CHART ANALYSIS

BY SUNNY JAIN

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 CONTENTS

INTRODUCTION

TYPES OF CHARTS

TRENDS

SUPPORT & RESISTANCE

PRICE PATTERNS

TIMEFRAMES

INDICATORS

CANDLESTICKS

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INTRODUCTION

Technical analysis is basically the study of price. There are many ways to study
price and the method we are going to learn here is by using price charts. Hence,
the name chart analysis.

Charts allow us to visually see the effects and the price movement itself. Chart
analysis is extremely useful in price-forecasting. Charting can be used by itself or
in conjunction with fundamental analysis. Price forecasting, however, is only the
first step in the decision-making process.

Market timing is the second more important step to determine. Minor price
moves can have a major impact on short-term traders. The precise timing of entry
and exit is very crucial to trading successfully. Simply put: timing is everything in
the market.

Chart analysis is the study of market action, using price charts, to forecast future
price direction. Natural disasters, fundamental analysis, political events, any
major news, quickly show up in some form of price movement, either up or down.
Another advantage of chart analysis is that the market price itself is a leading
indicator of the known fundamentals. Therefore, chart analysis can hint a
fundamental analyst that something important is happening or about to happen.

Lets get into the technical aspects of chart analysis.

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TYPES OF CHARTS
LINE CHARTS

Line charts connect each day’s closing price and is the simplest form of charting.

Line charts best indicate the trend of a stock, which we will get into later. Above
you can clearly see price moving in the upward direction. Line charts remove all
noise and give a very clean and simple picture of the price movement. Line charts
give importance only to the closing price of the instrument. In today’s date, most
analysts do not prefer using line charts due it’s over simplicity. Most analysts
prefer charts which display open, high, low and close data.

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BAR CHARTS

Bar charts show us the open, high, low and close of an instrument for that
particular time period. The chart above is a daily chart so each bar shows the
values for that particular day.

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Bullish bar means the close of the bar is greater than the open. A bearish bar
means the close of the bar is less than the open value.

CANDLESTICK CHARTS

There are many books written on just candlestick charting and they can go into
great detail. We will just cover the basics here to allow you to at least understand
how to analyze them.

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HEIKEN ASHI CHARTS

Heiken Ashi charts are an extension to candlestick charts in which they remove all
the noise (volatility) from the charts. See the comparison below:

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See how the heiken ashi chart is much cleaner and smoother and better displays
the trend of an instrument.

TRENDS
UPTREND

As the name clearly states, an uptrend is the price of an instrument going in the
upward direction. In technical terms, the price is bullish. An uptrend is defined by
price making higher tops and higher bottoms. In other words, higher highs and
higher lows.

The image below clearly shows that the trend is up. The above chart is of Nifty
Index and it clearly shows that since December 2016 the major trend has been
bullish with no sign of any change in trend.

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DOWNTREND

From September to December 2016 Nifty Index was in a major downtrend. A

downtrend is defined by price making lower lows and lower highs.

SIDEWAYS TREND

Yes, there are three types of trends. A sideways trend occurs when there is no
movement or direction in a particular instrument. The chart is just flat.

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From November 2016 to April 2017 this stock traded in a very narrow range and
did not give much movement, hence, this can be stated as a sideways trend.

It is very important to understand what is the underlying trend of the instrument

before you make any financial decision. Buying a stock which is in a long-term
downtrend may cause you to lose a lot of money. Entering an instrument in the
corresponding direction will improve your odds of success.

A change in trend can be identified by the image below.

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SUPPORT AND RESISTANCE
SUPPORT

Support, as the name implies, is when price stops at a particular point and
changes direction from there. The more times price stops at the same point the
stronger the support at that point.

See in the above example how price stopped twice approximately around the
same level and bounced from there.

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All the circled points can act as support if price were to come back to that point.
We mark those points as support points seeing how price quickly, with strength,
bounced from there. The stronger the bounce from a particular level, the stronger
the support there. What may have been considered a support level can also be
considered a resistance level in the future. Lets look into a resistance level.

RESISTANCE

Just like a support, a resistance is a place where price while moving up, stops, and
reverses from there. Supports are generally bottom points while resistances are
top points.

The two points circled in the image above indicate a major resistance level.
Considering how drastically price moved down from the left circle shows the
strength of the resistance. You can see how price came and stopped at the same
point in the future (second circle). Once price breaks a resistance level and goes
above it, that level becomes a support for the instrument.

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See the lines drawn in the image above. Each place price made a top and reversed
became a resistance point. The bigger the reversal from the top, the stronger the
resistance becomes.

The best way to look for support and resistance levels is to see price stopping
there multiple times. If a price is finding support at a level multiple times is an
indication that price does not want to move below that level and wants to go only
higher. That is not always the case but it is an indication. Same goes with
resistance. If a price is stopping at a particular level and not moving higher, clearly
means bulls are not ready to take the price up and hence you may see a
correction.

Support and resistance are great ways to gauge what price wants to do. Another
way to look at these is to see if price breaks the support or resistance levels. This
is usually called a breakout and these can be very good trading opportunities. A
support level means a lot of buyers are sitting at that particular level and not
allowing price to break. And so, if price does break that level means the bears
overpowered the bulls and price should go down. Same goes for resistance.

Understanding support and resistance is one of the most important factors of

chart analysis. Some of the most successful traders simply use only these two
parameters. If used correctly, they can be the most powerful tool for a trader.

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PRICE PATTERNS

I wont be covering price patterns in this book as I have already written a detailed
book which you can download for free from my website www.themastertrader.in.
In this book I have mentioned exactly how the patterns look and how to trade
them effectively.

TIMEFRAMES
When we talk about timeframes we are referring to the time period of an
instruments price and how its plotted on a chart. A typical chart will give you
timeframes ranging from Monthly, Weekly, Daily and Intraday such as: 60 minute,
30 minute, 15 minute, 5 minute, 1 minute and even 0. Depending on your analysis
you will choose a timeframe accordingly. The lower timeframes, 1,5, and 15
minute, will have more data and show more noise as compared to the higher
ones.

A daily chart will show just one bar/candle for that particular day. Whereas a 15
minute chart will show 25 bars/candles for one single day.

An intraday trader would prefer to work on the lower timeframes, 5 or 15 minute,

while a short-term trader would like to look at the higher timeframes, 60 minutes,
Daily, Weekly.

Lets look at the charts of the same instrument on different timeframes. For this
purpose I have taken charts for the month of May 2017.

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See the vast difference in both the daily and 15 minute charts. A lower timeframe
will always reveal more data but to some it might be beneficial whereas to others
it is just a distraction.

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A thorough chart analysis should be done from the monthly and weekly charts
and then to the lower timeframes. The purpose of that approach is to provide you
with the necessary long-term view as a starting point. The proper order to follow
is to begin with a solid overview and then gradually shorten the time horizon. The
order to be followed should be like this: monthly, weekly, daily, 4 hours, 60
minute and 15 minute. The larger timeframes can give you the overall trend of
the instrument and entries can be made on lower timeframes.

INDICATORS
Technical indicators are charting tools which help analysts better gauge the
instrument. Using these indicators you can come to conclude a buy or sell
decision. I personally avoid using any indicator because they are lagging in price,
meaning they form after price has already moved. In this book we will cover some
of the most common and important indicators used by analysts. The names
include: RSI, Stochastics, MACD, and Moving Averages.

Relative Strength Index (RSI)

I will not go into the theory or any of the calculations because it simply does not
matter to us as a trader. And if needed, it can be googled.

RSI is an oscillator, meaning, it is used to identify overbought and oversold market

conditions. The oscillator is plotted on the bottom of the price chart and
fluctuates within a horizontal band. When the oscillator reaches the upper limit of
the band, market is said to be overbought and could possibly reverse from there.
When the line is at the bottom of the range, market is oversold and could possibly
move up from there. An oscillator helps to measure market extremes and tells the
analyst when a market has become overextended.

RSI is plotted from 0 to 100 with horizontal lines drawn at 70 and 30 levels. If RSI
is above 70 it means it is in an overbought region. If RSI is below 30 it means it is
in an oversold region. The most popular period for the RSI are 9 and 14 days.

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Never trade any indicator on a standalone basis. Use it in combination with other
analysis but never by itself. Indicators are lagging and can give many false signals.

STOCHASTICS

This is also an oscillator and is plotted on a scale from 0 to 100. The overbought
and oversold regions are marked at 80 and 20 for this indicator. Stochastics have
two lines instead of just one: a slow line and a fast line. Trading signals are given
when the two lines cross. A buy signal is given when the faster line crosses above
the slower line from below 20. A sell signal is given when the faster line crosses
beneath the slower line from above 80. The time period used is usually 14 days.

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Again, this indicator should not be used on its own. Use stochastics as a
supporting indicator to your analysis.

MOVING AVERAGE CONVERGENCE DIVERGENCE (MACD)

This indicator is a momentum trend following oscillator which takes two moving
averages and subtracts the longer moving average from the shorter one. Buy/sell
signals are given based on a crossover, centerline crossover, or divergences. We
do not look for overbought or oversold zones with MACD.

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Again, this is not be used as a standalone indicator. The standard settings for this
indicator are 26,12,9.

MOVING AVERAGES

If an indicator is to be used it would be moving averages. Moving averages

smooth the price and make it easier to spot the underlying trend. A moving
average is constructed by averaging the closing price of many days. It is also
considered a lagging indicator. The shorter the average, the more sensitive it is to
price. A longer average is less responsive to trend changes.

Some of the most popular moving averages are 50 and 200 days. An uptrend is
considered when price remains above the 50 day moving average. Moving
averages are best used for support and resistance points and the 50 and 200 play
a major role in this. A close below the 50 day moving average is usually one of the
first signs that a stock is looking to reverse its trend.

Lets look at how some moving averages play a role on a stock.

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See the circled areas how price is finding support. A strong uptrend is considered
when price continuously remains above the 50 day moving average. A 20 day
moving average is also considered to be a good tool for support and resistance,
but not as strong as the 50 and 200.

Many analysts also use moving average crossovers for buy and sell signals. Some
of the most common ones being the 5 crossing the 20 moving average, 13
crossing the 34, 50 crossing the 200, etc. This is considered to be the simplest
form chart reading as all you have to do is follow two lines and take trades when
they crossover. If it were so easy we all would be billionaires by now. Crossovers
can work wonders depending on the market conditions. If the market is in a bull
trend, taking buy setups would be favorable. You can plot different moving
averages and see how they work for that instrument. Also try them on different
timeframes. While price may be above the 50 day moving average on the daily
timeframe, it may be below on the 15 minute timeframe.

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The image above shows two moving averages, 5 and 20. All the circles (I may have
missed some) indicate where the 5 crossed the 20 moving average. This is a daily
chart of the Nifty Index. In a months time, we got around 7-8 crossovers. Some
crossovers worked really well while some were very patchy. In my opinion,
moving average crossovers should be used by themselves and should be used for
confirmation with other analysis. They can give a lot of whipsaws and false
signals.

CANDLESTICK PATTERNS
This is a very important form of reading and understanding price behavior.
Candlesticks are one of the best tools to gauge the sentiments of the markets.
There are various patterns but we will cover only the most important ones. Again,
we will not get into the theory of each pattern.

DOJI

Doji is a candlestick pattern which is usually small in length and trades in a small
range with the open and close being relatively equal or near to each other. Doji
basically means an indecision in direction.

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All the squared boxes indicate dojis. A doji at the top or bottom of a trend can
indicate a pause in trend or a trend reversal. After a doji is formed the direction of
the trend is usually determined by the closing price of the next candle. If the next
candle closes above the doji high it usually indicates price will continue moving
higher.

ENGULFING PATTERN

There are two types of engulfing patterns, bullish and bearish. An engulfing
pattern is basically a candlestick whose body swallows the prior candle. A bullish
engulfing pattern would have a big green/white candle which completely engulfs
the previous candle. If this occurs, it is a strong indication of a bullish trend
occurring. A bearish engulfing pattern would have a big red/black candle
engulfing the previous candle. Is this occurs, it is a strong indication of a bearish
trend occurring. For bullish confirmation, price needs to cross the high of the
bullish engulfing candle. For bearish confirmation, price needs to cross the low of
the bearish candle.

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See the two boxes in the image above. The left one indicates a bearish engulfing
while the right one indicates a bullish engulfing. See how the whole body covered
the entire previous candle. The price moved nicely in both cases.

HAMMER (PIN BAR)

A hammer or what I like to call it, pin bar, is a trend reversal candlestick pattern
which works beautifully when at a top or bottom. A pin bar in an uptrend
indicates that price tried to go higher but was rejected hence hinting that bears
are trying to take control. A pin bar in a downtrend indicates that price tried to go
lower but was rejected. Lets see a few examples to understand this more clearly.

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In the image above, the first pin bar to the left is a perfect example of its beauty.
See how that became the lowest candle in the trend and how price reversed from
there. When price is coming down, we want to see a T-shaped pin bar for a price
reversal. This means that price tried going lower but was immediately rejected.

The third pin bar from the left was also a highly effective one where it
immediately rejected prices from going lower. The fourth pin bar is a T shaped
hammer but in an uptrend. These are also good signs of reversals and if the low of
the candle is taken out can be a good signal to sell.

The simple way to trade these patterns is if this candle is formed followed by a
downtrend, look to buy the cross of the high of the candle (see first box from
left). If a pin bar occurs in an uptrend sell below the low of the candle.

The bigger the size of the pin bars the more effective they are.

There are many more candlestick patterns but these are the most re-occurring
and most important ones to focus on. It is preferred to use them on higher
timeframes such as the daily or 60 minute as the signals are stronger. Candlesticks
are the best charting type to understand what price is trying to tell us. They can
be used in conjunction with other indicators or moving averages. They work
wonders if spotted near a support or resistance level.

TYPES OF TRADING
DAYTRADING (INTRADAY)

Daytrading or intraday trading means taking a position and closing it the same day
itself. In other words, buying a stock and selling it on the same day.

Everything discussed above can be applied to daytrading. Some tools work better
intraday while some work better on a larger timeframe. Some good timeframes to
use for intraday would be the 5, 15, 30 and 60 minutes. Many traders use the 1
and 3 minute charts as well. If you would like to learn some intraday trading
strategies you can visit my website www.themastertrader.in and take our trading
course.

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SHORT-TERM TRADING (POSITIONAL)

Positional trading means buying a stock and holding it for a short while, ranging
from a few days to few weeks. If you are bullish in a particular stock and think it
will move up in the coming days you will buy and hold it for the short term.

This is usually considered less risky as you give more time and space for the stock
to work out. Also, traders take positional bets because they do not have the time
to trade intraday.

LONG-TERM (INVESTING)

Investing is nothing but long-term trading. This is where you buy something and
hold it for at least 6 months and greater. Investors also use chart analysis to time
their entries and to see whether a stock is overbought or oversold.

Long-term trading allows the trader to avoid small whipsaws in prices and
continue to hold it regardless of the price movement.

Sunny Jain
+91-9819219358
sunny@themastertrader.in
www.themastertrader.in

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