Moving averages. Technical analysts use not only prices relating to individual dates, but also moving averages. A moving average is an average of a series of previous prices, for example the average of the last 200 daily prices. (Each day the oldest price is removed from the calculation of the average and the most recent price introduced). Chart patterns can be based on moving averages as well as daily prices.
One popular technique is to use moving averages and daily prices on the same chart. If the current price is a predetermined percentage above or below the moving average, a buy or sell signal may be indicated. For the market as a whole, the proportion of stocks currently above their moving average is seen as an indicator of general market sentiment. Points at which a chart of daily prices crosses a chart of moving averages are seen as significant. A daily price chart that crosses a moving average chart from below might be seen as providing a buy signal. The signal may be dependent upon whether the moving average is rising or falling at the time.
Studies have suggested that moving average strategies could be successful, e.g. stock returns following buy signals from a moving average rule were higher than those following sell signals.
Dow theory. This is one of the oldest technical tools, aimed to forecast the future direction of the overall stock market. Dow theory is based on the belief that market movements are analogous to movements of the sea. It sees three simultaneous movements in the market. Daily and weekly fluctuations correspond to ripples. Secondary movements (which last a few months) are the waves. Primary trends of a year or more are analogous to tides. It is the primary trend that is referred to as either a bull or a bear market. The daily or weekly
movements are seen as having little or no predictive value. However, secondary movements in stock indices are used to forecast changes in the direction of the primary trend. A bull market is characterized by both high and low points of successive secondary movements moving in an upward trend, especially if this were accompanied by rising volumes of stocks traded. Each new peak is above the previous peak, and each new trough is above the previous trough.
Trading volume should increase with moves made in the direction of the primary trend; for a rising primary trend, volume should be heavier for advances than for falls. The market is sustained by rising support levels and would break through successively higher resistance levels. When the market eventually falls through a support level and then is unable to bounce back beyond a previous resistance level, the beginning of a bear market is signaled.
A bullish primary trend is seen as being initiated by informed investors, who anticipate a recovery. Subsequently uninformed investors start buying, thereby reinforcing the upward trend.
While the uninformed investors continue to buy, the informed investors start to sell. Sales by informed investors cause the temporary downturns (the waves).
Elliot wave theory. The theory sees markets as moving in cycles. There are very long-run cycles that last many decades. Superimposed on these are cycles of shorter duration. In turn there are cycles of even shorter duration superimposed upon the latter cycles. This pattern of cycles within cycles continues down to cycles of very short duration.
Analysis of the Elliot cycles is based on waves. Each cycle has eight waves. Five waves carry the market up and three waves carry it down. At the end of the cycle the market is higher than at the beginning.
The pattern of waves entails a succession of support and resistance levels, similarly to Dow theory. Elliot wave theory assumes that markets are driven by investor psychology. After a fall in prices, investor optimism is seen as growing slowly at first but later the