written by reader Technical analysis

By hipockets, October 26, 2014

TECHNICAL ANALYSIS OF THE FINANCIAL MARKETS was mentioned weeks ago by another Irregular as an excellent reference for technical analysis (TA). ( I apologize for not being able to give him credit, but I could not find his name by searching SGS.) I bought the book because of his recommendation and because the book has 4 1/2 stars (out of 5) on Amazon. After starting to study it, I realized that reviewing the book might be a way to say “Thank You” to the Irregulars who are teaching me so much. I hope everybody finds this useful. If you don’t, you can complain to our CEO! :)

Before I get started – Joe, I was very disappointed when I found that Marxism was never mentioned. Not once! :)

The book was written by John H. Murphy; Revised 1999; New York Institute of Finance; IBSN 0-7352-006-1. Amazon’s price for a new book is about $55. Used books, as of today’s date, are available for between $25 and $30. The book has 542 pages, 19 chapters, and 4 appendices, all of which are listed at the end of this review.

To briefly sum up this review: I am glad that I bought the book. I have started using some of the techniques, and I’m convinced that it was money well spent. However, one wishing to learn TA cannot expect to read the book once and then magically be able to read charts. There must be a willingness to study the techniques and perhaps read some of the chapters more than once. Murphy says repeatedly that that the ability of analyze charts comes only with experience. TA is not a Holy Grail for guaranteeing stock performance, but I believe it has its uses.

The first edition, published in 1986, was TECHNICAL ANALYSIS OF THE FUTURES MARKETS. Although it did not specifically talk about stocks, many of the techniques can be used for either one. This second edition, published in 1999, contains much of the information from the first one, but there is much new information and the emphasis, of course, is on stocks. The differences between TA for futures and TA for stocks are well explained.

To benefit readers new to TA, one sentence from Chapter 5, and one from Chapter 6, might have been better placed early in Chapter 1. From Chapter 5: “The analyst must face the realization that he or she is dealing with percentages and probabilities. . . .” From Chapter 6: “The treatment of all chart patterns deals of necessity with general tendencies as opposed to rigid rules”.

The Good: A lot.

>> Murphy discusses many of the popular TA techniques in easy to understand language (usually, anyway, see the comment about “Elliot Wave Theory” below). Investors with no or little knowledge of TA and wanting to learn will find it invaluable. Investors who already use TA will probably learn additional techniques and at a minimum learn some nuances and variations of the techniques that they already use. There is a plethora of easy-to-read charts illustrating the techniques (easy to read except for some “Point and Figure” charts, see below), with explanations under each chart. The text font is large and easy to read.

The Bad: Not much. A few brabbles, just to be picky:

>> I earlier stated that the charts are easy to read. An exception: some of the ”Point and Figure” charts used a small font in order to pack as much data into the chart as possible. Sometimes the font size was so small that I had to use a magnifying glass.

>> I would like to have several practice charts at the end of most chapters with the question: “What is this chart telling us, and why?”

>> I would like to have a chapter on “Risk Analysis”, but since the risk would vary according to the expertise of the chart reader, I suppose such a chapter would not be possible.

>> I would like to have some discussion about the frequency of techniques occurring, e.g., “A head and shoulders pattern occurs roughly ”X” % of the time”. I would like it, but it probably can’t be done, once again due to the expertise of the chart reader. You might recognize a head and shoulders pattern, but I might not see any pattern at all.

>> The biggest complaint that I have is that Chapter 15, “Computers and Trading Systems”, says very little about software packages for PCs, although “Trade Station” is mentioned in the Chapter and later in Appendix C. I download end-of-day data daily and update my charts manually; I was hoping to find a review of some low cost software packages that would automate the procedure.

This is not a criticism of the book, but I feel that TA often would be of little use in working with microcaps. TA uses as its basis the buying and selling actions (derived from sales price and volumes) of shareholders. My thinking: The fewer the shares, the more the actions (warranted or otherwise) of a small number of shareholders can almost instantaneously affect the price. Conversely, I think TA would be of great benefit when investing in behemoths like JNJ.

Whole chapters are devoted to the basic concepts of many of the techniques. Murphy does not dive deeply into some of the topics, since some, such as Japanese Candlesticks and Elliot Wave Theory, have had whole books written about them. He lists several resources for such topics in one of the appendices.

After explaining the basics of a technique, he frequently writes about or mentions variations of the technique. When explaining RSI, “While 9 and 14 day spans are the most common values used…..some use shorter lengths, such as 5 or 7 days, to increase volatility….[or] 21 or 58 days to smooth out the RSI signals.” Also, he frequently mentions ways to confirm a signal. Many variations of moving averages are discussed.

Chapter 1 starts with a definition: “TA is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends”. It then lists the three basic assumptions of TA:
1. Market action discounts everything.
2. Prices move in trends.
3. History repeats itself.

(I think “History can repeat itself” or “History often repeats itself ” is more likely. :) )

There is a discussion about the differences between fundamental analysis and TA. Murphy says that, in essence, the fundamentals of a stock are built into the chart. “The fundamentalist studies the cause of market movement, while the technician studies the effect.” Later in the book, he says that charts are often leading indicators of changes in fundamentals and gives a few examples.

Chapter 13, which discusses Elliot Wave analysis, is hard for me to understand, although it seems to me to be a souped-up (I checked the spelling! :) ) version of moving averages. The basic theory is well explained—price movements come in 5 advancement (up) waves and 3 correction (down) waves. Then there are 9 different levels of magnitude. Etc. There are several explanatory charts — the thing that eludes me is how to easily apply the technique to buying/selling a stock. Since I am new to charting, and since this is a complicated topic, I will wait till I master the simpler techniques before getting into this one.

Gumlandians probably will not use the concepts of time cycles (Chapter 14) unless they are long-term investors, but it’s interesting to read about them. “. . . 37 different examples of the 9.6 year cycle, including caterpillar abundance in New Jersey, coyote abundance in Canada, wheat acreage in the U.S., and cotton prices in the U.S. . . . acted in synchrony ; that is, they turned at the same time. . . .” Seasonal cycles, typical stock market cycles, and the January Barometer are some of the topics worth reading.

Chapter 18 discusses evaluating the market as a whole and why it is important. Techniques such as the Advance-Decline Line and the McClellan Oscillator are discussed, and I found the information about comparing the various market averages very educational. If the comparison is to be meaningful, there is more to it than one would think.

Chapter 19 presents a 23 item check list that can be used when thinking about buying or selling. At first, I found the checklist to be intimidating, but after re-reading it, I saw that much of it would become second nature after understanding the techniques discussed in the previous chapters.

I will close by repeating the statement that “I’m glad that I bought the book”, and saying, “ Alan, I hope you were not overloaded with complaints! ”

Here’s the Table of Contents:

Chapter 1 Philosophy of Technical Analysis
Chapter 2 Dow Theory
Chapter 3 Chart Construction
Chapter 4 Basic Concepts of Trend
Chapter 5 Major Trend Reversals

Chapter 6 Continuation Patterns
Chapter 7 Volume and Open Interest
Chapter 8 Long Term Charts
Chapter 9 Moving Averages
Chapter 10 Oscillators and Contrary Opinion

Chapter 11 Point and Figure Charting
Chapter 12 Japanese Candlesticks
Chapter 13 Elliot Wave Theory
Chapter 14 Time Cycles
Chapter 15 Computers and Trading Systems

Chapter 16 Money Management and Trading Tactics
Chapter 17 The Link Between Stocks and Futures:
Intermarket Analasis
Chapter 18 Stock Market Indicators
Chapter 19 Putting It Altogether – A Checklist

Appendix A Advanced Technical Indicators
Appendix B Market Profile
Appendix C The Essentials of Building a Trading System
Appendix D Continuous Futures Contracts
Plus Glossary, Selected Bibliography, Selected Resources, and Index.


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