Technical Trading Strategies

Primer 1
Table of Contents
Objectives ............................................................................................................................................... 2
Trading volume ....................................................................................................................................... 3
Overbought ............................................................................................................................................. 3
Oversold .................................................................................................................................................. 3
Candlestick Chart .................................................................................................................................... 3
Support and Resistance Levels................................................................................................................ 5
Absolute price change............................................................................................................................. 6
Fibonacci sequence ................................................................................................................................. 6
Fibonacci ratios ................................................................................................................................... 6
Fibonacci retracement ............................................................................................................................ 6
Stochastic oscillator ................................................................................................................................ 7
Fast Stochastic Oscillator .................................................................................................................... 8
Slow Stochastic Oscillator ................................................................................................................... 8
Full Stochastic Oscillator ..................................................................................................................... 8
Williams %R............................................................................................................................................. 8

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Objectives

In this unit, we will learn some basic concepts that will help you to understand the
upcoming units better.

We will discuss some terminologies and concepts such as

 Trading volume
 Overbought
 Oversold
 Candlestick chart
 Support and resistance levels
 Absolute price change
 Fibonacci sequence

We will also cover the following technical indicators which will help you grasp the insights
behind the trading strategies that we will be discussing in the next video lecture.

 Fibonacci Retracement
 Stochastic Oscillator
 Williams %R

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Trading volume

Trading volume represents the number of securities traded during a particular

period of time. Higher the trading volume higher is the liquidity of the security in the
market. It means that if trading volume of a security is high, the security can be quickly
bought or sold without changing its price much. Suppose, on a particular day a Trader A
buys 150 shares of Microsoft while Trader B and C sells 100 shares and 200 shares of the
same company. In such a case, the trading volume will be the sum of 150, 100 and 200, that
is, 450 shares.

Overbought

Overbought is a condition when price of a security shoots up to such a level that it is

not justified by fundamentals. It happens when demand of a security unexpectedly
increases its price. Overbought condition is an indicator that the security is overvalued.
Deciding the level to which a security is overbought is very subjective. However, traders use
various technical indicators such as Relative Strength Index (RSI), Bollinger Bands, Stochastic
Oscillator etc. to identify overbought securities.

Oversold

Oversold is a condition in which the price of a security drops to such a level that it is
not justified by fundamentals. It happens when a decline in the demand of a security
unexpectedly reduces its price. Oversold condition is an indicator that the security is
undervalued. Deciding the level to which a security is oversold is very subjective. However,
investors use various technical indicators such as Relative Strength Index (RSI), Bollinger
Bands, Stochastic Oscillator etc. to identify oversold securities.

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Candlestick Chart

Candlestick chart or a Japanese candlestick chart is a type of chart which is used to

represent the various prices of a security on a particular day. It is the combination of a bar
chart and a line chart where the vertical lines above and below are called the shadows and
the bar or box between the lines is called the body. A candlestick represents the main four
prices of a security which are, opening price, closing price, high price and low price. The
image below shows how a candlestick is formed.

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Support and Resistance Levels

Support and resistance levels are very important concepts in technical analysis.
Support level is the price level at which the demand of the security will be strong enough to
prevent its price from declining further. One way to interpret the support level is, if the
price reaches or falls below the support level, the security is considered to be oversold while
the demand will overcome the supply and prevent the price from falling below the support
level.

Resistance level is the price level at which the selling pressure for the security will be
strong enough to prevent the price to climb above the resistance level. One way to interpret
the resistance level is that if the price touches or goes above the resistance level, the
security is considered to be overbought and the supply is expected to overcome the
demand and prevent the price from rising above the resistance level.

Generally, the lowest of the low prices over a period of time is considered as the
support level, while the highest of the high prices is used as the resistance level. However, it
is not necessary that the price cannot move beyond the support and resistance levels. In
such a case, the support and resistance levels have to be revised.

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Absolute price change

Absolute price change is the difference between the current day price and the price
‘n’ days ago. Absolute price change can be seen as a measure of volatility in the price of the
security and can be represented by the following formula:

Absolute price change = Current price of the security – Price of the security ‘n’ days ago

Fibonacci sequence

Fibonacci sequence is a series of numbers in which each successive number is the

sum of the preceding two numbers. The Fibonacci series is:

0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610……

Where,

● 2 is the sum of two preceding numbers (1+1)

● 3 is the sum of two preceding numbers (1+2),
● 5 is the sum of 2 & 3, and so on

Fibonacci ratios
Fibonacci sequence has many unique mathematical properties. One of them is the
Fibonacci ratios which are 23.6%, 38.2%, 61.8%, 161.8% and so on. These ratios can be
calculated in the following ways:

● The 23.6% ratio is the approximation which is calculated by dividing one number in
the series by the number that is three places to the right. For example: 13/55 =
0.2363.
● The 38.2% ratio is the approximation, calculated by dividing a number in the series
by the number which is two places higher. For example: 21/55=0.3818.
● The 61.8% ratio is the approximation, calculated by dividing a number in the series
by the number by its successive number. For example: 34/55=0.6181.

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 ● The Fibonacci ratio of 161.8% is also referred as "the golden ratio" or "the golden
mean" is denoted by Greek letter "φ" which is calculated by dividing a number in the
series by its preceding number. For example: 89/55=1.6181.

Fibonacci retracement

Fibonacci retracement is based on the Fibonacci ratios discussed above to identify

potential price reversal levels. The assumption behind this is that the price of a security will
retrace to a particular price level and then continue to move in its original direction. It
involves identifying the highest and lowest price levels over a period of time and assigning
them 100% and 0% ratios respectively and then, dividing the area between them into
horizontal lines of Fibonacci ratios of 23.6%, 38.2% and 61.8%. However, sometimes traders
also include 50% ratio because price level above 50% is an indicator of a strong trend. By
observing the price of a security through Fibonacci retracement, traders are able to
establish the support and resistance levels by identifying Fibonacci ratio levels at which the
price retraces back to the original direction. We will explain this in greater detail in the next
video lecture.

Stochastic oscillator

Stochastic oscillator is a momentum oscillator, which follows the speed and

momentum of the price of a security. Generally, it is calculated over a period of 14 days by
using the following formulas:

%K = (Current Close - Lowest Low) / (Highest High - Lowest Low) * 100

%D = 3-day Simple Moving Average (SMA) of %K

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There are three types of stochastic oscillators.

Fast Stochastic Oscillator

Fast %K = %K as calculated above

Fast %D = 3-period SMA of Fast %K

Slow Stochastic Oscillator

Slow %K = Fast %K smoothed with 3-period SMA

Slow %D = 3-period SMA of Slow %K

Full Stochastic Oscillator

Full %K = Fast %K smoothed with X-period Simple Moving Average

Full %D = X-period SMA of Full %K

For interpreting the Stochastic Oscillator, traditionally, readings of 80 and above

indicate that a security is overbought, while readings of 20 and below indicate that the
security is oversold. Hence, 80 is the overbought threshold and 20 is the oversold threshold.

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Williams %R

Williams %R is a momentum indicator which shows closing price in relation to the

high and low of the past N days. It helps in understanding if the price of the security is
trading near the high or low price or is trading in between them. It can be calculated by
using the following formula:

%R = (Highest High - Close) / (Highest High - Lowest Low) * (-100)

It ranges between 0 and -100 and is generally calculated over a period of 14 days.
Traditionally, a high reading of above -20 indicates that price is near its high while low
readings below -80 indicate that price is near its low for the given time period. Hence, -20
can be used as the overbought threshold and -80 as the oversold threshold. However, these
thresholds can be adjusted based on the characteristics of the security and type of analysis
to be done.

Williams %R

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