5 Technical Analysis

8/22/2019 5 Technical Analysis

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TECHNICAL ANALYSIS


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TECHNICAL ANALYSIS

Alternative approach to predicting stock pricebehavior

The technician does not consider value in thesense in which the fundamentalist uses it. Thetechnician believes the forces of supply anddemand are reflected in patterns of pr ice andvo lumeof trading.

By examination of these patterns, he predictswhether prices are moving higher or lower, andeven by how much. In the narrowest sense, the

technician believes that price fluctuation reflectlogical and emotional forces.

He further believes that price movements,whatever their cause, once in force persist for someperiod of time and can be detected.


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IMPORTANCE OF VOLUME

Volume is simply the number of shares or contracts

that trade over a given period of time, usually a day.

The higher the volume, the more active the security.

To determine the movement of the volume (up or

down), chartists look at the volume bars that canusually be found at the bottom of any chart. Volume

bars illustrate how many shares have traded per

period and show trends in the same way that prices

do.


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IMPORTANCE OF VOLUME CONTD


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Volume is an important aspect of technical analysis

because it is used to confirm trends and chart

patterns. Any price movement up or down with

relatively high volume is seen as a stronger, more

relevant move than a similar move with weakvolume. Therefore, if you are looking at a large

price movement, you should also examine the

volume to see whether it tells the same story.


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Say, for example, that a stock jumps 5% in one

trading day after being in a long downtrend. Is this a

sign of a trend reversal?

This is where volume helps traders. If volume is

high during the day relative to the average daily

volume, it is a sign that the reversal is probably for

real.

On the other hand, if the volume is below average,

there may not be enough conviction to support atrue trend reversal.


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Volume should move with the trend. If prices are

moving in an upward trend, volume should increase

(and vice versa). If the previous relationship

between volume and price movements starts to

deteriorate, it is usually a sign of weakness in thetrend.

For example, if the stock is in an uptrend but the

up trading days are marked with lower volume, it is

a sign that the trend is starting to lose its legs andmay soon end.


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VOLUMEAND CHART PATTERNS

The other use of volume is to confirm chart patterns

In most chart patterns, there are several pivotal

points that are vital to what the chart is able to

convey to chartists. Basically, if the volume is not

there to confirm the pivotal moments of a chart

pattern, the quality of the signal formed by the

pattern is weakened


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VOLUME PRECEDES PRICE

Another important idea in technical analysis is that

price is preceded by volume. Volume is closely

monitored by technicians and chartists to form

ideas on upcoming trend reversals. If volume is

starting to decrease in an uptrend, it is usually asign that the upward run is about to end


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DOW THEORY

Charles H. Dow formulated a hypothesis that the

stock market does not perform on a random basis

but is influenced by three distinct cyclical trends

that guide its general direction. By following these

trends, he said, the general market direction can bepredicted. Dow classified these cycles as primary,

secondary and minor trends. The primary trend is

the long-range cycle that carries the entire market

up or down.


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DOW THEORYCONTD.

The basic proposition in the Dow Theory is

relatively simple. A bull market is in process when

successive highs are reached after secondary

corrections and when secondary upswings advance

beyond previous secondary downswings

The theory also requires that the secondary

downswing corrections will be of shorter duration

than the secondary upswings. The reverse of these

propositions would be true of a bear market


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DOW THEORYCONTD.

The classical Dow Theory utilizes both the industrial

average and the transportation average in

determining the market position. When both

averages are moving in the same direction, valid

indicators of a continuing bull or bear market areimplied.


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PRIMARY TREND

The security price trend may be either increasing , it is called Bull Market.


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TREND LINES


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TREND

Trend is the direction of movement-it can be

increasing trend(Bullish), decreasing trend

(Bearish) and flat trend.

It represents the emotions ,sentiments of the

players in the market.


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TREND REVERSAL

The raise or fall in the share price cannot go on for

ever

The share price movement may reverse its

direction

Before the change of direction certain pattern in

price movement emerges

Change in the direction of the trend is shown by

violation of the trend line. If the scrip price cuts the

trend line from above it signals the possibility of the

fall in price


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PRIMARY TREND

Security price behavior shows an increasing or

decreasing trend

In the BULLISH market

Each peak is higher than the previous peak

Each bottom is higher than the previous bottom

In the BEARISH market

Each peak is lower than the previous peak

Each bottom is lower than the previous bottom


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SECONDARY TREND

Also known as intermediate trend

Moves against the main trend and leads to

correction

This corrects the over bought and over sold position This takes less time than the primary trend and

generally a lot quicker


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MINORTREND

Relate to day to day price fluctuations

It tries to correct the secondary trend movement

Considered to be of less significance to a chartist

than primary and secondary trend These three concepts of primary ,secondary and

minor trends form the basic foundation of Technical

Analysis


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SUPPORT LEVEL AND RESISTANCE

LEVEL

Support level exists at a price where there is a

reversal of the demand supply position

Resistance level exists at a price where there is a

reversal of demand supply position

This signifies that the share price cannot rise

beyond the resistance level

At the resistance level price , there will be more of

supply than demand and hence a reversal in trend

will take place


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GROUND RULES OF TECHNICAL

ANALYSIS

Rule 1: Market action discounts everything

The market price of the shares of a Company is

the culmination of all the factors affecting the

fortunes of the business of that company

Players in the market act upon any change in the

fundamental factors of a security by buying or

selling the shares

Any news that is awaited or has been received or

any new information about the company is

reflected in the market price. This is by means of a

demand / supply shift

If demand rises, the price goes up; if supply rises,

prices fall


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ANALYSIS Contd.

Rule 1: Market action discounts everything(contd.)

Technical analysts believe that whatever changes

occur in the fundamentals of a company, they are

discounted in the market.

By the time one tries to analyse what causes prices to

change rumours of war, merger news, etc. the

prices would have already changed. Further, trying to

forecast a price by analysing the fundamental factors is

too unwieldy, as there are just too many factors to beanalysed


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ANALYSIS CONTD

Rule 2: Prices move in trends and trends persist

Technical analysts believe that prices continue to move

in a certain direction unless some event occurs to

change its direction .Thus, technical analysts believe

that prices do not move in a random manner.

It has to be noted that the supply and demand balance

sets the trend in motion.

This trend does not change, unless the balance in the

demand / supply undergoes a change. This is aptly put

in the maxim The trend is yourfriend


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ANALYSIS CONTD

Rule 3:History repeats itself

Technical analysts believe that markets repeat

themselves. This belief is based on the fact that, it

is people who drive prices and market is the

reflection of the actions of the participants

Investors and traders tend to react in a similar way

every time an event occurs. These reactions

become transactions in the market place, which

tend to repeat.


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CHARTS

The basic tool of a technician is the price chart.

Charts can be made for different time horizons

depending on the use the technician wants to put it

to, ranging from a day to a week to a month

Accordingly, charts can be daily, weekly or monthly

depending on the time horizon for which we need to

apply the various technical analysis tools


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PRICE BAR CHART

A Bar is formed by joining the highest price and the

lowest price of a particular sale by a vertical line.

The closing price of the day is marked by a

horizontal mark on this vertical line


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LINE CHARTS

These charts are made up of closing prices.

Line Charts have time on the X-axis and price on its

Y-axis


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TOOLS OF TECHNICAL ANALYSIS

Moving Average

An average is the sum of prices of a share over

some weekly periods divided by the number of

weeks. This point is market on the latest date for

which a price bar has been plotted. This process is

repeated for the previous dates. The points thus

obtained are connected together to give the Moving

Average line


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HOWTOCALCULATE MOVING AVERAGE

Week Closing Price Total of Price for five weeks 5-week average=total/5

1 22

2 25

3 26

4 24

5 28.5 125.5 25.1

6 29 132.5 26.5

7 28 135.5 27.1

8 26.5 136 27.2

9 27.5 139.5 27.9

10 25 136 27.2

11 23.5 130.5 26.1


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WHATDOTHEMOVINGAVERAGESDEPICT

Moving Averages smoothen out the apparent erratic

movement of share prices and highlight the

underlying trend

In an Exponential Moving Average, more weight is

given on the most recent data and less weight isgiven to the older data


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EXPONENTIAL MOVING AVERAGE CHART


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MACD

MACD stands for

Moving Average Convergence /Divergence

MACD is a useful indicator for spotting major

changes in trend

MACD is a trend following momentum indicator

used to signal trend changes and to indicate trend

direction

Signals are generated by crossovers and

divergence from price


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MACD CONTD

The MACD method, developed by Gerald Appel, is a trending

indicator, telling us whether a stock is in an uptrend or a

downtrend. The direction of the long-term trend is the first

assessment you should make of any market. If it is

trending up, you want to be long (buying). If it is trending

down, you want be short (selling)

The simplest version of this indicator is composed of two lines:

the MACD line, which is the difference between two

exponential moving averages (EMAs) and a signal line, which

is an EMA of the MACD line itself. The signal or trigger line is

plotted on top of the MACD to show buy/sell opportunities.

Gerald Appel's MACD method uses a 26-day and 12-day

EMA, based on the daily close, and a 9-day EMA for the

signal line


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MACD CHART


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TOOLS OF TECHNICAL ANALYSIS CONTD...

Rate-of-Change (Momentum)

It indicates the rate of change of the price as compared to the

price a certain period back

ROC depicts the speed of upward or downward movements of

the price ahead of the price movement ROC is a price momentum or velocity indicator.

A rising ROC indicates a bullish increasing momentum

A falling ROC indicates a bearish decreasing momentum

ROC should always be used in conjunction with reversalsignals on the price chart.

ROC is a momentum indicator that measures velocity and

also leads the price action


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CALCULATIONOFRATE-OF-CHANGE

WEEK Closing Price Price Seven weeks ago Ratio of the two prices ROC=Ratio less 1

1 49

2 50

3 52

4 54

5 55

6 56

7 56 49 1.14 0.14

8 55 50 1.1 0.1

9 54 52 1.04 0.04

10 48 54 0.89 -0.11


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ROC CHART


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RSI

Relative Strength index(RSI)

The RSI is a momentum indicator, or oscillator, that

measures the relative internal strength of a market

(not against another market or index).

As with all oscillators, RSI can provide early

warning signals but should be used in conjunction

with other indicators.

Divergences are the most important signal provided

by RSI

The Relative Strength Index (RSI) can provide an

early warning of an opportunity to buy or sell


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RSI CONTD

Relative Strength index

This index emphasizes market moves before they

occur.

When the price of a stock advances, the closing

price is higher than the closing price of the previous

day. When the price of the stock declines, the

closing price is lower than the closing price of the

previous day.

However, the rise or fall of a market is not smooth.During the rising phase, the price falls several

times, while during the falling phase, the price rises

several times.


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Relative Strength index Contd

Relative Strength Index tells us whether the net

difference between the closing prices is increasing

or decreasing.

During the rising phase of the market, the prices

move up fast, and the differences between the

recent close and the previous close are large.

When the market reaches the top, these differencesreduce. When the market declines, the different

again become large


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Relative Strength index Contd.

RSI = 100 [100/ (1+RS)] Where

RSI = Average of 14 weeks up closing pricesAverage of 14 weeks down closing prices

This is powerful indicator and pinpoints buying and

selling opportunities ahead of the market. It ranges

in value from 0 to 100.

Values above 70 are considered to denote

overbought conditions, and values below 30 are

considered to denote oversold conditions.

If the RSI has crossed the 30 lines from below toabove and is rising, a buying opportunity is

indicated. If it has crossed the 70 lines from above

to below indicates a selling opportunity


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RSI CHART


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oscillator

The values of the 10-week moving average are

subtracted from the values of the 2-week moving

average. These differences are plotted on a

horizontal zero line


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What help does an Oscillator give?

An Oscillator is an excellent indicator of overbought

/ oversold conditions.

Values above the zero line indicate that buying is in

progress, while values below the zero line indicate

that selling is in progress. When the Oscillator

moves from negative to positive, it shows a

possible buying opportunity. When the Oscillator

moves down from the positive towards thenegative, it indicates that selling may be considered

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