TECHNICAL ANALYSIS

- By Prof. CA Harshit Shah

Partner
SJ Tutorials

TECHNICAL ANALYSIS IS A METHOD TO FORECAST THE

FUTURE OF ANY SECURITY USING :1. PRICE
2. VOLUME
3. OPEN INTEREST

IT IS THE STUDY OF THE MARKET ACTION THROUGH THE

HELP OF CHARTS AND OTHER TECHNICAL INDICATORS TO
FORECAST THE TREND.

ASSUMPTIONS OF TECHNICAL ANALYSIS :1.THE MARKET DISCOUNTS EVERYTHING

2.PRICE MOVES IN TRENDS
3.HISTORY TENDS TO REPEAT ITSELF

THE BASIS OF TECHNICAL ANALYSIS IS ON

VARIOUS THEORIES SUCH AS :1.DOW THEORY
2.ELLIOT WAVE THEORY

In 1897, Charles Dow developed two broad market averages. The "Industrial
Average" included 12 blue-chip stocks and the "Rail Average" was comprised
of 20 railroad enterprises. These are now known as the Dow Jones Industrial
Average and the Dow Jones Transportation Average.
The Dow Theory is the common ancestor to most principles of modern
technical analysis.

Interestingly, the Theory itself originally focused on using general stock

market trends as a barometer for general business conditions. It was not
originally intended to forecast stock prices. However, subsequent work has
focused almost exclusively on this use of the Theory.

Six assumptions of the Dow theory:1. The Averages Discount Everything.

2. The Market Is Comprised of Three Trends.

3. Primary Trends Have Three Phases.

4. The Averages Must Confirm Each Other.

5. The Volume Confirms the Trend.

6. A Trend Remains Intact Until It Gives a Definite Reversal Signal.

CRITICISMS OF DOW THEORY:

Dow theory generally misses 20% to 25% of a move
before generating a signal.
Use of closing prices (Line charts).
Signals in Dow theory are generally generated during
the second phase of the uptrend.

It was primarily used as an indicator of Economy which

was substituted to stocks and other underlying assets.
Subjectivity and difficulty in distinguishing the various
phases of trends.

The Elliott Wave Theory is named after Ralph Nelson Elliott.

The underlying forces behind the Elliott Wave Theory are of building up and
tearing down. The basic concepts of the Elliott Wave Theory are listed below.
Action is followed by reaction.
There are five waves in the direction of the main trend followed by three
corrective waves (a "5-3" move).
A 5-3 move completes a cycle. This 5-3 move then becomes two subdivisions
of the next higher 5-3 wave.
The underlying 5-3 pattern remains constant, though the time span of each
may vary.
The basic pattern is made up of eight waves (five up and three down) which
are labeled 1, 2, 3, 4, 5, a, b, and c on the following chart.

The following chart shows how 5-3 waves are comprised of smaller
cycles.

ELLIOTT THEORY:
Waves 1, 3 and 5 are called Rising or Impulsive Waves and Waves 2
and 4 are called Declining Waves.
After the 5 Wave advance, the 3 Wave Correction begins.
(represented by a, b, c)
The Basic Pattern:
0-1 is called Wave 1, (Impulsive Wave)
1-2 is called Wave 2, (Declining Wave)
2-3 is called Wave 3, (Impulsive Wave)
3-4 is called Wave 4, (Declining Wave)
4-5 is called Wave 5, (Impulsive Wave)
5-a is Wave a, a-b is Wave b, and b-c is Wave c.

1. LINE CHART
2. BAR CHART
3. CANDLE-STICK CHART

On an Arithmetic Scale, Price change shows

an equal distance for each unit of price
change whereas in an Logarithmic Scale, Price
change shows an equal distance for equal
percentage change.

THERE ARE VARIOUS INDICATORS IN TECHNICAL ANALYSIS

AMONGST WHICH WE WILL DISCUSS SOME HERE.
1. SUPPORT AND RESISTANCE
2. TRENDS
3. MOVING AVERAGES
4. MACD (MOVING AVERAGE CONVERGENCE DIVERGENCE)
5. BOLLINGER BANDS
6. FIBONACCI STUDEIS
7. OPTION ANALYSIS
8. RELATIVE STRENGTH INDEX

SUPPORT

THE PRICE AT WHICH MAJORITY OF THE TRADERS FEEL THAT THE PRICES WILL MOVE
HIGHER IS KNOWN AS A SUPPORT LEVEL.
IT IS THE PRICE WHERE THE TRADERS FEEL THAT PRICES WONT FALL ANYMORE AND WILL
TAKE A U-TURN.

RESISTANCE
THE PRICE AT WHICH MAJORITY OF THE TRADERS FEEL THAT THE PRICES WILL MOVE
LOWER IS KNOWN AS A RESISTANCE LEVEL.
IT IS THE PRICE WHERE THE TRADERS FEEL THAT PRICES WONT RISE ANYMORE AND WILL
TAKE A U-TURN.

More the trading that takes place in the Support or

Resistance area, more significant it becomes.
Amount of time spent in the support or resistance area is
a sign of better confirmation.
Volume also acts as a pivotal point in determination of
better future prices and confirms better the support or
resistance levels.

A TREND REPRESENTS A CONSISTENT CHANGE IN PRICE.

WHEN A TREND BREAKS IT IS KNOWN AS A BREAKOUT. THE PRICE
THEN GENERALLY MOVES TOWARDS THE DIRECTION OF THE
BREAKOUT.
THERE ARE THREE KINDS OF TRENDS :1. UPWARD TREND
2. DOWNWARD TREND
3. SIDEWAYS TREND
TRENDS ARE AMONGST THE MOST SEEN PATTERNS ON A CHART

IT IS A BULLISH TREND COMPRISING OF A SERIES OF HIGHER PEAKS AND TROUGHS

IT IS A BEARISH TREND COMPRISING OF A SERIES OF LOWER PEAKS AND TROUGHS

IT IS A SERIES OF HORIZONTAL PEAKS AND TROUGHS. IT IS ADVISABLE NOT TO INVEST IN

STOCKS SHOWING SUCH A CHART PATTERN.

It is a simple trend analysis technique which

averages out the prices for a particular period of
time.
In short it is a Curving Trend line which helps in
identifying the beginning of a new trend line or
end of a old trend line.

It is only an indicator tool and not a leading

tool. It only reacts and never anticipates.

Moving averages can be Simple or Weighted

When the Closing Prices move above the Moving Average, a Buy signal
is generated and if it moves below the moving average, a Sell signal is
generated.
A Shorter period Moving average gives an early signal in comparison
to longer period average, it also generates lots of noise and whipsaws.
Using 2 averages to generate signals is called as Double Cross Over
Technique.
A Buy Signal is generated when the Shorter one crosses the longer one
and vice-versa.
5 and 20days (Popular among future traders), 10 and 50 days (Popular
among stock traders) moving averages are considered to be very
popular cross over periods.

Using 3 averages to generate signals is called as Triple

Cross Over Technique.
4-9-18 days moving averages are considered to be very
popular Triple Cross over periods.

The shorter the moving average period, more closer they

move towards the price. Thus in an uptrend, 4 day average
should be higher than 9 day average, and 9 day higher
than 18 day average and vice-versa in a down trend.

MOVING AVERAGE CONVERGENCE DIVERGENCE

THE MACD IS A TREND-FOLLOWING MOMENTUM INDICATOR THAT SHOWS
THE RELATIONSHIP BETWEEN TWO MOVING AVERAGES.
THE MACD IS THE DIFFERENCE BETWEEN A 26-DAY AND 12-DAY MOVING
AVERAGE. A 9 DAY MOVING AVERAGE KNOWN AS THE SIGNAL LINE IS
PLOTTED ON TOP OF THE MACD TO SHOW THE BUY AND SELL
OPPORTUNITIES.
THE BASIC MACD TRADING RULE IS TO SELL WHEN THE MACD FALLS BELOW
ITS SIGNAL LINE AND BUY WHEN IT RISES ABOVE THE SIGNAL LINE.
AN INDICATION THAT AN END TO THE CURRENT TREND MAY BE NEAR OCCURS
WHEN THE MACD DIVERGES FROM THE SECURITY. A BEARISH DIVERGENCE
OCCURS WHEN THE MACD IS MAKING NEW LOWS WHILE THE PRICES FAIL TO
REACH A THE LOW. THE EXACT OPPOSITE HAPPENS DURING A BULLISH
DIVERGENCE.

 Option analysis can be done by analysing the open interest of calls and
puts.

Higher the open interest, higher the support or resistance.

Change in open interest is one of the most important tool for option
analysis.

 The following series of Fibonacci numbers

1,2,3,5,8,13,21,34,55,89,144 as the following salient features:
a) The sum of any 2 consecutive numbers equals the next highest
number.
b) The ratio of any number to its next higher number approximates
to 0.618.
c) The ratio of any number to its next lowest number approximates
to 1.618.

d) The ratio of alternate number approaches to 2.618 or its inverse

0.382.

 The most commonly used percentage retracements are

61.8%, 38% and 50%.
In a strong trend, a minimum retracement is usually around
38% and in a weak trend, the maximum retracement is
around 62%. (Retracements are measured from bottom of
an uptrend to the top of an uptrend and vice-versa)
The diagram on the next slide has some areas of
retracements marked with arrows. These retracements
provide nice supports and resistances.

 Developed by John Bollinger.

Using Standard deviation, Upper and Lower bands are fixed above and below
the moving average. Generally they are plotted around a 20 day moving
average and standard deviation on the either side covers at around 95% of the
price data.
Prices are said to be overextended if they touch the upper band and are
considered to be oversold if they touch the lower band.

As standard deviation is a measure of volatility, the bands are self adjusting,

widening during volatile markets and contracting during calmer markets.
Sharp price changes tend to occur after the bands tighten, as volatility
lessens.
Bottoms and tops made outside the bands followed by bottoms and tops
made inside the band call for a trend reversal.
A move that originates at one band tends to go all the way to the other band.
This observation is useful when projecting price targets.

 RSI technique was developed by J.Welles Wilder.

It is the most popular and trusted Oscillator tool used by most of the
traders.
RSI = 100 100 / (1+RS)
RS = Average of x days UP close
Average of x days DOWN close
14days is popularly used for the calculation of RSI and 14weeks in case
of a Weekly chart being used.
The RSI usually tops above 70 and bottoms below 30. Thus above 70 it
is in an overbought position and below 30 it is in an oversold position.
It is one of the strongest technical indicator and a widely used one.

The various chart patterns that we will study include:

Head and Shoulders
Inverse Head and Shoulders
Triangles
Double/Triple top
Double/Triple Bottom
Wedges
Flags
Cup and Saucer
Hammer and Hanging Man
Doji
Shooting Star
Engulfing
Harami

 The Hammer and Hanging man candles have small real

body (whether green or red) and should have long
single sided shadow.
An HAMMER appears on a down trend at or near the
bottom which suggests that the market is hammering
out a base.
An HANGING MAN appears on an uptrend at or near
the top which suggests that the market is creating a
top. One must wait for a close under the Hanging
mans real body before becoming BEARISH.

 A Shooting Star is a top reversal line just like the

Hanging man. A Shooting Star displays a long upper
shadow and its small real body is at or near the lows of
the session.
A Shooting Star shows trouble overhead. Because of the
Shooting Stars long bearish upper shadow, we dont
need any confirmation like the Hanging man.
A Shooting Star is a bearish reversal signal and it must
appear during a rally (Uptrend).

The DOJI is a session in which the Opening and

Closing prices are the same. It resembles a
Cross.
Like a Spinning Top, Doji indicate a market in
complete balance between Supply and
Demand.
Doji represents market at a juncture of
indecision and it can be an early warning that
the preceding rally is losing steam.

Dojis are extremely powerful in calling market

tops, (especially after a long white candle) but
however sometimes lose signal in calling the
market bottoms.
A close over the Dojis high is a signal that bulls
have regained strength.
The Dojis are more powerful when they occur
rarely compare to its past history on a particular
chart.

THE DRAGON FLY DOJI:

It forms with the Open and Close near or at the highs
of the candle. This candle signals bullish implications.
It resembles a Hammer without a real body.
Dojis are generally not important at the declines, but
however Dragon Fly is an exception. In a oversold
market, Dragon fly Doji is a bullish signal.
OTHER DOJIS:
Dojis with longer upper and lower shadows are called
as Long Legged Dojis.
A Doji appearing on a rally is called as Northern Doji
and that on a decline is called Southern Doji.

THE GRAVE STONE DOJI:

It is the bearish counter part to the Dragon fly Doji.
The Grave Stone Dojis Open, Close and low resides at
the bottom of the candle.
Grave Stone Dojis are extremely powerful in calling
top reversals. If a Grave stone Doji appears on a
market top and the next candle falls to the downside,
it confirms the earlier Dojis Signal of market topping.

TYPES OF DOJIS

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 A bullish engulfing pattern consists of a large white real body that engulfs a small
black real body during a downtrend. It signifies that the buyers are overwhelming
the sellers.
The Engulfing pattern is a major reversal pattern comprised of two opposite colored
bodies. This Bullish Pattern is formed after a downtrend. It is formed when a small
black candlestick is followed by a large white candlestick that completely eclipses the
previous day candlestick. It opens lower that the previous days close and closes
higher than the previous days open.

 A bearish engulfing pattern, occurs when the sellers are overwhelming the buyers.
This pattern consists of a small white candlestick with short shadows or tails followed
by a large black candlestick that eclipses or engulfs the small white one.

 The Harami is a commonly observed phenomenon. The pattern is composed of a

two candle formation in a down-trending market. The color first candle is the same
as that of current trend. The first body in the pattern is longer than the second one.
The open and the close occur inside the open and the close of the previous day. Its
presence indicates that the trend is over.

 Bearish Harami is a two candlestick pattern composed of small black real body
contained within a prior relatively long white real body. The body of the first candle
is the same color as that of the current trend. The open and the close occur inside
the open and the close of the previous day. Its presence indicates that the trend is
over.
For a reversal signal, confirmation is needed. The next day should show weakness.

 It is a Bearish Signal.
A Head and Shoulders (Top) is a reversal pattern which occurs following an extended
uptrend forms and its completion marks a trend reversal. The pattern contains three
successive peaks with the middle peak (head) being the highest and the two outside
peaks (shoulders) being low and roughly equal. The reaction lows of each peak can
be connected to form support, or a neckline.

As the head and shoulders pattern unfolds, volume plays an important role in
confirmation. Ideally, but not always, volume during the advance of the left shoulder
should be higher than during the advance of the head. These decreases in volume
along with new highs that form the head serve as a warning sign. The next warning
sign comes when volume increases on the decline from the peak of the head. Final
confirmation comes when volume further increases during the decline of the right
shoulder.

 The double top resembles the letter M.

It is a term used in technical analysis to describe the rise of a stock, a drop
and another rise roughly of the same level as the previous top and finally
followed by another drop. A double top is a reversal pattern which occurs
following an extended uptrend. This name is given to the pair of peaks
which is formed when price is unable to reach a new high. It is desirable to
sell when the price breaks below the reaction low that is formed between
the two peaks.
Broken support becomes potential resistance and there is sometimes a test
of this newfound resistance level with a reaction rally.

 It is used to describe a drop in the value of a stock (index), bounces back

and then another drop to the similar level as the previous low and
finally rebounds again. A double bottom is a reversal pattern which
occurs following an extended downtrend. The buy signal is when price
breaks above the reaction high which is formed between the two lows.
A double bottom pattern becomes official when the reaction high is
penetrated to the upside, ideally accompanied by expanding volume.

 There are 3 types of triangles, namely:

a) SYMMETRICAL TRIANGLES.
b) DESCENDING TRIANGLES.

c) ASCENDING TRIANGLES.

SYMMETRICAL TRIANGLES:
Symmetric Triangles are also called as COILS
These triangles show 2 Converging trend lines, the Upper line descending and
the Lower line ascending.
The Vertical line measuring the height of the pattern is referred to as BASE.
(AB)
The point of intersection of the above 2 trend lines is called as the APEX. (C)
A close outside either of the trend lines, completes the pattern.

A
C

B
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ASCENDING TRIANGLES:
It is similar to that of a Symmetric Triangle with a rising lower line except for
the flat or horizontal Upper line.
The Vertical line measuring the height of the pattern is referred to as BASE.

The point of intersection of the above 2 trend lines is called as the APEX.
A close outside either of the trend lines, completes the pattern.
This is generally a Bullish Pattern.

B
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DESCENDING TRIANGLES:
It is similar to that of a Symmetric Triangle with a declining Upper line except
for the flat or horizontal Down line.
The Vertical line measuring the height of the pattern is referred to as BASE.
The point of intersection of the above 2 trend lines is called as the APEX.
A close outside either of the trend lines, completes the pattern.
This is generally a Bearish Pattern.

C
B
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 A Wedge is similar to that of a symmetric triangle both in terms

of its shape and time except for its slant.
A Wedge usually lasts more than 1 month but not more than 3
months.
A Wedge has a noticeable slant either to the upside or the
downside which is opposite to that of prior trend i.e. it slants
against the previous trend.
Wedges often occur within the existing trend and are usually
continuation patterns. However appearance of wedge at the top
or bottom signifies reversal of the trend.

A Wedge can either be a falling Wedge or a raising Wedge.

 A Falling Wedge is considered to be bullish and a raising wedge

bearish.
A raising wedge at the end of a top is an early signal of beginning
of a down trend.

A falling wedge at the bottom signifies end of the bear trend.

Whether a Wedge appear at the middle or end of the move, the
general rule of raising wedge is a bearish signal and a falling
wedge is a bullish signal should be kept in mind.

FALLING WEDGE (BULLISH):

E

C
A
G
D
B
F

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RAISING WEDGE (BEARISH):

D
B
F

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