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← Back to Technical Analysis of the Financial Markets Overview JOHN J. MURPHY
NEW YORK INSTITUTE OF FINANCE
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Portions of this book were previously published as Technical Analysis of the Futures Markets (New York Institute of Finance, 1985).
Copyright © 1999 by John J. Murphy
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First edition: January 1999
Library of Congress Cataloging-in-Publication Data
Murphy, John J.
Technical analysis of the financial markets / John J. Murphy. p. cm. Rev. ed. of: Technical analysis of the futures markets. c1986. Includes bibliographical references and index. ISBN: 978-1-101-65919-9 1. Futures market. 2. Commodity exchanges. I. Murphy, John J. Technical analysis of the future markets. II. Title. HG6046.M87 1999 98-38531 332.64’4—dc21 CIP
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Version_2
To my parents, Timothy and Margaret and To Patty, Clare, and Brian
Contents
About the Author About the Contributors Introduction Acknowledgments
1 Philosophy of Technical Analysis
Introduction Philosophy or Rationale Technical versus Fundamental Forecasting Analysis versus Timing Flexibility and Adaptability of Technical Analysis Technical Analysis Applied to Different Trading Mediums Technical Analysis Applied to Different Time Dimensions Economic Forecasting Technician or Chartist? A Brief Comparison of Technical Analysis in Stocks and Futures Less Reliance on Market Averages and Indicators Some Criticisms of the Technical Approach Random Walk Theory Universal Principles
2 Dow Theory
Introduction Basic Tenets The Use of Closing Prices and the Presence of Lines Some Criticisms of Dow Theory Stocks as Economic Indicators Dow Theory Applied to Futures Trading Conclusion
3 Chart Construction
Introduction Types of Charts Available Candlesticks Arithmetic versus Logarithmic Scale Construction of the Daily Bar Chart Volume Futures Open Interest Weekly and Monthly Bar Charts Conclusion
4 Basic Concepts of Trend
Definition of Trend Trend Has Three Directions Trend Has Three Classifications Support and Resistance Trendlines The Fan Principle
The Importance of the Number Three The Relative Steepness of the Trendline The Channel Line Percentage Retracements Speed Resistance Lines Gann and Fibonacci Fan Lines Internal Trendlines Reversal Days Price Gaps Conclusion
5 Major Reversal Patterns
Introduction Price Patterns Two Types of Patterns: Reversal and Continuation The Head and Shoulders Reversal Pattern The Importance of Volume Finding a Price Objective The Inverse Head and Shoulders Complex Head and Shoulders Patterns Triple Tops and Bottoms Double Tops and Bottoms Variations from the Ideal Pattern Saucers and Spikes Conclusion
6 Continuation Patterns
Introduction
Triangles The Symmetrical Triangle The Ascending Triangle The Descending Triangle The Broadening Formation Flags and Pennants The Wedge Formation The Rectangle Formation The Measured Move The Continuation Head and Shoulders Pattern Confirmation and Divergence Conclusion
7 Volume and Open Interest
Introduction Volume and Open Interest as Secondary Indicators Interpretation of Volume for All Markets Interpretation of Open Interest in Futures Summary of Volume and Open Interest Rules Blowoffs and Selling Climaxes Commitments of Traders Report Watch the Commercials Net Trader Positions Open Interest In Options Put/Call Ratios Combine Option Sentiment With Technicals Conclusion
8 Long Term Charts
Introduction The Importance of Longer Range Perspective Construction of Continuation Charts for Futures The Perpetual Contract™ Long Term Trends Dispute Randomness Patterns on Charts: Weekly and Monthly Reversals Long Term to Short Term Charts Why Should Long Range Charts Be Adjusted for Inflation? Long Term Charts Not Intended for Trading Purposes Examples of Long Term Charts
9 Moving Averages
Introduction The Moving Average: A Smoothing Device with a Time Lag Moving Average Envelopes Bollinger Bands Using Bollinger Bands as Targets Band Width Measures Volatility Moving Averages Tied to Cycles Fibonacci Numbers Used as Moving Averages Moving Averages Applied to Long Term Charts The Weekly Rule To Optimize or Not Summary The Adaptive Moving Average Alternatives to the Moving Average
10 Oscillators and Contrary Opinion
Introduction Oscillator Usage in Conjunction with Trend Measuring Momentum Measuring Rate of Change (ROC) Constructing an Oscillator Using Two Moving Averages Commodity Channel Index The Relative Strength Index (RSI) Using the 70 and 30 Lines to Generate Signals Stochastics (K%D) Larry Williams %R The Importance of Trend When Oscillators are Most Useful Moving Average Convergence/Divergence (MACD) MACD Histogram Combine Weeklies and Dailies The Principle of Contrary Opinion in Futures Investor Sentiment Readings Investors Intelligence Numbers
11 Point and Figure Charting
Introduction The Point and Figure Versus the Bar Chart Construction of the Intraday Point and Figure Chart The Horizontal Count Price Patterns 3 Box Reversal Point and Figure Charting Construction of the 3 Point Reversal Chart
The Drawing of Trendlines Measuring Techniques Trading Tactics Advantages of Point and Figure Charts P&F Technical Indicators Computerized P&F Charting P&F Moving Averages Conclusion
12 Japanese Candlesticks
Introduction Candlestick Charting Basic Candlesticks Candle Pattern Analysis Filtered Candle Patterns Conclusion Candle Patterns
13 Elliott Wave Theory
Historical Background Basic Tenets of the Elliott Wave Principle Connection Between Elliott Wave and Dow Theory Corrective Waves The Rule of Alternation Channeling Wave 4 as a Support Area Fibonacci Numbers as the Basis of the Wave Principle Fibonacci Ratios and Retracements
Fibonacci Time Targets Combining All Three Aspects of Wave Theory Elliott Wave Applied to Stocks Versus Commodities Summary and Conclusions Reference Material
14 Time Cycles
Introduction Cycles How Cyclic Concepts Help Explain Charting Techniques Dominant Cycles Combining Cycle Lengths The Importance of Trend Left and Right Translation How to Isolate Cycles Seasonal Cycles Stock Market Cycles The January Barometer The Presidential Cycle Combining Cycles with Other Technical Tools Maximum Entropy Spectral Analysis Cycle Reading and Software
15 Computers and Trading Systems
Introduction Some Computer Needs Grouping Tools and Indicators Using the Tools and Indicators
Welles Wilder’s Parabolic and Directional Movement Systems Pros and Cons of System Trading Need Expert Help? Test Systems or Create Your Own Conclusion
16 Money Management and Trading Tactics
Introduction The Three Elements of Successful Trading Money Management Reward to Risk Ratios Trading Multiple Positions: Trending versus Trading Units What to Do After Periods of Success and Adversity Trading Tactics Combining Technical Factors and Money Management Types of Trading Orders From Daily Charts to Intraday Price Charts The Use of Intraday Pivot Points Summary of Money Management and Trading Guidelines Application to Stocks Asset Allocation Managed Accounts and Mutual Funds Market Profile
17 The Link Between Stocks and Futures: Intermarket Analysis
Intermarket Analysis Program Trading: The Ultimate Link The Link Between Bonds and Stocks The Link Between Bonds and Commodities The Link Between Commodities and the Dollar Stock Sectors and Industry Groups The Dollar and Large Caps Intermarket Analysis and Mutual Funds Relative Strength Analysis Relative Strength and Sectors Relative Strength and Individual Stocks Top-Down Market Approach Deflation Scenario Intermarket Correlation Intermarket Neural Network Software Conclusion
18 Stock Market Indicators
Measuring Market Breadth Sample Data Comparing Market Averages The Advance-Decline Line AD Divergence Daily Versus Weekly AD Lines Variations in AD Line McClellan Oscillator McClellan Summation Index New Highs Versus New Lows New High-New Low Index Upside Versus Downside Volume The Arms Index TRIN Versus TICK Smoothing the Arms Index Open Arms Equivolume Charting Candlepower Comparing Market Averages Conclusion
19 Pulling It All Together—A Checklist
Technical Checklist How to Coordinate Technical and Fundamental Analysis Chartered Market Technician (CMT) Market Technicians Association (MTA) The Global Reach of Technical Analysis Technical Analysis by Any Name Federal Reserve Finally Approves Conclusion
AAdvanced Technical Indicators
Demand Index (DI) Herrick Payoff Index (HPI) Starc Bands and Keltner Channels Formula for Demand Index
B Market Profile
Introduction
Market Profile Graphic Market Structure Market Profile Organizing Principles Range Development and Profile Patterns Tracking Longer Term Market Activity Conclusion
CThe Essentials of Building a Trading System
5-Step Plan Step 1: Start with a Concept (an Idea) Step 2: Turn Your Idea into a Set of Objective Rules Step 3: Visually Check It Out on the Charts Step 4: Formally Test It with a Computer Step 5: Evaluate Results Money Management Conclusion
DContinuous Futures Contracts
Nearest Contract Next Contract Gann Contract Continuous Contracts Constant Forward Continuous Contracts Glossary Selected Bibliography Selected Resources Index