized cycle, the (five-wave) motive modes are always denoted by the numbers (1, 2, 3, 4 and 5). Meanwhile, the (three-wave) corrective modes are always denoted by the letters (A, B, C). The concept of wave modes will be later discussed in details in part three.

Figure 2: the complete idealized eight wave EW cycle



Wave degrees

Initially, R.N. Elliott recognized nine different degrees of waves. They ranged from degrees as small as ripples on an hourly chart to the largest wave degree he could assume existed from the data that was available to him at the time. Since, as the theory implies, the degree progression in both directions is infinite, both A.J. Frost and Robert R. Prechter have suggested six additional wave degrees, of which three were of larger degree than the initial nine, while the remaining three were of lesser degree. Both Frost and Prechter have been accredited for standardizing the original labeling scheme, initially added by R.N. Elliott. In addition to that, they have suggested a general-but-more-detailed framework of the various wave degrees with respect to the range of span or duration of each degree. This addition, suggested that the most adequate or relevant time-frame chart for each wave degree would appear visibly. This is deemed as a very important aspect in EWP application, as it represents common grounds for EW practitioners when applying the EWT in practical life; imagine counting a wave degree without knowing what the minimum and maximum durations of this wave are, as well as what time-frame charts to use to chart this wave degree.

Table 1: The initial nine- degree waves of the EWP

Table 1 depicts the nomenclature of the initial nine EW degrees, with each wave degree following a unique labeling process. The maximum and minimum durations as well as the corresponding proposed time-frame chart for each wave degree are also offered as guidelines to aid in charting the waves.

The rationale behind the overriding (5-3) structure



It is consistently observed in all price actions that progression in either direction always takes the form of fluctuations (meaning that there are actions in the opposite direction as part of the entire move). EWP adds that since a one-wave occurrence does not allow fluctuation (action in the opposite direction), the minimum requirement for achieving fluctuation is three waves. Three waves in two opposite directions do not allow progress. Hence, to achieve a net progress or development in one direction over the other (i.e. the interrupting three waves), the main trend must contain at least a five-wave structure.

Part Two: Wave personality: characteristics and psychology of the E-Waves

Wave personality offers an in-depth focus on the aspect of crowd psychology and behavior of the market participants. The EWP attempts to offer a framework that enhances our understanding of the market action and behavior that was initially introduced and discussed in the classical approach of technical analysis.

The personality of each wave in the Elliott Wave sequence plays an integral part in the reflection of the mass psychology it embodies. As such, EW Analysts assume that each wave has its own mark or "signature" which generally reflects the psychology of that phase under observation. Thus, understanding how and why the waves develop is key to the application of the EWP.

The characteristics which will be described are in reference to the idealized form of the EW cycle previously presented in figure 2.

Characteristics of Wave(s) 1:

Commonly, during the bottom (start) of waves 1, the accompanied news is generally bad, the period often exhibits the occurrences of recession (during intermediate wave degrees), or even depression and war (during large wave degrees).

At this point and given that the input information on the current economic situation does not look good, fundamental analysts continue to lower their earnings estimates.

Quite commonly, waves 1 are formed as a part of the bottoming phase or more generally, during periods of disbelief and thus, tend to demonstrate deeper corrective movement in wave 2.

Wave 1, the rebound from a preceding bear trend, is constructive and offers a more structured rebound from undervalued price levels. This move often displays a subtle increase in volume and is relatively supported by market breadth.

The short interest level peaks as the majority of market participants believe that the overall trend is to the downside. Investors view the rally as a last chance to sell and get out.

When waves 1 rise from either large bases formed by the previous correction, or from extreme compression. They appear as dynamic and dramatic, and the result is that only moderate retraced is seen in wave 2.




Waves 2 act so as to interrupt the progress and the directional move of prices. They tend to heavily retrace (but not extend beyond) wave 1, especially, since they themselves occur mostly during the periods of disbelief, prior to the market-up phase.

More often than not, news and fundamentals tend to be worse during the end (bottom) of wave 2 when compared to the beginning (bottom) of wave 1.

Systematically, during wave 2, investors are convinced that the bear market is proceeding once more following the termination of wave 1, or what they had perceived to be another counter trend rally.

Waves 2 are often associated with downside non-confirmations. This usually takes the shape of a weakening downside momentum and breadth. Adding to this, waves 2 are often accompanied by low volume and volatility, indicating a drying up of selling pressure. It is not uncommon for waves 2 to take more time in formation compared to their preceding waves 1.


Waves 3 are strong and broad; the trend at this point is unmistakable. Waves 3 occur and are confirmed during the start of what the classic approach highlight as the mark-up phase.

Turnaround fundamentals stories begin to flow in the financial arena, causing an investor confidence re-build.

Waves 3 usually generate the greatest volume and price movement, as they most often extended beyond their normal limits, with respect to both time and distance.

During waves 3, successful classical pattern-breakouts are commonly observed; multi-continuation gaps, volume expansions, exceptional breadth (since almost all share prices and market sectors participate), as well as major Dow Theory trend confirmations and runaway price movement, which create large gains in the market, depending on the wave degree.

Corrections in waves 3 are usually weak and short-lived as those who bet on buying pull-backs suffer the likelihood of missing the move.


In principle, the occurrence of wave 4 implies that the best part of the growth phase which was evident in wave 3 has ended.



More often than not, waves 4 appear as a form of a sideways interruption. They develop as part of the building of a base for the final fifth wave move. In part, wave 4 is seen as the public participation phase as termed by the classical approach (Dow Theory).

Lagging stocks build their tops and begin declining during this wave, since only the strength of wave 3 is thought to have pulled them along for the upside participation. This initial deterioration in the market sets the stage for breadth divergences, non-confirmations and subtle signs of weakness during the fifth wave.


Specifically, in stocks, waves 5 are always less dynamic than waves 3 in terms of breadth. With the exception of fifth wave extensions (which will be discussed in part three), they usually display a weaker momentum as well.

As a general feature, volumes in waves 5 tend to be less when compared to wave 3 volumes.

During advancing waves 5, optimism runs extremely high as further public participation emerges, despite a narrowing of breadth. Nevertheless, market action does improve relative to prior corrective wave rallies.

Commonly, during the top (end) of wave 5, the accompanied news is positive, implying that prosperity and peace are guaranteed forever as arrogant complacency becomes evident in the financial community and financial news.

Characteristics of Wave(s) A:

During "A" waves of bear markets; the investment world is generally convinced that this reaction is just a pullback pursuant to the next leg of advance. The public surges to the buy side despite the first valid technically damaging cracks in trend patterns of individual stocks.

The "A" waves set the tone for the waves that follow. A five-wave A indicates a start of a directional or trending mode, while a three-wave A indicates that a flat or sideways mode will likely follow.

Characteristics of Wave(s) B:

"B" waves are phonies. They are sucker plays, bull traps, speculators' paradise, orgies of oddlotter mentality or expressions of dumb institutional complacency (or both).

They are often accompanied by an emotional advance of narrow list of stocks, which would be evident through non-confirming signs of TA-breadth and momentum indications.



B waves are often unconfirmed by all/broader market indices and are almost always expected to be completely retraced by the following wave C.

Characteristics of Wave(s) C:

"C" waves inherit most of the characteristics and properties of third waves in the sense that they are persistent and broad.

In the case of bearish "C" waves:

o They are usually devastating in their destruction. o There is virtually no place to hide except cash. o The false impression that the bull trend is back on track which was held throughout its

preceding waves A and B tend to fade away, as fear and occasionally multiple panic phases take over.

o Fundamentals ultimately collapse in response of the market action.

In the case of bullish "C" waves:

o They are constructive and often render sizable gains or returns in waves of larger degrees. o They usually give a fake indication that the bull trend is back to stay.



Part Three: Aspects and structure of the Elliott Wave Principle

Figure 3: Modal (structure) map of the EWP



The EWP is comprised of three key aspects, namely; pattern, ratio and time. Pattern: The aspect of pattern (or structure) is regarded as the most important one of the three aspects. This aspect describes and categorizes the various structures of the underlying waves, which ultimately add up to form a larger hierarchy of structure. Ratio: The aspect of ratio describes the relationship between the lengths of the waves of same and/or different degrees. Time: The aspect of time describes the relationship between the durations of the E-waves and E-cycles of same and/or different degrees. In this chapter, we will focus exclusively on the aspect of pattern (or structure).



Wave Function (role) According to the EWP, each wave has a role or function. This function is determined only by the relationship of that wave to the wave of one larger degree. As such, when a wave is termed as actionary, this means that this wave is responsible for the progression and development of the wave of one larger degree. Accordingly, this wave moves in the same direction and helps in building the wave of one larger degree. Conversely, when a wave is termed as reactionary, this means that this wave is responsible for the interruption and regression of the wave of one larger degree. Accordingly, this wave moves in the opposite direction and partially tears down the progress of the wave of one larger degree.

Figure 4: Wave function Wave Mode (structure)

In addition to the wave function, R.N. Elliott identified and differentiated between two fundamental types of waves with respect to their shape or structure, which he referred to as the mode. With respect to wave structure or mode, R.N. Elliott categorized the waves into motive waves and corrective waves. It is the fundamental distinction between those two that shapes the back bone of the EWP.

Motive waves

Definition: Motive waves are responsible for the progress and development of the overriding trend. They must always exist as a five-wave structure and adhere to the following rules:

1. Wave 2 does not extend beyond the start of wave 1. 2. Wave 4 does not extend beyond the start of wave 3. 3. Wave 3 always travels beyond wave 1. 4. Wave 3 is never the shortest of the motive waves 1, 3 and 5.



5. Waves 2 and 4 must be corrective in structure. These rules define the structure of the motive waves and ensure its purpose--that is the progress and development of the overriding trend. It is understood from the EWP that any structure failing to adhere to any one of the above rules is automatically identified (in mode) as a corrective structure, even if it takes the form of a five-wave structure. Types and characteristics of motive waves: There are two different types of motive waves, namely; Impulses (or Impulse waves) and Diagonals (or Diagonal waves). Impulses Impulses are types of motive waves that always exist as a five-wave structure. These five-wave structures must adhere to the primal rules of the motive waves. In addition to that, the following extra rules are exclusive to Impulses:

1. End of wave 4 does not overlap with end of wave 1. 2. Waves 1, 3 and 5 of an impulse wave must be motive in structure. 3. Extensions (to be discussed shortly) can never exist in all three waves; 1, 3 and 5 at once.

It is worth noting that waves 3 can only exist as Impulses. Structural or modal characteristics of impulses: Extension: Extensions are defined as--and are primarily the cause of an extra stretch or elongation of the impulse waves (with respect to time, length or both). Naturally, as a result of this stretch, subdivisions exist in abundance. Extensions are a very common modal characteristic of impulse waves and generally occur during one of the three actionary waves (1, 3, and 5) as they develop.



Figure 5: Types of extensions in impulse waves of bull and bear markets

Truncation: Truncation is another characteristic of impulses in which wave 5 fails to exceed the end of wave 3. In that sense, truncations only occur in impulse waves 5, and are generally perceived as a sign of weakness in the market. Truncations imply that although the market was able to develop into a 5-wave structure, this development was not associated with enough momentum to drive the market beyond the end of its preceding wave 3. Moreover, a truncation generally implies a sharp wave to follow in the opposite direction.



Figure 6: Bull and Bear market impulse truncations

Diagonals Diagonals are types of motive waves that always form as a five-wave structure. Diagonals must adhere to the primal (overriding) rules of the motive waves. However, these motive waves can never exist as middle motive waves i.e. motive wave 3. Moreover, unlike impulses, an overlap between waves 1 and 4 is accepted and is considered as a characteristic of such types of motive waves. Diagonals are identified as two rising (or falling) semi converging lines, or in less common cases diverging lines. Thus, it is important not to assume that this EW pattern will always resemble a classical wedge formation. Despite sharing almost similar psychology, their structures are not always identical. There are two types of diagonals, namely; Leading and Ending Diagonals. Leading Diagonals As the name implies, Leading Diagonals appear as motive waves that initiate the build and development of a new trend (a larger degree wave). They can appear only as wave 1 of a five-wave motive structure, or appear as wave A of an ABC Zigzag corrective development. Leading Diagonals are five-wave structures whereby waves 1, 3 and 5 are subdivided into five motive waves, while waves 2 and 4 are corrective in structure.



Figure 7: Converging and diverging Leading Diagonals

Ending Diagonals As the name implies, Ending Diagonals appear as motive waves that terminate the build and development of an existing trend (a larger degree wave). An Ending Diagonal can appear only as motive wave 5 or appear as wave C of an ABC corrective development. Being a member of the motive structures (or modes), the five waves of the Ending Diagonals strictly adhere to the primal (overriding) rules of the motive waves. However, the subdivisions of some of these five waves are somewhat different from the subdivisions of all other types of motive structures. Each wave of the five Ending Diagonal waves is subdivided into three waves (i.e. including waves 1, 3 and 5). In other words, all its subdivisions are corrective in structure. It is worth noting that waves 1, 3 and 5 in Ending Diagonals are corrective in structure and actionary in function (or role). Meanwhile, waves 2 and 4 are both corrective in structure and reactionary in function (or role).



Figure 8: Converging and diverging Ending Diagonals

Corrective waves

Definition:



Corrective waves appear in--and are exclusively responsible for all counter trend interruptions. In that sense, corrective structures primarily function as reactionary waves. However, they may also exist (in special cases) as actionary waves (for example: during waves 1, 3 and 5 of an ending diagonal). Corrective waves are primarily structured in the form of three waves or a more complex variation thereof. The fundamental difference between motive and corrective waves is that the latter will always break one or more of the cardinal rules of the motive wave. Thus, any five-wave structure that breaks any of the motive wave rules is corrective. The reason as to why they are called corrective is that being the sole driver for all counter trend interruptions corrective waves accomplish only a partial retracement, or "correction," of the progress achieved by any preceding motive wave. As for why corrective waves tend to cause only partial retracement, is that movements against trends of one larger degree appear as a struggle. This is primarily caused due to the overriding force of the larger degree trend which prevents counter trend movements to fully develop as motive structures. A byproduct of this situation is that corrective structures tend to be less identifiable and more varied than their motive counterparts. Types and characteristics of corrective waves: Corrective structures appear in two types, sharp and sideways. Sharp corrective structures are manifested through Zigzags, while, sideways structures are represented through Flats and Triangles. Sharp corrective structures: Zigzags Zigzags represent the most common form of the EW corrective pattern. They exist as a three-wave structure. The three waves are denoted by the letters A, B and C respectively. Wave B will never terminate beyond the start of wave A and wave C will travel beyond the end of wave A. In zigzags, the function of wave A is actionary because it helps build the wave of one larger degree (either wave 2 or 4). Meanwhile its structure is motive (can either an impulse or a leading diagonal), thus it is subdivided into five waves and adheres to the motive wave rules. Wave, B on the other hand acts as a reactionary wave, since it interrupts the progress of the wave of one larger degree (either wave 2 or 4), while its structure is corrective. Finally, wave C is actionary because it helps build the wave of one larger degree (either wave 2 or 4). Meanwhile its structure is motive (can either an impulse or an ending diagonal), thus it is subdivided into five waves and adheres to the motive wave rules. As such, Zigzags are commonly known by EW practitioners as 5-3-5s.



Figure 9: Bull and bear market Zigzags

Sideways corrective structures: In general, sideways corrective structures generally occur due to a stronger trend of one larger degree as well as a lack of countertrend pressure, relative to Zigzags. There are two types of sideways corrective structures, namely; Flats and Triangles. Flats Flats represent another form of the EW corrective pattern, where as the name implies they represent a sideways transition to the overriding direction (unlike Zigzags). Similar to Zigzags, they also exist as a three-wave structure, where each wave is labeled by the letters A, B and C respectively. However, Flats offers a variation from Zigzags in that wave A does not hold enough momentum to develop as a five wave structure as does wave A of a Zigzag. Instead, wave A of a flat structure develops into three waves. As a result, wave B of a Flat structure does not suffer the same pressure which causes it to partially retrace wave A as does wave B of a Zigzag. Its worth noting that wave A of a Flat structure is both actionary and corrective, wave B is both reactionary and corrective, and wave C is actionary and motive. As such, Flats are commonly known as 3-3-5s.



Types and characteristics of Flats: Regular Flats In regular Flats, wave B terminates at or near the start of its preceding wave A, while, wave C terminates at, near or faintly beyond wave B. Expanded Flats Expanded Flats are regarded as the most commonly recurring type of Flat formation. In this type, wave B terminates beyond the start of its preceding wave A, while, wave C terminates beyond the start of wave B (i.e. the end of wave A). Running Flats Running Flats are rare when compared to the former two Flat types already discussed. In this running Flat, wave B terminates beyond the start of its preceding wave A (similar to expanded flats). However, wave C fails to match the length of wave B. It is implied by this formation that the momentum of overriding trend is significantly strong to the extent that it forces the corrective pattern to tilt in its direction.



Figure 10: Bull and bear market Flat types



Triangles EW Triangles are yet another type of sideways corrective structures. They are similar to EW Flat corrections, in the sense that they reflect a form of temporary balance of forces (buyers and sellers). This is also synonymous to the interpretations of the classical approach of sideway corrections. However, unlike the Triangles in the classical approach, EW Triangles always act as continuation patterns (or wave degrees) to the larger degree trend or wave.

EW Triangles consist of 5 overlapping waves, in which each wave subdivides into three waves (five threes). Since they are corrective, they are labeled in letters as follows: (A, B, C, D, and E) respectively.

EW Triangles can be categorized into; Contracting and Expanding Triangles. There are three types of Contracting Triangles; Symmetrical, Ascending and Descending, while there is only one type of Expanding Triangles. Expanding Triangles are also referred to as Reverse Symmetrical Triangles. In general, they are corrective patterns that tend to precede the final move in the direction of the major trend.

Contracting Triangles

In Contracting Triangles:

1. Wave C never moves beyond the end of wave A. 2. Wave D never moves beyond the end of wave B. 3. Wave E never moves beyond the end of wave C.

Expanding Triangles

In Expanding Triangles:

1. Wave C always move beyond the end of wave A. 2. Wave D always move beyond the end of wave B. 3. Wave E always move beyond the end of wave C.



Figure 11: Bull and bear market EW Triangle types



Running Triangles:

Running Triangles are a very common case in contracting EW Triangles in which wave B exceeds the start of wave A.

Figure 11: Bull and bear market EW Running Triangle types



One final point with regards to the subject of wave function and wave mode: It is implied from the EWP that motive structures are always actionary. Whereas, corrective structures are mostly reactionary, but can also be actionary in role or function.

Part Four: Comparing the EWP to the Dow principle and the classical approach (relationships and similarities)

According to the Dow Theorys tenants, there are three main trend-frames; the major (primary), the intermediate and the minor trends. The Dow Theory focuses more specifically on the primary trends. The theory states that waves or trends have three phases. They are termed as the accumulation phase, the public participation phase and the distribution phase. The EWP elaborated and expanded on this concept by initially introducing nine various trend (wave) degrees, each with a specified range of durations as previously presented in part I.

Followers of the Dow Theory whom were later accredited for developing the classical approach managed to affirm, complement and expand Dows three phases of the market trend. Some suggested that an idealized form of a complete bull/bear succession will likely involve six phases. Three of which constitute the bull tranche of the succession, and are recognized as the accumulation the mark-up and the public participation phases respectively. In addition, three phases would make up the bear tranche of the succession and are termed as the distribution, the panic and the discouraged selling phases respectively. Advocates of the classic approach added that the discouraged selling and accumulation phases (which constitute market bottoms) occur during a period of disbelief in which the irrational crowd psychology is caught on the wrong side of the market. Meanwhile, the mark-up and fear driven-major panic phases occur during a period of belief in which the irrational crowd psychology is caught on the right side of the market. And finally, the public participation and distribution phases (which constitute market tops) occur during a period of euphoria and extreme optimism in which the irrational crowd psychology is again caught on the wrong side of the market.

When trying to relate the concepts offered through the Dow and classic approach to the EWP, we find that the classic approachs three bull market phases and three bear market phases seems quite compatible to the EWPs idea of a five wave bull market advance followed by a three wave bear market decline.

Finally, both the Dow Theory and the EWP made reference to volume, breadth and indices confirmations through their tenants and guidelines respectively. The Dow Theory tenants explained that volume and breadth act as a confirmation to the sustainability of the overriding trend. While the EWP further emphasized on this matter and explained the importance of volume, breadth and indices confirmations during advancing motive waves. While, characterizing corrective and ending waves to be more likely associated with divergences and non-confirmations from volume, breadth and other market indices.

As such there is little doubt that the EWP was largely influenced by Dow Theory and can be regarded as some form of extension to the Dow Theory, in which the EWP validates much of Dow Theory and may be regarded as an extension thereof.



Figure 12: Relationships and Similarities Between the EWP Dow/Classic Approach

Figure 12 depicts a complete EW cycle superimposed over the idealized six phases of complete bull/bear succession of the Dow/classic approach. As observed, the wave sequence 1 through 5 share similar characteristics, psychology and seem to fit quite well within the accumulation, mark-up and public participation phases, as does wave sequence A through C when compared to the following three phases.



Part Five: Summary and Conclusion

Unlike the Point and Figure approach in technical analysis which functions under the assumption that the market action contains unnecessary noise, the EWP indirectly implies that market action does not contain noise. The EWP contends that market action even at the smallest of time frames adheres to a predefined structured framework of patterns that is of fractal nature. These patters collectively collaborate to ultimately build a larger degree structure/trend and so on.

Moreover, through the interpretations of the social mood, crowd psychology and characteristics of each wave, EWP offers an extended and more detailed explanation of the Dow Theory with regards to understanding the market behavior and action.

On the other hand, the EWT has been criticized for its complexity and the many variations to the general (idealized) form of the theory. The issue that at times causes the theory to offer multiple scenarios at various junctures as the wave progresses in practical life, and thus, sometimes fails to support implementing an investment-decision process based on its findings.

In his book, Evidence-Based Technical Analysis, David Aronson wrote:

The Elliott Wave Principle, as popularly practiced, is not a legitimate theory, but a story, and a compelling one that is eloquently told by Robert Prechter. The account is especially persuasive because EWP has the seemingly remarkable ability to fit any segment of market history down to its most minute fluctuations. I contend this is made possible by the method's loosely defined rules and the ability to postulate a large number of nested waves of varying magnitude. This gives the Elliott analyst the same freedom and flexibility that allowed pre-Copernican astronomers to explain all observed planet movements even though their underlying theory of an Earth-centered universe was wrong.

Nevertheless, proper implementation of the EW analysis in conjunction with other tools and approaches of TA generally offers a better understanding of market action. While other tools and approaches of TA can aid the EWP in narrowing down the expected scenarios, thus reducing the limitations of the EWP.

Quoting John J. Murphy:

The key is to view EWT as a partial answer to the puzzle of market forecasting.

Reference material

In its entirety, the material expressed in this chapter is a simplified reproduction and tribute to the exclusive pioneering works of the Frost and Prechter on the EWP and the combined thoughts of Murphy and other authors on the subject.



Appendix B

Breadth Analysis (IFTA Required CFTe I Reading Material)

Tamar Gamal, CFTe, CETA

Egyptian Society of Technical Analysts (ESTA)

Introduction

What is a market (stock market)? A market is a place where both buyers and sellers exist to trade. Similar to any market, a stock market is a place where both buyers and sellers trade all kinds of listed

securities.

What is technical analysis? Technical analysis (TA) is the study of market action (in terms of price and volume), primarily through

the use of charts, for the purpose of forecasting future price trends.

Foundations, premise, and concepts in TA Market action discounts everything. Prices move in trends (and trends persist). History repeats itself.

Types of TA Indicators

Indicators that are calculated based on price.

Moving averages and MACD. Momentum oscillators RSI, CCI, and stochastic.

Indicators that are calculated based on volume.

On-balance volume OBV. Demand index DI. Volume zone oscillator VZO.



Indicators that are calculated based on advancing and declining issues.

Advance-decline line McClellan oscillator Market thrust index

History of Breadth Analysis Colonel Leonard P. Ayres, of Cleveland Trust Company, is generally credited with being the first to count the advancing and declining issues. In 1926, he produced his first work, which he called making the count of the market. However, 25 years earlier, Charles H. Dow, of Dow Theory fame, commented in his June 23, 1900, editorial in the Wall Street Journal about the number of advances and declines thusly, Of these 174 stocks, 107 advanced, 47 declined, and 20 stood still. However, it is widely accepted that Colonel Ayres and his associate, James F. Hughes, popularized the concept that is widely used today. When it comes to breadth analysis, as we know it today, Gregory L. Morris gets most of the credit for explaining, discussing and categorizing a large variety of indicators based on market breadth data. In his book Market Breadth Indicators, Gregory L. Morris discussed clearly every form of market breadth known to man, from basic to advanced applications, with hundreds of chart examples and valuable statistical results.

What Is Stock Market Breadth? Breadth analysis is one of the most valuable aspects in technical analysis. Breadth introduces a new dimension to analysis, where it reveals the true strength or weakness of the targeted market. Such dimension is not attainable from the standard price 8/volume chart. Market breadth indicators are sometimes referred to as broad market indicators, since they do not refer to individual stocks. Breadth is more related to indices, large or small capitalization, price or capital weighted, all are the same in breadth analysis. Stock market breadth is a tally of how many stocks rose versus declined in value. Unlike the Dow Jones Industrial Average or EGX (30) Index, which follows just 30 stocks, stock market breadth is a more inclusive ratio, taking almost all stocks traded on an exchange into account, rather than concentrating on just a few key stocks. Stock market breadth gives the investor a much larger overview of the market's overall trend. If more issues close higher today than yesterday, stock market breadth is said to be positive. If more issues close lower, stock market breadth is considered to be negative. Stock market breadth is often a key component of the technical analyst's arsenal of market indicators.

Types of Breadth Indicators

Indicators that are calculated based on advancing and declining issues. A/D line McClellan oscillator McClellan summation index



Indicators that are calculated based on volume. Up/down volume oscillator

Indicators that are calculated based on both A/D issues and volume. Market thrust index Thrust oscillator

Indicators that are calculated based on highs/lows. New hi/new lo oscillator

Indicators that are calculated based on moving averages. % of stocks above/below certain moving average

There are many ways and techniques that use or combine all three groups; their aim is to identify the overall health of the target market, in terms of trend analysis, for the sole purpose of forecasting trend reversals. Moreover, breadth analysis can also be applied to any sector in the market or to a specific industry group, as long as there is a way to determine their constituents and the components mentioned above. These indicators use different data than open, high, low, close, and volume. They are obviously related to prive movements but use other data: Number of stocks that advanced Number of stocks that declined Number of stocks that were unchanged Total advancing volume Total declining volume Total unchanged volume New 52-week high (how many stocks made new highs) New 52-week low (how many stocks made new lows) These data concern the overall market situation and not a particular stock. For example, during a day on the NYSE, we can have the following information. Number of stocks that rose: 1,243 (30%) Number of stocks that declined: 2,756 (67%) Number of unchanged stocks: 117 (3%) Advancing volume: 954,856,870 Declining volume: 2,051,149,098 Unchanged volume: 49,848,916



This means that the 1,243 stocks that rose during the day had total volume of 954,856,870, while the 2,756 stocks that declined had total volume of 2,051,149,098, and so on. Important signals are triggered when the market is continuing to make higher highs but market breadth indicators are not confirming. This means that the rise is not confirmed by the overall market, as more and more stocks are failing to confirm the market rise, which is obviously a signal of a potential reversal. Advance-Decline Line The advance-decline line is perhaps the most commonly known and used market breadth indicator of all time. Probably because of its simple calculation and application, the advance-decline line has stood the test of time. It is a long- term indicator that shows the general trend of a certain market. Advance-decline formula:

AD Line = Advancing Issue Declining Issues. The difference is added cumulatively to show it as a trend-following indicator that provides valuable information every day the market trades. There are many variations of the advance-decline line, such as A/D ratio or smoothed versions of the advance-decline line itself. In his book Opportunity Investing, Gerald Appel discussed using a 10-day moving average of the advance-decline line along with negative/positive divergence with respect to the S&P 500 index to spot trend reversals. On the other hand, Stan Weinstein and his colleague Justin Mamis preferred using the 10-day moving average of the advance-decline line as the signal for a 30-day moving average of the same difference, as discussed in his book Secrets for Profiting in Bull and Bear Markets. However, Gregory Morris, in his book Market Breadth Indicators, stated that he preferred to use a 21-day moving average for most of his work. Using raw or smoothed versions of the advance-decline line is primarily dependent on the market under study; choppy markets will require a certain degree of smoothing, while other developed markets, with huge numbers of issues traded every day, will require far less or no smoothing to begin with. Time is also an important factor here; peaks may require a certain degree of smoothing due to the rapid changes in the advance-decline difference, while bottoms may not due to the dull environment that surrounds them.

Calculation of A/D line A/D Line = (# of Advancing Stocks # of Declining Stocks) + Previous Period's A/D Line Value

Example: Day 1, Advancing stocks= 35, Declining stocks= 25,

A/D Line= (35 25) + 0 = 10

Day 2, Advancing stocks= 45, Declining stocks= 25, A/D Line= (45 25) + 10 = 30

Day 3, Advancing stocks= 50, Declining stocks= 17,



A/D Line= (50 17) + 30 = 63



Plotting the A/D values

The drawback of this calculation is that with time, the numbers of shares and companies increase in the stock market, especially with the new IPOs that appear from time to time. This will obviously change the A-D line values with time and can distort the results. Another way to calculate the A-D line to overcome this problem is to take a ratio by dividing advancing issues by declining issues: AI/DI. Obviously, the results will also be accumulated as in the first calculation. Another way to calculate the A-D ratio is to take the difference between advancing and declining stocks and divide by the total of advances plus declines.

A-D ratio = (A-D) / (A+D) *100

Using A/D line

Zero crossovers Crossing above/below zero levels can be useful, but dont expect this to happen regularly, A/D is a cumulative/medium to long-term indicator, and the way it is calculated will not allow oscillating around the zero line often.

Divergences



This is where the A/D is most useful, when NOT confirming price action, the A/D is of great importance. A rising market with a declining A/D line reflects that though the market is making new highs, nonetheless, lesser stocks are following this uptrend every day, indicating that the current uptrend may reverse soon. A declining market with a rising A/D line reflects that though the market is declining, the number of stocks that are following that decline is getting lesser every day.

General trend analysis This is where you get to apply support/resistance, breakouts, trendlines and other classical techniques on the A/D line.

The red line (upper part of chart) represents the A/D line for the Egyptian market. The black line (lower part of chart) is the EGX (30) Index. In the above chart, A/D is confirming EGX (30) uptrend. Both EGX (30) and A/D line are forming higher lows higher highs formation.



A/D line (red line / upper part of chart) confirming EGX (30) (black line lower part of chart uptrend in the period from 20042007.

EGX (30) upper panel and A/D line lower panel. Failure to confirm the EGX (30) higher lows/higher highs during Aug Nov 2009 was the first sign of weakness (-ve divergence); during late October, the A/D line broke below previous support levels. This was another sign



of weakness (S/R breakouts); later during 2010, the A/D line failed to confirm any of EGX (30) higher highs/higher lows.

A/D line failed to confirm EGX (30) breakout, followed by breaking below previous support levels, was enough of a signal to forecast the very sharp decline that followed. Later, after few months and only few weeks before Jan 25 2011, again the A/D closed below previous support levels, indicating that market conditions are far from healthy.

A/D line failure to confirm EGX (30) breakout during Jan 2012, followed by breaking below previous support, was another good example of how the A/D is a leading indicator that marks medium to long-term potential



moves. The A/D line upside breakout during Aug 2012 was a good example of A/D confirming the EGX (30) move that went to nearly the 6,000 level a few weeks later.

NSYE A/D line upper panel and NY Composite lower panel. Again, a good example of -ve divergences on the A/D line that lead to significant declines later during Nov 2007 to Feb 2008.



The above chart shows the S&P 500 along with an A-D line for the NYSE data. As we can see, during March 2003, the A-D line was rising along with the S&P 500. During May of the same year, the A-D line broke its resistance before the S&P. The A-D line was a leading indicator for the S&P 500 in some cases, and in other cases was moving along with the S&P (coincident). At the right edge of the chart, during end of April 2004, the A-D line was showing some weakness, forming lower highs formation, and broke a support, which was not confirmed yet by the S&P 500.

S&P

A-D line

NASDAQ

A-D line



The NASDAQ index along with its A-D line. As we can see, the A-D line rose during March 2003, confirming the market strength. At the end of April 2004, the A-D line witnessed lower highs formation and violated a support, which was not confirmed yet by the NASDAQ. McClellan Oscillator The McClellan oscillator is a breadth oscillator created by Sherman and Marian McClellan in 1969. The McClellan oscillator uses the daily advancing minus declining stocks by smoothing them with two different exponential moving averages and then taking the difference between them. It is a short/medium-term indicator that shows the general trend of a certain market. The idea about the indicator came when both Sherman and his wife, Marian, discovered that when the stock market declined sharply, both moving averages 19 and 39 EMA of breadth data reached very low levels. During a strong upward move, both moving averages were reaching very high levels. They discovered that when both moving averages went to oversold levels, this was a good time to buy, even before a crossover occurred between both moving averages. By the same token, when the market moved sharply to the upside and both moving averages reached overbought levels and then began to decline, this was a signal to sell.

Calculation of McClellan oscillator

1. Calculate the daily difference between advancing stocks and declining stocks.

2. Calculate a 19-day exponential moving average of the difference between advancing stocks and declining stocks.

3. Calculate a 39-day exponential moving average of the difference between advancing stocks

and declining stocks.

4. Take the difference between 19-day EMA and 39 days EMA. The McClellan oscillator thus consists of one line that moves above and below a zero level. Obviously, crossovers between the two moving averages coincide with zero-level violations. The idea of the McClellan oscillator sounds a lot like the MACD.

Using the McClellan oscillator

Zero crossovers When the McClellan crosses zero to the upside it means that the 19-day EMA broke the 39-day EMA to the upside. A violation of zero to the downside coincides with the 19-day EMA breaking the 39-day EMA downwards. (Of course, we are using moving averages of A-D.) The zero crossover technique is not recommended, as it leads to many whipsaws. However, usually positive values in the oscillator are seen as bullish, while negative values are seen as bearish.

Divergences

The McClellan oscillator can track divergences with price action. Usually, when the price of the market gauge is still rising and the McClellan declines, it is considered a negative divergence.



Positive divergences can occur too. We recommend waiting for a price confirmation after such divergences, as they may not always lead to profitable moves. False divergences can occur sometimes, so waiting for confirmation is required. Obviously, divergences that occur in the same direction of the major trend are more significant.

Overbought and oversold

The McClellan oscillator is very useful when it reaches overbought levels and then begins to turn down, or reaches oversold levels and turns up afterward. As we know, it is an unbounded oscillator, so overbought and oversold zones can be detected by visual inspection. Usually for the NYSE the +200 and -200 levels serve as strong overbought and oversold levels. These are not fixed levels, however, as each market has a different number of stocks and volatility often changes in the stock market, so OB/OS levels change.

EGX (30) (upper panel) and McClellan oscillator (lower panel) during 20082010. +ve and ve divergences occurred during the 2-year period, and most of them were successful. The McClellan oscillator is a very short-term indicator that must be confirmed along with price action and is better used in the direction of the upper degree trend.



EGX (30) (upper panel) and McClellan oscillator (lower panel) during 20122013. Most signals were successful, and divergences and zero-crossovers are shown on the chart above. All signals were applied in the same direction as the upper degree trend.

S&P 500 (upper panel) and McClellan oscillator (lower panel) during 20122013. Most divergences were successful. Another way to confirm divergences is to wait for a cross above/below the zero line (marked by a circle) and will still be leading and early.



EGX (30) (upper panel) and McClellan oscillator (lower panel) during 20112012. Overbought signals are another advantage when using the McClellan oscillator. Visual inspection is the best technique for marking such levels, and one should understand that such levels will change over time and will need some adjustments.

EGX (30) (upper panel) and McClellan oscillator (lower panel) during 20102012.



Oversold signals are another advantage when using the McClellan oscillator. Visual inspection is the best technique for marking such levels, and one should understand that such levels will change over time and will need some adjustments. McClellan Summation Index This indicator is also created by the McClellan's. The Summation Index is a cumulative function of the McClellan oscillator. It is more smoothed than the normal McClellan oscillator.

Calculation of McClellan Summation Index

1. Calculate todays McClellan oscillator value.

2. Add each previous value of the McClellan oscillator to the cumulative total. McClellan Summation Index shows the real trend of the McClellan oscillator. It is more of a medium to long-term indicator that will show the true strength/weakness of the market on a longer timeframe. Caution is needed when using the Summation Index because signals are usually leading, but sometimes the lead time is a bit longer than expected. Summation Index signals have very high credibility, but the issue of the lead time sometimes becomes very confusing; this is where the discipline is needed and highly appreciated.

Using McClellan Summation Index

Zero-crossovers Usually, when the Summation index is moving above zero and rising, it tells us that money is entering the market. When it is declining and going below zero, it indicates that money is leaving the market. It is a breadth measure that shows us the bigger picture. Sometimes the zero line will act as support/resistance.

Divergences

Unlike the McClellan, the Summation Index is a smoothed indicator, and it gives us early signals of potential strength or weakness. Divergences are very significant when they appear. Divergences on the Summation index are rarely false.

General trend analysis Breaking below/above previous support/resistance levels is also a good technique when using the McClellan Summation Index. Moreover, the general trend of the Summation Index is of great importance. Swings are not common within this indicator and hence, once you point out a change in the indicator direction, it is quite possible that the change will continue in the new direction.


Last updat

IFTA_CFTe_Syllabus

Documents

Transcript of IFTA_CFTe_Syllabus