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Fundamental or
Technical Analysis?
nFundamental analysis – Financial statement (Huge amount of data)
the belief that every
security eventually sells for Time lag
its intrinsic value Inadequate disclosure
Subjectivity
nTechnical analysis – Confidence on market
the belief that security
prices follow recurrent, Conceptual framework
predictable patterns Quick response
Judicious blend of both approaches is required to
arrive at better results
Market Dynamics
Supply and Demand
Suppl
y
Price
Deman
d
Quant
ity
Theoretical Foundation
Edwards & Magee (1997) state the basic assumptions of technical
analysis
A security’s market value is based on supply and demand
Supply and demand are based on both rational and irrational factors
Security prices tend to move in persistent trends
Changes in trends occur due to shifts in supply and demand
Shifts in supply and demand can be detected using charts of market
transactions
Some chart patterns tend to repeat themselves
History repeats itself
Bird’s Eye View of 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
View Points
Price Change in price reflects changes in investors attitude
Time Movement in price is a function of time
Volume Intensity of price change is reflected in volume
Breadth Price change is measured across sectors or industries
Strengths
Can be used on almost any instrument
Can be used to analyse data over a wide range of time periods
There are many charting tools and techniques
The basic principle of charting is easy to understand
Weaknesses
It is subjective ie. open to individual interpretation
The past does not necessarily repeat itself
It is based on probability not certainty
The data used must be timely and accurate
Volume characteristics
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Dow Theory Charles Dow (1900)
Average discounts everything
Market has three movements
Primary movements (bull or bear market, “the tide”)
Secondary movements (corrections, “the wave”)
Minor movements (daily fluctuations, “of little importance”)
Primary trends (up & down) usually has three movements
1st results from sighted investors
Increased company earnings causes 2nd move
When all financial news are good the final move accompanied by rampant
speculation
To signal a bull or bear trend two averages must confirm each other
Only closing prices are used
A trend remains effective until a reversal has been signaled by both averages
Trends and movements
Dow Jones Industrial Average,
January 2, 2001 to October 3, 2003
12,000
The primary direction is either bullish or bearish,
and reflects the long-run direction of the market.
11,000
10,000
Level
9,000
Secondary
trends,
8,000 temporary
departures
Corrections
, reversions
7,000
to the
01/01 04/01 07/01 10/01 primary
01/02 04/02 07/02 10/02 01/03 04/03 07/03 10/03
direction Date
Chart Type
Plotting the past price history of a security to look for
patterns that suggest shifts in the underlying supply
and demand relationship or investor attitudes
Line Chart (close only)
Bar Chart
Point & Figure Chart
Japanese Candlestick
Charting Stocks
Candlesticks Bars
Bullish Bearish Bullish Bearish
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Neutral Patterns
Neutral Patterns
Reversal Patterns
Reversal Patterns
Reversal Patterns
Bullish Patterns
Bullish Patterns
Bullish Patterns
Bearish Patterns
Bearish Patterns
Bearish Patterns
Bearish Patterns
Reversal days
The two-day reversal
Point and Figure Charts, I.
Point-and-figure charts attempt to show only major price moves and
their direction.
The point and figure chart maker decides what price move is major.
That is, it could be $2, $5, or any other level. (Point)
A major up-move is marked with an “X”
A major down-move is marked with an “O”
Start a new column when there is a direction change.
Buy and sell signals are generated when new highs or new lows are
reached.
Congestion area, the area between buy and sell signals—a time of
market indecision concerning its trend.
Point and Figure Charts, II.
Stock Price Formation
Point & Figure Chart
Point and Figure Charts, III.
Further
Technical
ReferenceInvestors for long term investors by W Clay Allen
Basic Technical Tools
Trend Lines
Short term
Medium trend
Long term
Moving Averages
Price Patterns
Indicators
Cycles
Trend Lines and Channels
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.
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Three Stages of a Trend
Bull Market Bear Market
Distributi
on
Excess
Big Move Big Move
Despair
Accumulati
on
Properties of Trend Line
The greater the number of touches the more important the trend
line becomes.
The angle of Trendline
Extension of Trend line.
Trendline with Chart patterns
Spacing of the two points
Number of Touches
Extension of Trendline
Incorrect Angle
Trendline with Chart Patterns
Spacing between 2 points
Support & Resistance
Support and resistance lines
indicate likely ends of trends.
Resistance results from the
inability to surpass prior highs. Breakout
Support results from the
inability to break below to
prior lows.
What was support becomes
resistance, and vice-versa.
Support Resistance
PIVOT POINT ANALYSIS FOR
RESISTANCE AND SUPPORT
PIVOT POINT =( HIGH+LOW+CLOSE)/3
RESISTANCE-1=2*PIVOT POINT-LOW
SUPPORT-1=2*PIVOT POINT-HIGH
RESISTANCE-2=PIVOT POINT+(HIGH-LOW)
SUPPORT-2=PIVOT POINT-(HIGH-LOW)
Price Patterns
Reversal pattern
Bullish reversal
Bearish reversal
Continuation pattern
Usually accompanied and confirmed by volume
Reversal pattern
Head and shoulders (Top, Bottom)
Rounding Tops and Bottoms ( Saucers)
Ascending and descending Triangles (used more as a continuation pattern)
Double and triple Tops and Bottoms
Diamonds
Rising and falling Wedges
V formation (Spikes)
5 Major Chart Patterns
Wedge &
triangles
Head &
shoulders W
Cup &
Rounded handle
bottom
5151
5 Major Chart patterns (either way up)
Head & shoulders
Cup & handle
Rounded top
Wedge & triangles
5252
Head and shoulders
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Head and Shoulders
5555
Rounding top and Bottom
l Rounding formations are
characterized by a slow reversal of
trend (they are also known as cup
& handle).
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Rounded Bottom
5858
Cup and Handle !!!
Hard to find but worthwhile
6060
Triangles
Triangles are reversal as well as
continuation formations.
Three flavors:
Ascending
Descending
Symmetrical
Typically, triangles should break out
about half to three-quarters of the way
through the formation.
Triangle or Wedge
Descending Triangle
Tar
get
lin e
More contact points = greater reliability
6464
Broadening Formations
These formations are like reverse
triangles.
These formations usually signal a
reversal of the trend.
Rising and falling Wedges
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Continuation pattern
Flags
Rectangles
Pennants
Island
Gap
Common Least important
BreakawayHeavy volume
Runaway Heavy volume
Exhaustion an end of a trend
Flags
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Moving Averages
Simple moving average
Weighted moving average
Exponential moving average
Calculation of moving averages
Simple moving average
Day 1 2 3 4 5 6 7 8 9
Price ($) 16 17 17 10 17 18 17 17 17
5 Day SMA 15.4 15.8 15.8 15.8 17.2
Weighted moving average
Day 1 2 3 4 5
Price ($) 16 17 17 10 17
Weighting 1/15 2/15 3/15 4/15 5/15
Weighted value 1.07 2.27 3.40 2.67 5.67
5 Day WMA 15.07
Calculation of moving averages
EMA(current) = ( (Price(current) - EMA(prev) ) x Multiplier) +
EMA(prev)
For a percentage-based EMA, "Multiplier" is equal to the EMA's specified percentage.
For a period-based EMA, "Multiplier" is equal to 2 / N where N is the specified number
of periods.
multiplier for 100 days EMA = 2/100=0.02
Day Price EMA(prev) diff Diff*mult EMA
1 16 - - - 15
2 17 15 2 0.04 15.04
3 19 15.04 3.96 0.079 15.119
4 17 15.119 1.881 0.037 15.156
5 20 15.156 4.844 0.096 16.252
6 17 16.252 0.748 0.015 16.267
7 21 16.267 4.733 0.095 16.362
8 17 16.362 0.368 0.013 16.375
9 19 16.375 2.624 0.052 16.427
Relative Strength Index (RSI)
RSI was developed by Welles Wilder as an oscillator to gauge
overbought/oversold levels.
RSI is a rescaled 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).
Also, realize that stocks can remain overbought or oversold for long periods of
time, so RSI alone isn’t always a great timing tool.
RSI Example Chart
Stochastic
Advance analysis
On balance volume
Moving average envelop
Bollinger band
Relative strength index
Stochastic
Oscillator
ROC (Rate of Change oscillator)
Moving average oscillator ( MACD)
And many
On Balance Volume
On Balance Volume was developed by Joseph Granville, one of the most famous
technicians of the 1960’s and 1970’s.
OBV is calculated by adding volume on up days, and subtracting volume on
down days. A running total is kept.
Granville believed that “volume leads price.”
To use OBV, you generally look for OBV to show a change in trend (a
divergence from the price trend).
If the stock is in an uptrend, but OBV turns down, that is a signal that the price
trend may soon reverse.
OBV Example Chart
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Divergence, OBV failed
● Fifth level
OBV confirms
trend change
but doesn’t lead
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 is best used in choppy (trendless) markets, and is subject to whipsaws
(in and out rapidly with little or no profit).
MACD Example Chart
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Elliot Wave Principle (1)
R.N. Elliot formulated this idea in a series of articles in Financial World in
1939.
Elliot believed that the market has a rhythmic regularity that can be used to
predict future prices.
The Elliot Wave Principle is based on a repeating 8-wave cycle, and each
cycle is made up of similar shorter-term cycles.
Elliot Wave adherents also make extensive use of the Fibonacci series.
The Elliot Wave Principle (2)
Fibonacci Numbers
Fibonacci numbers are a series where each succeeding number is the sum of the two
preceding numbers.
The first two Fibonacci numbers are defined to be 1, and then the series continues as
follows: 1, 1, 2, 3, 5, 8, 13, 21…
As the numbers get larger, the ratio of the numbers approaches the Golden Mean:
1.618:1.
This ratio is found extensively in nature, and has been used in architecture since the
ancient Greeks (who believed that a rectangle whose sides had the ratio of 1.618:1 was
the most aesthetically pleasing).
Technical analysts use this ratio and its inverse, 0.618, extensively to provide
projections of price moves.
Too Many Others To List
There are literally hundreds of indicators and thousands of trading systems.
A whole semester could easily be spent on just a handful of these.
There is nothing so crazy that somebody doesn’t use it to trade.
For example, many people use astrology, geometry (Gann angles), neural networks,
chaos theory, etc.
There’s no doubt that each of these (and others) would have made lots of money at
one time or another. The real question is can they do it consistently?
As the carneys used to say, “You pay your money, and you take your chances.”
References (Books)
The Technical Analysis course by Thomas A Meyers
The psychology of Technical Analysis by Tony Plummer
The Technical Analysis of Stock Option & Future advance trading system & techniques
by William F Eng
Using Technical Analysis The Basic by Clifford Pistolese
Technical Analysis of Stock Trends by Robert D Edwards, John Magee
Technical Analysis Explained by Martin J Pring
Mathematics of Technical Analysis by Clifford J Sherry
Technical Analysis Plain and Simple
Technical Analysis of Financial Market by John J Murphy
Technical Analysis for Long Term Investors by W Clay Allen
The Midas Method of Technical Analysis by Paul Levine
References (WWW)
Nseindia
Investopedia
Stockcharts
Smartinvesor
Stockta
Tradingcoach
Daytrading
Wilkipedia
Chartsmart
Deepinsight
Ft
Litwick (for candle stick analysis)
Traders
and many more
