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This is a continuation of the discussions related to:
http://forum.srilankaequity.com/t10367-profit-making-secrets-market-price-vs-invisible-hand
http://forum.srilankaequity.com/t10429-collection-of-profit-making-secret-posts#70837
(I was told by you, our discussions have been very interesting so far. But this discussion may be a little different. Since we will touch ‘technical analysis’, I may sound a little technical today. There are two possibilities: either you will love it or you will hate it. Anyway, here we go)
As we now believe, the market is made up of four variables namely; time, price, share and volume. So far, we took 3 variables individually into our discussions. (I will skip the remaining variable, volume, for the time being: hope to discuss that in next post).
And with help of those 3, we made our probability of winning 30+10+10+10 = 60%
OK?
Today, I like to go one more step further.
Let’s take multiple variables together to our discussion.
In other words, let’s discuss multiple variables in parallel. Or in other words, let’s observe the inter dependant movement patterns of multiple variables. (Those are just words, don’t think about it too much; I also don’t)
First of all, (keep in mind that) this type of (multiple variable) analysis is not limited to stock market. In fact, there have been mathematical ‘tools’ to support this for a long time (even before the start of stock market).
.
.
One such tool is the ‘graph’ (or chart).
A graph or chart is a tool help to ‘visualize’ a ‘relationship’ between two ‘variables’.
Hey, it is nothing big. Yu must have seen the graph they show during ‘limited over’ cricket match: runs Vs over graph OR run rate graph.
CHARTS and PATTERNS:
So, all of us have seen charts.
Anyway, I believe it is useful to refresh ourselves on some fundamentals to some extent.
Let’s talk about;
Two dimensional charts (2D charts):
Sounds a little science fictional?
Well, these are the type of charts we see everyday. In that ‘overs mtach’, in stock market etc.
In fact, almost all the charts we see fall under this category.
Now comes some jargon….
2D charts have two axes (one horizontal, one vertical), can easily draw on a paper. We assign one variable to one axis each.
(If you do no want to get your mind twisted, you may skip the following ‘extra note’).
EXTRA NOTE:
How about representing more than two variables in a chart?
Can we do that?
Yes, but then we need to have 3D (3 dimensional) charts.
Well, that would look like a 3D picture (like a transparent block of grass). In fact, with some ‘illusion tricks’, we can model 3D charts on a paper (computer screen) as well. However, to analyze these, an average person has to put some above average ‘thinking’ effort.
Then how about representing all of our 4 variables in a chart?
Can we do it?
Yes certainly, but for that we need to have a 4 dimensional chart (4D chart).
(Sounds crazy? yes it is)
But the problem is, as human beings, visualizing a 4D picture is beyond our usual thinking capacity.
Hmmm… visualizing the full picture of the stock market is not limited by any tool but it is limited by the limited capacity (physical and psychological) of this poor creature, human.
END OF EXTA NOTE
Now back to 2D charts:
We said almost all ‘charts’ are 3D charts.
Therefore, hereafter, let’s call all 2D charts just ‘charts’.
OK?
As we heard earlier, charts are not limited to the market. To ensure, let’s look at four examples.
Example-1: Temperature charts:
You may have seen these. For example, let’s take the city of Colombo. We can, at every minute, read and note down the atmospheric temperature. Then at the end of the day, we can plot our readings on a chart (with two axes; time horizontally – X axis and temperature – Y axis).
We call it the “intraday temperature chart of Colombo”.
Likewise, if we need a ‘one year daily’ chart, we can take the average daily temperature and plot on a graph for one year.
Hope you understand what I am talking about.
Let’s take another example.
Example-2: Electricity demand graph.
In services like electricity generation, ‘they’ need to monitor the demand (usage) patterns of the ‘commodity’ so that ‘they’ can take necessary action to change the capacity of the ‘system’ to cater for the ‘demand’.
Sounds like Greek?
Ok, to simplify; if the ‘engineer in charge’ sees that when it comes near 7 in the evening, the usage of electricity is becoming high, he can increase the capacity of some ‘generators’ as required. (This is a theoretical scenario, in practice, in Sri Lanka, the situation may vary a little).
In this situation, the daily demand pattern will be very handy.
OK?
Example-3: Coin-toss chart.
Take a (fair) coin. Toss it 20 times a minute. Note down how many heads you get. Do the same in next minute and so on.
Now plot the results in a chart.
We get what we call ‘coin-toss chart’.
Example-4: Lottery results chart.
Consider a ‘random number’ lottery like ‘Saturday Fortune’ lottery.
Add up the winning numbers (4 or 5 numbers) together in each draw (week). We call the addition of these numbers for one draw is one result.
Then plot a chart with all available results.
(May be we can use ‘weeks’ as X axis and results (addition of 4~5 numbers) as Y axis.
Now, a million rupee question!:
Can you tell me the difference between Example 1 (or 2) and Example 3 (or 4)?
(If you can, you already know everything I am going to discuss today! So let’s meet another day)
If you can’t, let’s continue.
A chart usually follows a pattern. The pattern can be of any shape. But, (in my view) there are two main types of patters.
1. Random patterns
2. Trending patterns (or sequential patterns or patterns with a memory or patterns with a momentum)
According to my observation, the difference between the above two is the ‘source of life’ of all theories behind ‘Technical Analysis’ w will discuss later today.
What is a random pattern?
There are events we experience which is not influenced by any of past incidents. Say, we toss a coin. We’ll get head or tail. Now, does that result influence the result when we toss it next time?
NO.
So, a one toss has no influence whatsoever on another toss.
We may call then ‘independent’ events or events with ‘no memory’ or events with ‘no momentum’ or random events.
In these events, there is no memory carried forward.
Example 3 and 4 fall in to this category.
Does it (random pattern) help, if we know the pattern in the past, to predict future events?
Not at all!!
So, we will gain next to nothing by staring at a Random Pattern (Only benefit may be calming your mind looking at random patterns in night sky stars)
Therefore, forget them and move onto ‘trending patterns’.
In Example-1 and 2, we will see a clear trend or trending pattern. We will usually observe gradual incremental increases or decreases of the value (temperature – Celsius or Fahrenheit, Electricity – Megawatts). Usually, by looking at the pattern, we will be able to draw fairly accurate predictions of what would happen during next hour or so.
Agreed?
Why do such patterns exist?
As I observe, behind such patterns, almost always, there is some force in action: there is some series of similar series of actions taking place one behind another: sometimes due to a common behavior or sometimes due t one action triggering another action. I would like to call this the “memory effect” (residual effect or momentum).
For example, in case of electricity demand; in the evening, one house switch on lights so demand increased by a fraction then on top of that another house switches on so demand goes up by another fraction and so on and so on. Houses’ demands are not independent; each house will add to the existing demand. Hence the momentum or the memory will be in effect. So we will witness an ‘uptrend’, ‘downtrend’, ‘peaks’ or ‘bottoms’ (in the pattern).
Make sense?
OK.
Now how about patterns in the stock market?
Are they ‘trending’ or ‘random’?
In my view, most of them are ‘trending’ patterns.
Why is it so? Why are they trending?
My explanation is: it is because,
The stock market has a
.
.
MEMORY!
Yes, you read right, sock market has a memory.
The following explanation is for those who think I have gone nuts.
What are the components (actions) Stock Market is made up of? OR
What are the cells the market is made up of? OR in other words,
What does make the market move?
The answer is
Transactions!
(Four variable transactions to be precise)
Yes, (my theory is), the market is made up of transactions, thousands, hundred thousands of buy/sell transactions.
Any contradictions?
OK.
Then, who make these transactions?
O course., People;
People like you and I:
Just Human beings:
Then, who is a human being?
My definition: ‘Human being is nothing but a living entity with a memory’.
-Nothing less nothing more.
(We can argue on this, but, just think, if you loose all your memory tonight. All memory n the sense, you don’t know who you are, do not know any language, do not know where you are, you know nothing. You are live because the breathing system works without the support of the conscious memory.
Now, who R U according to you? What is the difference between you and other living entities?
For sure, at least, you cannot do a transaction in the Market where other humans are capable of doing.
Further discussion on this is not today’s agenda and neither it is agenda of this forum altogether. Hence let’s get back to our track).
Agreed?
OK.
This ‘Memory’, obviously should and does come in to effect in all activities by human.
Therefore, this memory affects all of our
actions;
reactions;
interactions and
(more interestingly)
transactions!!!
(I like rhyming words).
So, all transactions in the market inhere this memory from humans (us).
Then the transactions bequeath this memory to the share market.
Makes sense so far?
(Sounds like we are fathers and mothers of the stock market; doesn’t it)
(Hmmm…then whom are we blame at when things go wrong)
In other words, ‘memory’ is an integral part of transactions; transactions are integral pars of the market: hence ‘memory’ is an integral part of the share market.
No more arguments.
Therefore, the patterns seen in the market are influence by this memory. Hence the patterns are trending. Hence the patterns are ‘predictable’! That means we can use ‘technical analysis’ to predict price movements.
If someone argue that ‘technical analysis’ (or chart reading or pattern analysis) has no basis, above argumentation will be my ‘laser guided missile’ against them.
(I am not against anyone or anything; just making the reasoning loud only. After all, by saying anything against anyone will not bring anything to this ‘living entity with a memory’.)
So, we argue ‘trending patterns’ exist in the market due to memory effect.
Memory exists because of time. (No need to prove I guess)
Therefore, we can use ‘trending patterns’ in association with (the variable) time.
(We spent too much time on Charts; let’s move on)
END OF CHARTS and PATTERNS
OK. Now, if you are with me so far, then, we can start our main discussion. i.e. how to analyze multiple ‘variables’ together.
We can, in theory, analyze any number of variables together. But due to our capacity limitations mentioned earlier, let’s take only two (at a time) together:
i.e. let’s talk of variable ‘pairs’.
As we know now, in the market, there are 4 variables altogether: time, price, share and volume.
So, in total, we can think of following possible pairs.
1. Time & price
2. Time & share
3. Time & volume
4. Price & share
5. Price & volume
6. Share & volume
Can you think of any other pair?
[Almost forgot to say; when we analyze two variables together, we usually assign one as ‘independent variable’ (x-axis) and the other as the ‘dependant variable’ (y-axis) at our convenience. Usually (but not necessarily), what is more important is assigned as the ‘dependent variable’. ]
Let’s take few (of important ones) for our discussions one by one.
Here cones the most popular one first:
* Time and price (or Price Vs time)
This is the mostly talked two-variable analysis in the market; aided by price Vs time charts.
(Usually, we (used to) call those who believe in this ‘chartist’ or technical analysts.
Most (almost all) charts we see fall under this category (:daily, weekly, intraday etc.))
To analyze Price/time charts, usually two methods a are used by (technical) analysts ;
a. Chart patterns
b. Indicators
A pattern is an easily identifiable shape in the chart: used to identify a ‘continuation’ or a ‘reversal’ of a trend; and usually a ‘name’ is given to each.
There are many names such as; head and shoulder, cup with handle, double top triple top etc etc. I loosely call trend lines, support and resistance levels also patterns.
As I have noticed, based on my experience, the key to use patterns successfully is, to use only very few (one or two patterns), and train your ‘mind and body’ to ‘be one’ with it.
Trying to use too many patterns will distract you and make the whole process useless.
What patterns to select is totally personal taste I believe.
(There could be some patterns look like your loved one’s face also)
So in a nutshell:
Select your own selected ‘best’ pattern and master it.
(Personally, I have experienced the power of two patterns; double bottom and double top: to such extent the sometimes I almost become like an obedient follower of them)
Then a word on Indicators:
(Technical) Indicators are mathematical tools to aid identifying trends or changes of trends in a chart. There are dozens if not hundreds of indicators such as: moving averages, MACD, RSI, CCI, pivotal points, Bollinger bands etc etc.
As with patterns, key to success is select one or two and master them.
There could be in-depth, sophisticated ways of using and analyzing these patterns and indicators. But my suggestion is, never try to over depend on them or never over-do the analysis.
After all, all these patterns and indicators are just visual derivatives of the two (trending) variables price and time. Everything here depends of the underlying ‘forces’ or the ‘memories’ in the market.
So the patterns or indicators DO NOT drive the market, they are driven by the market (or by us – human beings – just ……with a memory)
I will give an example:
Suppose you got a new car with ‘fully loaded’ very modern ‘futuristic’ features. You may have; smart key, auto adjust seats, voice commanding, auto navigation, adaptive cruse control, TV,DVD, reverse cameras, multi airbags, all disc with ABS and so on.
But, ultimately, your mobility depends on the conditions of tires and the road!
Imagine, there are big craters along the road or there is a big puncture on one of the tires.
Then all those highly sophisticated features become of very little use for ‘moving forward’.
Likewise, think all these patterns and indicators are ‘enhancing’ tools only, not primary factors.
Suppose, your auto navigator indicates your car is in Japan but you have just parked your car in the home garage in Colombo. Would you believe the ‘navigator’ or your common sense?
(That’s all about ‘technical analyses today. There are thousands of articles/books you can find and read I you are interested to study more)
Now, let’s look at another pair.
• Volume Vs time
Just like Price Vs time we can draw Volume Vs time charts. There are patterns we can identify and indicators we can use as well. However, analyzing volume vs time alone is less popular than price/time.
However, volume is used widely to verify the trends in Price/time charts.
[I have seen some indicators used to analyze three variables (price, volume and time) together as well (such as Accumulation Distribution indicator).]
Most of my views on Price/time is also valid for Volume/time analysis.
Shall we take different pair now?
• Price & Share
Hmm… have you heard of such an analysis?
Well, I bet you have heard half of it.
How can we analyze price against shares?
We cannot compare the prices of different shares together; can we?
In order to compare apple to apple, in this type of situations, there is a mathematical concept call ‘normalizing’.
One of ‘normalizing’ methods used in the market is P/E ratio.
P/E (Price to earnings) ration provides us with a mechanism to compare prices of different shares.
The idea is that lower the P/E ration of a share, cheaper the price of it.
So, in general, lower P/E ma mean the share is undervalued.
I you like; you can plot a chart o P/E Vs share and try to identify the ‘bottom most’ shares.
Instead of P/E, you can consider NAVPS (Net asset value per share, or book value) Vs share as well. The usage is similar to that of P/E.
(I will take only those pairs or our discussion today.)
To make our analyses more effective, we can consider looking at multiple ‘pairs’ as well.
For example; you can consider a share with Low P/E and with a ‘double bottom’ as an undervalue share with a ‘trend reversal’.
Then, likewise, if we want, we can take an analyze all of the above mentioned ‘pairs’ one by one.
Since it can make our discussion too long, I will stop here.
Just one more word;
In my view, “using ‘multiple pairs’ together” is capable of boosting your success-chances to unimaginable heights.
So why not try it out.
There are successful ‘traders’ who use only technical analysis tools to generate ‘instant’ fortunes. There could be some of them among us also.
Anyway, without going into extremes, let’s assign our favorite (one or two) techniques a modest incremental probability of making profits. Shall we assign 7.5%?
OK?
If so, If we buy only 'potential to grow' shares and buy only during identified time frames and buy only at a price below 'average perceived value', and use a couple of technical analysis tools to buy/sell, then, our chances of making profit will become 30+10+10+7.5 = 67.5% !!!!
That means out of 3, we will make profits 2 times.
Hmmmmm…..
Next time, let’s see if we can increase our winning chances further.
Additional Note:
There was a question about when we should sell a share once we have bought.
My suggestion is that; we buy a share for many reasons (potential to grow, so on), so, if (a time comes when) some of those reasons does not exist anymore; it will be a good time to consider disposing the shares.
Anyway, I plan to discuss this further later.
http://forum.srilankaequity.com/t10367-profit-making-secrets-market-price-vs-invisible-hand
http://forum.srilankaequity.com/t10429-collection-of-profit-making-secret-posts#70837
(I was told by you, our discussions have been very interesting so far. But this discussion may be a little different. Since we will touch ‘technical analysis’, I may sound a little technical today. There are two possibilities: either you will love it or you will hate it. Anyway, here we go)
As we now believe, the market is made up of four variables namely; time, price, share and volume. So far, we took 3 variables individually into our discussions. (I will skip the remaining variable, volume, for the time being: hope to discuss that in next post).
And with help of those 3, we made our probability of winning 30+10+10+10 = 60%
OK?
Today, I like to go one more step further.
Let’s take multiple variables together to our discussion.
In other words, let’s discuss multiple variables in parallel. Or in other words, let’s observe the inter dependant movement patterns of multiple variables. (Those are just words, don’t think about it too much; I also don’t)
First of all, (keep in mind that) this type of (multiple variable) analysis is not limited to stock market. In fact, there have been mathematical ‘tools’ to support this for a long time (even before the start of stock market).
.
.
One such tool is the ‘graph’ (or chart).
A graph or chart is a tool help to ‘visualize’ a ‘relationship’ between two ‘variables’.
Hey, it is nothing big. Yu must have seen the graph they show during ‘limited over’ cricket match: runs Vs over graph OR run rate graph.
CHARTS and PATTERNS:
So, all of us have seen charts.
Anyway, I believe it is useful to refresh ourselves on some fundamentals to some extent.
Let’s talk about;
Two dimensional charts (2D charts):
Sounds a little science fictional?
Well, these are the type of charts we see everyday. In that ‘overs mtach’, in stock market etc.
In fact, almost all the charts we see fall under this category.
Now comes some jargon….
2D charts have two axes (one horizontal, one vertical), can easily draw on a paper. We assign one variable to one axis each.
(If you do no want to get your mind twisted, you may skip the following ‘extra note’).
EXTRA NOTE:
How about representing more than two variables in a chart?
Can we do that?
Yes, but then we need to have 3D (3 dimensional) charts.
Well, that would look like a 3D picture (like a transparent block of grass). In fact, with some ‘illusion tricks’, we can model 3D charts on a paper (computer screen) as well. However, to analyze these, an average person has to put some above average ‘thinking’ effort.
Then how about representing all of our 4 variables in a chart?
Can we do it?
Yes certainly, but for that we need to have a 4 dimensional chart (4D chart).
(Sounds crazy? yes it is)
But the problem is, as human beings, visualizing a 4D picture is beyond our usual thinking capacity.
Hmmm… visualizing the full picture of the stock market is not limited by any tool but it is limited by the limited capacity (physical and psychological) of this poor creature, human.
END OF EXTA NOTE
Now back to 2D charts:
We said almost all ‘charts’ are 3D charts.
Therefore, hereafter, let’s call all 2D charts just ‘charts’.
OK?
As we heard earlier, charts are not limited to the market. To ensure, let’s look at four examples.
Example-1: Temperature charts:
You may have seen these. For example, let’s take the city of Colombo. We can, at every minute, read and note down the atmospheric temperature. Then at the end of the day, we can plot our readings on a chart (with two axes; time horizontally – X axis and temperature – Y axis).
We call it the “intraday temperature chart of Colombo”.
Likewise, if we need a ‘one year daily’ chart, we can take the average daily temperature and plot on a graph for one year.
Hope you understand what I am talking about.
Let’s take another example.
Example-2: Electricity demand graph.
In services like electricity generation, ‘they’ need to monitor the demand (usage) patterns of the ‘commodity’ so that ‘they’ can take necessary action to change the capacity of the ‘system’ to cater for the ‘demand’.
Sounds like Greek?
Ok, to simplify; if the ‘engineer in charge’ sees that when it comes near 7 in the evening, the usage of electricity is becoming high, he can increase the capacity of some ‘generators’ as required. (This is a theoretical scenario, in practice, in Sri Lanka, the situation may vary a little).
In this situation, the daily demand pattern will be very handy.
OK?
Example-3: Coin-toss chart.
Take a (fair) coin. Toss it 20 times a minute. Note down how many heads you get. Do the same in next minute and so on.
Now plot the results in a chart.
We get what we call ‘coin-toss chart’.
Example-4: Lottery results chart.
Consider a ‘random number’ lottery like ‘Saturday Fortune’ lottery.
Add up the winning numbers (4 or 5 numbers) together in each draw (week). We call the addition of these numbers for one draw is one result.
Then plot a chart with all available results.
(May be we can use ‘weeks’ as X axis and results (addition of 4~5 numbers) as Y axis.
Now, a million rupee question!:
Can you tell me the difference between Example 1 (or 2) and Example 3 (or 4)?
(If you can, you already know everything I am going to discuss today! So let’s meet another day)
If you can’t, let’s continue.
A chart usually follows a pattern. The pattern can be of any shape. But, (in my view) there are two main types of patters.
1. Random patterns
2. Trending patterns (or sequential patterns or patterns with a memory or patterns with a momentum)
According to my observation, the difference between the above two is the ‘source of life’ of all theories behind ‘Technical Analysis’ w will discuss later today.
What is a random pattern?
There are events we experience which is not influenced by any of past incidents. Say, we toss a coin. We’ll get head or tail. Now, does that result influence the result when we toss it next time?
NO.
So, a one toss has no influence whatsoever on another toss.
We may call then ‘independent’ events or events with ‘no memory’ or events with ‘no momentum’ or random events.
In these events, there is no memory carried forward.
Example 3 and 4 fall in to this category.
Does it (random pattern) help, if we know the pattern in the past, to predict future events?
Not at all!!
So, we will gain next to nothing by staring at a Random Pattern (Only benefit may be calming your mind looking at random patterns in night sky stars)
Therefore, forget them and move onto ‘trending patterns’.
In Example-1 and 2, we will see a clear trend or trending pattern. We will usually observe gradual incremental increases or decreases of the value (temperature – Celsius or Fahrenheit, Electricity – Megawatts). Usually, by looking at the pattern, we will be able to draw fairly accurate predictions of what would happen during next hour or so.
Agreed?
Why do such patterns exist?
As I observe, behind such patterns, almost always, there is some force in action: there is some series of similar series of actions taking place one behind another: sometimes due to a common behavior or sometimes due t one action triggering another action. I would like to call this the “memory effect” (residual effect or momentum).
For example, in case of electricity demand; in the evening, one house switch on lights so demand increased by a fraction then on top of that another house switches on so demand goes up by another fraction and so on and so on. Houses’ demands are not independent; each house will add to the existing demand. Hence the momentum or the memory will be in effect. So we will witness an ‘uptrend’, ‘downtrend’, ‘peaks’ or ‘bottoms’ (in the pattern).
Make sense?
OK.
Now how about patterns in the stock market?
Are they ‘trending’ or ‘random’?
In my view, most of them are ‘trending’ patterns.
Why is it so? Why are they trending?
My explanation is: it is because,
The stock market has a
.
.
MEMORY!
Yes, you read right, sock market has a memory.
The following explanation is for those who think I have gone nuts.
What are the components (actions) Stock Market is made up of? OR
What are the cells the market is made up of? OR in other words,
What does make the market move?
The answer is
Transactions!
(Four variable transactions to be precise)
Yes, (my theory is), the market is made up of transactions, thousands, hundred thousands of buy/sell transactions.
Any contradictions?
OK.
Then, who make these transactions?
O course., People;
People like you and I:
Just Human beings:
Then, who is a human being?
My definition: ‘Human being is nothing but a living entity with a memory’.
-Nothing less nothing more.
(We can argue on this, but, just think, if you loose all your memory tonight. All memory n the sense, you don’t know who you are, do not know any language, do not know where you are, you know nothing. You are live because the breathing system works without the support of the conscious memory.
Now, who R U according to you? What is the difference between you and other living entities?
For sure, at least, you cannot do a transaction in the Market where other humans are capable of doing.
Further discussion on this is not today’s agenda and neither it is agenda of this forum altogether. Hence let’s get back to our track).
Agreed?
OK.
This ‘Memory’, obviously should and does come in to effect in all activities by human.
Therefore, this memory affects all of our
actions;
reactions;
interactions and
(more interestingly)
transactions!!!
(I like rhyming words).
So, all transactions in the market inhere this memory from humans (us).
Then the transactions bequeath this memory to the share market.
Makes sense so far?
(Sounds like we are fathers and mothers of the stock market; doesn’t it)
(Hmmm…then whom are we blame at when things go wrong)
In other words, ‘memory’ is an integral part of transactions; transactions are integral pars of the market: hence ‘memory’ is an integral part of the share market.
No more arguments.
Therefore, the patterns seen in the market are influence by this memory. Hence the patterns are trending. Hence the patterns are ‘predictable’! That means we can use ‘technical analysis’ to predict price movements.
If someone argue that ‘technical analysis’ (or chart reading or pattern analysis) has no basis, above argumentation will be my ‘laser guided missile’ against them.
(I am not against anyone or anything; just making the reasoning loud only. After all, by saying anything against anyone will not bring anything to this ‘living entity with a memory’.)
So, we argue ‘trending patterns’ exist in the market due to memory effect.
Memory exists because of time. (No need to prove I guess)
Therefore, we can use ‘trending patterns’ in association with (the variable) time.
(We spent too much time on Charts; let’s move on)
END OF CHARTS and PATTERNS
OK. Now, if you are with me so far, then, we can start our main discussion. i.e. how to analyze multiple ‘variables’ together.
We can, in theory, analyze any number of variables together. But due to our capacity limitations mentioned earlier, let’s take only two (at a time) together:
i.e. let’s talk of variable ‘pairs’.
As we know now, in the market, there are 4 variables altogether: time, price, share and volume.
So, in total, we can think of following possible pairs.
1. Time & price
2. Time & share
3. Time & volume
4. Price & share
5. Price & volume
6. Share & volume
Can you think of any other pair?
[Almost forgot to say; when we analyze two variables together, we usually assign one as ‘independent variable’ (x-axis) and the other as the ‘dependant variable’ (y-axis) at our convenience. Usually (but not necessarily), what is more important is assigned as the ‘dependent variable’. ]
Let’s take few (of important ones) for our discussions one by one.
Here cones the most popular one first:
* Time and price (or Price Vs time)
This is the mostly talked two-variable analysis in the market; aided by price Vs time charts.
(Usually, we (used to) call those who believe in this ‘chartist’ or technical analysts.
Most (almost all) charts we see fall under this category (:daily, weekly, intraday etc.))
To analyze Price/time charts, usually two methods a are used by (technical) analysts ;
a. Chart patterns
b. Indicators
A pattern is an easily identifiable shape in the chart: used to identify a ‘continuation’ or a ‘reversal’ of a trend; and usually a ‘name’ is given to each.
There are many names such as; head and shoulder, cup with handle, double top triple top etc etc. I loosely call trend lines, support and resistance levels also patterns.
As I have noticed, based on my experience, the key to use patterns successfully is, to use only very few (one or two patterns), and train your ‘mind and body’ to ‘be one’ with it.
Trying to use too many patterns will distract you and make the whole process useless.
What patterns to select is totally personal taste I believe.
(There could be some patterns look like your loved one’s face also)
So in a nutshell:
Select your own selected ‘best’ pattern and master it.
(Personally, I have experienced the power of two patterns; double bottom and double top: to such extent the sometimes I almost become like an obedient follower of them)
Then a word on Indicators:
(Technical) Indicators are mathematical tools to aid identifying trends or changes of trends in a chart. There are dozens if not hundreds of indicators such as: moving averages, MACD, RSI, CCI, pivotal points, Bollinger bands etc etc.
As with patterns, key to success is select one or two and master them.
There could be in-depth, sophisticated ways of using and analyzing these patterns and indicators. But my suggestion is, never try to over depend on them or never over-do the analysis.
After all, all these patterns and indicators are just visual derivatives of the two (trending) variables price and time. Everything here depends of the underlying ‘forces’ or the ‘memories’ in the market.
So the patterns or indicators DO NOT drive the market, they are driven by the market (or by us – human beings – just ……with a memory)
I will give an example:
Suppose you got a new car with ‘fully loaded’ very modern ‘futuristic’ features. You may have; smart key, auto adjust seats, voice commanding, auto navigation, adaptive cruse control, TV,DVD, reverse cameras, multi airbags, all disc with ABS and so on.
But, ultimately, your mobility depends on the conditions of tires and the road!
Imagine, there are big craters along the road or there is a big puncture on one of the tires.
Then all those highly sophisticated features become of very little use for ‘moving forward’.
Likewise, think all these patterns and indicators are ‘enhancing’ tools only, not primary factors.
Suppose, your auto navigator indicates your car is in Japan but you have just parked your car in the home garage in Colombo. Would you believe the ‘navigator’ or your common sense?
(That’s all about ‘technical analyses today. There are thousands of articles/books you can find and read I you are interested to study more)
Now, let’s look at another pair.
• Volume Vs time
Just like Price Vs time we can draw Volume Vs time charts. There are patterns we can identify and indicators we can use as well. However, analyzing volume vs time alone is less popular than price/time.
However, volume is used widely to verify the trends in Price/time charts.
[I have seen some indicators used to analyze three variables (price, volume and time) together as well (such as Accumulation Distribution indicator).]
Most of my views on Price/time is also valid for Volume/time analysis.
Shall we take different pair now?
• Price & Share
Hmm… have you heard of such an analysis?
Well, I bet you have heard half of it.
How can we analyze price against shares?
We cannot compare the prices of different shares together; can we?
In order to compare apple to apple, in this type of situations, there is a mathematical concept call ‘normalizing’.
One of ‘normalizing’ methods used in the market is P/E ratio.
P/E (Price to earnings) ration provides us with a mechanism to compare prices of different shares.
The idea is that lower the P/E ration of a share, cheaper the price of it.
So, in general, lower P/E ma mean the share is undervalued.
I you like; you can plot a chart o P/E Vs share and try to identify the ‘bottom most’ shares.
Instead of P/E, you can consider NAVPS (Net asset value per share, or book value) Vs share as well. The usage is similar to that of P/E.
(I will take only those pairs or our discussion today.)
To make our analyses more effective, we can consider looking at multiple ‘pairs’ as well.
For example; you can consider a share with Low P/E and with a ‘double bottom’ as an undervalue share with a ‘trend reversal’.
Then, likewise, if we want, we can take an analyze all of the above mentioned ‘pairs’ one by one.
Since it can make our discussion too long, I will stop here.
Just one more word;
In my view, “using ‘multiple pairs’ together” is capable of boosting your success-chances to unimaginable heights.
So why not try it out.
There are successful ‘traders’ who use only technical analysis tools to generate ‘instant’ fortunes. There could be some of them among us also.
Anyway, without going into extremes, let’s assign our favorite (one or two) techniques a modest incremental probability of making profits. Shall we assign 7.5%?
OK?
If so, If we buy only 'potential to grow' shares and buy only during identified time frames and buy only at a price below 'average perceived value', and use a couple of technical analysis tools to buy/sell, then, our chances of making profit will become 30+10+10+7.5 = 67.5% !!!!
That means out of 3, we will make profits 2 times.
Hmmmmm…..
Next time, let’s see if we can increase our winning chances further.
Additional Note:
There was a question about when we should sell a share once we have bought.
My suggestion is that; we buy a share for many reasons (potential to grow, so on), so, if (a time comes when) some of those reasons does not exist anymore; it will be a good time to consider disposing the shares.
Anyway, I plan to discuss this further later.
+ rep for your valuable time..
