Technical Analysis

ByK.PRABHAKARAN,

ASSISTANT PROFESSOR-FINANCE, RVS FACULTY OF MANAGEMENT,

COIMBATORE.

Technical Analysis

Technical analysis is the attempt to forecast stock prices on the basis of market-derived data.

Technicians (also known as quantitative analysts or chartists) usually look at price, volume and psychological indicators over time.

They are looking for trends and patterns in the data that indicate future price movements.

TECHNICAL ANALYSIS  

The technical analyst deal with only three pieces of data: price, trading volume, and open interest.  He evaluates them to form an opinion on the likely direction of prices over the next several days.

Technical analysts believe that the historical performance of stocks and markets are indications of future performance.

Types of Charts

Line Chart Candlestick Chart Bar Charts

Line Chart

Line chartStock Price

Declining Trend

Channel

Trough

Buy Point

Rising Trend Channel

Flat Trend Channel

Sell Point

Peak

Declining Trend

Channel TroughBuy Point

Trend Lines

There are three basic kinds of trends: An Up trend where prices

are generally increasing. A Down trend where

prices are generally decreasing.

A Trading Range.

Support & Resistance

Support and resistance lines indicate likely ends of trends.

Resistance results from the inability to surpass prior highs.

Support results from the inability to break below to prior lows.

What was support becomes resistance, and vice-versa.

Support

Resistance

Breakout

Head and Shoulders

This formation is characterized by two small peaks on either side of a larger peak.

This is a reversal pattern, meaning that it signifies a change in the trend.

Head

Head

Left Shoulder

Left Shoulder

Right Shoulder

Right Shoulder

Neckline

Neckline

H&S Top

H&S Bottom

Head & Shoulders Example

Sell Signal

Minimum Target PriceBased on measurement rule

Double Tops and Bottoms

These formations are similar to the H&S formations, but there is no head.

These are reversal patterns with the same measuring implications as the H&S.

Target

Double Top

Double Bottom

Target

Double Bottom Example

Triangles

Triangles are continuation formations.

Three flavors: Ascending Descending Symmetrical

Typically, triangles should break out about half to three-quarters of the way through the formation.

Ascending

Descending

Symmetrical

Symmetrical

Rounded Tops & Bottoms

Rounding formations are characterized by a slow reversal of trend.

Rounding Top

Rounding Bottom

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2.CANDLESTICK CHART

High

Upper Shadow

Low

Lower Shadow

Open

Bullish Bearish

Body

Close

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Candle Stick Charting

Green is an example of a bullish pattern, the stock opened at (or near) its low and closed near its high

Red is an example of a bearish pattern. The stock opened at (or near) its high and dropped substantially to close near its low

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Top example is called a hammer and is a bullish pattern only if it occurs after the stock price has dropped for several days.

Bottom is an example of a Doji.

Candle Stick Charting

Japanese Candlesticks(Example)

20

3.Bar Chart

Bar Chart

This is a bar (open, high, low, close )

Example

Double bottomGap, should getfilled

Nov to Mar Trading range

Descendingtriangles

Technical Indicators

There are hundreds of technical indicators used to generate buy and sell signals.

We will look at just a few Indicators Moving Average Moving Average Convergence/Divergence

(MACD) Relative Strength Index (RSI) Bollinger Bands Pivot Point Money Flow Index

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Moving Average

Calculated by applying a percentage of today's closing price to yesterday's moving average value.

The most commonly used moving averages are of 10,20, 30, 50, 100 and 200 days.

For example: a 10-day simple moving average is calculated by adding the closing prices for the last 10 days and dividing the total by 10.

Moving Average

The Moving Average Technical Indicator shows the mean instrument price value for a certain period of time.

There are four different types of moving averages:

Simple moving averages Exponential moving averages Smoothed moving averages Linear Weighted moving averages

Exponential Moving Average:

The exponential moving average is a type of moving average that gives more weight to recent prices in an attempt to make it more responsive to new information.

Formula:

Example for EMA

Moving Average Convergence/Divergence (MACD)

MACD was developed by Gerald Appel as a way to keep track of a moving average crossover system.

Appel defined MACD as the difference between a 12-day and 26-day moving average. A 9-day moving average of this difference is used to generate signals.

When this signal line goes from negative to positive, a buy signal is generated.

When the signal line goes from positive to negative, a sell signal is generated.

MACD Example Chart

Relative Strength Index (RSI) RSI was developed by Welles Wilder as an

oscillator to measure overbought/oversold levels.

RSI is a measure of the ratio of average price changes on up days to average price changes on down days.

The most important thing to understand about RSI is that a level above 70 indicates a stock is overbought, and a level below 30 indicates that it is oversold (it can range from 0 to 100).

Relative Strength Index (RSI)

The relative strength index (RSI) is one of the most

used tools in Technical analysis. RSI helps to signal the overbought and oversold conditions in a security.

Formula: 100

RSI = 100 -------- 1 + RS

Average Gain First RS = -----------------

Average Loss Average Gain = Total Gains / n Average Loss = Total Loss / n

RSI Example Chart

OversoldOverbought

RSI Example

Bollinger Bands Bollinger bands were created by John Bollinger

(former FNN technical analyst, and regular guest on CNBC).

Bollinger Bands are based on a moving average of the closing price.

They are two standard deviations above and below the moving average.

A buy signal is given when the stock price closes below the lower band, and a sell signal is given when the stock price closes above the upper band.

When the bands contract, that is a signal that a big move is coming, but it is impossible to say if it will be up or down.

Bollinger Bands Example Chart

MONEY FLOW INDEX (MFI)

Money flow index was discovered by Created by Gene Quong and Avrum Soudack.

Money flow is positive when the typical price rises. This is due to buying pressure. A ratio of positive and negative money flow is then plugged into an RSI formula to create an oscillator that moves between zero and one hundred.

FORMULA

MFI EXAMPLE

MONEY FLOW INDEX

0

1020

30

40

5060

70

Mar

-08

Jun-

08

Sep

-08

Dec

-08

Mar

-09

Jun-

09

Sep

-09

Dec

-09

Mar

-10

Jun-

10

Sep

-10

Dec

-10

Mar

-11

Jun-

11

Sep

-11

Dec

-11

YEAR

MFI MFI

Pivot Point

A technical indicator derived by calculating the numerical average of particular share high, low and closing prices. The pivot point is used as a predictive indicator.

If the following day’s market price falls below the pivot point, it may be used as a new support level.

Support and resistance are price levels at which movements should stop and reverse direction.

Formula for Pivot Point

Pivot Point (P) = (High + Low + Close) / 3

Support level 1(S1) = ((2*pivot point) – high))

Resistant level 1(R1) = ((2*pivot point) – low))

Support level 2(S2) = ((pivot point) – (R1-S1))

Resistant level 2(R2) = ((pivot point) + (R1-S1))