Technical Analysis Overview

INTRODUCTION TO

TECHNICAL ANALYSIS OF STOCKS BY DEVESH C NANKANI (BCA , MBA)

IF NOT THE GODS…… PUT THE ODDS ON YOUR SIDE ! !

SECURITIES ANALYSIS The two facets

❚ Fundamental Analysis ❚ Technical Analysis

Searching the Future from the Past “The

Future is nothing but the past entering through another door”

What is Technical Analysis ❚ TA is the study of past price / volume movement of a trade-able security done with the purpose of estimating the expected price movement in the foreseeable future. ❚ The “Raw material” for this study is PRICES - Open , High , Low , Close and Volumes

Technical Analysis Where is it used? ❚ ❚ ❚ ❚

In In In In

the the the the

FOREX Markets COMMODITIES Markets EQUITY Markets BULLION/ METALS Markets

WHY Technical Analysis ? ❚ Gives one a ‘feel’ of the direction of price movement ❚ Helps traders and investors alike, to reevaluate their investment decision faster ❚ Brings in a systematic and often rational approach to the investment process ❚ Give an advanced warning signal of an impending reversal ❚ ‘Corrects’ the deficiency of not being ‘close’ to the management

BASIC ASSUMPTIONS OF T.A

❚ Markets discounts everything ❚ Markets move in a Trend ❚ History repeats itself What we learn from History is that we never learn from History

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Types of price charts ❚ Closing Price Chart (Line Chart) ❚ Bar Chart - depicting the OHLC as a Bar ❚ Japanese Candlesticks Chart depicting OHLC as a Candle

The Paradox of Periodicity ❚ The paradox as we may call it is that a particular period's chart is actually to be used for trading in the next higher trading period. ❚ This means that a daily chart (chart which plots daily price data) should actually be used for weekly (medium term) trading and NOT for daily trading

Bull and Bear MarketsPhases and features PHASES OF A BULL MARKET Phase I - Revival of Confidence Phase II Improvement in Corporate earnings Phase III - Speculation PHASES OF A BEAR MARKET Phase I - Abandonment of Hope Phase II - Slackness in Business Phase III - Distress selling

Defining a TREND ❚ An Up trend is said to occur when prices are generally going higher with small “corrections” on the opposite (down) side Higher High and Higher Low formation ❚ A Down trend is said to occur when prices are generally going lower with small “corrections on the opposite (up) side. Lower High and Lower Low formation ❚ A flat trend indicates oscillating prices

Up trend definition

TREND REVERSAL ❚ A trend is said to be reversed when the basic conditions defining the trend are broken. ❚ For instance : An up trend is said to be broken when prices fail to make higher highs and higher lows (which is the basic condition of an up trend)

Down trend defn and reversal

Drawing Trendlines ❚ When the trend is up , the trend line, which represents support to prices, is drawn by joining the “higher lows” ❚ When the trend is down , the trend line, which represents resistance to prices, is drawn by joining the “Lower Highs”

Support and Resistance Levels ❚ A support level is the price area where prices are likely to find buying interest when they are in a falling/ corrective mode ❚ Similarly a resistance level is the price area where prices are likely to having selling pressure when prices are in an upmove / corrective rise

Support and resistance lines

Role Reversals ❚ One of the basic uses of support and resistance levels is that when these levels are penetrated they reverse roles. ❚ For example: The Sensex had major resistance at 6000 levels since the year 2000. But now that is above this level, the level of 6000 became a support level. The psychology is important to understand.

Support / resistance lines – on Reliance

UNDERSTANDING PRICE PATTERNS

❚ Continuation Patterns The Rectangle The Flag The triangle

❚ Reversal Patterns Double / Triple Tops Double / Triple Bottom Head and Shoulder (normal/inverse) Rounding Falling wedge

Continuation patterns on Reliance –

Double Top formationSiemens

Double Bottom pattern WIPRO

Head and Shoulder pattern

Inv Head and Shoulder on Nikkei index

Rounding bottom – Silverline

The Fibonacci relevance ❚ Fibonacci number series is a mathematical series where each number is obtained from the sum of its previous two numbers eg.

1,2,3,5,8,13,21,34,55 and so on ❚ The ratio of any number to it’s previous number tends towards 1.618 - called GOLDEN RATIO/ DIVINE RATIO ❚ The ratio of any number to its succeeding number tends towards 0.618. ❚ There are many instances in the Universe or in NATURE to prove the importance of the fibonacci series and the Golden ratio.

Fibonacci (contd) ❚ As the fibonacci series affects humans in a variety of ways, Technical analysts often use the numbers in this series to refine their parameters. For eg Instead of using a 30 day moving average one may use a 34 (fib) days moving average. ❚ Major turning points in the markets have been observed in the past, on fibonacci days eg. 13th week or 34th day after a peak or a fall ❚ Elliot Wave analysis and Retracement analysis methods of technical analysis - use fibonacci series / ratios as their base and have been proved quite effective.

RETRACEMENTS ❚ After an up or down move prices usually retrace by 38.20% or 50% or 61.80% of the earlier move. You may note that 38.2% and 61.80% are fibonacci ratios. ❚ Calculating Retracement levels If price has moved up from say, 4216 to 8610 then the initial support level of 38.2% will be calculated as follows: 8610 – ((8610-4216)*0.382) = 6932 CONVERSE for a down move

Sensex Retracement levels

Moving Averages – their importance ❚ Moving Average used for (a) indicating the trend and (b) for actual trading decisions ❚ Most widely used are exponential MA – most common values are – 5/10/20 for short term ; 34/50 for medium term and 100/144/200 for long term periods ❚ Two MA systems- Buy / Sell signal is linked to the crossover of the two MA, one of short period and other of longer period.

Moving Average – contd. . . ❚ Buy Signal : generated when the short term MA cuts the Long term MA from BELOW ❚ Sell Signal :generated when the short term MA cuts the Long term MA from ABOVE ❚ Most preferred combinations are 5 / 21 ; 10 / 34 and 50 / 200 DMA ❚ Past observation shows that for the Sensex daily chart , the 34 DMA is a reliable trend decider for medium term.

Two (S/t) Moving Avg crossover – Sun Pharma

Two Moving Avg (L/t) – Sun Pharma

Using Price Indicators ❚ Indicators, also referred to, as oscillators are graphs based on statistical computation of actual past price data, plotted along with the price charts. ❚ The main function of an Indicator is: ❚    Help identify over-bought and over sold conditions ❚   Help judge the strength of a price move and ❚   Indicate the possibility of trend reversal. ❚ All the price patterns and trendline concepts which are applicable to price charts are also applicable to indicators.

Overbought/oversold zones

The MACD indicator – HPCL

Concept of Divergence ❚ A Divergence means that the indicator and the price action are giving opposite suggestion. ❚ A Positive Divergence occurs when the price makes a newer low but the indicator does not ❚ A Negative Divergence occurs when the price makes a newer high but the indicator does not. ❚ Important : Divergences need to be confirmed before acting on them.

Positive Divergence in Alok Ind

Negative divergence in Alok Ind

Introduction to Candlesticks ❚ ❚ ❚ ❚ ❚

Types of Candles •   Bullish candle •   Bearish Candle •   A Doji Candle •   Shadow

Candl est ick Patterns ❚ Hammer pattern or Hanging man pattern. ❚ Bullish or Bearish engulfing pattern. ❚ Piercing and Dark cloud cover. Morning Star and Evening star. ❚ Three rising pattern and Three falling pattern.

Candlestick Patterns

Candlesticks patterns

STUDY methods - Summary ❚ Interpretation of Price PATTERNS ❚ Use of INDICATORS/ Oscillators - like MACD / RSI/ ROC / Stochastics

❚ Moving AVERAGES -

Like Simple Avg / Exponential Avg / Weighted Avg etc

❚ FIBONACCI Studies

including Retracement

Theory

❚ Japanese CANDLESTICK Charting Method

Technical Analysis …. Is it the Ho ly Gr ail ?? ❚ Certainly NOT! (and for that matter neither is fundamental analysis!)

❚ Price Charts are perhaps the only reliable tool for the common investor to corroborate the fundamental changes happening in a company / industry OR even an economy. ❚ It will help you to time your entry and exit . . . . Just near the timing

The Pre-requisite ❚ First - Believe in the science ❚ Throw off emotions - remember the Market is always right!!! ❚ Accept that you WILL be wrong 30% of the times. ❚ Be a Consistent follower - The worst mistake would be to jump between the two analytical approaches

One may as well put this as a

STATUTORY WARNING! Technical Analysis is a Science which is EASY to learn BUT DIFFICULT to implement.

THA NK Y OU