TECHNICAL ANALYSIS

Theory of Price Gaps

What is a Gap in technical analysis?
A gap is an area on a price chart in which there were no trades. It is easy to see gaps if you take candle stick charts. Let us try to understand gaps in another way. The fluctuations in stock prices are coherent in nature. That means that the price rises or falls gradually. Thus, in rising scrip, if on one day the low was Rs 100 and the high was Rs 135, on the next day the low would be Rs 130 and the high Rs 140. Here, the low for the next day falls within the high-low range of the previous day. But suppose for the second day, the low was Rs 145 and the high Rs 150. Then, the low for the next day has fallen above the previous day High-Low range, or it was higher than the previous days high. So, when one draws bar charts showing High-Lows every day, there would be a discontinuity, termed as a Gap in technical theory. An interesting feature of Price gaps is that it gets filled within a short amount of time. That is, the price would come back to fill the price gap of Rs 140 Rs145, where there was no trade in the previous days. In simple terms-a gap occurs when the current bar opens above the high or below the low of the previous bar. On a price chart, a space appears between the bars indicating the gap.

Types of price gaps

Gaps can be subdivided into four basic categories: Common Gaps Breakaway Gaps Runaway Gaps and Exhaustion Gaps.

Common gaps:
Common gaps are common and uneventful. If a Gap is formed when the markets are moving in a narrow range, it is called a Common Gap.

Breakaway Gaps:
A breakaway gap ends a consolidation pattern and happens as prices break out. Often, they would be accompanied by huge volumes. Break-out Gaps are generally not filled for a long time, i.e. in the case of an uptrend, the price does not fall back to wipe off

the gains. They may be filled as and when the prices retrace after a substantial up move. If the breakout happens to be a downtrend, the prices may not rise soon to wipe off the loss.

Runaway Gaps:
Runaway gaps are best described as gaps that are caused by increased interest in the stock. For runaway gaps to the upside, it usually represents traders who did not get in during the initial move of the up trend and while waiting for a retracement in price, decided it was not going to happen. Increased buying interest happens all of a sudden, and the price gaps above the previous days close. This type of runaway gap represents an almost panic state in traders. Also, a good uptrend can have runaway gaps caused by significant news events that cause new interest in the stock. Runaway gaps can also happen in downtrends. This usually represents increased liquidation of that stock by traders and buyers who are standing on the sidelines. These can become very serious as those who are holding onto the stock will eventually panic and sell but sell to whom? The price has to continue to drop and gap down to find buyers. So, in either case, runaway gaps form as a result of panic trading.

Exhaustion Gap:
An exhaustion gap occurs at the end of a price move. If there have been two or more gaps before it, then this kind of gap should be regarded very skeptically. A genuine exhaustion gap is filled within a few days to a week. It is generally not easy to distinguish between the Runaway and Exhaustion Gaps. Experience in reading charts will help in due course. The best clue available is that Exhaustion Gaps are not the first Gaps in the chart, i.e. they follow the Runaway Gaps and usually occur when the runaway Gap is nearing completion. Exhaustion Gaps do not indicate whether the trend will reverse, they only call for a halt in the price movement. This completes our discussion on gaps. I hope it has filled in some gaps in your trading knowledge. Here are some additional hints :

A gap has relevance only to a daily or short term trader. On spotting a gap in a daily chart, immediately question yourself as to which of the four kinds of gaps it is. Generally, short-term trades should be in the direction of the gap. The larger the gap and the stronger the volume, the more likely it is prices will continue to trend in that direction. A breakaway gap provides an immediate buy point, particularly when it is confirmed by heavy volume. The third upside gap raises the possibility of an exhaustion gap. Traders should look for the gap to be filled in approximately one trading week. If the gap is filled and selling pressure persists, then that issue should be shorted. If the gap is the third one to the downside, then traders should be alert for a buy signal.

Gaps are powerful signals to make profits if used intelligently. They should not be acted on in isolation. View the gap within the context of the other technical results.

Summary of Chart Patterns

Heres the summary of what we have discussed so far: Charts Chart analysis is the technique of using patterns formed on a chart to get an idea about the price movement of a share. There are two types of chart patterns: reversal and continuation. A continuation pattern suggests that the prior trend will continue upon completion of the pattern. A reversal pattern suggests that the prior trend will reverse upon completion of the pattern. Flag and Pennants: Flags and pennants are continuation patterns formed after a sharp price movement. The move consolidates, forming a flag shape or pennant share, and suggests another strong move in the same direction of the prior move upon completion. Triangles: There are three main types of triangle patterns symmetrical, descending and ascending, which are constructed by converging trend lines. A symmetrical triangle, which is formed when two similarly sloped trend lines converge, typically suggests a continuation of the prior trend. A descending triangle, which is formed when a downward sloping trend line converges towards a horizontal support line, suggests a downward trend after completion of the pattern. An ascending triangle, which is formed when an upward sloping trend line converges towards a horizontal resistance line, suggests an uptrend after completion of the pattern. Cup with handle: A cup-and-handle pattern is a bullish continuation pattern that suggests a continuation of the prior uptrend. Double tops and Double bottoms: A double top is a bearish reversal pattern, which suggests that the preceding up trend will reverse after confirmation of the pattern.

A double bottom is a bullish reversal pattern, which suggests that the prior downtrend will reverse.

Head and shoulders: A head-and-shoulder suggests a reversal in the prior uptrend. An inverse head and shoulders suggests a reversal in the prior downtrend Wedges: A wedge chart pattern suggests a reversal in the prior trend when the price action moves outside of the converging trend lines in the opposite direction of the prior trend. Rounding Bottom: A rounding bottom is a long-term reversal pattern that signals a shift from a downward trend to an upward trend Triple tops and triple bottom: A triple top is a reversal pattern formed when a security attempts to move past a level of resistance three times and fails. Upon failure of the third attempt the trend is thought to reverse and move in a downward trend. A triple bottom is a reversal pattern formed when a security attempts to move below an area of support three times but fails to do so. Upon failure of the third attempt below resistance the trend is thought to reverse and move upward.

Reversal Patterns 5 : Triple tops and Triple bottoms

Triple top is a bearish reversal pattern formed when a share price that is trending upward tests a similar level of resistance three times without breaking through. When the stock fails to move past the resistance level three times, it is assumed that the stock price would come down. This pattern is difficult to spot in the earlier stages of formation. In the triple-top formation, each test of resistance at the upper end should be marked with declining volume at each successive peak. And again, when the price breaks below the support level, it should be accompanied by high volume. Example of triple top pattern:

Triple bottom is a bullish reversal pattern formed when a share price that is coming down tests a similar level of support three times without breaking through. When the stock fails to move past the support level three times, it is assumed that the stock price would resume the uptrend. In this pattern, volume plays a role similar to the triple top, declining at each trough as it tests the support level, which is a sign of diminishing selling pressure. Again, volume should be high on a breakout above the resistance level on the completion of the pattern. Example of triple bottom pattern:

Reversal Patterns 4 : Rounding Bottom

The rounding bottom is a long-term reversal pattern that signals a shift from a downtrend to an uptrend. The pattern resembles the cup and handle pattern but, without the handle. Volume is one of the most important confirming measures for this pattern where volume should be high at the initial peak (or start of the pattern) and weaken as the price movement heads toward the low. As the price moves away from the low to the price level set by the initial peak, volume should be rising. The way in which the price moves from peak to low and from low to second peak may cause some confusion as the long-term nature of the pattern can display several different price movements. The price movement does not necessarily move in a straight line but will often have many ups and downs. What is important is the general direction of the stock price. Example of a rounding bottom pattern:

Reversal Patterns 3 : The Wedges

The wedge pattern is more like a symmetrical triangle pattern, the only difference is that it has converging trend lines which slat in either upwards or downward direction. There are two main types of wedges falling and rising. A falling wedge slopes downward-it is a bullish pattern. In a falling wedge, the upper (or resistance) trend line will have a sharper slope than the support level in the wedge construction. The lower (or support) trend line will be clearly flatter as you can see in the figure given below. The stock prices tend to move between the resistance and support lines formed with a downward bias. The price movement in the wedge should at minimum test both the support trend line and the resistance trend line twice during the life of the wedge. The more times it tests each level, especially on the resistance end, the higher quality the wedge pattern is thought to be. The buy signal is formed when the price breaks through the upper resistance line. This breakout move should be on heavier volume, but due to the longer-term nature of this pattern, its important that the price has successive closes above the resistance line. Example of falling wedge:

Conversely, a rising wedge is a bearish pattern. A rising wedge slopes upward. The upper (or resistance) trend line will have a flatter slope than the support level in the wedge construction. The lower (or support) trend line will clearly slop sharp as you can see in the figure given below. The stock prices tend to move between the resistance and support lines formed with a upward bias. The price movement in the wedge should at minimum test both the support trend line and the resistance trend line twice during the life of the wedge. The more times it tests each level, especially on the support end, the higher quality the wedge pattern is thought to be. Example of a Rising wedge:

Reversal Patterns 2 : Head and Shoulders

The head-and-shoulders pattern is one of the most popular and reliable chart patterns in technical analysis. And as one might imagine from the name, the pattern looks like a head with two shoulders. A Head and Shoulders pattern forms when one peak, followed by a higher peak, which is then followed by a lower peak, and finally a break below the support level established by the two troughs formed by the pattern. The head-and-shoulders is a signal that a share price is set to fall.. As the Head and Shoulders pattern unfolds, volume plays an important role in confirmation. Ideally, but not always, volume during the advance of the left shoulder should be higher than during the advance of the head. This decrease in volume and the new high of the head, together, serve as a warning sign. The next warning sign comes when volume increases on the decline from the peak of the head. Final confirmation comes when volume further increases during the decline of the right shoulder

Inverse Head and shoulders Pattern:

The second version, the inverse head and shoulders, signals that a share price is set to rise and usually forms during a downward trend. As the name indicates, it is a mirror image of the head and shoulders pattern signaling that the price is set to raise .Needless to say, volume plays an important role here too. Without the proper expansion of volume, the validity of any breakout becomes suspect. Head and Shoulder

Inverse Head and Shoulder

Reversal Patterns 1 : Double tops and double bottoms

Introduction
Reversal implies a change in direction. Thus, reversal patterns are chart formations that tend to reverse the direction of the trend. These patterns can be spotted on the daily, weekly or monthly charts. The Existence of a prior trend is the most important prerequisites in analyzing trend reversal patterns. Many a time, a pattern that appears on the chart resembles a reversal pattern. However, if there were no major prior trends before the occurrence of this pattern, it becomes suspect. If on the other hand, one finds that a downward reversal pattern is being formed on the chart when the market has appreciated considerably, that reversal pattern is of significance and should be studied carefully. The second point to be studied carefully is the volume. Volume can provide insights in trend reversals. It should be used as a corroborative evidence of a trend, not as primary evidence. Volume can also be used to confirm price changes. When a trend starts, and there is no pick up in volume activity, that may mean that the trend is weak and does not have commitment. Volume precedes the price. If there is a pickup in volume, then that may mean that a change in price may be approaching. The direction of the movement during this increase in volume can be indicative of the upcoming action. In the following sessions we explain some important reversal patterns

Double tops and double bottoms:

Double top and double bottom formations are also called M and W patterns. A double top is simply two peaks. The pattern forms when the share price makes a run up to a particular level, then drops back from that level, then make a second run at that level, and then finally drop back off again resulting in a M shaped formation. It is a reversal pattern. For confirmation that a double top has actually formed and that a reversal in the uptrend is at hand, a common strategy is to look for declining volume going into the second peak and rising volume on a break below the bottom of the trough which has formed between the two peaks (support).Here too, volume plays an important part. Example of Double top:

Double Bottom
This is the opposite chart pattern of the double top as it signals a reversal of the downtrend into an uptrend. The pattern forms when the share price makes a run down to a particular level, then trades up from that level then makes a second run down to at or near the same level as the first bottom, and then finally trades back up again, resulting in a W shaped formation. For confirmation that a double bottom has formed and that a reversal in the downtrend is at hand , a common strategy is to look for declining volume going into the second trough and rising volume on the break of the peak which has formed between the two troughs (resistance). Example of double Bottom:

Continuing patterns 3 : Cup with handle

As its name implies, there are two parts to the pattern: The cup and the handle. A cupand-handle pattern resembles the shape of a tea cup on a chart. This is a bullish continuation pattern where the upward trend has paused, and traded down, but will continue in an upward direction upon the completion of the pattern. The cup is a bowlshaped consolidation and the handle is a short pullback followed by a breakout. There should be a substantial increase in volume on the breakout above the handles resistance. The stronger the volume on the upward breakout, the clearer the sign that the upward trend will continue. The Shape of the cup itself is also important: it should be a nicely rounded formation, similar to a semi-circle. Example of a Cup with handle:

Continuing patterns 2 : Triangles

Whenever there is a convergence of two trend lines flat, ascending or descending with the price of the security moving between the two trend lines, it takes shape of a triangle. A triangle formation can be any of the following types : Symmetrical Triangle , Ascending Triangle and Descending Triangle. All the three are continuing patterns, meaning that it signals a period of consolidation in a trend followed by a resumption of the prior trend. Symmetrical triangle formation: it is formed by the convergence of a descending resistance line and an ascending support line. The two trend lines in the formation of this triangle should have a similar slope converging at a point known as the apex. The price of the security will bounce between these trend lines, towards the apex, and typically breakout in the direction of the prior trend. that is , if preceded by a downward trend, the focus should be on a break below the ascending support line. If preceded by an upward trend, look for a break above the descending resistance line. As the symmetrical triangle extends and the trading range contracts, volume should start to diminish. This refers to the tightening consolidation before the breakout. The symmetrical triangle can extend for a few weeks or many months. If the pattern is less than 3 weeks, it is usually considered a pennant. Typically, the time duration is about 3 months. Symmetrical triangle is a neutral formation. The future direction of the breakout can only be determined after the break has occurred. Attempting to guess the direction of the breakout can be dangerous. Even though a continuation pattern is supposed to breakout in the direction of the long-term trend, this is not always the case .A break in the opposite direction of the prior trend should signal the formation of a new trend. Example :

Ascending Triangle: The ascending triangle is a bullish pattern, which gives an indication that the price of the security is headed higher upon completion. The pattern is formed by two trend lines: a flat trend line being a point of resistance and an ascending trend line

acting as a price support. The ascending triangle indicates that the sellers are now less interested in the stock and the buyers volume is increasing. Once the demand increases, the price naturally will tend to go up and break the resistance levels and resume the upward trend.

Descending Triangle: Descending triangle is just the opposite of ascending triangle. If an ascending triangle was a bullish pattern, a descending triangle is a bearish pattern .In a descending triangle formation, the two trend lines drawn will show a flat support line and a downward-sloping resistance line. Indicating that the prices will fall further. As the pattern develops, volume usually contracts. When the downside break occurs, there would ideally be an expansion of volume for confirmation. Volume confirmation is important.

Continuing patterns 1 : Flag & Pennant

A continuing pattern indicates that the prior trend will continue onward upon the patterns completion. The Flag and pennant are two short-term continuation chart patterns that are formed when there is a sharp price movement followed by a generally sideways consolidation. The price then moves sharply either upwards or downwards but generally in the same direction as the move that started the trend. By using the term Flag it doesnt mean that the trend formation would look exactly like a flag. The basic characteristic of a flag pattern is that it will have two trend lines sloping generally in the opposite direction of the initial price movement The buy or sell signal is formed once the price breaks through the support or resistance level, with the trend continuing in the prior direction. This breakthrough should be backed by heavier volume to improve the signal of the chart pattern. EXAMPLE

You may notice the following There are two trend lines drawn, both sloping downwards e in the opposite direction of the initial price movement. Through the trend lines you see certain price level beyond which the stock prices neither fall nor rise. These points are support and resistance levels in the flag pattern. Once the price breaks out of the resistance level, the stock prices continues to move in the initial direction ie upwards. PENNANT The pennant is slightly different from the flag pattern. Here the two trend lines converge towards each other and the direction of the pennant is not important as in the case of flag.

EXAMPLE

The attributes of the flag and pennant are similar and it can be summarized as follows: SHARP PRICE MOVEMENT It all starts from a prior trend. There should be evidence of a prior trend either upwards or downwards. Such a price movement should be backed by heavy volume.Such moves may also contain gaps (well discuss the theory of gaps later). Such a move usually halts or pauses temporarily causing sideways movement for sometime, resulting in a flag or pennant formation. DURATION The sideways movement (flag/pennant) can last from 1 to 12 weeks. There is some debate on the timeframe and some consider 8 weeks to be pushing the limits for a reliable pattern. Ideally, these patterns will form between 1 and 4 weeks. Once a flag becomes more than 12 weeks old, it would be classified as a rectangle. A pennant more than 12 weeks old would turn into a symmetrical triangle. The reliability of patterns that fall between 8 and 12 weeks is therefore debatable. BREAKING THE FLAG/PENNANT For a bullish flag or pennant, a break above resistance signals that the previous advance has resumed. For a bearish flag or pennant, a break below support signals that the previous decline has resumed. HEAVY VOLUME Volume is the key. Volume should be heavy during the advance or decline that forms the flagpole. Heavy volume provides legitimacy for the sudden and sharp move that creates the flagpole. An expansion of volume on the resistance (support) break lends credibility to the validity of the formation and the likelihood of continuation.

A study of chart patterns

One of the basic assumptions of technical analysis is that- history repeats itself, mainly in terms of price movement. Chart patterns are graphical representations of historical price movements of stocks. So, when you analyses those price movements on chart , it reveals certain repeating patterns .It shows where the prices have been, where the buyers and seller lurk and often times the trading psychology at work in the market. If human emotions drive buying and selling behavior, then careful analysis of the chart patterns can help to determine where such emotions may next surface. Chart patterns depict trading psychology in motion. However it should be remembered that identifying chart patterns and their subsequent signals is not an exact science. While there is a general idea and components to every chart pattern, in our opinion, the price movement does not necessarily correspond to the pattern suggested by the chart. TYPES OF CHART PATTERNS There are two basic types of patterns continuing patterns and reversal patterns. A continuing pattern indicates that the prior trend will continue onward upon the patterns completion. A reversal pattern signals that a prior trend will reverse on completion of the pattern. The main patterns are discussed below. Types of continuing Patterns Flag, Pennant Triangles- Symmetrical Triangle , Ascending Triangle and Descending Triangle Cup with Handle Types of reversal patterns Double Top and Double Bottom Head and Shoulders and Inverse Head and Shoulders. Falling Wedge and Rising Wedge Rounding Bottom Triple Top and Triple Bottom In the next few pages well look in detail about each of the above patterns.

Importance of Volume in Technical Analysis

VOLUME Volume is simply the total number of buyers and sellers exchanging shares over a given period of time, usually a day. Higher the volume, more active the share. The data regarding volume of a share will be readily available on your online trading screen. Most financial sites carry data about volume. For example if the Stocks volume for the day was 1,500,000 shares that means 1,500,000 shares were sold by someone and bought by someone on that day. Volume as such may not be an attractive piece of information. But try to combine the volume data with support and resistance levels youll get the real picture. For example Say stock A ltd broke a resistance level and went up further. Also since it broke through a critical level we would expect it to go up even more in the near future. Now, let us also consider the volume traded on that day say 3 lakh shares were exchanged. On a normal day 1o lakh shares are traded. That means, Volume was way below average for that day. So, all the big investors were not trading. They could come in the very next day and decide they are bearish on the stock. They sell and cause a panic. So the stock goes down the next day. This is the importance of volume. Most traders will not buy a stock when it breaks a critical level unless volume is high. The reverse is also true. If a stock goes down with little volume it could mean the same thing. The majority of investors were not trading. When they come back they could see this stock and decide it is too low. So they buy it and the price goes up. In short, Volume is a critical factor in technical analysis. Any support and resistance level is not valid unless it is backed by adequate volume. 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 the trend. 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 and may soon end. TIPS ON VOLUME ANALYSIS Investors must always look at price patterns in conjunction with their associated volume pattern, never alone. A stock may appear to go up but the volume pattern must confirm that analysis Careful analysis of the volume of selling that occurred above current resistance will help you estimate how long a stock will stall at that level

Well-above-normal volume is essential when separating a true from a false breakout above resistance. If a stock is truly in a healthy uptrend, then volume should rise as prices rise. If this is the case, then the volume indicates that buyers are chasing the stock. This increases the probability that the uptrend will continue

Support and Resistance

Hi there, As i said in my last article, the next major concept is that of support and resistance. These are two terms that are used very frequently by stock analysts. To put in very simple terms -Support is the price level below which a stock is not expected to fall. Resistance, on the other hand, is the price level which a stock is not expected to surpass. You also need to go thru the next topic on volume to fully understand the concept of support and resistance. SUPPORT AND RESISTANCE Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic is that, when the price declines, there will be more demand for the particular share. By the time the price reaches a particular level (called support level), it is believed that demand will overcome supply and prevent the price from falling below support Resistance is just the opposite of support. A Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. The logic behind the theory is that , as the price advances , sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches a particular level (called the resistance level) it is believed that supply will overcome demand and prevent the price from rising above resistance. In the book Trading for a Living, Dr. Alex Elder gives a simple, but effective image of support and resistance A ball hits the floor and bounces. It drops after it hits the ceiling. Support and resistance is like a floor and a ceiling, with prices sandwiched between them. When a stocks price has fallen to a level where demand at that price increases and buyers begin to buy, this creates a floor or support level. When a stocks price rises to a level where demand decreases and owners begin to sell to lock in their profits, this creates the ceiling or resistance level.

Shown below is a typical share price movement on a chart. The two lines drawn horizontally are called trend lines. The red arrows illustrate resistance or ceiling. As you can observe, the price fails to pass above that particular level. Similarly the blue arrows illustrate support level or floor beyond which the price fails to fall.

HOW TO RECOGNIZE SUPPORT AND RESISTANCE. You can identify support and resistance levels by studying a chart. (See the chart above) Look for a series of low points where a stock falls to this level, but then falls no further. This is a support level. When you find that a stock rises to a certain high, but no higher, you have found a resistance level. The more times that a stock bounces off support and falls back from resistance, the stronger these support and resistance levels become. It creates a self-fulfilling prophecy. The more often it happens, the more likely it is to happen again. The more those historical patterns repeat themselves, the more traders know, and the more confident they become in forecasting the future behavior of the stock. ROUND NUMBERS One type of universal support and resistance that tends to be seen across a large number of securities is round numbers. Round numbers like 10, 20, 35, 50, 100 and 1,000 tend be important in support and resistance levels because they often represent the major psychological turning points at which many traders will make buy or sell decisions. Buyers will often purchase large amounts of stock once the price starts to fall toward a major round number such as Rs 50, which makes it more difficult for shares to fall below the level. On the other hand, sellers start to sell off a stock as it moves toward a round number peak, making it difficult to move past this upper level as well. It is the increased buying and selling pressure at these levels that makes them important points of support and resistance and, in many cases, major psychological points as well.

THE IMPORTANCE OF SUPPORT AND RESISTANCE Support and resistance analysis is an important part of trends because it can be used to make trading decisions and identify when a trend is reversing. For example, if a trader identifies an important level of resistance that has been tested several times but never broken, he or she may decide to take profits as the share price moves toward this point because it is unlikely that it will move past this level. THE PSYCHOLOGY BEHIND SUPPORT AND RESISTANCE To understand the psychology behind support and resistance, we need to first categorize market participants. Market participants can typically be classified into: 1) The longs -traders who have a BUY position and stand to profit if prices increase. 2) The shorts -traders who have a SELL and stand to profit if prices decrease. 3) Traders who got out of their previous positions prematurely. 4) Traders who are undecided on which side of the market to be on and are looking for entry points either on the short side or the long side. Assuming now, that prices start advancing from a support area, the longs who bought around this area would have regretted not buying more. So, every time prices come back to the support area, they would likely decide to buy more. Traders on the short side however, would have likely realized that they are on the wrong side of the market and they would be hoping for prices to come back to the support area where they entered their short positions so that they can get out and at least break even. The traders who had previously got out of their long positions at the support area would likely be annoyed at themselves for getting out too early and would thus be looking for a chance to get into a position again at or around the support area. The traders who were previously undecided on which side they wanted to be on would likely decide to want to enter the market on the long side after observing the advance in prices. As such, they would be looking to enter whenever there is a good buying opportunity, which is at or around the support area. These traders now all have the same resolve to buy should a good opportunity present itself and should prices decline to the support area, there would be buying taking place by all four groups which would result in prices being pushed up. ROLE REVERSAL Once a resistance or support level is broken, its role is reversed. If the price falls below a support level, that level may become resistance. If the price rises above a resistance level, it may often become support. As the price moves past a level of support or resistance, it is believed that supply and demand has shifted, causing the breached level to reverse its

role. For a true reversal to occur, however, it is important that the price make a strong move through either the support or resistance. In almost every case, a stock will have both a level of support and a level of resistance and will trade in this range as it bounces between these levels. NUMERICAL WAY TO CALCULATE SUPPORT AND RESISTANCE There are many ways to calculate levels of support and resistance (Pivot point method, Moving averages, Fibonacci numbers etc). One of the most common is to use a series of formulas to calculate pivot points, described herein Calculate the pivot point as follows, using the previous days high, low, and close: Pivot or P = (High + Low + Close) / 3 Calculate the first support point (S1) = (P x 2) H Calculate the second support point (S2) = P (High Low) Calculate the first resistance point (R1) = (P x 2) Low Calculate the second resistance point( R2) = P + (High Low) Adjusted Pivots Many traders adjust their value for P as follows: O = Todays Opening Price P = O + (H + L + C) / 4 (where H, L & C are from the previous days stock details) Pivot points are short-term indicators, and ultimately it is the traders responsibility to use them wisely, in conjunction with other confirming indicators. Pivot points keep changing everyday since its based on daily data.

Trend lines
TREND Trend in technical analysis means direction. It is one of the most important concepts in technical analysis. After plotting the stock prices on a chart, a line is drawn through the price movement to identify the direction of price. Its called trend line and it could slope either downwards or upwards. A principle of technical analysis is that once a trend has been formed, it will remain intact until its broken. When there is little movement up or down its a sideways or horizontal trend .If you observe financial magazines or channels you might recall experts saying about sideways movement in stocks A sideways trend is actually not a trend on its own, but a lack of a well-defined trend in either direction. In any case, the market can move only in these three ways: up, down or nowhere.

LENGTH OR TIME FRAME OF A TREND Trend lines can move in a same direction for any length of time until something major happens in the market that brings a change in the demand -supply balance and hence a change in price direction. A trend of any direction can be classified as a long-term trend, intermediate trend or a short-term trend depending on the time frame we are talking about. In terms of the stock market, a major trend (long term trend) is generally categorized as one lasting longer than a year. An intermediate trend is considered to last between one and three months and a near-term trend is anything less than a month. A long-term trend may be composed of several intermediate trends, which often move against the direction of the major trend. If the major trend is upward and there is a downward correction in price movement followed by a continuation of the uptrend, the correction is considered to be an intermediate trend. The short-term trends are components of both major and intermediate trends. See the graph below:

As explained earlier, a long term trend is one which lasts for a year or more .So in order to analyze the long term direction of a stock you need to take the stock chart of a year or more. Similarly to analyze a medium term trend you need to check the graph for a 6 month period or so. Short term trend can be analyzed by taking the graph for a short period ,say 10 or 30 days . In short, a stock chart should be constructed to best reflect the type of trend being analyzed. DRAWING A TREND LINE Drawing trend lines are the basics of technical analysis. The explanation on how to draw may be confusing to a learner, but in actual practice its no big deal. In an uptrend analysis, draw a line from the lowest low, up and to the highest minor low point preceding the highest high, so that the line does not pass though prices between the two low points. This when completed will be an upward trend line similarly , To draw a downward trend line , draw a line from the highest high, down and to the lowest minor high point preceding the lowest low, so that the line does not pass though prices between the two low points . You may also refer to the figure given above. The blue line starts from the lowest low and up to the highest minor low point preceding the highest high and the downward trend line represented by the red line starts from the highest high and down to the lowest minor high point preceding the lowest low point. Thats about trend lines. Drawing trendlines is just the beginning. To move further, you need to learn something called support and resistance levels more about that in our next section. ..

Types of Charts
We said in the first section that Charts are the working tools of the technical analyst and they have been developed in various forms and styles to represent graphically almost anything and everything that takes place in the stock market. There are three main types of charts that are used to analyse price movements. They are the line chart, the bar chart and the candlestick chart. LINE CHART Line chart is the simplest of the three charts. A simple line chart draws a line from one closing price to the next closing price. When strung together with a line, it reveals the general price movement of a share over a period of time.

BAR CHARTS The most basic tool of technical analysis is the bar chart. This chart displays basic market price data over a defined period of time. Daily bar charts note the open, high, low and closing price of an asset. Rising vertically, the bar marks the high and the low of a given time period, with the starting price marked by a horizontal line, or tick, to the left and the ending or closing price marked by a tick to the right. Structure of a bar chart

CANDLESTICK CHART Another type of chart used in technical analysis is the candlestick chart, so called because the main component of the chart representing prices looks like a candlestick, with a thick body and usually a line extending above and below it, called the upper shadow and lower shadow, respectively. The top of the upper shadow represents the high price, while the bottom of the lower shadow represents the low price. Patterns are formed both by the body and the shadows. Candlestick patterns are most useful over short periods of time, and mostly have significance at the top of an uptrend or the bottom of a downtrend, when the patterns most often signify a reversal of the trend. While the candlestick chart shows basically the same information as the bar chart, certain patterns are more apparent in the candlestick chart. The candlestick chart emphasizes opening and closing prices. The top and bottom of the real body represents the opening and closing prices. Whether the top represents the opening or closing price depends on the color of the real bodyif it is white/ blue/green, then the top represents the close; black / red or some other dark color, indicates that the top was the opening price. The length of the real body shows the difference between the opening and closing prices. Obviously, white/green/blue real bodies indicate bullishness, while black/red real bodies indicate bearishness, and their pattern is easily observable in a candlestick chart.

Structure of a candlestick chart

CONCLUSION What we know so far is about the types of charts. While line charts are the simplest form of charts, candlesticks are more advanced and they reveal stories not detected with other charts. Whether you use a line chart or candlestick chart, you need to draw trend lines to find out direction of the stock prices. More about that in the next section- trend lines.

Technical Analysis
MEANING Technical analysis is a completely different approach to stock market investing- it doesnt try to find the intrinsic value of a company or try to find whether a share is mispriced or undervalued. A technical analyst is interested only in the price movements in the market. So, it all about analyzing the demand and supply or a price volume analysis. TECHS VS FUNDAS Technical analysis is a study of supply and demand in a market to determine what direction, or trend, will continue in the future. Investors who follow fundamentals try to spot shares that has the potential to increase in value, while investors who follow technical analysis buy assets they believe they can sell to somebody else at a greater price. Although technical analysis and fundamental analysis are seen by many as polar opposites many market participants have experienced great success by combining the two. There are distinct advantages for both the schools of thought. its better to be versed with the pros and cons of both and take advantage of both the schools. The purpose of mentioning technical trading tools here is to help you understand the relevance of technical terms used by experts in the stock recommendations. Technical

analysis requires special charting software to accumulate data and convert it into information. Generally, online trading software offered by leading brokers has options to do technical analysis. CHARTS -WORKING TOOLS OF A TECHNICAL ANALYST. A technical analyst works with the help of charts. A chart is nothing but a graphical representation of the current price movement of a stock. There are various forms and styles of charts and it represents graphically almost anything and everything that takes place in the stock market. BASIC ASSUMPTIONS Technical analysis is based on three assumptions: MARKETS DISCOUNTS EVERYTHING. Technical analysis assumes that, at any given time, a stocks price reflects everything that has or could affect the company including fundamental factors. Technical analysts believe that the companys fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market. PRICE MOVES IN TRENDS In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction unless something happens to change the supply -demand balance. Such changes will take time and are usually detectable in the action of the market itself. Most technical trading strategies are based on this assumption. HISTORY TENDS TO REPEAT ITSELF Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends. Although many of these charts have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves.

Understanding Bollinger Bands.

What are they?
Introduced by John Bollinger in the 1980s, Bollinger Bands are a pair of trading bands representing an upper and lower trading range for a particular market price. A stock is expected to trade within this upper and lower limit as each band or line represents the predictable range on either side of the moving average. Generally, 80-85% of the price action happens within these bands. All trading softwares will have options to display Bollinger bands. Bollinger Bands consist of a set of three lines drawn in relation to securities prices. The middle line is a measure of the intermediate-term trend, usually a simple moving average that serves as the base for the upper band and lower band. The interval between the upper and lower bands and the middle band is determined by volatility. The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition, prices are high at the upper band and low at the lower band.

Why use them?

Finds support and resistance levels: The upper band usually indicates a resistance level while the lower band usually indicates a support level. If you take a close look at any Bollinger band, you will find that the price usually bounce off the Bollinger band whenever it touches the upper or lower band. With this observation, you can use the upper and lower bands as support and resistance when planning your trade. Helps to find where to Enter and Exit: Bollinger Bands can be very useful trading tools, particularly in determining when to enter and exit a market position. For example: entering a market position when the price is midway between the bands with no apparent trend, is not a good idea. Generally when a price touches one band, it switches direction and moves the whole way across to the price level on the opposing band. If a price breaks out of the trading bands, then generally the directional trend prevails and the bands will widen accordingly. Gauges volatility: The Bollinger Band is an indicator that helps you to measure the volatility of the market. It can tell you the current situation of the market by using its upper and lower band. Whenever the market has low volatility, the bands will be narrow and whenever the market has high volatility, the bands will be wide. Shows Breakoutsone of the lesser known uses of Bollinger bands is the prediction for breakouts or gaps. As the bands squeeze a share price, the price range grows very narrow.

Some trading systems identify that this is a prime time for the price to breakout of this range. Usually a large price gap is the result. The difficulty is to know the direction of the price breakout.

Understanding Average True Range.

The Average True Range (ATR) is an indicator that measures volatility. A stocks range is the difference between the high and low price on any given day. It reveals information about how volatile a stock is. Large ranges indicate high volatility and small ranges indicate low volatility. Average true range is built on this principle of range. To understand ATR, you must first try the concept of true range.

What is True range?

True Range is the greatest of the following three values: 1.The difference in price between todays high and todays low of a stock. 2.The difference in price between yesterdays close to todays high. 3.The difference in price between yesterdays close to todays low. True range is always a positive number (negative numbers from the calculation above are to be ignored). Average true range is simply an average of the true range- usually 14-days. Calculating the Average True Range Indicator is slightly complex, though it is possible with a spreadsheet. Fortunately, most of the trading screens provide the average true range indicator as a part of their service. Care should be taken to use sufficient periods in the averaging process in order to obtain a suitable sample size, i.e. an average true range using only 3 days would not provide a large enough sample to give you an accurate indication of the true range of the securitys price movement. A more useful period to use for the average true range would be 14.

What does ATR indicate?

The value returned by the average true range is simply an indication as to how much a stock has moved either up or down on average over the defined period. High values indicate that prices are changing a large amount during the day. Low values indicate that prices are staying relatively constant. The ATR (Average True Range) indicator also helps to determine the average size of the daily trading range. In other words, it tells how volatile the market is and how much does it move from one point to another during the trading day.

ATR is not a leading indicator means it does not send signals about market direction or duration, but it gauges one of the most important market parameter price volatility. The logic behind ATR is that over the last several days on average, if the stock price has moved X points, we could safely assume that unless some shocking market news comes along, this range will remain relatively consistent. In short, ATR indicator is a tool for short term traders.Since it shows the average price range of a share, traders also use it to place stop loss orders.

Understanding Williams %R
Williams %R is a simple momentum oscillator explained by Larry Williams for the first time in 1973.It shows the relationship of the close relative to the high-low range over a set period of time. Typically, Williams %R is calculated using 14 periods and can be used on intraday, daily, weekly or monthly data. The time frame and number of periods will likely vary according to desired sensitivity and the characteristics of the individual security. The scale ranges from 0 to -100 with readings from 0 to -20 considered overbought, and readings from -80 to -100 considered oversold. This momentum indicator is, in fact , the inverse of the Fast Stochastic Oscillator. The default setting for Williams %R, as said above, is 14 periods, which can be days, weeks, months or an intraday timeframe. A 14-period %R would use the most recent close, the highest high over the last 14 periods and the lowest low over the last 14 periods. The indicator would appear below the price chart on your trading screen. An example of how Williams %R would look is given below.

Reading W %R signals.

Heres a collection of pointers you should be following in order to interpret William %R signals correctly. Williams %R moves between 0 and -100, which makes -50 the midpoint. A Williams %R cross above -50 signals that prices are trading in the upper half of their high-low range for

the given look-back period. Conversely, a cross below -50 means prices are trading in the bottom half of the given look-back period Low readings (below -80) indicate that price is near its low for the given time period. High readings (above -20) indicate that price is near its high for the given time period. Williams %R makes it easy to identify overbought and oversold levels. Readings from 0 to 20 considered overbought, and readings from -80 to -100 considered oversold. However, It is important to remember that overbought does not necessarily imply time to sell, and oversold does not necessarily imply time to buy. A security can be in a downtrend, become oversold and remain oversold as the price continues to trend lower. Once a security becomes overbought or oversold, traders should wait for a signal that a price reversal has occurred %R can be used to gauge the six month trend for a security. 125-day %R covers around 6 months. Prices are above their 6-month average when %R is above -50, which is consistent with an uptrend. Readings below -50 are consistent with a downtrend. In this regard, %R can be used to help define the bigger trend (six months). Like all technical indicators, it is important to use the Williams %R in conjunction with other technical analysis tools.

Understanding Stochastic oscillators.

Stochastic indicator:
The Stochastic oscillator is a technical indicator that shows the momentum. It is designed to oscillate between 0 and 100. Low levels mark oversold markets, and high levels mark overbought markets. Overbought means prices are too high, ready to turn down. Oversold means prices are too low, ready to turn up. Technical analysts believe that a value of 20 or below indicates an oversold condition and that a value of 80 or above indicates an over bought condition. This indicator was popularized by George lane decades ago and is now included in most software packages.

What does it measure?

The Stochastic oscillator measures the capacity of bulls to close prices near the top of the recent trading range and the capacity of bears to close them near the bottom. Bulls may push prices higher during the day, or bears may push them lower, but the stochastic oscillator measures their performance at closing timethe crucial money-counting time in the markets. If bulls lift prices during the day but cannot close them near the high of the recent range, the stochastic oscillator turns down, identifying weakness and giving a sell signal. If bears push prices down during the day but cannot close them near the lows, the

stochastic oscillator turns up, identifying strength and giving a buy signal. An example of how Stochastics appears below the stock price chart is shown below:

Fast & Slow Stochastics:

There are 2 main types of setting, the Fast Stochastic and the Slow stochastic. Fast Stochastics: use shorter Time Periods, and Shorter Averages this creates more fluctuations but conversely also more false alarms Slow Stochastics: use longer time periods and longer average periods this creates a smoother flow and gives the ability to see trends clearer, the drawback is the Indicator lags price and is less responsive.

How is the indicator plotted?

The term stochastic refers to the location of a current price in relation to its price range over a period of time. The stochastic is plotted as two lines %K, a fast line normally represented by a blue line and %D, a slow line, normally red. These two lines have the following characteristics: The default setting for the Stochastic Oscillator is 14 periods, which can be days, weeks, months or an intraday time frame. The %K line is basically a representation of where the market has closed for each period in relation to the trading range for the 14 periods used in the indicator. The %D line is a 5 period moving average of %K. Sounds very complicated, isnt it? Dont worry. You dont need to learn about how combustion engine works to drive a car. What you need to do is to follow these simple rules. Rule 1- Use the stochastic oscillator just like RSI to identify overbought and oversold levels in the market. When the lines that make up the indicator are above 80, it represents a market that is potentially overbought and when they are below 20, it represents a market that is potentially oversold. The developer of the indicator George Lane recommended waiting for the %K line to trade back below or above the 80 or 20 lines as this gives a better signal that the momentum in the market is reversing.

Rule 2- Watch for a crossover of the %K line and the %D line. When %D is below the 20 mark and the faster %K line crosses the slower %D line, it is a sign that the market may be heading up and when %D is above the 80 mark and the %K line crosses below the %D line this is a sign that the market may be heading down. Rule 3- The third rule is to watch for divergences where the Stochastic trends in the opposite direction of price. As with the RSI this is an indication that the momentum in the market is waning and a reversal may be in the making. For further confirmation many traders will wait for the cross below the 80 or above the 20 line before entering a trade on divergence. Rule 4- Never rely solely on Stochastics or any other technical indicator for that matter. Always use technical indicators as additional tools. Stochastics uses the Price Open, High, Low and Close for the period, so it can be used well in conjunction with RSI, which uses only Close Price as the input. That completes our lesson on Stochastics. The nicest thing about the stochastic is that it can keep up with fast moving, volatile or even trading range markets.

Understanding RSI (Relative strength Index)

Introduction
The name Relative Strength Index is slightly misleading as the Relative Strength Index does not compare the relative strength of two securities, but rather the internal strength of a single security. Relative Strength Index (RSI) is a very popular momentum indicator.

What does it measure?

RSI measures the speed and change of price movements. RSI oscillates between zero and 100. When the RSI line moves higher, it is understood that price is enjoying increased strength and as the RSI line moves lower, it is understood that the price is suffering from a lack of strength. However, technical analysts believe that a value of 30 or below indicates an oversold condition and that a value of 70 or above indicates an over bought condition. When Wilder introduced the Relative Strength Index in 1978, he recommended using a 14day Relative Strength Index. Since then, the 9-day and 25-day Relative Strength Indexes have also gained popularity. The most popular is the 14 day RSI. Shown below is an example of how the RSI would be displayed below your stock prices chart

Tips for Using the RSI Indicator

As with all technical indicators, RSI is a way of measuring odds its not a full-blown, foolproof system to gauge price trends. It is usually best used in conduction with other indicators. Though considered an oscillator, the relative strength index has qualities of momentum indicators, and can be used in that capacity. For instance, some investors interpret a cross of the 50 level (the mid-point of the scale) as a signal of momentum bullish or bearish in itself. If the stock has been trending up, but the relative strength indicator starts to trend down, there is a divergence and you would prepare to enter a bearish trade (down direction). Its the vice versa for bullish trades. Once the stock becomes overbought (RSI reaches the point 70) or oversold (RSI at 30), or has price divergence you should always wait for some type of confirmation that a price reversal has indeed occurred. RSI should not be used in isolation. It must be used in combination with other indicators to help build a clear picture. The RSI oscillator should not be confused with another trading tool unfortunately called the Relative strength. The other tool compares a stocks or indexs performance to other stocks or indices in a group, and ranks that stock or index, assigning a relative strength score. The other tool is powerful too, but is unrelated to the RSI indicator discussed here. RSI is a versatile momentum oscillator that has stood the test of time. Hope you have got information about RSI and how it can be used to take decisions.

Understanding Average Directional Index (ADX)

Introduction:
Average directional index evaluates the strength of the current trend, be it up or down. The ADX is an oscillator that fluctuates between 0 and 100. The indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. A reading above 40 indicates that the trend is strong and a reading below 20 indicates that the trend is weak. An extremely strong trend is indicated by readings above 50.

What does it measure?

ADX does not indicate trend direction, only trend strength. It is a lagging indicator; that is, a trend must have established itself before the ADX will generate a signal that a trend is underway. ADX can also be used to identify potential changes in a market from trending to nontrending. When ADX begins to strengthen from below 20 and moves above 20, it is a sign that the trading range is ending and a trend is developing. The ADX indicator does not provide buy or sell signals for investors. It does, however, give you some perspective on where the stock is in the trend. Low readings and you have a trading range or the beginning of a trend. Extremely high readings tell you that the trend will likely come to an end. Overall, what is important to understand is that this indicator measures strong or weak trends. This can be either a strong uptrend or a strong downtrend. It does not tell you if the trend is up or down, it just tell you how strong the current trend is.

Construction of ADX.

We will not go into the formulas for the Indicator here. However what we need to know is that: ADX is derived from two other indicators The first one is called the positive directional indicator(sometimes written +DI) and the second indicator is called the negative directional indicator(-DI) The +DI Line shows how strong or weak the uptrend in the market is. The -DI line shows how strong or weak the downtrend in the market is. ADX is the average of the above two lines and hence, it shows the strength of the current movement.

On screen, the ADX appears below the stock price chart. The +DI (normally a green line) and DI lines (red line) would accompany the ADX (Black line). So you see three lines as shown in the figure below.

More tips:

When the ADX starts rising from a low level it signals the beginning of a trend. The trend is confirmed when the ADX has risen above the 20-25 value and the +DMI line has crossed the DMI line (in case of an uptrend). The ADX signal generally does not move above 60 or 70. ADX above these levels are considered to be over bought levels. When the ADX has reached an overbought level and starts consolidating it can signal the end of the current trend. The decline of the ADX signals the consolidation or indecision of the market. When the ADX drops below 10, the current trend is virtually dead. Be ready for the beginning of a new trend bullish or bearish. Dont assume that since your current position has given you an ADX reading of 10 (or lower) implying that your trend is over and that the subsequent ADX move above 20 will take you in the opposite direction. Thats a terribly wrong assumption. An ADX reading above 20 implies the beginning of a new trend; whereas; a rise above 25 implies a trending market; even a bearish market. So, know this it is possible to have a reading of 35 and the market can be falling like a rock. An upward moving ADX does not specify market direction only market trend. This is a very important point to note. That completes our lesson on ADX. More about indicators in our next lesson.

Understanding MACD
Developed by Gerald Appel in the late seventies, Moving Average ConvergenceDivergence (MACD) is one of the simplest and most effective indicators available.

The two components of MACD.

The MACD indicator is comprised of two exponential moving averages (EMA), covering two different time periods, which help to measure momentum in the security. The two exponential moving averages are the 12 period EMA and the 26 period EMA. The MACD is the difference between these two moving averages. A 9-day EMA of MACD is plotted along side to act as a signal line to identify turns in the indicator. MACD is all about the convergence and divergence of the above said two moving averages.

Histogram
Another aspect to the MACD indicator that is often found on charts is the MACD histogram. Thomas Aspray added a histogram to the MACD in 1986. The MACDHistogram represents the difference between MACD and its 9-day EMA, the signal line. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA. Whats said above would be clearer if you follow the MACD signal given below. The idea behind this momentum indicator is to measure short-term momentum compared to longterm momentum to help determine the future direction of the asset. Note that the red line is the 9 day average of the MACD (and not of the stock price).

MACD signal is available on any standard online trading screen. Your online trading screen will have the option to select the MACD signal from the choices of technical indicators. The exact location of this operation varies between trading screens, but will almost always be titled technicals ,indicators, studies, oscillators or analysis. It may be a button on the chart, an option available by right-clicking on a chart or a menu above the chart. MACD signal will be displayed below the stock price chart. It generates three meaningful signals for the investor: They are 1. Crossover signal 1- MACD line crosses the signal line. 2. Crossover signal 2- MACD Line crosses the line Zero(center line) 3. Divergence signal- MACD line ( or histogram) and the price of the stock (as seen on the price graph) diverge (i.e. moves in the opposite direction) You must also read: How to read the signals generated by MACD to get a firm grip on the subject.

Understanding Moving average

An average that moves! As its name implies, a moving average is an average that moves. They do not predict price direction, but rather show the current direction with a lag. Moving averages are based on past prices, which mean they will lag behind current prices. It will be presented in graphical form on your online stock trading terminal. Moving averages form the building blocks for many other technical indicators and overlays, such as Bollinger bands and MACD (explained later in this section). Most analysts use the 50 day, 100 day and the 200 day moving averages. The 200-day moving average is the important moving average. Example: To begin calculating a 200-day moving average of Infosys, the closing prices of Infosys over the last 200 days would be added together, and then divided by 200. That provides the average price at which Infosys was sold over the last 200 days. That point would be marked on the chart today. To make the average move, each subsequent day the same process is repeated, and the new point is added to the chart. After a few weeks you have the 200-day moving average moving along the chart where its relationship to Infosyss price each day can be seen. Note that in calculating the moving average each day, the oldest of the 200 closes is dropped and the new days close is added (Only the prices over the most recent 200 days are added together and divided by 200 each day). So, the 200-day moving average is simply a shares average closing price over the last 200 days. The 200-day moving average is perceived to be the dividing line between a stock that is technically healthy and one that is not. Furthermore, the percentage of stocks above their 200-day moving average helps determine the overall health of the market. Many market

traders also use moving averages to determine profitable entry and exit points into specific securities.

Purpose of moving averages:

Primary function of a moving average is to identify trends and reversals, measure the strength of an assets momentum and determine potential areas where an asset will find support or resistance. Moving averages are easier to see and analyse on a chart. There are different types of moving averages-simple moving average (explained above) and exponential moving average. The Exponential Moving Average differs from a Simple Moving Average both by calculation method and in the way that prices are weighted. The Exponential Moving Average (shortened to the initials EMA) is effectively a weighted moving average. With the EMA, the weighting is such that the recent days prices are given more weight than older prices. The theory behind this is that more recent prices are considered to be more important than older prices, particularly as a long-term simple average (for example a 200 day) places equal weight on price data that is over 6 months old and could be thought of as slightly out-of-date. A moving average can be a great risk management tool because of its ability to identify strategic areas to stop losses.

What is the right moving average?

Moving averages come in various forms, but their underlying purpose remains the same: to help technical traders track the trend of financial assets by smoothing out the dayto-day price fluctuations. There is nothing called right moving average. A 50-day moving average should be right for the intermediate term and 150 or 200-day moving average should work well for a long term investor

Types of indicators/Oscillators
Before moving on to the next lesson, heres the summary of the last three lessons: Technical indicators are tools that provide an indication about the condition or direction of the stock market. These indicators are generally used as additional information before one takes a decision to buy or sell a share. They provide unique perspective on the strength and direction of the market. Oscillators are a type of technical indicator. Most of the indicators work on the principle of averages. For technical indicators, there is a trade-off between sensitivity and consistency. In an ideal world, we want an indicator that is sensitive to price movements, gives early signals and has few false signals (whipsaws). Sensitiveness of an indicator/oscillator to price movements in the market would depend on the time interval for which the indicator is constructed. For example a 5 day RSI would be more sensitive than a 14 day RSI. The 5 period RSI would have more overbought and oversold readings. It is up to each investor to select a time frame that suits his or her trading style and objectives. The shorter the period selected, the more sensitive the indicator becomes. If we increase the sensitivity by reducing the number of periods, an indicator will provide early signals, but the number of false signals will increase. If we decrease sensitivity by increasing the number of periods, then the number of false signals will decrease, but the signals will lag and this will skew the risk reward ratio. From here on, for ease of understanding, we will discuss the prominent types of technical indicators/oscillators from the point of view of what exactly it measures. Whether it is leading or lagging and whether its signals are crossovers or not would be discussed at appropriate places.

Prominent indicators/oscillators.
Indicators that show the trend

Moving average MACD (Moving average convergence/ divergence) Average directional index.

Indicators that show momentum

RSI (relative strength index) Stochastic oscillator Williams %R

Indicators that measures volatility

Average true range Bollinger bands Before moving further, I would also like to explain in brief about the difference between trend, momentum and volatility. Momentum- It measures the degree of acceleration in a stock price. It is a short term measurement. In other words, Momentum measures the speed of price change and provides a leading indicator of changes in trend. When momentum slows, this is taken to mean that there might be a change in direction. Momentum is significant because it signals the strength of price trends Trend A trend can be defined as the general direction in which the market is movingin. A trend can be either upwards (bullish trend) or downwards (bearish trend) or sideways (lack of direction). Volatility The relative rate at which the price of a stock moves up and down If the price of a stock moves up and down rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility. In other words, Volatility refers to the amount of uncertainty about the swings in price of a stock. A higher volatility means that a stocks value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a securitys value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.

Oscillators
What are oscillators?
Oscillators are technical indicators that measure a stocks momentum as it oscillates between an overbought and an oversold zone and then give a buy/sell signal. Oscillators have recently caught the fancy of most traders. Oscillators give out crossover model signals to in dictate a change in trend. Oscillators are typically plotted in two ways. 1. Banded oscillators: Plotted within a range between 0 and 100, in this method, the zone between 0 and 30 is considered the oversold zone while the zone between 70 and 100 is considered overbought. When the oscillator reaches an extreme value in any end, either up or down, the implication is that price has moved too fast and too far. This would warn investor to be ready to face a sudden reversal or a period of consolidation or sideways movement. Investors should typically buy when oscillators feature in the lower end of the range and sell when the oscillator line reaches the upper end of the range. 2. Centered oscillators: The other way to plot oscillators is on either side of a zero line and the oscillator moves between positive and negative values. Called centered oscillators, they fluctuate above and below a central point or line. These oscillators are good for identifying the strength or weakness, or direction, of momentum behind a securitys move. In its purest form, momentum is positive (bullish) when a centered oscillator is trading above its center line and negative (bearish) when the oscillator is trading below its center line. MACD (discussed later) is an example of a centered oscillator that fluctuates above and below zero.

What are oversold and overbought conditions?

Oversold is a condition where it appears that a stock has declined to the point where the selling is over and buyers will likely step in and push the stock higher. Over bought is a condition where it appears that a stock has reached a price peak and is now likely to turn down. However, overbought is not meant to act as a sell signal, and oversold is not meant to act as a buy signal. Overbought and oversold situations serve as an alert that conditions are reaching extreme levels and close attention should be paid to the price action and other indicators.

An example of relative strength index (RSI) , one of the most commonly used oscillators is given below.

The blue line on the picture above is the stocks RSI which moves within a band of 30 -70. When ever the RSI breaches the 30 mark it signals an oversold situation and the stock bounces back. The zone above 70 is considered as overbought. Note that the stock price has shown a drop in price after it breaches the upper limit of the band at 70.

A few words of caution

Too Many indicators and oscillators!

The best technical indicators are those that have in the past been tried, tested and proven successful. Nowadays, every other technical analyst develops a new technical indicator or oscillator regularly. There are hundreds of oscillators available. In fact, you will be confused as to which one would give you good signals. Our advice to you is to follow the tried and tested indicators. Also, keep in mind the following points: Do not attempt to master all technical indicators and oscillators. Just pick up knowledge in about three of them. Do not analyse stocks price by applying just one indicator use about 2 or 3 complementary indicators, as using just one indicator may give you a false signal. Using 2

3 indicators can confirm the signals given by one indicator, but if you get a different signal from another complementary indicator then you must not rush into the trade. Take your time to study. With time you will develop the art of judging profitable trades using technical indicators. Do not expect to morph into an expert on day one and carry out trades based on a knee-jerk assessment. First put your new found knowledge to test and begin trading only if youre proven correct most of the time.

How does a technical indicator work ?

How does a technical indicator work?
Technical indicators are derived from technical charts which are graphical or pictorial representations of the market activity in terms of upward or downward movements in stock prices over a period of time. Mathematically, a technical chart is a plot of a set of price data (on the vertical axis) as a function of time (on the horizontal axis). The price data can include a stocks opening price, closing price, days high or low price, average price, or a combination of these. The plotted data points on the chart can show as individual points or as small bars. When all the data points on the chart are joined, a wave-like pattern is obtained. This pattern is then subjected to technical analysis by experts, who apply standard mathematical formulae to these price movements in order to arrive at technical indicators, from which they can predict the future market price of a stock or its market trend (upward/downward movement).

Types of signals- Crossovers and Divergence

The indicators show the signals in one of the two ways- through crossovers or divergence. Crossover indicators are constructed with an upper limit and a lower limit. When the limits set are breached, it signals that the trend in the indicator is shifting and that this trend shift will lead to a certain movement in the price of the underlying security. Divergence means the direction of the price trend and the direction of the indicator trend moves in the opposite direction. This signals that the direction of the price trend may be weakening as the underlying momentum is changing. Divergence is a key concept. Divergences can serve as a warning that the trend is about to change. There are two types of divergences: positive and negative. In its most basic form, a positive divergence occurs when the indicator advances and the underlying security declines. A negative divergence occurs when an indicator declines and the underlying security advances.

The concepts of crossovers and Divergence would become clear to you once you learn more about indicators and oscillators.

How do technical indicators help the investor/trader?

If you have watched the stock market action on a computer screen, you would have noticed that stock prices keep fluctuating almost every second and it is impossible to make head or tail of the pattern if all the price movements are planted on a chart. So, to smooth out the data, technical analysts plot any one of the high/low/open/close/average prices on the charts. This also helps in understanding the movements of an extremely volatile stock and then predicting its future price movement. Technical indicators also help an investor in the following. 1. They determine support and resistance levels. Even an amateur technical chartist can determine important technical levels, which when breached will take a stocks price lower (support levels) or higher (resistance levels). 2. Some indicators can help determine the future price of a share. 3. Technical indicators help in establishing trends (upward or downward), which are critical for both traders and investors. 4. Technical indicators always alert a technical analyst of any major price action/volatility is about to occur in a stocks price. Even you will be able to interpret the alerts once you are through all the articles featured in this topic. Next we need to look at something called oscillators. more about that in our next lesson.

Introduction to technical indicators

What is a technical indicator?
In stock market analysis, a technical indicator is nothing but a tool that provides an indication about the condition or direction of the economy. Indicators take the form of calculations based on the price and the volume of a security and measures factors such as volatility and momentum. They are also used as a basis for trading as they can form buyand-sell signals. Indicators provide an extremely useful source of additional information. Technical analysis is broken into two main categories:1. Chart patterns (discussed in technical analysis part 1) 2. Indicators and oscillators ( discussed below)

What does it offer?

Some technical indicators, such as moving averages are derived from simple formulas and the mechanics are relatively easy to understand. Others, such as stochastic, 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.

Types of indicators:
There are basically two types of indicators based on what they show users: 1. Leading indicators 2. Lagging indicators. Leading indicators, as their name implies, are designed to lead price movements. That isthe indicators move first and price action follows. Some of the more popular leading indicators are commodity channel index, Momentum, relative strength index, stochastic oscillators and Williams %R. The advantage of using leading indicators is that the signals act as warning against a potential strength or weakness. Leading indicators are more sensitive to price fluctuations. Lagging indicators as their name implies, follow the price action and are commonly referred to as trend-following indicators. It has less predictive qualities. The usefulness of lagging indicators tends to be lower during non-trending periods but highly useful during trending periods. This is due to the fact that lagging indicators tend to focus more on the trend and produce fewer buy-and-sell signals. This allows the trader to capture more of the trend instead of being forced out of their position based on the volatile or sensitive nature of the leading indicators. Moving averages and Bollinger bands are examples of lagging indicators.

Where to find these indicators?

Most of the common indicators and oscillators are available readily on your online trading platform screen. Know it: Always remember- Technical Indicators are sources of additional information. The purpose of indicators is to indicate. This may sound very straightforward, but sometimes investors ignore the price action of a security and focus solely on an indicator. Indicators filter price action with formulas. As such, they are derivatives and not direct reflections of the price action. This should be taken into consideration when applying analysis. Any analysis of an indicator should be taken with the price action in mind. What is

the indicator saying about the price action of a security? Is the price action getting stronger? Weaker? Indicators should be studied in context of other technical analysis tools. An indicator may show a buy signal but the chart pattern and fundamentals may be weak. There are two types of indicators leading (one that leads the price change) and lagging indicators(one that follows the price action)