Demystify Technical Analysis

Techncial Analysis

Agenda

Different Kinds of Indicator.
• •

Leading Indicators Lagging Indicators

Moving Averages .
• • • •

What is moving averages ? Different Types of Moving Averages.  Simple  Exponential  Weighted. Properties of good Moving Average Strategies of Moving Average .

Benefits and Drawback of Indicators Lagging Indicators
• • •

Moving Averages MACD Average Directional Index Relative Strenth Index Stochastic Rate of Change.

Leading Indicators
• • •

Volatility Indicators.

Bollinger Bands Common Gaps Breakout Gaps Runaway Gaps Exhaustion Gaps Martingale System Anti Martingale System

GAPS
-

Money Management
-

2

Technical Analysis

What does a Technical Indicator Offer?

 Technical indicator offers a different perspective from which to analyze the price action.

Some, such as moving averages, are derived from simple formulas and the mechanics are relatively easy to understand. Others, such as Stochastics, have complex formulas and require more study to fully understand and appreciate. Regardless of the complexity of the formula, technical indicators can provide unique perspective on the strength and direction of the underlying price action.

 A simple moving average is an indicator that calculates the average price of a security

over a specified number of periods. If a security is exceptionally volatile, then a moving average will help to smooth the data. A moving average filters out random noise and offers a smoother perspective of the price action. When is market is in Trading range zone RSI would tell you the condition of the market such as Overbought and Oversold level.

3

Technical Analysis

Why Use Indicators?
 Indicators serve three broad functions: to alert, to confirm and to

predict.

 An indicator can act as an alert to study price action a little more

closely. If momentum is waning, it may be a signal to watch for a break of support. Or, if there is a large positive divergence building, it may serve as an alert to watch for a resistance breakout.

 Indicators can be used to confirm other technical analysis tools. If

there is a breakout on the price chart, a corresponding moving average crossover could serve to confirm the breakout. Some investors and traders use indicators to predict the direction of future prices.

4

Technical Analysis

My Two Friends
 Friend 1 : Tells me whatever you do I am with you. Right or

Wrong I am with you and I will follow you. Lagging Indicator : Moving Averages, MACD , ADX

 Friend 2 : Tells me Don’t do this Don’t do that.

Leading Indicator : Market is overbought don’t buy , Market is oversold don’t sell it . RSI, Stochastic, ROC.
5

Technical Analysis

Lagging Indicator
As their name implies, lagging indicators follow the price action and are commonly referred to as trend-following indicators. Rarely, if ever, will these indicators lead the price of a security. Trend-following indicators work best when markets or securities develop strong trends. They are designed to get traders in and keep them in as long as the trend is intact. As such, these indicators are not effective in trading or sideways markets. If used in trading markets, trend-following indicators will likely lead to many false signals and whipsaws. Some popular trend-following indicators include moving averages (exponential, simple, weighted, variable) and MACD.

6

Technical Analysis

Lagging Indicators
 Moving Averages

 MACD

 Average Directional Index

7

Technical Analysis

What is Moving Averages?

A simple moving average is formed by computing the average (mean) price of a security over a specified number of periods. While it is possible to create moving averages from the Open, the High, and the Low data points, most moving averages are created using the closing price. For example: a 5-day simple moving average is calculated by adding the closing prices for the last 5 days and dividing the total by 5.

8

Technical Analysis

Moving Averages

9

Technical Analysis

Different Kinds of Moving Averages
 Simple Moving Average

 Weighted Moving Average

 Exponential Moving Average

10

Technical Analysis

Simple Moving Average

A simple moving average is formed by computing the average (mean) price of a security over a specified number of periods. While it is possible to create moving averages from the Open, the High, and the Low data points, most moving averages are created using the closing price. For example: a 5-day simple moving average is calculated by adding the closing prices for the last 5 days and dividing the total by 5.

11

Technical Analysis

Weighted Moving Average
 A weighted moving average is simply a moving average that is

weighted so that more recent values are more heavily weighted than values further in the past.
* BS E - S ENS EX (15 ,46 7.39 , 1 5,79 8.4 2, 15 ,331 .35, 15 ,76 0.52 , + 40 3.1 70) 2150 0 2100 0 2050 0 2000 0 1950 0 1900 0 1850 0 1800 0 1750 0 1700 0 1650 0 1600 0 1550 0 1500 0 1450 0 1400 0 1350 0 4 11 Jun e 18 25 2 9 July 16 23 30 6 13 Au gu st 20 27 3 10 17 Se ptemb er 24 1 8 15 Octo be r 22 29 5 12 Nov emb er 19 26 3 10 17 24 31 7 De cemb er 20 08 14 21 28 4 11 Fe bru ary 18 25 3 10 March 17 24 31

12

Technical Analysis

Exponential Moving Average
 In order to reduce the lag in simple moving averages, technicians

often use exponential moving averages (also called exponentially weighted moving averages). EMA's reduce the lag by applying more weight to recent prices relative to older prices. The weighting applied to the most recent price depends on the specified period of the moving average. The shorter the EMA's period, the more weight that will be applied to the most recent price. The formula for an exponential moving average is:
 EMA(current) = ( (Price(current) - EMA(prev) ) x Multiplier) +

EMA(prev)
 (2 / (Time periods + 1) ) = (2 / (10 + 1) ) = 0.1818 (18.18%)

13

Technical Analysis

Which one is better ?

14

Technical Analysis

Properties of Good moving Average
 Moving averages are portable trendline , So good

moving average should act as good Support levels.

15

Technical Analysis

Properties of Good moving Average

16

Technical Analysis

Properties of Good moving Average

17

Technical Analysis

Properties of Moving Averages

18

Technical Analysis

Moving Averages
 When two moving averages are used the longer is for

trend identification and the shorter for timing timing

 It is the interplay between the two which gives you the

 Classics are 5 and 20 day and 10 and 40 day  On stocks, 7 and 21 work well

19

Technical Analysis

Right Moving Average Period

20

Technical Analysis

2 Moving Average Cross over
 Market signal

Bullish – When short term moving Average ( i.e 5 Day ) crosses Long term Moving Average (i.e 20 Day ) and goes up . It’s a Golden Coress

 Bearish – When short term moving Average (i.e 5 Day )

crosses Long Term Moving Average (i.e 20 Day ) and goes Down . Its Death Cross

21

Technical Analysis

2 Moving Average Cross over

22

Technical Analysis

2 Moving Average Cross over

23

Technical Analysis

Guppy Moving Averages

24

Technical Analysis

Benefits and Drawbacks of Moving Averages
 Benefits : • As it is a lagging indicator you will always be able to capture the big

moves when it come along.

• It act as a good support and Resistance . • It also shows the underlying Trend  Drawback : • All the lagging indicator gives many whipsaws when it comes to side

ways market.

• Some time there is significant amount of money is left on the table

as it gives late signals. Although some lag can be removed by using Exponential MA
Technical Analysis

25

Moving Average Convergence Divergence
 Introduction
Developed by Gerald Appel, Moving Average Convergence/Divergence (MACD) is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend-following characteristics. These lagging indicators are turned into a momentum oscillator by subtracting the longer moving average from the shorter moving average.

• •

MACD Formula The most popular formula for the "standard" MACD is the difference between a security's 26-day and 12-day exponential moving averages. Using shorter moving averages will produce a quicker, more responsive indicator, while using longer moving averages will produce a slower indicator, less prone to whipsaws. Of the two moving averages that make up MACD, the 12-day EMA is the faster and the 26-day EMA is the slower. Closing prices are used to form the moving averages. Usually, a 9-day EMA of MACD is plotted along side to act as a trigger line. A bullish crossover occurs when MACD moves above its 9-day EMA and a bearish crossover occurs when MACD moves below its 9-day EMA
26

Technical Analysis

Calculation of MACD

27

Technical Analysis

MACD Signals
 MACD generates bullish or Bearish signals from three

main sources:
• Positive divergence • Bullish moving average crossover • Bullish centerline crossover

28

Technical Analysis

Bullish Divergence
 When Prices are falling on remain same but the Indicator

moves up then it is called Bullish Divergence

29

Technical Analysis

What is Positive Divergence and Negative Divergence
 When Prices are going up or remaining same but

Indicator is coming down is called Negative Divergence.

30

Technical Analysis

MACD Cross Over
 Buy : When MACD Crosses above its Average .  Sell : When MACD Crosses below its Average.

31

Technical Analysis

Centerline Crossover

32

Technical Analysis

MACD Benefits
 One of the primary benefits of MACD is that it incorporates aspects of

both momentum and trend in one indicator. As a trend-following indicator, it will not be wrong for very long. The use of moving averages ensures that the indicator will eventually follow the movements of the underlying security. represents the convergence and divergence of two moving averages. The standard setting for MACD is the difference between the 12 and 26-period EMA. However, any combination of moving averages can be used. The set of moving averages used in MACD can be tailored for each individual security. For weekly charts, a faster set of moving averages may be appropriate. For volatile stocks, slower moving averages may be needed to help smooth the data. No matter what the characteristics of the underlying security, each individual can set MACD to suit his or her own trading style, objectives and risk tolerance.

 MACD can be applied to daily, weekly or monthly charts. MACD

33

Technical Analysis

MACD Drwaback
 Can Be Applied on Any Time Frame : MACD can be applied to daily, weekly or monthly

charts. MACD represents the convergence and divergence of two moving averages. The standard setting for MACD is the difference between the 12 and 26-period EMA. However, any combination of moving averages can be used. The set of moving averages used in MACD can be tailored for each individual security. For weekly charts, a faster set of moving averages may be appropriate. For volatile stocks, slower moving averages may be needed to help smooth the data. No matter what the characteristics of the underlying security, each individual can set MACD to suit his or her own trading style, objectives and risk tolerance.

 Can not be applied to see historical levels : MACD calculates the absolute difference

between two moving averages and not the percentage difference. MACD is calculated by subtracting one moving average from the other. As a security increases in price, the difference (both positive and negative) between the two moving averages is destined to grow. This makes its difficult to compare MACD levels over a long period of time, especially for stocks that have grown exponentially.

34

Technical Analysis

Average Directional Index
 Wells Wilder introduced this revolutionary concept in New Concept in

Technical Trading System . amount from – DI , DI

 + DI is greater then –DI add that Amount to +DI and Deduct the same  If –DI is greater than + DI then add to –DI and deduct that amount from –

35

Technical Analysis

Trading using +DI and –DI
 Buy : When + DI crosses above – DI  Sell : When – DI crosses above + DI

36

Technical Analysis

Is the Market is Trading or Trending ???????????????
 Average Directional Index is nothing but the Absolute difference between + DI

and – DI .

 When ADX is above 25 it is considered to be Trending Market . When it is below

25 it is considered Trading . Commodity to Security ) .

( Note : Threshold value may vary from

37

Technical Analysis

Trending and Trading Market

38

Technical Analysis

Average Directional Index (ADX)

39

Technical Analysis

Benefits and Drawbacks of Lagging Indicators
 One of the main benefits of trend-following indicators is the ability to catch a

move and remain in a move. Provided the market or security in question develops a sustained move, trend-following indicators can be enormously profitable and easy to use. The longer the trend, the fewer the signals and less trading involved. trading range. Another drawback of trend-following indicators is that signals tend to be late. By the time a moving average crossover occurs, a significant portion of the move has already occurred.

 The benefits of trend-following indicators are lost when a security moves in a

40

Technical Analysis

Leading Indicator
Many leading indicators come in the form of momentum oscillators. Generally speaking, momentum measures the rate-of-change of a security's price. As the price of a security rises, price momentum increases. The faster the security rises (the greater the period-over-period price change), the larger the increase in momentum. Once this rise begins to slow, momentum will also slow. As a security begins to trade flat, momentum starts to actually decline from previous high levels. However, declining momentum in the face of sideways trading is not always a bearish signal. It simply means that momentum is returning to a more median level.

41

Technical Analysis

Leading Indicator
 Relative Strenth Index ( RSI )

 Stochastic

 Rate of Change

42

Technical Analysis

Relative Strength Index
 Developed by J. Welles Wilder and introduced in his 1978 book,

New Concepts in Technical Trading Systems, the Relative Strength Index (RSI) is an extremely useful and popular momentum oscillator. The RSI compares the magnitude of a stock's recent gains to the magnitude of its recent losses and turns that information into a number that ranges from 0 to 100. It takes a single parameter, the number of time periods to use in the calculation. In his book, Wilder recommends using 14 periods.

43

Technical Analysis

Divergence
 Bearish Divergence - when prices are making higher highs but the indicator

is making lower highs.  Upmove is weakening.

 Bullish Divergence - when prices are making lower lows but the indicator is

making higher lows.  Downmove is weakening.

44

Technical Analysis

RSI Bullish/Bearish Divergence

45

Technical Analysis

RSI Bearish Divergence

46

Technical Analysis

RSI Overbought and Oversold
 Overbought : RSI when enters 70 level the market is considered to be

overbought .

 Oversold : RSI when enters 0 level the market is considered to be oversold  Important point :Only trade when trade when they are exiting Overbought and

Oversold levels.

47

Technical Analysis

Properties of RSI
 Normal Technical Analysis can aslo be applied to RSI like Trendline,

Fibonacci Retracement or Projection etc….

48

Technical Analysis

Stochastic
 Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a

momentum indicator that shows the location of the current close relative to the high/low range over a set number of periods. Closing levels that are consistently near the top of the range indicate accumulation (buying pressure) and those near the bottom of the range indicate distribution (selling pressure).

49

Technical Analysis

Stochastic Buying and Selling
- NSE50 - 1 MONTH (4,566.00, 4,759.00, 4,566.00, 4,746.95, +149.650) 6400 6300 6200 6100 6000 5900

P P P O O O
Stochastic Oscillato r (39.3942)

5800 5700 5600 5500 5400 5300 5200 5100 5000 4900 4800 4700 4600 4500 4400 4300 100 90 80 70 60 50 40 30 20 10 17 24 31

O
17 24 1 8 October 15 22 29 5 12 November 19 26 3 10 December 17 24 31 7 2008 14 21 28

4 11 February

O

18

25

3 10 March

O

50

Technical Analysis

Stochastic strategy

51

Technical Analysis

Rate of Change

ROC is a momentum indicator that measures velocity and also leads the price action.

Rate of Change, ROC, can be very useful, because it is a leading indicator (ROC changes direction before the underlying price).

•Divergences •Divergences can provide warnings or alerts of weaknesses in market trends, but do not represent actual buy or sell signals. It is essential to wait for a confirmation from the price itself that the overall trend has reversed. •Zero-line crossings •Although the long-term price trend is still the overriding consideration, a crossing upward through the zero line can confirm a buy signal and a crossing downward through the zero line, a sell signal. •Trendline Violations •The trendlines on the ROC chart are broken sooner than those on the price chart. The value of the momentum indicators is that it turns sooner than the market itself, making it a leading indicator.

52

Technical Analysis

Rate of Change ( ROC )
TATA POWER COMP (1,163.00, 1,188.00, 1,100.50, 1,160.45, -3.10010) 1650 1600 1550

P P O O P

1500 1450 1400 1350 1300 1250 1200 1150 1100 1050 1000

O

Price ROC (-195.600)

P O O O

400 350 300 250 200 150 100 50 0 -50 -100 -150 -200 -250 -300 -350 -400 -450 -500 -550 -600 3 March 10 17 24 31

26

3 10 December

17

24

31 2008

7

14

21

28

4 February

11

18

25

53

Technical Analysis

Benefits and Drawbacks of Leading Indicators
 There are clearly many benefits to using leading indicators. Early

signaling for entry and exit is the main benefit. Leading indicators generate more signals and allow more opportunities to trade. Early signals can also act to forewarn against a potential strength or weakness. Because they generate more signals, leading indicators are best used in trading markets. These indicators can be used in trending markets, but usually with the major trend, not against it. In a market trending up, the best use is to help identify oversold conditions for buying opportunities. In a market that is trending down, leading indicators can help identify overbought situations for selling opportunities. higher returns comes the reality of greater risk. More signals and earlier signals mean that the chances of false signals and whipsaws increase. False signals will increase the potential for losses. Whipsaws can generate commissions that can eat away profits and test trading stamina.

 With early signals comes the prospect of higher returns and with

54

Technical Analysis

Bollinger Bands

Introduction

Developed by John Bollinger, Bollinger Bands are an indicator that allows users to compare volatility and relative price levels over a period time. The indicator consists of three bands designed to encompass the majority of a security's price action.

  

A simple moving average in the middle An upper band (SMA plus 2 standard deviations) A lower band (SMA minus 2 standard deviations)

Standard deviation is a statistical term that provides a good indication of volatility. Using the standard deviation ensures that the bands will react quickly to price movements and reflect periods of high and low volatility. Sharp price increases (or decreases), and hence volatility, will lead to a widening of the bands.

55

Technical Analysis

Formula

56

Technical Analysis

Signaling System
 Buy : After Prolonged Selling the Candel gives closing outside the band and next candel is

inside band than amove above highes high is Buying signal .

 Sell : After Prolonged Buying spree candelstick move above BB and Next Daxt Day candel

comes in BB then A move below Lowest Low of Candel is your Short Signal.

57

Technical Analysis

Bollinger Bands
 Sideways consolidation Breakouts.

58

Technical Analysis

Bollinger Band Breakout

59

Technical Analysis

Band Envelop and Bollinger Bands

60

Technical Analysis

Conclusion • To identify periods of high and low volatility • To identify periods when prices are at extreme, and possibly unsustainable, levels. • As stated above, securities can fluctuate between periods of high volatility and low volatility. Being able to identify a period of low volatility can serve as an alert to monitor the price action of a security. Other aspects of technical analysis, such as momentum, moving averages and retracements, can then be employed to help determine the direction of the potential breakout

61

Technical Analysis

GAPS
 Gaps are nothing but the vacuum left by the Prices.  Upside Gap : when Today’s low is higher than previous Days High .  Down Side Gap : When Today’s High is Lower than Previous Day’s

Low .

62

Technical Analysis

Mind the Gap
Common gap – occur in low volume caused by lack of

interest. (sometimes filled but be careful) break or patterns complete. (often filled)

 Breakaway gap – occur in heavy volume when trendlines

 Runaway gap – occur in moderate volume during a trend.

(generally filled and will provide support on reversal) a market move. (pretty much always filled)

Exhaustion gap – occurs in heavy volume near the end of

63

Technical Analysis

Mind the Gap

64

Technical Analysis

NAS NAS/NMS COMPSITE, Last Trade [Hi/Lo/Cl Bar] Daily 16Nov00 - 08Feb01 NAS NAS/NMS COMPSITE , Last Trade, Hi/Lo/Cl Bar 19Jan01 2841.25 2752.06 2770.38 Pr USD 3100

3000

2900

2800

2700

2600

2500

2400

2300 21Nov00 28Nov 05Dec 12Dec 19Dec 26Dec 02Jan 09Jan 16Jan 23Jan 30Jan 06Feb

.BSESN, Last Trade [O/H/L/C Bar] Daily 11Feb05 - 30Jun05 .BSESN , Last Trade, O/H/L/C Bar 01Jun05 6729.39 6763.28 6721.22 6745.83

FREEZE Pr INR 6900

6850

6800

6750

6700

6650

6600

6550

6500

6450

6400

6350

6300

6250

6200

66
11Feb05 18Feb

Technical Analysis
25Feb 04Mar 11Mar 18Mar 25Mar 01Apr 08Apr 15Apr 22Apr 29Apr 06May 13May 20May 27May 03Jun 10Jun 17Jun 24Jun

6150

Gaps

67

Technical Analysis

Money Management
 The most Important part of your Trading Career.  Two Types of Money Management Systems • Martingle System • Anti Martingle System  Martingale System  Anti Martingale System

68

Technical Analysis

TABLE OF TRADES
No of Lossing Trades 10 9 8 7 6 5 4 3 2 1 0
69

Amt of Lossing Trades (10) (9) (8) (7) (6) (5) (4) (3) (2) (1) 0

No of Winning Trades 0 1 2 3 4 5 6 7 8 9 10

Amt of Winning Trades 0 2 4 6 8 10 12 14 16 18 20

Total Inflow/ Outflow (10) (7) (4) (1) 2 5 8 11 14 17 20

Technical Analysis

Martingale System
 You make a bet and if you lose you double your bet. If you lose again

you double your bet. You keep doing this until you win and then go back to your original bet.
 You bet Rs 5 and you lose.

Your next bet is Rs. 10. If you lose: Your next bet is Rs 20. If you lose: Your next bet is Rs 40. If you lose: Your next bet is Rs 80. If you lose: Your next bet is Rs 160. If you lose: If you win you will get back 320 so net inflow is your original Rs 5
 Is it a Good bet.

70

Technical Analysis

Anti Martinalge System
 Anti Martingale System tells to Invest double in a winning

streak and either slow down or remain constant on your bets during the losing periods.

71

Technical Analysis

End of Session 3

72

Technical Analysis

Sign up to vote on this title
UsefulNot useful