Demystify Techncial Analysis Session 3

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
 Leading Indicators
• Relative Strenth Index
• Stochastic
• Rate of Change.
 Volatility Indicators.
• Bollinger Bands
 GAPS
- Common Gaps
- Breakout Gaps
- Runaway Gaps
- Exhaustion Gaps
 Money Management
- Martingale System
- Anti Martingale System
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.
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.
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.
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.
Lagging Indicators
 Moving Averages
 MACD
 Average Directional Index
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.
Moving Averages
Different Kinds of Moving Averages
 Simple Moving Average
 Weighted Moving Average
 Exponential Moving Average
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.
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 18 25 2 9 16 23 30 6 13 20 27 3 10 17 24 1 8 15 22 29 5 12 19 26 3 10 17 24 31 7 14 21 28 4 11 18 25 3 10 17 24 31
Jun e July Au gu st Se ptemb er Octo be r Nov emb er De cemb er 20 08 Fe bru ary March
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%)
Which one is better ?
Properties of Good moving Average
 Moving averages are portable trendline , So good

moving average should act as good Support levels.
Properties of Moving Averages
Moving Averages
 When two moving averages are used the longer is for

trend identification and the shorter for timing
 It is the interplay between the two which gives you the

timing
 Classics are 5 and 20 day and 10 and 40 day
 On stocks, 7 and 21 work well
Right Moving Average Period
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
Guppy Moving Averages
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
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
Calculation of MACD
MACD Signals
 MACD generates bullish or Bearish signals from three

main sources:
• Positive divergence
• Bullish moving average crossover
• Bullish centerline crossover
Bullish Divergence
 When Prices are falling on remain same but the Indicator
moves up then it is called Bullish Divergence
What is Positive Divergence and Negative Divergence
 When Prices are going up or remaining same but
Indicator is coming down is called Negative Divergence.
MACD Cross Over
 Buy : When MACD Crosses above its Average .
 Sell : When MACD Crosses below its Average.
Centerline Crossover
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.
 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.
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.
Average Directional Index
 Wells Wilder introduced this revolutionary concept in New Concept in
Technical Trading System .
 + DI is greater then –DI add that Amount to +DI and Deduct the same
amount from – DI ,
 If –DI is greater than + DI then add to –DI and deduct that amount from –
DI
Trading using +DI and –DI
 Buy : When + DI crosses above – DI
 Sell : When – DI crosses above + DI
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 . ( Note : Threshold value may vary from
Commodity to Security ) .
Trending and Trading Market
Average Directional Index (ADX)
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.
 The benefits of trend-following indicators are lost when a security moves in a
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.
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.
Leading Indicator
 Relative Strenth Index ( RSI )
 Stochastic
 Rate of Change
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.
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.
RSI Bullish/Bearish Divergence
RSI Bearish Divergence
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.
Properties of RSI
 Normal Technical Analysis can aslo be applied to RSI like Trendline,

Fibonacci Retracement or Projection etc….
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).
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
5800
5700
P 5600
5500
P 5400
5300
5200
5100
P 5000
4900
4800
O 4700
4600
O 4500
4400
O 4300
Stochastic Oscillato r (39.3942) 100
90
80
70
60
50
40
30
20
O O O 10
17 24 1 8 15 22 29 5 12 19 26 3 10 17 24 31 7 14 21 28 4 11 18 25 3 10 17 24 31
October November December 2008 February March
Stochastic strategy
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.
Rate of Change ( ROC )
TATA POWER COMP (1,163.00, 1,188.00, 1,100.50, 1,160.45, -3.10010)
1650
1600
P 1550
P 1500
P 1450
1400
1350
O
O 1300
O 1250
1200
1150
1100
1050
1000
Price ROC (-195.600) 400

350
300
250
200
150
P 100
50
0
O O O
-50
-100
-150
-200
-250
-300
-350
-400
-450
-500
-550
-600
26 3 10 17 24 31 7 14 21 28 4 11 18 25 3 10 17 24 31
December 2008 February March
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.
 With early signals comes the prospect of higher returns and with
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.
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.
Formula
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.
Bollinger Bands
 Sideways consolidation Breakouts.
Bollinger Band Breakout
Band Envelop and Bollinger Bands
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
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 .
Mind the Gap
Common gap – occur in low volume caused by lack of
interest. (sometimes filled but be careful)
 Breakaway gap – occur in heavy volume when trendlines

break or patterns complete. (often filled)
 Runaway gap – occur in moderate volume during a trend.

(generally filled and will provide support on reversal)
Exhaustion gap – occurs in heavy volume near the end of

a market move. (pretty much always filled)
Mind the Gap
NAS NAS/NMS COMPSITE, Last Trade [Hi/Lo/Cl Bar] Daily
16Nov00 - 08Feb01
Pr
NAS NAS/NMS COMPSITE , Last Trade, Hi/Lo/Cl Bar USD
19Jan01 2841.25 2752.06 2770.38
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 FREEZE
11Feb05 - 30Jun05
Pr
.BSESN , Last Trade, O/H/L/C Bar INR
01Jun05 6729.39 6763.28 6721.22 6745.83
6900
6850
6800
6750
6700
6650
6600
6550
6500
6450
6400
6350
6300
6250
6200
6150
11Feb05 18Feb 25Feb 04Mar 11Mar 18Mar 25Mar 01Apr 08Apr 15Apr 22Apr 29Apr 06May 13May 20May 27May 03Jun 10Jun 17Jun 24Jun
Gaps
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
TABLE OF TRADES
No of Lossing Amt of Lossing No of Winning Amt of Total Inflow/

Trades Trades Trades Winning Outflow
Trades
10 (10) 0 0 (10)
9 (9) 1 2 (7)
8 (8) 2 4 (4)
7 (7) 3 6 (1)
6 (6) 4 8 2
5 (5) 5 10 5
4 (4) 6 12 8
3 (3) 7 14 11
2 (2) 8 16 14
1 (1) 9 18 17
0 0 10 20 20
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:
If you win you will get back 320 so net inflow is your original Rs 5
 Is it a Good bet.
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.
End of Session 3

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Demystify Techncial Analysis Session 3

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Demystify Technical Analysis

 Different Kinds of Indicator.

 Benefits and Drawback of Indicators

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

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

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

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

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

 Average Directional Index

 Simple Moving Average

 Weighted Moving Average

 Exponential Moving Average

 A weighted moving average is simply a moving average that is

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

The formula for an exponential moving average is:

 EMA(current) = ( (Price(current) - EMA(prev) ) x Multiplier) +

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

 Moving averages are portable trendline , So good

 When two moving averages are used the longer is for

 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

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

• As it is a lagging indicator you will always be able to capture the big

• It act as a good support and Resistance .

• It also shows the underlying Trend

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

 MACD generates bullish or Bearish signals from three

• Bullish moving average crossover

• Bullish centerline crossover

 Sell : When MACD Crosses below its Average.

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

 Sell : When – DI crosses above + DI

 Average Directional Index is nothing but the Absolute difference between + DI

 One of the main benefits of trend-following indicators is the ability to catch a

 Relative Strenth Index ( RSI )

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

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

Price ROC (-195.600) 400

 There are clearly many benefits to using leading indicators. Early

 A simple moving average in the middle

 Sideways consolidation Breakouts.

• To identify periods when prices are at extreme,

 Gaps are nothing but the vacuum left by the Prices.

 Breakaway gap – occur in heavy volume when trendlines

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

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

 Two Types of Money Management Systems

 Anti Martingale System

No of Lossing Amt of Lossing No of Winning Amt of Total Inflow/

 You bet Rs 5 and you lose.

 Anti Martingale System tells to Invest double in a winning

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