Technical AnalyisWorkshop-Study Material[1]

7/21/2019 Technical AnalyisWorkshop-Study Material[1]

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Workshop on Computerised Technical Analysis of Stocks&

Techniques of Successful Trading!___________________________________________________________________________

Academy of Practical Technical Analysis Research & Training

Contents

Preface

Section I - Technical Analysis & Dow Theory

Chapter 1 Technical Analysis

Definition

History, Philosophy & Basic TenetsAdvantages & limitations of Technical AnalysisChart Construction - Types of Charts

Chapter 2 Dow Theory

Markets discount everythingDefinition of Trend - Uptrend, Downtrend, Sideways & Mixed TrendRetracement & ConsolidationBasic Structure of the Trend - Impulse & Corrective Waves

The Dynamic ImpulseDifferent Chart durations & their time frame validity

Section II - Technical Indicators

Chapter 3 Support & Resistance

DefinitionFactors determining Support & Resistance

Previous Important / Significant highs & lows Trend lines Fibonacci Retracement levels

Chapter 4 Breakouts & Breakdowns

DefinitionImportance of Volumes on Breakouts / BreakdownsConfirmation of a Breakout / BreakdownPullback & Final Thrust






Chapter 5 Continuation Patterns

Triangles Symmetrical / Ascending / Descending Wedges - Rising / Falling

Price & Time targets in respect of the above patterns

Rounding Bottoms / Cup & Handle patternFlags & PennantsHead & Shoulders

Chapter 6 Japanese Candlestick Reversal Patterns

HammerShooting Star / Inverse HammerHanging ManPiercing Pattern / Engulfing Bullish PatternDark Cloud Cover / Engulfing BearishTweezers Tops / Bottoms (Double Tops / Bottoms)Abandoned Baby Tops / Bottoms (Island Reversals)

Chapter 7 Moving Averages

Types - Simple / Weighted / ExponentialSignals in respect of Moving AveragesDifferent Combinations of Moving Averages

Chapter 8 Oscillators - Momentum Indicators RSI / StochasticsMACDOverbought & Oversold zonesNegative & Positive Divergence

Chapter 9 Trading SystemUnderstanding the Indicators and their strike rateChoosing between different Tools/IndicatorsCombining different Tools/Indicators for optimum resultsHow to form a Trade Set-upIngredients of a Successful Trade setup






Section III - Case Studies

Trade Setup I - Accumulation on a correction / fall

Trade Setup II - At Support / Resistance levels

Trade Setup III - At Breakouts / Breakdowns along with Continuation Patternsgiving Price & Time targets

Trade Setup IV - At Market Bottoms/Tops with a Japanese CandlestickReversal Pattern

Trade Setup V - Based on Moving AveragesTrade Setup VI - Based on Oscillators / Momentum Indicators

Trade Setup VII - Trading System combining the above

Section IV - Golden Rules of Trading






Preface

Stock markets are highly volatile. The sharp movements that occur in stock prices provide uswith great opportunities to make profits if one can time the markets. However, majority of thetraders find themselves on the losing side and end up making huge losses. This is mainly due tothe characteristics of the human mind viz. - Greed, Fear and Hope. Some people never bookprofits as they are greedy for more profits whereas some panic and book losses in the fear oflosing heavily only to see the stock move the way they had predicted after they have exited.The worst affected are those who are on the wrong side of the market trend but still hold on toa stock in the hope that their price levels will come sooner or later.

Technical Analysis is the art of predicting and forecasting future price trends based on thecurrent and the historical price data. It is a study of price charts along with volumes and isbased on demand & supply and also depicts the psychology of the masses. The charts take intoaccount everything that is likely to impact the prices, some of the factors being fundamentalreasons, stock specifics news / results, occurrence of events affecting some sectors / stocks,political events, natural disasters etc. To summarize Technical Analysis includes everythingthat can impact the prices, and the way the prices move indicate the future price trends or thedirection in which the stock prices are likely to move in the future.

The patterns made in the price charts depict the psychology of the masses and will work acrossall markets viz. equities, commodities, currency etc. Also patterns will work across all timehorizons i.e. patterns made during the earlier markets highs or lows are likely to be repeated,may be the price levels of the stocks can differ. Technical Analysis helps in spotting changes intrends and price patterns based on which one can take timely investment / trading decisions. Itis a very effective tool to time the markets i.e. determine the entry levels, the stop-loss as wellas the target levels. However, a word of caution here is that Technical Analysis is not infallible,as it is linked to the psychology of the masses and minds of people can be confused, fluctuatingand indecisive at times. At such times Technical Analysis may fail or may not give clearindications of the direction.

To generate positive returns from the stock markets on a consistent basis, just technicaltools and indicators are not enough. One needs a combination of Technical Indicators, aproper money management system and most importantly a sound psychological

conditioning of the mind. Also as a trader, one needs a well defined Trade Set-up basedon which one can determine the entry point in a stock, the stop-loss levels, the targetlevels (Risk to Reward ratio) and the approximate time horizon. This is an attempt tounderstand the age old as well as time tested theories of technical analysis in the contextof our markets & times and practically use it in our investment / trading decisions,thereby protecting our capital & generating better returns on the same.

ALL THE BEST!!






History, Philosophy, Basic Tenets of Technical Analysis

Technical Analysis is a study of the past price action to predict the future priceTrends. This means that the price of a share tells us as to how the share is going tomove in the future and any reasons, let it be Fundamental or Technical, that could leadto a rise or a fall in the share prices is reflected in the price of that share. To give asimple example if a company is going to post excellent results, this will be reflected inthe share price with a good rise which will be on account of insider buying. Similarly theopposite of this also is true. What we saw above was a fundamental factor responsiblefor the movement in the share prices. Besides these Fundamental factors there areTechnical Factors viz. the Laws of Demand & Supply which also could lead to sharpmovements in the share prices. These factors work on Mass Psychology and are closelylinked to the Human Mind. Under a given set of circumstances all minds tend to work inthe same direction. The theories of Technical Analysis are based on this concept andhence the share price movements can be predicted more often than not based on thesetheories .

Hence Technical Analysis is a subject which can successfully identify thebeginning of a sharp rise or fall in the share prices. However, it is incorrect to saythat Technical Analysis can predict or forecast all the moves correctly, as atcertain times the markets itself are undecided.

Though Technical Analysis is being practiced in the West as well as some Asiancountries like Japan for more than past 100 to 150 years, it has become popular in Indiaonly in the last 15 to 20 years.

To sum it up Technical Analysis:

A study of price charts along with volumes.

Is based on the law of Demand and Supply.

Works best in stocks that have a mass following.

Depicts the mindset of masses i.e. mass psychology.

The basic difference between Technical Analysis and Fundamental Analysis is that FAtries to find reasons for a stock to move up or down and based on the reasons predictsthe price movements whereas TA is not concerned with the reasons and it believes thatthe way a stock price moves currently tells you where it is heading for in the future.






Advantages of Technical Analysis:

It is independent of any news or occurrence of events as any of these arereflected in the stock price.

Most of the Fundamental information such as announcement of Results or anyother which affects the price of a share reaches a common Investor the last butan Investor following TA can get early signals based on price movements thoughhe may not know the exact nature of information.

Since TA is based on Mass Psychology which can change and is fluctuating attimes, Technical Analysis recommends use of Stop-losses which if strictly

implemented can save Traders and Investors from a much bigger loss in thefuture.

Limitations of Technical Analysis

If not backed by proper study of Fundamentals, TA cannot distinguish betweensmall moves and big moves as well as Stocks that move on support of masses andstocks that are manipulated by a few individuals or groups or so calledOperators.

Many a times Stop-Losses based on Technical Analysis get triggered in choppymarket conditions and the price moves back to its original level or as expected.

TECHNO - FUNDA - The Best Approach

Ideally one should use a combination of both Fundamental Analysis as well as TechnicalAnalysis to decide on an Investment strategy. Fundamental Analysis should be used to

spot stocks which have a potential to rise and Technical Analysis should be used todetermine the timing i.e. the entry and exit levels.






Chart Construction

The X-axis on a chart plots the periods for which prices are plotted and the Y-axis plotsthe value or the price of the share. This could range from a few hours to a few years.This means that prices can be plotted based on the prices that range from hours toyears. Thus we could have minute charts as well as hourly, daily, weekly, monthly,quarterly, yearly charts based on the above data.

Short Term Traders trade on the basis of daily charts as they are more interested in theimmediate movement in the stock prices, whereas Medium term to Long term Tradersare more dependent on weekly / monthly charts as they want more returns for whichthey are prepared to wait for a longer duration.

There are 3 types of charts which are commonly used by chartists. These are

1. Line charts: The closing prices are plotted on the graph and are joined to form aline.

2. Bar Charts: The Bar uses open / high / low / close for the session.3. Candlestick Charts: Also use open / high / low / close for the session.

The 4 quotes that are used to construct a Bar Chart or a Candlestick chart are in theorder of Open / High / Low / Close

Line Chart






In a Bar chart the open is indicated by a small hash (- ) which is drawn on the left side of

the Bar and the close by another hash on the right side of the bar.

BAR CHARTS

High High High OpenHigh

Open Close Close

Close Open Close Open

Low Low Low Low






CANDLESTICK CHARTS

In a Candlestick chart the real body i.e. the 2 ends of the body, show the opening and the

closing price for the given period. The lines at the top and bottom of the real body arecalled the shadows and they denote the high and the low for that session. The rectangleis called as the real body of the candle and it denotes the open and the close. The colourof the body denotes the open and the close of that session. If the open to close is on thehigher side i.e. it is a bullish candle and vice versa if the close is lower than the open it isa bearish candle. Generally the colors used to denote bullish candles are white, green orblue and the bearish candles are red or black.

Low

Open

High

Close Open

Close

Low

High






Dow Theory & Trend Analysis

Charles H. Dow after whom the “Dow Jones” Wall Street index in named is the founderof many theories and his contribution to the theory of Technical Analysis is immense.Even after so many years what he propagated is still valid and he is rightly termed asthe “Grandfather” of Technical Analysis.

Dow defines Trend as the direction in which the market moves. Based on the same wehave:

An Uptrend

A Downtrend A Sideways Trend

In an Uptrend the share prices move in the upward direction making new highs in theprocess. Hence the best indication of an Uptrend is the prices making a higher top – higher bottom.

H 4

H 3

Uptrend H 2

H 1 L4

L 3

L 2 L 1

As seen above prices make a higher top as well as a higher bottom and one should tryand buy on every correction in an uptrend.






In a Downtrend the share prices move in the downward direction making new lows inthe process. Hence the best indication of a downtrend is the prices making a lower top– lower bottom.

H 1

H 2L 1

Down Trend H 3

L 2 H 4

L 3

L 4

As seen above prices make a lower high as well as a lower low and one should try and

sell on every rise.

In a Sideways trend the share prices move in a narrow band , neither going upward nordownward. One should wait for a cleat cut breakout and not trade in a sideways trend.

Sideways Trend

Dow has also defined Trend in terms of time, viz.

Primary (Major) - 1 to 3 yearsSecondary (Intermediary) - 6 to 12 monthsMinor - 3 to 6 months

However, a trader should decide his own trading timeframe and accordingly decidewhich charts to use.






Time frame validity of different charts

Time frame validity means the time frame for the signals spotted in the charts ofdifferent durations hold good. Normally a signal spotted is valid for around 5 to 8 timesof its duration. This means that a signal in a daily chart is valid for the next around 5 to 8days, and the expected move should begin in that time frame.

Period Seen Valid ForDaily Charts At the end of the Day Short term

( 4 - 6 Days)

Weekly Charts At the end of the Week Medium Term(4 - 6 Weeks)Monthly Charts At the end of the Month Long Term

(4 - 6 Months)Intraday (60 Mins) During the day Short Term

(1 - 2 Days)Intraday (30 Mins) During the day Intraday Trades

(2 - 3 Hrs)

Importance of Volumes

Volumes lead prices. If prices start moving up on high volumes, there is a very goodchance that this rise will be sustained. However, it very important to understand wherethe volumes have occurred and the price movement that that has taken place along withthe volumes.

Broadly one can conclude that:

Price Action InterpretationPrice Rise with high volumes Bullish

Price Rise with low volumes Not so Bullish

Price Fall with high volumes Bearish

Price Fall with low volumes Not so Bearish






Though the above is true and applicable in normal situations, there are some exceptionsand at extreme points i.e. at highs where the prices have already moved up sharply andat lows when the prices have fallen sharply this logic may not work.

Hence, if one sees a good price rise at an important bottom with a significant rise involumes, one can go long. However, one must take the average volume for the past 5 to8 sessions and not for just one session as that can lead to a whip-saw (false signal).

High volumes at significant Bottoms and Breakouts normally indicate the Trend.However prices can fall on not so high volumes and hence at significant market tops onemay not always see high volumes which may follow later. However, breakouts orbreakdowns which indicate a further continuation of a move have to be normallyaccompanied by high volumes.






Theory of Support & Resistance

Theory of Support and Resistance

A stock is said to have taken Support at a price level when in a downward move, it stopsand moves in the upward direction. Vice-versa a stock is said to have taken Resistanceat a price level when in an upward move, it stops and moves in the downward direction.

SUPPORT RESISTANCE

Ideally in an Uptrend one should buy or go long on every fall at a significantsupport level and in a Downtrend one should sell or go short on every rise at asignificant resistance level.

Following are the tools for Support and Resistance.

Previous Significant Highs and Lows

Trendlines

Retracement Levels

Significant highs and lows are those levels from where the markets have moved up orhave fallen down sharply in the past. When the stock prices test these levels anytime inthe future, they will act as strong support and resistance levels.

A Trend line is another excellent tool which gives us important Support and Resistancelevels. A trendline is a line joining 2 or more significant highs or lows or 2 importantprices, which gives important support and resistance levels.

Trend lineSupport

Trend lineResistance






Basic Rules for drawing Trendlines

Trendlines are lines drawn by joining 2 significant points on the chart.

The angle of a good Trendline should be from 0 to 45 degrees.

Support is when a share price touches a Trendline and moves up.

Resistance is when a share price touches a Trendline and moves down.

One should Buy when the price takes support on the Trendline and moves up &Sell when the price meets with resistance at a Trendline and moves down.

Channel Lines are 2 parallel lines within which the price of a share moves in asideways trend. They are very effective in a sideways market and also when thetrend changes from sideways to either direction.

Retracement is the correction that occurs in the price of a share. In a falling marketthe retracement will be in the upward direction and in a rising market it will be in thedownward direction.

A B

61.8% R 38.2% S

50%R50%S

38.2% R

61.8% S






Normally it is seen that 38.2 %, 50 % and 61.8 % are good retracement levels and themarkets have a tendency to take support in case of an uptrend and face resistance incase of a downtrend at or around these levels. These levels also give an indication of thecurrent trend or a likely change in the same. Although the retracement levels workmore often than not, there could be times where the prices may move beyond thenormal retracement levels.

Consolidation is a process where the prices move sideways or in a range before a bigmove is likely to commence. It is like that the market is taking a breather before a bigmove is about to commence. The move after consolidation is normally in the direction ofthe prevailing trend.






Breakouts and Breakdowns

Breakout is the phenomenon where the prices move upwards out of a rangebreaking an important resistance level in the process. Normally a breakout is to besupported by high volumes and it indicates a further up move in that stock.

Breakdown is the phenomenon where the prices move downwards breaking animportant support level in the process. Normally a breakdown is to be supported byhigh volumes and it indicates a further down move in that stock.

Pullback is the tendency of the share prices to come back towards the Trend lineafter a breakout or a breakdown and is a precursor to a big / dynamic move that isto follow.

Support becomes Resistance and Resistance becomes Support on a breakout /breakdown of a Trend line.

A Breakout or a Breakdown has to be supported by high volumes and theabsence of it may lead to loss of momentum and failure of the pattern.






Continuation Patterns Patterns are formations on charts which can be identified by a set of similarcharacteristics which occur time and again. Patterns reflect the mindset of the masses atthat point of time and work very well in trended markets.

Continuation Patterns are patterns which occur in continuation of a move. They showthe continuation of the trend. Needless to say that one can get an entry when a part ofthe move is already over and not at the beginning of a move. The best thing aboutcontinuation patterns is that, once the pattern is confirmed these patterns give a senseof the targets in terms of price as well as time and they work accurately most of thetimes. Though one gets an entry based on a continuation pattern not exactly at thebeginning of a move, the targets come very fast in most of the continuation patterns.

Symmetrical Triangle Breakout






Symmetrical Triangle Breakdown

Rising Wedge: A Wedge is a sloping triangle. In case we have a break down from anupward sloping triangle it is termed as a rising wedge. All the other properties oftriangles remain the same for a Rising Wedge. A Rising Wedge at or near the market top

is very bearish and a sharp decline in the prices is likely once the prices break downfrom the rising wedge.

Rising Wedge Breakdown






Falling Wedge: In case we have a breakout from a downward sloping triangle it istermed as a Falling Wedge. All the other properties of triangles remain the same for aFalling Wedge. A Falling Wedge at or near the market bottom is very bullish and a sharprally in the prices is likely once the prices break out from the rising wedge.

Falling Wedge Breakout

Head & Shoulders Pattern:

This pattern resembles the anatomy of the human body. I.e. two shoulders and the headwith the head placed on the two shoulders. Head & Shoulders pattern occurring at amarket top is a strong downward reversal pattern. The Trend line joining the twoshoulders and the head is termed as the neckline.

The target after the breakdown and the pullback, in case there is one, is equal to thelength measured from the neckline to the top of the head. The same length is measureddownside from the neckline level or the pull back towards the neckline, whichever ishigher. The target of price movement of C to D in the diagram shown below is equal to

the price movement of A to B. Head and Shoulders pattern at significant market tops canlead to trend reversal from bullish to bearish and as such is also termed as a reversalpattern.






Head & Shoulder pattern

Inverse Head & Shoulder Pattern

The Inverse Head & Shoulder pattern is exactly opposite of the Head & Shoulderspattern and occurs at market bottoms. The Inverse H & S is an upward reversalpattern. The Trendline joining the two shoulders and the head is termed as theneckline.

The target after the breakout and the pullback, in case there is a pull back, is equal to thelength from the neckline to the bottom of the head. The target of price movement of C toD in the above case is equal to the price movement of A to B. Inverse Head & Shoulderspattern at significant market bottoms can lead to a trend reversal from bearish tobullish and as such is also termed as a reversal pattern.






Flags / Pennants:

Flags & Pennants appear in the continuation of a move. Normally after a steep rally or afall the markets pause momentarily or consolidate before the move begins again in thesame direction.

Flag Breakout Pennant Breakout

The difference between a flag and a pennant is that, in a flag there is a rectangle and in apennant there is a triangle after the flagpole which resembles the sharp rally or the fallbefore the consolidation.

The targets for both patterns are measured similarly. The length of the flagpole is

replicated once the breakout or the breakdown occurs and the target measured fromthe breakout / breakdown point is equal to the length of the flagpole.






Flag Breakdown Pennant Breakdown






Japanese Candlestick Reversal Patterns

The Japanese have been using candlesticks since around 3 centuries and traders wereusing the same to trade in rice and paddy. Candlestick patterns have become popular inthe West and then in India in the last 20 to 25 years and they provide a lot of variety incharting. Though there are hundreds of candlestick patterns, the primary patterns areimportant and keep repeating time and again and also work very effectively in ourmarkets.

We will cover the bullish patterns at market bottoms and the corresponding bearishpatterns at market tops.

Hammer (Bullish at Market Bottoms)






Inverted Hammer (Bearish at Market Tops)

Inverted Hammer – Long Upper Shadow,very small Body, no Lower Shadow

Bearish Patterns (at Significant Market Tops)

Shooting Star (Bearish at Market Tops) - Resembles an Inverted Hammerbut appears after a big bullish candle with a gap between the two bodies







Hanging Man (Bearish at Market Tops) - Only on confirmation of the low of thehammer being broken on a closing basis


HangingMan

Sell on Closingbelow the low of the

Hanging Man

Piercing Pattern (Bullish at Market Bottoms)

Piercing Pattern(cutting into 50% or more of the 1 st body)

Bullish Patterns (at Significant Market Bottoms)






Dark Cloud Cover (Bearish at Market Bottoms)


Dark Cloud Cover(covering 50% or more of the 1 st body)

Bullish Engulfing Pattern (Bullish at Market Bottoms)

Bullish Engulfing Pattern(engulfing the 1 st body fully)







Bearish Engulfing Pattern (Bearish at Market Tops)


Bearish Engulfing Pattern(engulfing the 1 st body fully)

Morning Star Pattern (Bullish at Market Bottoms)

MorningStar


Cutting into 50% or more of the 1 st body






Evening Star Pattern (Bearish at Market Tops)

EveningStar


Cutting into 50% or more of the 1 st body

Tweezers Bottoms (Double Bottoms - Bullish at Market Bottoms)


Tweezers Bottoms






Tweezers Tops (Double Tops - Bearish at Market Tops)


Tweezers Tops

Bullish Island Reversals (Bullish at Market Bottoms) - Also termed asAbandoned Baby Bottoms

Island Reversals

At Significant Market Bottoms






Bearish Island Reversal (Bearish at Market Tops) – Also termed asAbandoned Baby Tops

Island Reversals

At Significant Market Tops

Combinations of Doji (Bearish at Market Tops)


Gravestone Doji Harami Cross






Spinning Tops (Bearish at Market Tops)


Spinning Top






Theory of Moving Averages

Moving Averages theory is the most conventional theory and is used by most Analystsvery successfully. Though at times the Moving Averages give late signals, but they aresafe and work more often than not and help us determine the trend of the market.

Commonly used Moving Averages are

Simple Moving Average (SMA) Weighted Moving Averages (WMA) Exponential Moving Averages (EMA)

SMA gives equal weightage to all the data.

WMA gives more weightage to the latest data.

EMA has the best of both and covers a larger period of time. It is the most popular as ithelps spot early signals.

Ideal combinations for different durations of charts.

Most Traders prefer a combination of 3 MA s for confirmation.

Some of the common combinations used are:

13 / 34 / 55 - For a move in 15 to 30 trading sessions.



1 hour/ 3 hours / 5 hours - For Intra-Day to 1 day.

Moving Averages theory is a confirmatory theory and is criticized on the count thatmany a times it gives late signals but the positive thing is that it gives confirmed signals.






MOVING AVERAGE TRADING SYSTEM WITH A 3 TO 4 WEEKS VIEW

For a buy signal

Buy I

Buy II

Book

profit

55 Days EMA

34 Days EMA

13 Days EMA

Trading System based on Moving Averages

Buy Signal for 15 to 30 days time frame:

MAs used –13 / 34 / 55

Signals from MA s.

3 MA s should be almost parallel and equidistant and turning upwards.

The 3 MA s should be in the Ascending order i.e. lowest MA at the bottom, andhighest MA at the top.

The first signal to buy (Anticipatory) is when the price cuts the Short term MAfrom the bottom.

The second signal to buy (Confirmatory) is when the Short term MA cuts theLong term MA from the bottom which confirms that the trend is going tocontinue.

When the 2 nd MA line cuts the third MA line, though the trend continues toremain up, a good correction normally occurs and one should book profits.

In case the trend changes in between, the Short term or the lowest MA will turndown. If this happens one should exit the stock.






When the trend changes from up to down.

For a Sell Signal

Sell Signal for 15 to 30 days time frame:

Sell I

Sell II

BookProfit

55 Days EMA

34 Days EMA

13 Days EMA

MAs used –13 / 34 / 55

3 MA s should be almost parallel and equidistant and turning downwards.

The 3 MA s should be in the order such as the lowest MA at the top, and highestMA at the bottom.

The first signal to sell (Anticipatory) is when the price cuts the Short term MAfrom the top.

The second signal to sell (Confirmatory) is when the Short term MA cuts theMedium term MA from the top.

When the 2 nd MA line cuts the third MA line, though the trend continues toremain down, a good correction normally occurs and one should book profits.

In case the trend changes in between, the Short term or the lowest MA will turnup. If this happens one should exit the stock.






Sell

3 Days EMA

8 Days EMA

EMAs used –3 / 8

Sell Signal for 3 to 5 Trading Sessions:

Buy

3 Days EMA

8 Days EMA

EMAs used-3 / 8

Buy Signal for 3 to 5 Trading Sessions:






Oscillator Analysis

Oscillators or momentum indicators as that are called at times give an advanceindication of change in trend. Oscillators are drawn along with the price to spot signals.

Some commonly used Oscillators are

RSI (14 E 9) -Relative Strength Index

STOCHASTICS (% K 5, % D 3, E 3)

MACD (9 24 E 9) - Moving Average Convergence Divergence

The most common of the above is the RSI and the Stochastics. Between these two, manytraders prefer the Stochastics as it is smoother and does not turn too often. Also it helpsspot smaller moves. MACD gives good signals but late signals.

STOCHASTICS (% K 5, % D 3, E 3)

The 2 dotted lines are the overbought and oversold zones.

The Oscillator has 2 lines. One is the Oscillator line and the other is the trigger line.

When the Oscillator goes above the overbought zone, it means that a lot of buying hastaken place and that a downward correction may be overdue. Similarly when theOscillator goes below the oversold zone, it means that a lot of selling has taken placeand that an upward correction may be overdue.

The overbought and oversold zones are normally 70 and 30 in the RSI and 75 and25 in the Stochastics. However, they are indicative and can be changed as per thestock as well as the market conditions.






Signals based on the Oscillators

1.

DivergenceNegative Divergence

Sell in the overbought zone when there is a Negative Divergence between theprice and the Oscillator. I.e. the price making a higher top but Oscillator making alower top.






Positive Divergence

Buy in the oversold zone when there is a Positive Divergence between the price

and the Oscillator. I.e. the price making a lower bottom top but Oscillator makinga higher bottom.






2. Crossover

Sell Sell

BuyBuy

RSI 14 E 9 (in daily charts)

Oscillator Line Trigger Line

Over Bought

Over Sold

Buy in the overbought zone when the Oscillator line cuts the trigger line frombelow on the first day.

OR

Sell in the overbought zone when the Oscillator line cuts the trigger line fromabove on the first day

An Oscillator gives early signals but it also gives many whipsaws (falsesignals). To avoid this it should be used along with patterns and otherindicators and not in isolation.






Successful Trading System

It is very important to understand the use of each Indicator and also where theIndicator works or fails. More so the combination of the tools or the indicators which ifused together in combination gives extremely positive results. This is what a successfultrading system is. It should be able to determine the extent of the move and be able todistinguish between a normal move and a dynamic move which can give phenomenalreturns. It should also determine the point of entry and the stop-loss levels which willdetermine the risk to reward ratio in a trade. If one is right on these parameters, thetrade is bound to be to be successful as the psychological or the mental makeup of atrader is positive and helps him implement the trade in a confident manner.

To conclude, a successful trading system is a combination of technical tools orindicators, the financials as well as the right trading psychology which goes a long wayin the execution of a trade.

Stop-Loss

The word Stop-loss means stopping a further loss. It means that one should square ofthe deal if it goes against him as it would save a further bigger loss. That means a traderwho has a long position has to keep his stop-loss at a price which is lower than that.

Similarly a trader carrying a short position should have his stop-loss at a higher level.Stop-losses are ideally meant to protect a trader or an investor from a sudden change oftrend of the markets in general or a stock in particular.






Different Techniques of placing Stop-losses

There are specific points where a trader should place the stop-loss.

1. Below the bottom of a move in case of a buy and Above the top of a move in case of a sell

Stop-Loss

Sell

Buy

Stop-Loss

2. Above or Below the Trendline in case of a breakout

Stop-Loss Trend line

Buy

Stop-Loss

Trend line

Sell






Concept of Trailing Stop-losses

The concept of trailing stop-loss works extremely well in a clearly trended market.

Trailing stop-loss means changing ones stop-loss with the move and avoiding the risk ofa sudden movement against the direction in which one is trading. The main advantageof a trailing stop-loss is that one does not end up booking profits very early in a dynamicmove and gets the benefit of almost the full move and gets out when there could be achange of trend.

Trailing Stop-Loss in an Upward Move

Trailing Stop-Loss in a Downward Move

OriginalStop-loss

2nd Trailing S-L

1st Trailing S-L

3rd Trailing S-L

4th

Trailing S-L

1st Trailing S-L

2nd Trailing S-L

3rd Trailing S-L

4 th Trailing S-L

OriginalStop-loss






Formulating a Successful Trading System

“A Trader must create a system or be enslaved by another man’ssystem.” - William Blake

A Trading system is a combination of technical tools or indicators, the financials as wellas the right trading psychology which goes a long way in the execution of a trade.

If one does not get those parameters on which the system is based one should refrainfrom trading in the market at that point of time. Most of the traders lose money becausethey indulge in random trading based on their instincts.

A trader must be disciplined enough not to have a go at the markets on a hearsay or arandom basis. He has to have a reason which should ideally be supported by the pricepatterns.

Based on the Technical parameters one can develop his own trading system based onthe tools he prefers. An example of an ideal trading system is given below:

A reversal pattern at the right place : A right place for a reversal pattern is at a

significant market top or a bottom. This can be identified by a rise of around 8 /13 or 21 days from an important high or a low. Also if one is buying or sellingafter a correction, one must also ensure that the pattern has occurred at theretracement level of at least 50 %.

Risk to Reward ratio of 1: 3 on every trade spotted : One cannot time themarket to perfection all the time and end up buying at bottoms and selling attops. Hence a good strategy has to be formed to supplement the Technical signalsone generates. At times a trader can end up losing money even if his call is rightbut is not supported by the right trading strategy and vice versa. One has to buy

or sell in such a way that his R to R ratio is always 1: 2 or more. Trendline Support or Resistance / Breakout or Breakdown supported by

strong volumes along with a continuation pattern.

Japanese Candlestick Reversal Patterns.

A Signal based on Moving Averages.

A signal based on Oscillators.






Section III - Case Studies

Trade Setup I - Accumulation on a correction / fall

Trade Setup II - At Support / Resistance levels

Trade Setup III - At Breakouts / Breakdownsalong with a Continuation Pattern giving Price & Time targets

Trade Setup IV - At Market Bottoms/Tops with a Japanese Candlestick ReversalPattern

Trade Setup V - Based on Moving Averages

Trade Setup VI - Based on Oscillators / Momentum Indicators







Trade Setup I - Accumulation on a correction / fall based on Volumes

Fig.1.1 MTNL Weekly Chart - Oct 1999

Fig.1.2 Bhel Monthly Chart - Nov 2000

Rise in Prices

Rise in Volumes

Fall in Prices

Rise in Prices

Rise in Volumes






Fig.1.3 India Bulls Daily Chart - Oct 2007

Fig.1.4 Unitech Weekly Chart - March 2009

Rise in Prices

Rise in Volumes

Rise in Pricesafter consolidation

Rise in Volumes






Trade Setup II - Buy / Sell at Support / Resistance levels

Fig.2.1 SBI Weekly Chart - 1998-99

Fig.2.2 Reliance Daily Chart - March 2009

Multiple Resistances

Multiple Supports






Fig.2.3 ACC Daily Chart - June - July 2009

Fig.2.4 Renuka Sugars - Daily Chart 2008

Multiple Supports

Resistance 1 Resistance 2






Trade Setup III - At Breakouts / Breakdowns along with a Continuation Patterns

Fig.3.1 Infosys Daily Chart - March - May 2006

Fig 3.2 Reliance Capital Daily Chart - March - May 2008

Breakdown

Likely TGTafter

Breakdown

Breakdown

Likely TGT






Fig 3.3 BSE Sensex Monthly Chart -2003

Fig 3.4 Nifty Daily Chart - 2008

TimeTGT

Likely TGT

Triangular Formation

Rising WedgeBreakdown






Fig 3.5 Nifty Daily Chart - 2002

SymmetricalTriangular

Breakout

Breakout‘V’ Pattern

RoundingBottom






Fig 3.6 Tata Motors Weekly - 2009

Fig 3.7 Oriental Bank - Weekly 2009

Inverse H&SBreakout

‘V’ Pattern

Breakout






Fig 3.8 Reliance Capital - Daily Sept 2007

Fig 3.9 Cummins - Weekly chart August 2009

Inverse H&SBreakout






Fig 3.10 BSE Sensex - Daily chart August 2007

Fig 3.11 Vijaya Bank - Daily chart May 2009






Fig 3.12 Tata Motors - Weekly chart June - July 2009

Trade Setup IV - At Market Bottoms/Tops withJapanese Candlestick Reversal Patterns

Fig 4.1 BSE Sensex Weekly Chart -2004






Fig 4.2 Nifty Daily Chart - Oct 2008

Fig 4.3 Reliance Weekly Chart - 2008/2009






Fig 4.4 BSE Sensex Daily Chart - Feb 2007

Fig 4.5 BSE Sensex Daily Chart - Feb 2007






Fig. 4.6Tata Motors Weekly Chart - July 2007

Fig 4.7 Hind Oil Exploration Weekly Chart - May 2006






Fig 4.8 Balrampur Chini Weekly Chart - March - Aug 2007

Fig 4.9 BSE Sensex Daily Chart - April 1999






Fig. 4.10 BSE Sensex Daily Chart - Feb 2008






Trade Setup V - Based on Moving Averages

Fig 5.1 Nifty Weekly Chart – March 2009






Fig 5.2 SBI Weekly Chart - March 2008

Fig 5.3 Nifty Daily Chart - July 2009






Fig 5.4 Reliance Capital Daily Chart - Jan 2009






Trade Setup VI - Based on Oscillators / Momentum Indicators

Fig 6.1 BSE Sensex Weekly Chart - Nov 2007 - Jan 2008

Fig 6.2 Nifty Daily Chart - March - April 2003






Fig. 6.3 Nifty Daily Chart - March - April 2003

Fig 6.4 SBI Weekly Chart - Dec 2006






Fig 6.5 Nifty Daily Chart - July - Sept. 2009

Fig 6.6 SBI Daily Chart - Jan 2009







Fig 7.1 Nifty Weekly Chart - Jan 2008

Fig 7.2 L&T Monthly Chart - Mar - Jun 2009






Section IV – Golden Rules of Trading

Trend is your Friend!!

“Trend is your Friend” Always Trade in the direction of the Trend withreasonable stop - loss levels and never against it. As a Trader one isconcerned about the Trend for the next 4 to 5 days. If, after a continuousrise or a fall for a few days some reversal patterns appear, one can takethis as a trading opportunity.






Ride on Profits & Cut Losses

“Ride on Profits & cut losses” If a trading decision is right one canpartly book profits partly & wait for more gains depending upon inwhich phase of the settlement one is in. However, if one is caught onethe wrong side, it is better to square of rather than wait for things tohappen in your favour. However, if one is certain and has decided the

stop – loss levels, one should not panic and reverse the decision in haste.






Don’t be too Greedy!!

“Do not be too Greedy” Even though one is one the right side of theTrend and one should ride the trend one should not get too greedy andbook profits at pre-decided target levels.






Take Trading decision Yourself!!

“Take Trading decisions yourself” and do not listen to others. Also donot be biased while analyzing if one has already taken a position.






Always be Flexible!!

“Always be Flexible” This means that if one is following a certain trendor a pattern and if there is a change in the Trend and if one is convincedabout it, he should immediately reverse his position rather than waitingfor things to happen. In fact one should be so fast that he should changeand trade in the direction of the Trend.






Don’t be a compulsive Trader!!

“ Do not be a compulsive Trader” Trade only when you sense anopportunity and not as a matter of habit as this can lead to heavy losses.





Make use of all the Trading Tools!!

“Make use of all the Trading Tools” for and do not be over dependenton any particular tool or be biased towards or against any particulartool. No one Technique or Tool seen above is more important or less

important than the others. All are equally important. Different Toolswork better than other & give different results at times. Ideally oneshould use a combination of Japanese Candlesticks Patterns /Trendlines as well as previous significant levels for Support &

Technical AnalyisWorkshop-Study Material[1]

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