Week 11 Technical Analysis.pdf

8/10/2019 Week 11 Technical Analysis.pdf

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Technical Analysis


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Technical Analysis

Technical analysis differs significantly from fundamental

analysis.

Technical analysis is a controversial set of techniques for

predicting market direction based on

Historical price and volume behavior

Investor sentiment

Technical analysts essentially search for bullish (positive)

and bearish (negative) signals about stock prices or market

direction.


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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.


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Chartism

Chartists use bar charts, line charts, candlestick, or

point and figure charts to look for patterns which may

indicate future price movements.

They also analyze volume and other psychological

indicators (breadth, % of bulls vs % of bears, put/call

ratio, etc.).

Strict chartists dont care about fundamentals at all.


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Bar Chart


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Japanese Candlestick


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Point and Figure Chart


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Drawing the Charts

Each bar is composed of 4elements:

Open

High

Low

Close

Note that the candlestick body isempty (white) on up days, andfilled (some color) on down days

In a bar chart the close is markedon the right and the open on theleft side of the bar. Open

Close

High

Low

Standard

Bar Chart

Japanese

Candlestick

Open

Close

High

Low

Standard

Bar Chart

Japanese

Candlestick


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Bar Chart


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Japanese Candlestick


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Drawing Point & Figure Charts

Point & Figure charts areindependent of time.

An X represents an up move.

An O represents a down move.

The Box Size is the number ofpoints needed to make an X or O.

The Reversal is the price changeneeded to recognize a change indirection.

XXXXX

OO

XXXX

OOOO


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Breakout in a rounding bottom


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Head and Shoulders Pattern


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Wedge Pattern


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A Triple Top Pattern


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Triangle Pattern


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Nov to Mar

Trading range

Double

bottom

Descending

triangles

Gap, should

get filled


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Chart Formations

Once a chart is drawn, technical analysts examine it for various formationsor pattern types in an attempt to predict stock price or market direction.

One example is the head-and-shoulders formation.

When the stock price pierces the neckline after the right shoulder is

finished, it is time to sell.


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Dow Theory

Dow Theory on stock price movement is a form of technical

analysis. The theory was derived from 255 Wall Street Journal

editorials written by Charles H. Dow (18511902), journalist,

founder and first editor of the Wall Street Journal and co-

founder of Dow Jones and Company along with Edward

Jones, and Charles Bergstresser. Following Dow's death,

William Peter Hamilton, Robert Rhea and E. George

Schaefer organized and collectively represented "Dow

Theory," based on Dow's editorials. Dow himself never used

the term "Dow Theory," nor presented it as a trading system.


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Dow Theory

The Dow theory is a method that attempts to interpret and signal changes inthe stock market direction.

The Dow theory identifies three forces:

a Primary Direction or trend,

a Secondary Reaction or (corrections), and

Daily (minor) fluctuations.

Daily fluctuations are essentially noise and are of no real importance.


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Dow Theory

Primary Trend Called the tide by Dow, this is the trend that defines the long-term

direction (up to several years). Others have called this a secular bullor bear market.

Secondary Trend

Called the waves by Dow, this is shorter-term departures from theprimary trend (weeks to months). These are basically the correctionstaking place in the market due to over-pricing or under-pricing of thesecurities.

Minor Trends

Day to day fluctuations which are not significant in Dow Theory


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Primary Trend

The security price trend may be either increasing or decreasing.

When the market exhibits the increasing trend, it is called bullmarket and when it exhibits a decreasing trend it is called bearmarket.


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Primary Trends


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Phases Market Trends in Dow Theory

Major market trends are composed of three phases: an accumulation phase, apublic participation phase, and a distribution phase.

The accumulation phase (phase 1) is a period when investors "in the know" are

actively buying (or selling) stock against the general opinion of the market.

During this phase, the stock price does not change much because these investors

are in the minority absorbing (or releasing) stock that the market at large is

supplying (or demanding).

Eventually, the market catches on to these astute investors and a rapid price

change occurs in the public participation phase (phase 2). This occurs when

trend followers and other technically oriented investors participate. This phase

continues until rampant speculation occurs.

At this point, the astute investors begin to distribute their holdings to the market in

the distribution phase (phase 3).


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Market Indicators

There are various technical indicators that help in determining the

movement of the overall market. The overall market movements affect

the individual share prices. These indicators are price and the volume oftrade.

A series of technical indicators used by traders to predict the direction of

the major financial indexes are called the market indicators. Most

market indicators are created by analyzing the number of companies that

have reached new highs relative to the number that created new lows.


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Market Indicators

Some of the most common market indicators are:

Volume of Trade

Advance/Decline Index

Breadth Index

Short Sales

Odd-lot Trading etc.


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Market Indicators

Volume of trade: Charles Dow gave special importance to the volume of

a market. Volume of trade expands along with the bull market and

narrows down with the bear market.


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Market Indicators

Breadth of the Market: The term breadth of the market is often used to study

the advances and declines that have occurred in the stock market. Advances

means the number of shares whose prices have increased from the previous

days trading. Declines indicate the number of shares whose price have fallen

from the previous days trading. Its is a comparatively easy indicator to

construct and study as the data required for it can be easily derived from the

business newspapers.

The net difference between the number of stock advanced and declined

during the same period is the breadth of the market. A cumulative index of net

differences measures the market breadth.


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Breadth of Market

Day Advances Declines Net Breadth BSE Index

21.02.2000 1486 774 712 712 5876.89

22.02.2000 1310 966 344 1056 5883.33

23.02.2000 898 1225 -327 729 5642.46

24.02.2000 1108 1091 17 746 5810.17

25.02.2000 931 1279 -348 398 5623.08

In the above table it can be seen that there is a definite degree of

positive correlation between the breadth of the market and the index of

the market


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Short Sales

Short selling is a technical indicator, which refers to the selling of shares

that are not owned. The bears are the short sellers who sell now in the

hope of purchasing at a lower price in the future to make profits. Whenthe demand for a particular share increases, the outstanding short

positions also increases and it indicates future rise of prices. These

indicators cannot be exactly correct but they depict the general situations.


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Odd Lot Trading

Shares are generally sold in a lot of hundred. Shares, s old in smaller lots,

fewer than 100 are called odd lot. Such buyers and sellers are called odd

lotters. The ratio between the odd lot purchase and odd lot sales(purchase

% sales) is the odd lot index. If odd lot purchase is more than the odd lot

sales then the index will rise and if the odd lot selling is more than the odd

lot buying then the index will fall.

Professional investors do not trade in odd lots. They are also technically

strong. So, if there are more number of odd lotters in the market then the

market sentiments are said to be technically weak.


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Relative Strength Index (RSI)

RSI was developed by Wells Wilder. Identifies the inherent technical strength and weakness of a particular scrip or

market. RSI can be calculated for a scrip by adopting the following formula

RSI =

RS =

If the share price is falling and RSI is rising, a divergence issaid to have occurred.

Divergence indicates the turning point of the market.

100100

1 Rs

+

Average gain per day

Average loss per day


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Week 11 Technical Analysis.pdf

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