Technical analysis

TYPES OF ANALYSIS

Fundamental Analysis

Study fundamental factors

Technical Analysis

Study Price action alone

Fundamental vs. Technical

• Demand/Supply

Analysis

• Gather news

• Examine economy

data

• Study the related

industry

• Study related markets

• Study the cause of

market movement

• Study the price action

• Study historical and current

price movements

• Compare the current price

movements with the

historical price movements

• Use this comparison as a

tool to forecast future price

action

• Study the effect i.e.

historical price movement

Fundamental Analysis Technical Analysis

DOES TECHNICAL ANALYSIS WORK?

DO WE HAVE A CHOICE?

Good technical analysis is perhaps the only tool which gives an individual / a common man a decent chance vis-à-vis the professional / commercial organizations!!

FUNDAMENTAL V/S TECHNICAL

The fundamentalists study the

cause of market movement

While

The technicians study the

effect!!

Fundamental Analysis -

Components

1. Economic Analysis

2. Industry Analysis

3. Company Analysis

Purpose : To assess the Intrinsic value

of shares. Enable Value Investing

Economic Analysis factors

GDP, GNP

Monetary Policy

Inflation

Interest Rates

International Influences

Fiscal policy

Budget deficits

FDI

FII

Government

spending

Exports

Tax policy

Money flow

Cross-border

investments

NRI investments

Industry Analysis - Factors

Industry life cycle

Product life cycle

New entrants

Competitor threat

Market behaviour

Employment data

SEZ

Exports, Imports

Company Analysis Factors

Brand identity

Product diversification

Pricing

Accessibility of inputs

Financing / funding

New ventures

Purchasing power

Consumer behaviour

Profitability ratios

Liquidity ratios

Turnover ratios

ROE /ROI

Leverage ratios

Capital structure

Cash inflows

Capital assets

Growth / solvency/ efficiency ratios

Technical Analysis-

Is it required?

Martin J. Pring, goal of technical analysis is “to

identify a trend and ride with it until enough

evidence proves that the trend has reversed

direction”

market action does take into account every aspect

/ factor (such as demand- supply situation, other

fundamentals, political factors, psychology of

investors, sentiments, emotions, weather

conditions, etc.)

INTRODUCTION

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.

Basically, Technical analysis is a tool to study price action alone.

Technical Analysis

Technical Analysis is not concerned with the intrinsic value of a share or commodity future.

It deals with the forces of Demand & Supply as reflected in the behavior of the market.

It is a study of predicting future price movements, based on the earlier price movements in the scrip .

It is a study of Prices with Charts being the Primary Tool.

BASIC ASSUMPTIONS:

Theory of Technical Analysis is based

on three basic premises:

Market Action discounts everything.

Prices move in trends. Trends tend to

persist!

History repeats itself.

DOW THEORYOriginated by Charles Dow

Founder of the Dow Jones Company and editor of Wall Street Journal

Mr. Charles Dow is known as the Father of Modern Day Technical Analysis.

In 1897, Charles Dow developed two broad market averages.

The "Industrial Average" included 12 blue-chip stocks (Dow Jones Industrial Average)

“Rail Average" INCLUDED 20 railroad enterprises. (Dow Jones Transportation Average).

The Dow Theory is the ancestor of most principles of modern technical analysis.

This theory was first stated by Dow in a series of columns in the Wall Street Journal between 1900 and 1902.

Dow (and later Hamilton and Rhea) believed that market trends forecast trends in the economy.

BASIC TENETS OF DOW

THEORY

Averages by discounting everything.

The market has three basic trends.

Major Trend has three phases

Volume must confirm the trend.

A trend is assumed to be in effect till it gives definite signals that it has reversed!

DOW THEORY - BASIC TRENDS

Primary TrendCalled “the tide” by Dow, this is the trend that defines the long-term direction (up to months or even years). Primary trend is the major underlying trend in the market.

Secondary / Intermediate TrendCalled “the waves” by Dow, this is medium term movements or departures from the primary trend (weeks to months)

Minor Trend (Day to day fluctuations)Called “ripples” by Dow they generally show nervousness with rapid up or down swings. Not significant in Dow Theory

TRENDS

DOW THEORY - BASIC

TRENDS

EXPLAINING BASIC

TRENDS

Up trendline

Down trendline

Elliot Wave theory

Ralph Nelson Elliot developed the

concept in the 1930s.

collective investor psychology (or crowd

psychology) moves from optimism to

pessimism and back again in a natural

sequence.

These swings create patterns, as

evidenced in the price movements of a

market at every degree of trend

Elliot Wave

In the first small

five-wave

sequence,

waves 1, 3 and 5

are motive, while

waves 2 and 4

are corrective.

look at charts of

market action

and identify any

completed five-

wave and three-

wave structures

Elliot wave

THE TREND LINES

The trend line is the simplest of all technical tools

Some basic rules on trend line applications:

Trend lines should touch at least two points (highs or

lows) and possibly be confirmed by a third point.

The breaking of a trend line is the best signal that the

market has changed direction.

The longer the trend line stays intact and the more

times the trend line is tested signifies the strength of

the underlying trend.

It is important to note that the steepness of a trend line

has a major significance to the underlying trend.

Support and resistance line

PLOTTING A TREND LINE

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Union Bank Of India

Plotting a Trend Line -

Join Any 2 Consecutive Bottoms

to plot a Trend Line to judge an Uptrend.

OPoint No 2

OPoint No 1

Union Bank (45.6000, 46.5000, 45.1500, 45.3500, -0.30000)

Trend Lines

There are three basic

kinds of trends:

An Up trend where

prices are generally

increasing. (Bullish)

A Down trend where

prices are generally

decreasing. (Bearish)

A Trading Range.

(Range bound trend)

UPTREND:

Higher tops and

higher bottoms.

DOWNTREND:

Lower tops and

Lower bottoms.

SIDEWAYS:

Narrow range

movements.

ALL TREND LINES CAN BE MEASURED

IN DEGREE USING A SIMPLE COMPASS.

Prof. A. G. Mendhi

Line 1- Steep Line – Up trend is rising too

fast & not favorable.

Prof. A. G. Mendhi

45 degrees- This line is the most preferred -signifies a more

stable trend where prices are moving at a reasonable speed

Flat trend Signifies the general

uncertainty of a trend-less market.

SUPPORTS AND RESISTANCES

SUPPORT:

In some measure, the word support is self-explanatory. It signifies important reaction to lows or troughs. It is that region where the demand is high enough to overcome supply pressure. More often than not, a support level is identified by a previous low.

RESISTANCE:

It is the opposite of support and represent a price level where selling pressure overcomes buying pressure and a price rise is turned back. Quite often, a resistance level represented is identified by a previous peak.

HOW TO MEASURE THE SIGNIFICANCE OF SUPPORT AND RESISTANCE LEVELS?

1. The time spent there

2. Volume of activity

3. Whether the S&R level is recent

SUPPORT LINE

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Union Bank Of India

Plotting a Trend Line -

Extend The Line As The Price Moves Further

This Line Will Now Act As A Good Support

OPoint No 2

OPoint No 1

h

h

Support Level

Or Buying Level

Support Level

Or Buying Level

Union Bank (45.6000, 46.5000, 45.1500, 45.3500, -0.30000)

RESISTANCE LINE

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RESISTANCE

MCX - Turnear

Turnear (1,710.00, 1,725.00, 1,687.00, 1,697.00, -52.0000)

Channel Line : Support & Resistance

SUPPORT AND

RESISTANCE

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12100SILVER 1 KG - 1 MONTH (10,409.00, 10,430.00, 10,251.00, 10,282.00, -110.000)

CONSOLIDATION AND

BREAKOUT

Look out for breakouts from a long consolidation / range bound phase for good opportunities.

1. Longer the phase of consolidation, more significant the breakout,

2. Market may retreat to earlier position hence, wait to reconfirm the breakout and

3. Watch the volumes to avoid false breakouts.

TYPES OF CHARTS

Line Chart

Bar Chart

Point and Figure chart

Japanese Candle Stick ChartImportant price information should

cover high, low, open and close

prices

LINE CHART

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GOLD 10GM - 1 KG - 1 MONTH (6,268.00, 6,287.00, 6,268.00, 6,276.00, +9.00000)

For plotting line charts only one price field can be used – preferably close

Drawing Bar ChartsEach bar is composed of 4 elements:

Open

High

Low

CloseNote that the candlestick body is empty (white) on up days, and filled / solid (black or some color) on down days

Open

Close

High

Low

Standard

Bar Chart

Japanese

Candlestick

Open

Close

High

Low

Standard

Bar Chart

Japanese

Candlestick

Bar chart

Chart PAttern

A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future price movements.

Chartists use these patterns to identify current trends and trend reversals and to trigger buy and sell signals.

A reversal pattern signals that a prior trend will reverse upon completion of the pattern.

A continuation pattern, on the other hand, signals that a trend will continue once the pattern is complete.

Continuation and Reversal

PatternsHead & Shoulders

Inverted Head &

Shoulders

Triple Tops

Triple Bottoms

Double tops

Double Bottoms

Cup and HAndle

Symmetrical

Triangles

Ascending Triangles

Descending

triangles

Flags

Pennants

Gaps

Trend Reversal pattern – Head

& Shoulder ; inverted head &

shoulder

Double Tops and Double

Bottoms

Triple Tops and Triple

Bottoms

Bullish Continuation pattern –

cup and handle

Rounding bottom / saucer

bottom – long term reversal

pattern

Triangles

The symmetrical triangle is a pattern in which two trendlines converge toward each other.

In an ascending triangle, the upper trendline is flat, while the bottom trendline is upward sloping. This is generally thought of as a bullish pattern in which chartists look for an upside breakout.

In a descending triangle, the lower trendline is flat and the upper trendline is descending. This is generally seen as a bearish pattern where chartists look for a downside breakout.

Triangles

Pennant and flag

Pennants have converging trendlinesduring their consolidation period and they last from one to three weeks

a flag resembles a parallelogram (or rectangle) marked by two parallel trend lines that tend to slope against the prevailing trend.

The pennant, however, is identified by two converging trend lines and more horizontal which resembles a small symmetrical triangle

Flag and Pennants

Wedge

A technical chart pattern composed of

two converging lines connecting a series

of peaks and troughs.

Falling wedges indicate temporary

interruptions of upward price rallies.

Rising wedges indicate interruptions of a

falling price trend.

Falling Wedge – continuation or

reversal

Point and figure chart – double

top

Point & Figure charts use rising columns of X's and descending columns of O's to represent these price movements.

double top buy signal occurs when a column of Xs, which are used to note rising prices, exceeds the top of the previous X column.

Point and figure – Double

bottomA double bottom sell signal is given when a column of Os, which show declining prices, falls one box below the previous O column.

Point and figure chart

Candlesticks

the candlestick has a wide part, which is called the "real body".

This real body represents the range between the open and close of that day's trading. When the real body is filled in or black, it means the close was lower than the open.

If the real body is empty, it means the opposite: the close was higher than the open.

candlesticks

candlestick

If the upper shadow on the filled-in body

is short, it indicates that the open that

day was closer to the high of the day.

A short upper shadow on a white or

unfilled body dictates that the close was

near the high.

Candlestick signals

"long black body" or "long black line". The long black line represents a bearish period in the marketplace.

the "long white body", or "long white line"-opposite of long black body

Spinning Tops are very small bodies and can be either black or white.

It shows a very tight trading range between the open and the close, and it is considered somewhat neutral.

SPINNING top

If a spinning top formation is found after a

prolonged uptrend, it suggests that the bulls

are losing interest in the stock and that a

reversal may be in the cards.

On the other hand, if this formation is found

in an defined downtrend, it suggests that the

sellers are losing conviction and that a

bottom may be forming.

long bulling candles in August

1999 to March 2000 – dotcom

bubble

the stock opened near the low of the day and closed near the high.

Hammer – when a security trades significantly lower than its opening, but

rallies later in the day to close either above or close to its opening price.

Cadlestick signals

A hammer occurs after a security has been

declining, possibly suggesting the market is

attempting to determine a bottom.

If a stock opens down and the price drops

throughout the session only to come back

near the opening price at close, it is called a

hammer.

The tail is twice as long as the body

Inverted Hammer

(bullish)

Shooting Star (bearish)

The Hammer (bullish)

and Hanging Man

(bearish) patterns are

formed with a single

candlestick. The real

body is small and can be

either color. The lower

shadow is long...

typically, three times the

length of the real body.

HAMMER chart

Hanging man chart

Shooting star

Hanging Man

After three days a rising price, the

hanging man appears; on the following

day, the stock price drops by more

than 20%

Hanging man

Rising Three Methods

a very bullish chart.

It shows an upward trend on

day one with investors

taking a few trading

sessions to relax to prepare

for the next rise in price that

occurs on the fifth day.

Even though the pattern

shows us that the prices are

falling for three straight

days, a new low is not seen

and the bulls prepare for the

next leg up.

Bullish Mat Holdbegins with a long white day

and then, on the second day

of trading, the issue gaps up

and is a black day.

The second, third, and fourth

days see the issue falling off

slightly but not trading

outside the range of the long

white day on day one.

Finally, the last day in the

pattern is another long white

day that closes above the

close of the first long white

day.

Doji

Dojis form when a

security's open and close

are virtually equal.

A doji candlestick looks

like a cross, inverted

cross, or plus sign.

Alone, doji are neutral

patterns.

Long –legged doji

A type of candlestick formation where

the opening and closing prices are

nearly equal despite a lot of price

movement throughout the trading day.

This candlestick is often used to signal

indecision about the future direction of

the underlying asset.

Suggests a shift in the direction of the

trend may be coming.

Evening staran early indication that the

uptrend is about to reverse.

A bearish candlestick pattern consisting of three candles :

1. The first bar is a large white candlestick located within an uptrend. 2. The middle bar is a small-bodied candle that closes above the first white bar.3. The last bar is a large red candle that opens below the middle candle and closes near the center of the first bar's body.

Morning starearly indication that the

downtrend is about to reverse.

A bullish candlestick pattern

that consists of three candles

1. The first bar is a large red

candlestick located within a

defined downtrend.

2. The second bar is a small-

bodied candle that closes

below the first red bar.

3. The last bar is a large

white candle that opens

above the middle candle and

closes near the center of the

first bar's body.

Morning star

DOJI EVENING STAR

Tristar

signals a reversal in the current trend. This pattern is formed when three consecutive dojicandlesticks appear at the end of a prolonged trend.

a bearish tri-star pattern at the top of the uptrend and is used to mark the beginning of a shift in momentum.

a series of three consecutive doji candles leads to a sharp reversal of the given trend

HARAMIAn excellent

pattern for

indicating a trend

change or pause

is the Harami.

the second real

body must form

completely inside

the first. The color

of the second

candle needs to

be the opposite of

the first.

HARAMI - BullishHarami Candlestick

pattern will forecast short-

term price reversals.

Harami bullish

HARAMI - BEARISH

HARAMI - BEARISH

Piercing LineThe Piercing Line

(bullish)

engulfing pattern except

the second candlestick

should close at least

halfway into the real body

of the first

Dark Cloud Cover

(bearish

Piercing line chart

DARK CLOUD COVER

Engulfing pattern

Engulfing pattern. It

is characterized by

the second day's

real body completely

engulfing the first

day's.

Engulfing -bullish

Engulfing bearish

Technical Tools

Moving Averages

Price Patterns

Indicators

MOVING AVERAGE

ANALYSISMoving averages are used to provide a smooth reference

point for

Individual Assets

Market indices

Commodity prices

Interest rates

Foreign exchange rates

Changes each day are noted.

○ Most recent day is added and oldest day is dropped

MOVING AVERAGES

Three types of moving

averages-

1. Simple Moving Average,

2. Linear Weighted Average and

3. Exponential Average

Example of simple moving average

DAY PRICE CALCULATION SMA

1 440

2 446

3 461

4 446

5 463 (440+446+461+446+463) / 5 451.2

6 458 (446+461+446+463+458) / 5 454.8

7 472 (461+446+463+458+472) / 5 460.0

8 470 (446+463+458+472+470) / 5 461.8

9 464 (463+458+472+470+464) / 5 465.4

10 476 (458+472+470+464+476) / 5 468.0

11 481 (472+470+464+476+481) / 5 472.6

LINEAR WEIGHTED AVERAGE

Day Weight Price Weighted

1 1 100 100

2 2 1 120 240 120

3 3 2 110 330 220

4 4 3 130 520 390

5 4 135 540

Total 10 1190 1270

So a 4 day weighted moving average 119 127

(= 1190 / 10 = 119.00)

More Weight is given to the latest data

& Less Weight is given to the past data.

Used for Long term Averages.

TYPES OF AVERAGES

Linearly weighted average gives higher weight to recent prices and less weight to old prices and average is taken.

This still has the disadvantage of covering only the length of the average itself (acceptable to commodity futures which have limited life).

Exponentially smoothed average does not have this drawback.

SMOOTHING FACTORTO CALCULATE A SMOOTHING

FACTOR FOR FIVE DAY EM AVERAGE:

DIVIDE 2 BY 6

Smoothing Factor will be 0.33

For six days average, the smoothing factor

will be 2 divided by 7 i.e. 0.29

For ten days average, the smoothing factor

will be 2 divided by 11 i.e. 0.18 and so on…..

Example of 5 day Exponential Moving

Average

DAY PRICE CALCULATION EMA

1 440 Start 440.00

2 446 441.98

3 461 448.26

4 449 448.50

5 463 453.29

6 458 454.84

7 472 460.50

8 470 463.64

9 464 463.76

10 476 )] 467.80

11 481 472.15

STRATEGY USING MOVING

AVERAGES

31

November

7 14 21 28 5

December

12 19 26 2

2006

9 16

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BUY

SELLNCDEX - Gold KG - N

GOLD KG-N (8,015.00, 8,025.00, 7,970.00, 8,004.00, -29.0000)

Example of Moving averages:

Long & Short Moving

Averages

Prof. A. G. Mendhi

March April May June July August September

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P

OP

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SYSTEM BUYS WHEN 3 PERIOD MOV AVG CROSSES 18 PERIOD

DENOTED BY AN UP ARROW

SYSTEM SELLS ON VICE VERSA DENOTED BY A DOWN ARROW

PalmOil (1,466.00, 1,474.00, 1,460.00, 1,470.00, -8.0000)

CALCULATING RSI

• As with any relative strength study, the RSI compares today’s closing prices with prices over the past x days; the price comparison is relative to itself! More specifically the relative comparison is achieved by comparing x number of day up averages to x number of day down averages. These up and down averages uncover the direction of the strength in the market.

• 100

• RSI = 100 – --------

• 1+RS

• Average of 14 day’s close UP

• Where.. RS = --------------------------------------------------

• Average of 14 days close DOWN

Prof. A. G. Mendhi

Prof. A. G. Mendhi

Indicators

Indicators are used in two main ways: to confirm price movement and the quality of chart patterns, and to form buy and sell signals.

There are two main types of indicators: leading and lagging. A leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price movement.

Oscillators

Oscillator indicators have a range, for

example between zero and 100, and

signal periods where the security is

overbought (near 100) or oversold (near

zero).

MACD

Stochastic

RSI

RSI

CML vs SML

The CML is a line that is used to show the rates of return, which depends on risk-free rates of return and levels of risk for a specific portfolio. SML, which is also called a Characteristic Line, is a graphical representation of the market’s risk and return at a given time.

2. While standard deviation is the measure of risk in CML, Beta coefficient determines the risk factors of the SML.

3. While the Capital Market Line graphs define efficient portfolios, the Security Market Line graphs define both efficient and non-efficient portfolios.

4. The Capital Market Line is considered to be superior when measuring the risk factors.

5. Where the market portfolio and risk free assets are determined by the CML, all security factors are determined by the SML.

CML

SML

REFERENCES:Technical Analysis of the futures markets by John J. Murphy (New York Institute of Finance)

Technical analysis explained by Martin J. Pring

Getting started in Technical analysis by Jack D. Schwager

Technical Analysis for the Rest of Us By Clifford Pistolese Publisher: Tata McGraw Hill

Numerous websites of commodity exchanges – training modules

Commodity futures & options – a step-by-step guide to successful trading by George Kleinman

Inter market Technical Analysis - Trading Strategies for the Global Stock, Bond, Commodity, and Currency Markets by Wiley

Thank You and Best wishes for

your internal exam

QuestionsDistinguish Fundamental and Technical

analysis

Write brief notes on a)Economic analysis b)

Industry analysis c) company analysis

Explain the types of charts and chart patterns

applied in Technical analysis

Describe Dow theory and Eliot wave theory

Explain in detail the candlestick patterns and its

signals.