Effective Trading in Financial Markets Using Technical Analysis

EFFECTIVE TRADING IN
FINANCIAL MARKETS USING

TECHNICAL ANALYSIS
This book provides a comprehensive guide to effective trading in the financial markets
through the application of technical analysis through the following:
• Presenting in-depth coverage of technical analysis tools (including trade set-ups)

as well as backtesting and algorithmic trading
• Discussing advanced concepts such as Elliott Waves, time cycles and momentum, volume,
and volatility indicators from the perspective of the global markets and especially India
• Blending practical insights and research updates for professional trading, investments,
and financial market analyses
• Including detailed examples, case studies, comparisons, figures, and illustrations from
different asset classes and markets in simple language
The book will be essential for scholars and researchers of finance, economics and management
studies, as well as professional traders and dealers in financial institutions (including banks)
and corporates, fund managers, investors, and anyone interested in financial markets.
Smita Roy Trivedi is Assistant Professor, International Banking and Finance Group at the
National Institute of Bank Management, Pune, India. She has been engaged in teaching,
training, and research in international banking, technical analysis, and algorithmic trading.
Her publications include the book Financial Economy: Evolutions at the Edge of Crises
(co-authored with Sutanu Bhattacharya, 2018). Her research has been published in Empirical
Economics, Economic Papers, and Asia-Pacific Financial Markets.
Ashish H. Kyal is Founder of Waves Strategy Advisors, based in Mumbai, India, a Chartered
Market Technician (CMT) and member of CMT-USA. He has worked with leading invest-
ment banks such as Lehman Brothers and Nomura Holdings. His articles have appeared in
newsletters of CMT-USA, International Federation of Technical Analysts (IFTA-London)
Reuters, and Bloomberg and a research paper in the Journal of the Society of Technical Analysts.
He is a frequent speaker on CNBC TV18, ET NOW, Bloomberg Quint, Rajya Sabha TV,
and National Institute of Bank Management.
‘Investors ignore technical analysis near the end of bull markets, when buy and hold
is in vogue. Today the approach is at a nadir of interest, just when people need it
most. Get ahead of the next rush to understand and apply technical analysis. In
their comprehensive overview, Roy Trivedi and Kyal first introduce you to the key
terms of financial markets and then elucidate all established aspects of the technical
analysis field. If you start with this book, you will have a foundation for deciding
the next step to take in expanding your knowledge.’
– Robert R. Prechter, Elliott Wave theorist, author and
co-author of 14 books, including Elliott Wave Principle,
and Conquer the Crash (New York Times best seller, 2002)
‘There are lots of books about technical analysis available, but almost all of them are
written by practitioners. Thus, a collaboration of academic and practitioner, as seen
in this book, is rare but welcome. The lacking interest of academics in technical
analysis is driven by the wide acceptance of the efficient market hypothesis. It seems
very intuitive that financial market actors trade on the information available to
them and that this leads to adjusted prices. Any other behavior would be irrational.
Moreover, such behavior would be punished by future price developments of
financial prices so that these markets reinforce rational behavior.
Seen from this perspective, the price of a financial asset depends on its future returns,
discounted by interest rates and considering its riskiness. The role of fundamental anal-
ysis is then trying to learn about these determinants. In this world, there is no role for
technical analysis. What should we learn from looking backwards if the price is only
determined by future developments? At least this is the world of finance as it should
be in principle. In reality, however, we know that markets are imperfect. This book
rightly discusses in its Chapter 1, imperfections which may “justify” the use of techni-
cal analysis. Overall, there are good theoretical and empirical reasons why technical
analysis can be a useful tool to forecast financial market developments (e.g., Hsu et al.,
2016). However, as is true for fundamental analysis, the use of an analytical tool – and
technical analysis is such a tool – requires expertise. This book provides some academic
background in the beginning and then introduces and explains the main concepts of
technical analysis. The presentation is clear and applied, providing many examples and
also links to programming. Thus, I highly welcome this book which contributes to
compile and spread expertise on technical analysis in financial markets.’
– Lukas Menkhoff, head of department, International Economics,
DIW Berlin (the German Institute for Economic Research)
‘Those who dismiss technical analysis as unscientific have to confront the long and
consistently profitable track records of legendary traders such as Linda Raschke.
Whether you are studying technical analysis as a skeptic or a believer, Roy Trivedi
and Kyal’s book will serve as a comprehensive guide. The chapter on algorithmic
trading is particularly helpful to those who plan to implement technical analysis in
an automated program.’
– Ernest P. Chan, author of Quantitative Trading, Algorithmic Trading:
Winning Strategies and Their Rationale and Machine Trading:
Deploying Computer Algorithms to Conquer the Markets
‘In the last four decades, “Technical Analysis” (TA) has become an important tool
in the hands of analysts, researchers and practitioners in any financial /commodity
markets. While fundamental analysis continues to be the mainstay of traditional
market analysts, advent of technology has made the role of TA as important as that
of fundamental analysis, if not more.
Given this trend, I feel that the book on TA by Smita and Ashish will be a very
handy guide to any intending market specialist. The USP of this book is that it
helps the reader in climbing up the learning curve on the subject in a smooth glide
path but at the same time, without compromising on the thoroughness. Start-
ing from the basic principles, the book traverses through a large canvas which
includes study of patterns (reversal and continuation), candlesticks, moving aver-
ages, momentum, volume, and volatility indicators and finally concludes with a
glimpse of algorithmic trading. The authors employ a very simple and lucid style
to explain even difficult concepts with appropriate illustrations. I am sure the book
will evoke an enthusiastic response from the readers.’
– G. Mahalingam, whole time member, Securities and
Exchange Board of India, and former executive director,
Reserve Bank of India
‘This book is an amazing toolkit to understand trading/investing as a data-driven

science. The toughest act in money making is the art of keeping emotions aside,
and this book explains the calibrated techniques and tools in a simplified manner.’
– Kamlesh Jain, MRICS, CA, founder, Innovation India in
and the Attention Institute, and former executive director,
Nomura, head of Global Equities
‘The timing of this book’s publication – amid the global COVID-19 financial crisis
of 2020 – is perfect for introducing a new generation to the value of technical
analysis. The chapter on Elliott waves provides a solid review of the basic principles
of wave analysis using recent examples and easy-to-understand summaries of
important points. Long-term investors who read this book will be well prepared
for the next secular bear market. And short-term traders will gain a quick return
on the time invested in reading it.’
– Mark Galasiewski, chief equity analyst for Asia and
Emerging Markets, Elliott Wave International
‘Smita and Ashish have put together a comprehensive piece of work on how to
effectively use technical analysis (TA) in today’s financial markets. The book is
thoroughly researched, and a lot of references and credits are made to academic
studies and well-respected technical analyses by authors throughout. They start with
laying out the groundwork and foundations of financial markets and trading (infra)
structure, especially in India, before even touching on analyses techniques which
give the reader a solid foundation for understanding the TA concepts further on.
The main part of the book on TA, covers the most important and popular
approaches in the field. Starting with various charting formats, then moving on to
more subjective analyses tools like trends, price patters, indicators and even Elliott
Wave, to finish with more quantitative tools and rules-based trading using tools like
Excel and Python.
Although the majority of examples and explanations are geared towards the
Indian markets, the language of technical analysis is universal. I recommend this
book for every aspiring Technical Analyst who wants to get a solid understand-
ing of the general TA framework and the various technical analysis tools that the
authors discuss.’
– Julius de Kempenaer, senior technical analyst at Stockcharts.com,
director of RRG Research, and the creator of Relative
Rotation Graphs(R)
EFFECTIVE TRADING IN
FINANCIAL MARKETS
USING TECHNICAL
ANALYSIS
Smita Roy Trivedi and

Ashish H. Kyal
First published 2021
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
52 Vanderbilt Avenue, New York, NY 10017
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2021 Smita Roy Trivedi and Ashish H. Kyal
The right of Smita Roy Trivedi and Ashish H. Kyal to be identified
as authors of this work has been asserted by them in accordance with
sections 77 and 78 of the Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or reproduced or
utilised in any form or by any electronic, mechanical, or other means, now
known or hereafter invented, including photocopying and recording, or in
any information storage or retrieval system, without permission in writing
from the publishers.
Research, analyses, or other information contained in this book are for
educational purposes only, and do not constitute investment advice.
Authors have made every effort to provide accurate information and web
addresses but neither the authors or the publisher are responsible for any
errors or changes occurring after publication. Authors or the publisher
do not assume any responsibility for third-party websites or the content
therein.
Trademark notice: Product or corporate names may be trademarks or
registered trademarks, and are used only for identification and explanation
without intent to infringe.
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-Publication Data
A catalog record for this book has been requested
ISBN: 978-0-367-31354-8 (hbk)
ISBN: 978-0-367-31355-5 (pbk)
ISBN: 978-0-429-31648-7 (ebk)
Typeset in Bembo
by Apex CoVantage, LLC
Visit the eResources: www.routledge.com/9780367313555
CONTENTS
List of figures xii

List of tables xviii
List of abbreviations xix
Prefacexx
Acknowledgementsxxv
1 Introduction to technical analysis 1

1.1 Technical analysis and trading in the financial markets 1
1.2 Evidence on the use of technical analysis 3
1.3 Technical analysis profitability and the efficient market
paradigm 4
1.4 What explains the profitability of technical analysis? 5
1.5 Financial markets: the trader’s playground 7
1.5.1 Functions of financial markets 7
1.5.2 Types of financial markets 8
1.5.3 Infrastructure of trading 10
1.6 Key takeaways 15
2 Basic principles of technical analysis 17

2.1 Introduction 17
2.2 Time frame of the chart 18
2.3 Types of charts 20
2.3.1 Bar chart 20
2.3.2 Line chart 20
2.3.3 Point and figure chart 21
viii Contents
2.3.4 Candlesticks 23
2.3.5 Heinken Ashi candlestick 23
2.4 Dow Theory and its application 26
2.4.1 Basic tenets of technical analysis 26
2.4.2 Main criticisms of Dow Theory 28
2.5 Trend analysis 29
2.5.1 Definition of trend 29
2.5.2 Drawing trend lines 29
2.5.3 Support and resistance 32
2.5.4 Potential support and resistance patterns 32
2.6 Use of trend analysis in trading 34
2.6.1 Fan principle 34
2.6.2 Channel line 35
2.6.3 Retracements 37
2.6.4 Case studies 39
3 Classical reversal and continuation patterns 44

3.1 Introduction 44
3.2 Reversal patterns 44
3.2.1 Head and Shoulders 45
3.2.2 Double Top and Bottom 48
3.2.3 Triple Tops and Bottoms 50
3.2.4 Saucers and spikes 51
3.3 Continuation patterns 52
3.3.1 Triangles 53
3.3.2 Flags and pennants 56
3.3.3 Wedges 57
3.4 Gaps 59
3.4.1 Breakaway Gaps 59
3.4.2 Runaway Gaps 59
3.4.3 Exhaustion Gaps 61
3.4.4 Island Reversals 61
3.4.5 Case studies: combining Gaps with other
patterns 63
4 Candlesticks patterns and their use in trading strategies 67

4.1 Introduction 67
4.2 Concept of candlesticks 68
4.2.1 Long candlesticks 70
4.2.2 Short candlesticks 70
Contents ix
4.2.3 Doji candlesticks 71

4.2.4 Long upper shadows only 71
4.2.5 Long lower shadows only 71
4.2.6 Candles with both long upper and lower
shadows 71
4.3 Reversal patterns 73
4.3.1 Hanging Man and Hammer 73
4.3.2 Engulfing pattern (tsutsumi) 75
4.3.3 Dark cloud cover (kabuse) 76
4.3.4 Piercing line (kirikorni) 79
4.3.5 Evening Star and Morning Star 80
4.3.6 The Three Black Crows and the Three Advancing
White Soldiers 82
4.3.7 Harami pattern 82
4.3.8 Tweezers tops and bottoms 86
4.3.9 Belt Hold lines (yorikiri) 86
4.3.10 Three Mountains and Three Rivers 86
4.4 Continuation patterns 88
4.4.1 Windows 88
4.4.2 Bullish Rising Three Methods and the Bearish
Falling Three Methods 88
4.4.3 Separating lines 90
5 Moving averages and their use for trading strategies 94

5.1 Introduction 94
5.2 Concept of moving averages 95
5.2.1 Types of moving averages 97
5.2.2 Choice of period 102
5.3 Using moving averages to understand the trend, support
and resistance 104
5.3.1 Which moving averages to use? 105
5.4 Crossover technique 106
5.4.1 Double crossover 106
5.4.2 Triple crossover technique 108
5.5 Case studies: using moving averages for trading 109
6 Momentum indicators and stochastics 113

6.1 Introduction 113
6.2 Momentum and Rate of change 114
6.3 RSI 119
x Contents
6.4 MACD 122
6.5 Stochastics 124
6.6 HA Stochastic 125
6.7 Case studies: framing trading strategies with momentum
indicators 127
A. State Bank of India 127
B. Nifty 50 128
7 Volatility and volume indicators 135

7.2 Volatility indicators 137
7.2.1 Moving average envelopes 137
7.2.2 Bollinger Bands® 138
7.2.3 ATR 141
7.3 Volume-based indicators 143
7.3.1 Volume oscillators 143
7.3.2 The Chaikin Money Flow Index 144
7.4 Case studies: using volatility indicators for trading
decisions 146
A. Reliance industries 146
B. Nifty 50 147
8 Elliott Wave Principles 150

8.1.1 What is a ‘wave’? 151
8.2 The Fibonacci sequence 151
8.2.1 The golden ratio 151
8.3 Understanding impulse patterns 151
8.3.1 Rules of impulse patterns 152
8.3.2 Understanding degrees 154
8.3.3 Variations to the impulse pattern 154
8.4 Corrective waves 160
8.4.1 Zigzag correction (5–3–5) 160
8.4.2 Flat correction pattern 164
8.4.3 Triangle 170
8.4.4 Diametric pattern: new patterns discovered by
Glenn Neely (1995) of NEoWave 173
8.5 Channelling 179
Contents xi
9 Time cycles 185

9.2 Characteristic of cycles 186
9.2.1 Period 187
9.2.2 Amplitude 187
9.2.3 Phase 187
9.3 Left and right translation 187
9.4 Principles of cycles 188
9.4.1 Principle of summation 188
9.4.2 Principle of harmonicity 188
9.4.3 Principle of synchronicity 188
9.4.4 Principle of nominality 188
9.4.5 Principle of variation 189
9.4.6 Principle of proportionality 189
9.4.7 Principle of commonality 189
9.5 Detecting the cycles 190
9.5.1 Observational analysis 190
9.5.2 Selecting oscillator indicator parameters 192
9.5.3 Detrending for cycle identification 192
9.5.4 Envelopes 194
9.6 Combining time cycles with an Elliott Wave 196
10 Introduction to backtesting and algorithmic trading 203

10.2 Concept of algorithmic trading 204
10.3 Using Excel for algorithmic trading 207
10.3.1 Getting data for backtesting and live signal
generation 207
10.3.2 Basic Excel functions to know 207
10.3.3 Coding trading strategies 210
10.4 Introduction to Python 221
10.4.1 Basics in Python 222
10.4.2 Using Python for backtesting 229
11 Conclusion 246
References254
Index260
FIGURES
2.1 GBP/USD movement, 2015–2019 (monthly chart). Created

with Eikon, Refinitiv 19
2.2 GBP/USD movement, 2019 (daily chart). Created with
Eikon, Refinitiv 19
2.3 Construction of a bar 20
2.4 Line chart of GBP/USD. Created with Eikon, Refinitiv21
2.5 Construction of candlesticks 23
2.6 Candlesticks chart of GBP/USD. Created with Eikon, Refinitiv 25
2.7 Heiken Ashi candlesticks chart of GBP/USD. Created with
Eikon, Refinitiv 26
2.8 Drawing the trend line 30
2.9 Tentative and valid trend line 31
2.10 Support and resistance 33
2.11 Support and resistance trend line in the Nifty (daily chart).
Created with Amibroker 33
2.12 Role reversal of support and resistances 34
2.13 Fan principle 35
2.14 Channel line 36
2.15 Channels in the Nifty (hourly chart). Created with Amibroker 36
2.16 DJIA daily chart analysis. Created with Amibroker 37
2.17 Fibonacci retracements on a Nifty daily chart. Created
with Amibroker 38
2.18 Bar technique on Altria Group Inc. daily chart. Created
with Amibroker 39
2.19 Analysis of crude oil futures in INR (continuous contract;
weekly chart). Created with Amibroker41
2.20 DJIA (daily chart). Created with Amibroker 41
Figures xiii
3.1 Head and Shoulders pattern 45

3.2 Head and Shoulder pattern on the Nifty (hourly chart). Created
with Amibroker 46
3.3 Inverse Head and Shoulder pattern on MCX crude oil (weekly
chart). Created with Amibroker 47
3.4 Inverse Head and Shoulder pattern on Alcoa Corp (weekly
chart). Created with Amibroker 48
3.5 Double Top pattern 49
3.6 Double Bottom formation on MMM (daily chart). Created
with Amibroker 49
3.7 Triple Top pattern 50
3.8 Triple Bottom pattern on EUR/USD (weekly chart). Created
with Amibroker 51
3.9 Saucer 52
3.10 Inverse ‘V’ spike at market top 52
3.11 Continuation pattern: Symmetrical Triangle 53
3.12 Ascending Triangle 54
3.13 Descending Triangle 54
3.14 Symmetrical Triangle pattern on USD/INR (daily chart).
3.15 Descending Triangle pattern on the DJIA (daily chart). Created
with Amibroker 55
3.16 Continuation pattern: flags 56
3.17 Continuation pattern: pennants 56
3.18 Wedge 57
3.19 Wedge pattern on the Nifty Index (daily chart). Created with
Amibroker58
3.20 Flag, pennants, and wedge on the DJIA (daily chart). Created
with Amibroker 58
3.21 Breakaway Gap 60
3.22 Runaway Gap 60
3.23 Island Reversal 61
3.24 Runaway Gap, Exhaustion Gap, Island Reversal,
and Breakaway Gap 62
3.25 Gaps on Facebook (daily chart). Created with Amibroker 63
3.26 Gap, wedge, and flag on the Nifty (daily chart). Created
with Amibroker 64
3.27 Analysis of channels and gaps on Apple Inc. (daily chart).
4.1 Candlesticks: the anatomy 68
4.2a Long-body candles 69
4.2b Marubozu candles 70
4.3 Short candlesticks (spinning tops) 71
4.4 Doji candlesticks 72
xiv Figures
4.5 Candles with long shadows 72

4.6 Doji on the Nifty (hourly chart). Created with Eikon, Refinitiv 73
4.7 Hammer and Hanging Man 75
4.8 Hanging Man and Hammer on EUR (weekly chart). Created
4.9 Engulfing pattern 76
4.10 Bearish engulfing on HDFC Ltd. Created with Amibroker 77
4.11 Bullish engulfing on HDFC Bank. Created with Amibroker 77
4.12 Bullish and bearish engulfing on the Nifty (daily chart). Created
4.13 Dark cloud cover 78
4.14 Piercing line 79
4.15 Piercing line on Hindustan Zinc (daily chart). Created with
Amibroker79
4.16 Evening Star 80
4.17 Morning Star 80
4.18 Evening Star on the Nifty (daily chart). Created with
Eikon, Refinitiv 81
4.19 Morning Star on AUD (daily chart). Created with Eikon, Refinitiv 82
4.20 Three Black Crows 83
4.21 Three White Soldiers 83
4.22 Three White Soldiers on Raymond. Created with Amibroker 84
4.23 Three Black Crows on Raymond. Created with Amibroker 84
4.24 Harami pattern on CAD. Created with Eikon, Refinitiv 85
4.25 Bearish Harami on Maruti. Created with Amibroker 85
4.26 Tweezers tops and bottoms 86
4.27 Belt Hold: bullish and bearish 87
4.28 Bullish Belt Hold and Evening Star on GBP (daily chart).
Created with Eikon, Refinitiv 87
4.29 Three Mountain Tops on GBP (weekly chart). Created with
Eikon, Refinitiv 87
4.30 Tasuki gaps 89
4.31 Rising Three Methods 89
4.32 Rising Three Methods on GBP (daily chart). Created with
Eikon, Refinitiv 90
4.33 Falling Three Methods 91
4.34 Separating lines 91
4.35 Separating lines on GBP (weekly chart). Created with
Eikon, Refinitiv 92
5.1a 30-period moving average on the Euro. Created with
Eikon, Refinitiv 96
5.1b 30- and 60-period moving averages on the Euro. Created with
Eikon, Refinitiv 96
5.2 SMA and EMA on the Euro. Created with Eikon, Refinitiv 99
Figures xv
5.3 AMA and EMA on the Euro. Created with Eikon, Refinitiv 101
5.4 Moving average as support and resistance. Created with Eikon,
Refinitiv104
5.5 Comparing AMA, centred moving average, and EMA. Created
5.6 Double crossover on the State Bank of India (30-minute chart).
5.7 Sideways movement and moving averages. Created
5.8 Triple crossover. Created with Eikon, Refinitiv 108
5.9 Using moving averages: EUR/USD (daily chart). Created with
Eikon, Refinitiv 110
5.10 Gold futures in INR (daily chart). Created with Amibroker 111
6.1 Movement of prices reflected by moving average and momentum 116
6.2 Moving average and momentum on the GBP (daily chart).
6.3 RSI: negative divergence. Created with Eikon, Refinitiv 121
6.4 RSI: positive divergence. Created with Eikon, Refinitiv 121
6.5 MACD. Created with Eikon, Refinitiv 123
6.6 MACD with MACD forest. Created with Eikon, Refinitiv 124
6.7 %D and %K line on EUR chart. Created with Eikon, Refinitiv 125
6.8 SBI combined analysis. Created with Amibroker 127
6.9 Nifty 50 index (monthly chart). Created with Eikon, Refinitiv 129
6.10 Nifty daily chart analysis (May–July 2019). Created with Eikon,
Refinitiv129
6.11 Nifty 50 Index (weekly chart). Created with Amibroker 130
6.12 Nifty daily chart analysis (July 2019–April 2020). Created with
Amibroker131
6.13 Nifty 50 Index (hourly chart). Created with Amibroker 132
7.1 Moving average envelopes. Created with Eikon, Refinitiv 137
7.2 Bollinger Bands (EUR hourly chart). Created with
7.3 Bollinger Bands overbought and oversold levels
(EUR hourly chart). Created with Eikon, Refinitiv 140
7.4 Bollinger Bands (Nifty daily chart). Created with Amibroker 141
7.5 ATR (EUR hourly chart). Created with Eikon, Refinitiv 142
7.6 Volume and volume ROC on SBI (daily chart). Created with
7.7 Chaikin Money Flow Index on SBI (daily chart). Created with
7.8 Reliance industries (daily chart). Created with Amibroker 146
7.9 Nifty 50 (daily chart). Created with Amibroker 148
8.1 The basic pattern 152
8.2a Wave 2 completely retraced wave 1: not allowed 153
xvi Figures
8.2b Wave 3 is the shortest among impulse waves: not allowed 153
8.2c Wave 4 enters the territory of wave 1: not allowed 154
8.3 Degrees of waves 155
8.4 Wave 3 extended and subdivided 156
8.5 Impulse pattern (Nifty hourly chart). Created with Amibroker 156
8.6 Ending diagonal pattern 157
8.7 Ending diagonal pattern (Nifty daily chart). Created
with Amibroker 158
8.8 Fifth failure pattern 159
8.9 Fifth failure pattern (Maruti weekly chart). Created
with Amibroker 160
8.10 Zigzag pattern 161
8.11 Zigzag pattern (Nifty daily chart). Created with Amibroker 162
8.12 Double zigzag pattern 163
8.13 Triple zigzag pattern 163
8.14a Flat pattern correcting up move 164
8.14b Flat pattern correcting down move 165
8.15a Irregular flat correcting up move 166
8.15b Irregular flat correcting down move 166
8.16 Running flat correction 167
8.17a Double flat correction 168
8.17b Double flat correction 168
8.17c Triple flat correction 169
8.18 Double zigzag correction (EUR/USD weekly chart). Created
with Amibroker 169
8.19 Triangular pattern 170
8.20a Triangular pattern with an irregular wave B 171
8.20b Irregular triangle pattern in a bear market 172
8.21 Triangle pattern (ICICI Bank weekly chart). Created
with Amibroker 172
8.22a Bow-Tie Diametric pattern in a bear market 173
8.22b Diamond-shaped Diametric pattern in a bull market 174
8.23 Bow-Tie Diametric pattern (Facebook daily chart). Created
with Amibroker 174
8.24 Alternation between wave 2 and wave 4 175
8.25a Double combination pattern 176
8.25b Double combination pattern 176
8.26a Triple combination pattern 177
8.26b Triple combination pattern 177
8.26c Triple combination pattern 178
8.27 Triple zigzag pattern (Nifty daily chart). Created with Amibroker 178
8.28 Channels (Maruti weekly chart). Created with Amibroker 181
8.29 Application of an Elliott wave (DJIA weekly chart). Created
with Amibroker 181
Figures xvii
8.30 Impulse pattern (DJIA weekly chart). Created with Amibroker 182
9.1 Characteristic of cycles 187
9.2 Nested cycles 190
9.3 Time cycles (Nifty daily chart). Created with Amibroker 191
9.4 Cyclicality (DJIA weekly chart). Created with Amibroker 192
9.5 Cyclicality with momentum indicator (DJIA weekly chart).
9.6 Detrending using a ratio of price to a 39-month centred
moving average (DJIA monthly chart). Created with Amibroker 194
9.7 39-week centred moving average with 20% envelope (Alcoa
weekly chart). Created with Amibroker 195
9.8 109-day time cycle with a 55-day envelope and detrended
oscillator (Nifty daily chart). Created with Amibroker 196
9.9 86-week time cycle and an Elliott Wave pattern (USD/INR
9.10 164-week time cycle and Elliott Wave pattern (Berger Paints
9.11 Time cycles and Elliott Waves (USD/INR weekly chart).
9.12 Time cycles and Elliott Waves (Nifty daily chart). Created
with Amibroker 201
1 0.1 Accessing data from Eikon: flow chart 221
10.2 Downloading Python from Anaconda: flow chart 222
10.3 Python output (INR open prices) 236
10.4 Python output (HDFC adjusted close and open prices) 238
10.5 Python output (HDFC adjusted close, EMA 30, EMA 40) 239
10.6 Python output (HDFC adjusted close, EMA 30, EMA 40
using loc) 240
11.1 Global indices at a glance, 2009–2020 (monthly chart).
1 1.2 Crude oil (monthly chart). Created with Eikon, Refinitiv 247
11.3 EUR/USD (monthly chart). Created with Eikon, Refinitiv 248
11.4 The DJIA and the Nifty 50 (daily chart). Created with Amibroker 249
11.5 The DJIA (daily chart) technical outlook before the crash
of October 1987. Created with Amibroker 250
11.6 DJIA (daily chart) technical outlook before the crash of
February 2020. Created with Amibroker 251
11.7 Relative performance of US sectors during 2008 fall. Created
with Amibroker 252
11.8 Relative performance of Indian sectors during 2020 fall.
TABLES
2.1 Price data for point and figure chart 22

2.2 Intra-day point and figure (reversal size = 2) 22
2.3 Intra-day point and figure (reversal = 1) 22
2.4 Calculation of Heiken Ashi candlestick values 24
5.1 Calculation of three-period moving average 95
5.2 Calculation of SMA, EMA, and LWMA 97
5.3 Calculation of KAMA 100
5.4 Calculation of centred moving average 103
6.1 Comparison of prices with three-period moving average and
momentum115
1 0.1 Relative references and absolute references 208
10.2 Data arrangement in Excel sheet ‘Ch10_2’ 210
10.3 Calculation of the average, SMA, and EMA 211
10.4 EMA 10, 20, and the double crossover signal 213
10.5 Transaction prices and returns 214
10.6 Performance metrics of double crossover signals 1 and 2 215
10.7 RSI calculation 216
10.8 Entry and transactions prices 217
10.9 ATR calculation 218
10.10 Calculation of take-profit and stop-loss levels 219
10.11 Calculation of trade running, profit-target hit, and stop-loss hit 219
10.12 Calculation of exit and profit/loss percentage in Excel 219
10.13 Calculation of performance metrics in Excel 220
10.14 Evaluation of the trading strategy 220
10.15 Operators in Python (in ascending order of precedence) 223
ABBREVIATIONS
AMA Adaptive moving average

ATR Average true range
AUD Australian dollar
CAD Canadian dollar
CMA Centred moving average
DJIA Dow Jones Industrial Average
EMA Exponential moving average
ETF Exchange-traded fund
EUR Euro
GBP Great Britain pound
HA Heiken Ashi
HASTOC Heiken Ashi Stochastic
IDE Integrated Development Environment
INR Indian rupee
LWMA Linearly weighted moving average
MACD Moving average convergence divergence
NSE National Stock Exchange
NZD New Zealand dollar
ROC Rate of Change
RSI Relative Strength Index
SMA Simple moving average
USD United States dollar
XLB Materials Select Sector SPDR
XLF Financial Select Sector SPDR Fund
XLP Consumer Staples Select Sect. SPDR
XLV Health Care SPDR
XLY Consumer Discretionary SPDR
PREFACE
It is but human nature to look for patterns. From the movement of the earth to
the starry patterns in the sky, from the waves in the sea to the cycles of life, it is the
quest for pattern, rhythm, and cycles which distinguishes the human relationship
with nature. Is it surprising then that we look for such patterns in our economies
and financial markets? The existence of patterns or the lack thereof (a random
walk, perhaps?) form the core of our analysis of financial markets. Technical analysis
is a quest for such patterns, patterns in the past which would allow us to look into
the future with more certainty. To predict the future movement of the markets, we
look into the canvas of the past for hidden designs. Not surprisingly, Charles Dow,
whose writings lie at the genesis of technical analysis, compared trends of varying
time frames to the tides, waves, and ripples of the sea (Dow and Sether 2009). In
financial markets, it is the existence of these patterns that brings in a structure for
trading decisions. In this book, we take you on a journey to identify those struc-
tures, enabled by the myriad approaches to technical analysis.
Globally, financial markets have faced sharp movements and seemingly unpre-
dictable turns in the last few years. The last 10 years have seen an economic down-
turn, a trade war, and, finally, a pandemic play out in the financial markets. It is
useful to tell ourselves the power of patterns remains undiminished even amongst
the seeming chaos. If you look at the Dow Jones Industrial Average (DJIA) from
the 1987 crash and the chart of the Nifty Index for 2020 so far, the precipitous fall
remains uncannily similar (for relevant charts, see the Conclusion of this book).
Technical analysis in this scenario can give the much-needed tools to traders for
navigating the labyrinth of the volatile financial markets.
That said, there are several books available on technical analysis. From tomes
that every technical analyst has grown up reading, such as John Murphy, Martin
Pring, Robert Prechter, to newer books by Kirkpatrick and Dahlquist, Ernest P
Chan (on algorithmic trading), this book stands on the solid foundation laid by
Preface xxi
other technical analysts. The book owes to the academic research on technical
analysis by economists such as Lukas Menkhoff, Mark P. Taylor, Christopher J.
Neely, George E. Pinches, and Peter Saacke.
Why then this volume? First, this book brings forth a juxtaposition of the aca-
demic and practitioner perspectives on technical analysis. We have combined in
this book a focus on the conceptual clarity associated with each technical approach,
case studies which underline the practical application of these technical analysis
concepts, and snippets of academic research that put the technical analysis approach
in a bigger perspective.
Second, there is always more to say on technical analysis than is available. Each
day brings in newer applications and case studies and a better understanding of what
works in the markets. With the present global pandemic, we have put together
cases from different asset classes and markets demonstrating the purposeful applica-
tion of technical tools.
Third, in our role as teachers, we have felt a need for a structured approach to
learning technical analysis covering each important domain including the backtest-
ing of the technical analysis strategies. This book has a rounded approach to learn-
ing technical analysis to keep up with the changing skill sets required.
We have underlined the practical application by using as many cases as possible
and relating them with the overall context of the market. We showcased trend fol-
lowing methods that traders can adopt to ride the trend, using simple but effective
methods. Last but not least, we have combined advanced methods like the Elliott
Wave with time cycles and other technical indicators in an easy, understandable,
and systematic fashion along with a few trade set-ups.
Structure of the book and resources

Technical analysis is a myriad collection of approaches to predict the future move-
ment in asset prices given the historical movement. We have structured the book
keeping in view this comprehensive approach to technical analysis. Again, the con-
cepts by themselves are not useful without case studies on their application. We
therefore strengthened the conceptual discussion with recent studies, also covering
the market movement in 2020 post the pandemic.
Chapter 1 sets the tone for the book by introducing the readers to a compre-
hensive view of the technical analysis paradigm. It places technical analysis in the
broader framework of trading in financial markets, presenting the rich empiri-
cal evidence on the use of technical analysis by professionals and research on the
profitability of technical analysis. The chapter also discusses the financial market
infrastructure required for trading and compares trading paths: fundamental and
technical analysis.
Chapter 2 takes up the building blocks of technical analysis with an understand-
ing of Dow Theory, the essential foundation on which the different approaches of
technical analysis rests. Technical analysis is based on the understanding of trends,
as the identification of reversals lies at the core of technical analysis. The chapter
xxii Preface
covers in detail the analysis of trend through the definition of trend lines, the draw-
ing of trend lines, and the identification of support and resistance patterns. Focused
case studies on recent market movement are brought in to underline the applica-
tion of trend analysis.
Chapter 3 takes up classical technical analysis which stems from the broad
notion underlying Dow Theory. The classical patterns embody the essentials of
technical analysis, with a belief that patterns are repetitive and can be used to pre-
dict the future price movement. The visual patterns are formations appearing on
the charts, which can help us to predict a reversal or a continuation in the trend.
Price forecasting requires a careful understanding of the prior movement and the
reason behind the formation of the pattern to be able to predict future prices cor-
rectly. The chapter considers in detail the important reversal and continuation pat-
terns with recent case studies.
Candlesticks, traditionally used by traders of the East, go back a long way in his-
tory, to the legendary Munehisa Homma, who used the candlesticks for trading in
the Japanese rice market during the late 18th century. With their introduction to
the Western world, the popularity of the candlestick patterns has immensely grown.
What lies behind the popularity of candlesticks is that it brings in the simplicity of
the patterns with a rich understanding of market psychology. In Chapter 4, we
consider in detail the concept of candlesticks and reversal and continuation pat-
terns. The patterns are supplemented by case studies to explain how candlesticks
patterns can be traded effectively.
Prices demonstrate a tendency to move towards the mean values historically
so that mean reversion is one of the commonly observed phenomena of financial
markets. If prices do indeed tend to move towards the mean, it is important to
understand how this can be used to generate effective trading signals. Chapter 5
details the concept of ‘mean’ or ‘average’ and its use in trading. Moving averages are
frequently used to understand the general trend in the market and act as dynamic
support and resistant to the price movement. The chapter discusses in detail the
various kinds of moving averages and their use in trading. The chapter takes up
the crossover methodology for generating trade signals, discussing the Double and
Triple Crossover strategies as well as the use of moving averages of different time
frames with recent case studies.
This chapter takes up momentum indicators and stochastics, one of the most
popular technical analysis indicators. If moving average shows the direction of the
trend, Momentum gives the strength of the trend. Chapter 6 begins with a dis-
cussion of the concept of Momentum and how it shows the strength in the trend,
by considering a simple momentum indicator: the Rate of Change (ROC). The
chapter then takes up two of the most popular momentum-based indicators: the
Relative Strength Index (RSI) and the Moving Average Convergence Divergence
(MACD). Stochastics which use the position of price in a range to generate trad-
ing signals are discussed next. Stochastics show whether prices are in the upper or
lower end of the trading range and are therefore much suited for swing recognition
and reversal confirmations. Chapter 6 puts together in the last section detailed cases
Preface xxiii
studies on recent market movement to show how the various momentum indica-
tors can be used effectively for trading.
Chapter 7 takes up the volatility indicators most popularly used by traders,
namely Bollinger Bands and the average true range (ATR). Furthermore, the
understanding of volatility is combined with the knowledge of how to use volume
for trading, as there is strong support to the link between volume and volatility.
Chapter 7 takes up two important volumes-based indicators, the volume oscillator
and the Chaikin Money Flow Index, which can help us refine the trading deci-
sions. Chapter 7 ends with recent case studies showing the effective use of volatility
indicators for trading.
Chapter 8 takes up one of the most intriguing technical analysis approaches,
the Elliott Wave theory, which uses the concept of the fractal nature to form an
in-depth understanding of the trend in a market over a long period. Developed by
Ralph Nelson Elliott in the 1930s, in an Elliott Wave, the smallest of the waves
combine together to form higher-degree wave patterns which, in turn, combine
to make a much higher-degree wave construction. This leads to high forecasting
ability of Elliott Wave Theory stretching years ahead. Chapter 8 starts with the
concepts and principles of Elliott Wave Theory. The understanding of impulse and
corrective waves is taken up next, supplemented with cases with detailed analysis
of the patterns. Detailed case studies are used for showing the application of Elliot
Wave techniques.
Chapter 9 gives comprehensive coverage of time cycles and their effective use
for trading. The cycle periodicity can change requiring a trader to keep tweak-
ing the cycle length from time to time to keep it in sync with changing market
dynamics. There are recurring cycles in financial markets, and by identifying the
cyclicality, one can forecast the possible tops or bottoms and accordingly take trad-
ing positions. In this chapter, the foundation is laid with an in-depth understanding
of the concept of time cycles: the characteristic of cycles, left and right translation,
principles of cycles, and detecting the cycle. Chapter 9 then takes up the combin-
ing of time cycles with Elliott Wave Principles, with pertinent case studies, which
correctly used, can be one of the most effective tools for a trader.
The effectiveness of trading on the basis of visual analysis is reduced to the
extent emotions impacts the trader. Algorithmic trading refers to the automation
of the trading process, whereby the generation of buy or sell signals and the execu-
tion of such signals as trades happen on the basis of programmed instructions or
algorithms. It is not surprising therefore that popularity of algorithmic trading has
grown in recent years amongst not only institutional but also retail traders. While
algorithmic trading may be based on either fundamental or technical analysis or
both, the chapter focuses on trading algorithms based on technical analysis, given
the purview of the book. First, a detailed look at the basic concepts behind algo-
rithmic trading is taken up. Chapter 10 then takes up backtesting of trading strate-
gies with Microsoft Excel and Python, two software tools which rank high in terms
of utility and simplicity. For each, the basics of the software are taken up first with
examples, before moving on to the backtesting of trading strategies. The chapter is
xxiv Preface
supplemented with a number of rich eResources which have been crafted keeping
in view the reader who may not have prior knowledge of the two software tools,
Excel and Python.
How best to progress on the journey of learning the technical trading tools? For
the novice trader or new student of technical analysis, we recommend a sequential
read of the chapters. The order of the chapters has been decided by keeping in
mind the escalation of the level of difficulty and time required to master that par-
ticular technical analysis approach. As you learn the concepts in each chapter, we
suggest continued practice on live charts for a thorough understanding.
For the trader experienced in technical trading, we suggest reading Chapters 1
and 2 first for an understanding of the fundamentals of technical analysis. This will
help in getting the maximum out of the book as basic concepts have been clari-
fied in these two chapters to set a strong foundation to the rest of the book. The
remaining chapters in the book can be read standalone as each technical indicator
or approach can be a journey in itself. That said, Chapter 10 (on backtesting and
the introduction to algorithmic trading) requires a knowledge of technical analysis
indicators, so covering Chapters 5, 6, and 7 are prerequisites to its understanding.
Although the book has used a large number of charts for concepts and cases,
charts being the mainstay of technical trading, there are always more resources that
we would want to share with our readers. An understanding of Chapter 10 requires
readers to go through the Excel and Python notebook files which have been used
as examples, included in the eResource on this book’s page on the Routledge
website: www.routledge.com/9780367313555.
An understanding of technical analysis is a continuous process, a journey along
which each application teaches something anew. The process of writing the book
has been elating for us as we appreciated time and again the technical skills required
for recognizing patterns and trends in the market. We hope you find the journey
through the book as exciting!
ACKNOWLEDGEMENTS
Our book stands on the foundation of a rich literature on technical analysis: aca-
demic research, books and articles. We stand in deep appreciation to the legacy of
such work which have shaped our own conception of technical analysis. We find
it extremely encouraging to have received feedback and support from stalwarts in
the field of technical analysis.
We thank Robert R. Prechter (Elliott Wave theorist and author of Elliott Wave
Principle, and Conquer the Crash) for his uncanny observation and guidance espe-
cially for shaping up the Elliott Wave chapter and his minute observations on the
charts. We are touched by his modesty and eagerness to share his knowledge. His
hand-holding during the phase of the book is inspirational for us and vindicates the
fact that we are on correct path and importance of technical analysis is only going
to increase in an impulsive third wave for decades to come!
We thank Lukas Menkhoff (professor and head of department, International
Economics, DIW Berlin, the German Institute for Economic Research) for his
valuable guidance on research directions in technical analysis and his kind support
for the book. His research on technical analysis has remained core to shaping our
understanding of the deeper roots of technical trading profitability as well as helped
to put technical analysis in the bigger perspective of financial market research.
We thank G. Mahalingam (whole time member, Securities and Exchange Board
of India, and former executive director, Reserve Bank of India) for his support and
encouragement for the book. His views and analysis of market events have always
helped to appreciate the underlying currents that shape financial markets. His guid-
ance and mentorship are deeply appreciated.
We thank Ernest P. Chan (author of Quantitative Trading, Algorithmic Trading:
Winning Strategies and Their Rationale and Machine Trading: Deploying Computer
Algorithms to Conquer the Markets) for his encouraging comments on the book.
The future of trading is closely linked to its automation through algorithmic
xxvi Acknowledgements
trading, and his books have guided our perception of application of technical
trading in this field.
We thank Mark Galasiewski (chief equity analyst for Asia and Emerging Markets,
Elliott Wave International), Kamlesh Jain (founder, Innovation India In and The
Attention Institute), Julius de Kempenaer (senior technical analyst at Stockcharts.
com, director of RRG Research, and creator of Relative Rotation Graphs(R)) for
their valuable feedback and review about the book.
A big thank-you to the editorial team of Routledge. Thanks to Shoma
Choudhury for her support and guidance throughout the revision and restruc-
turing of the book. Thanks to Rimina Mohapatra for her patience and prompt
response to our many queries and her constant support through the revision pro-
cess. Thanks to Brinda Sen and Anvitaa Bajaj for their support and cooperation.
Charts in the book have been made using charting tools of Eikon, Refinitiv and
Amibroker: comments on the chart represents the authors’ views. We thank the
anonymous referee(s) for the constructive suggestions which helped immensely
in strengthening the manuscript. Errors, if any, are ours.
Smita Roy Trivedi

I thank my institute, National Institute of Bank Management (NIBM), Pune,
which enabled an academic to develop a passion for and expertise in technical
analysis. I am grateful to Rajiv Abhyankar, former chief general manager, Bank of
Baroda, for his wonderful advice on the manuscript and detailed feedback on select
chapters. In writing the book, I have kept in mind my students at NIBM and the
professional dealers whose ideas, queries, and suggestions have shaped the structure
and flow of the book. I thank them for the continuous feedback and suggestions.
I thank my colleagues at NIBM who motivate me to lean in every day.
I owe greatly to the support of my spouse, Akshoy Trivedi, and daughter, Ashmi:
they are the ‘wind beneath my wings’. Through the demanding months of writing
of this book, it is their unwavering support, understanding and constant encour-
agement that sustained me. Thanks to Akshoy for sharing more than equal house-
hold responsibilities which enabled me to focus on the book. His keen feedback on
my writing, as also invaluable suggestions on the presentation is hugely appreciated.
Ashmi is our blessing and inspiration. Her thoughts and values make me see
the world anew each day. Discussing technical analysis with her and her witty
comments made the writing process easier than it would have been. Our family is
completed by two irrepressible canines: Momo, who appreciates books, and Popo,
who does not. Their lovable presence fills each day with the little joys that makes
writing enjoyable.
I will be always indebted to my mother, Subhra Roy, who passed away dur-
ing the writing of the book. To say she was a constant source of inspiration and
encouragement is an understatement. I am grateful for the presence of my father,
RN Roy, in our lives and his encouragement. Ma was, as always, excited about this
book making to print. I dedicate the book to her fond remembrance.
Acknowledgements xxvii
Ashish H. Kyal
I would like to thank CMT Association as had it not been for them, I would not
have been known in the field of technical analysis. My special thanks to Bob Pre-
chter, whose work has continued to inspire me even now. His perception about
the social causality called socionomics, with a very different way of looking at
cause and effect in financial world, has always intrigued me. Martin Pring, Ralph
Acampora, and Walter Murphy had been instrumental for shaping up my technical
analysis career by acting as guides and mentors at every aspect. I would not have
the knowledge or understanding about financial markets without learning from
Martin’s books. How can I not thank Mark Galasiewski who has again been a
mentor to me, a guide, and, above that, a friend during difficult market situations.
I would like to thank my students, my mentees and subscribers for believing
in me and my work during various phases of market and trusting my ability with
complete faith and acceptance, especially during times like this of pandemic when
the volatility is at historical levels. They have been inspirational for me to keep
going and exploring various aspect of technical analysis.
I would like to bow towards my Guru – Sadhguru Jaggi Vasudev – who has
been a guiding force that has raised my capability to manage multiple facets of
life during the demanding situations without losing the balance. It is rightly said
that without the blessings and grace of my parents we cannot exist. My father –
Harishanker Kyal – has been an epitome of inspiration who has taught me to
never give up and to always keep moving forward irrespective of the situations.
Words cannot describe the compassion and care of a mother – Kiran – who always
pushed me towards being a better human being above everything else. This book
would not have been possible without the support and understanding of my wife –
Munmun, and I would not have seen myself growing in this field if she would not
have been with me when I was too engrossed in technical analysis over anything
else. I worked relentlessly to make this book happen, but without the support of
my entire family, it would not have been possible. I would like to thank my brother,
Somesh, and sister-in-law, Neeta, who have always inspired and pushed me towards
my goals and exploring my full potential. My children – Jash and Pratyush and my
nieces Pritika and Aarna – have taught me how to be joyful while working which
is very important to create anything with best quality.
1
INTRODUCTION TO TECHNICAL
ANALYSIS
The Only Game in Town.

– Mohamed A. El-Erian1
1.1 Technical analysis and trading in the financial

markets
What is your game? The fascination of our times with the financial markets and
efforts to ‘beat the market’ makes trading no less than an adrenalin-pumping sport.
Trading is a game, played solo with the rest of the market! And technical analysis is
the much-needed skill to win consistently in the game of trading.
At the core of trading is the idea that assets are not valued correctly which makes
it possible to buy an undervalued asset (sell an overvalued one) and thereby reap
gains from the price rise (fall). If markets always determined the true value of a
security, as markets would do if they were ‘efficient’, it would be impossible to ‘beat
the markets’. However, the efficiency paradigm of the financial markets has largely
been questioned (Thaler, 2015), and astute traders know that while we cannot be
right in our valuation every time and ‘beat the market’, it is possible, with the right
strategy, to outwit the market and make profits.
Technical analysis is one of the essential strategies, which when rightly used,
can help traders to make profits and win in the trading game. The fascination
with technical analysis as a skill set for trading in markets is reflected in not only
the growing literature on technical analysis but also the copious advice that pours
through blogs and forums to traders. This book is all about using technical analysis
effectively to make our mark in trading.
What is technical analysis? Technical analysis encompasses several loosely held
paradigms, all of which are based on the analysis of a financial asset’s price and
volume data to predict its future movement. Depending on the technical analysis
2 Introduction to technical analysis
approach, the analysis of price and volume data involves visualization on charts
and/or calculation of various statistical measures of the data. At the core of tech-
nical analysis is the idea that the market movement of an asset in the future is
predictable on the basis of the past, and price (and volume) data alone suffice for
such prediction. Fundamental analysis of assets, on the contrary, would juggle with
several variables for predicting prices. The focus on price (and volume) frees us
from the cacophony of other variables, undoubtedly, adding to the popularity of
technical analysis.
Placing a successful trade requires an understanding of where prices are heading.
Trading effectively is all about forecasting correctly the future price movement.
A trader will buy the security, the price of which is expected to move up and sell
the one, whose price is expected to fall. Similarly, traders in the foreign exchange
market will buy the currency expected to appreciate and sell the one expected to
depreciate.
Traders commonly use fundamental analysis or technical analysis or a combina-
tion of both to forecast the future market movements. Fundamental analysis is a
systemic study of the factors that can impact the price of an asset to predict the
future price of the asset. Investment or trading in an asset class requires a knowl-
edge of the economic factors that move the asset. For equities, the valuation will
majorly depend on company-specific factors, most importantly the financials of the
company and macroeconomic factors that impact the specific industry. For curren-
cies, a host of macroeconomic factors (economic and non-economic) impact the
appreciation or depreciation of the currency. The factors impacting the assets are
frequently modelled and used to forecast future prices. Contrasted with this, tech-
nical analysis is the methodological study of charts and price movement to forecast
prices in any market. It considers market action as reflected in chart patterns and
predicts the future movement of prices based on a specific assumption regarding the
previous patterns. The most important assumption underlying such a prediction is
that the chart patterns seen are repetitive in nature and therefore they can be used
to successfully predict the future movement.
Thus, while fundamental analysis delves into why the market moved the way it
did, technical analysis is unconcerned about the causes of market movement. Fun-
damental analyses of markets thus look at the reasons why the markets have moved.
For example, fundamental analysis of foreign exchange markets considers all the
factors that can impact exchange rate determination while that for equity markets
looks at the macroeconomic variables and company-specific factors relevant to that
stock. This is in contrast to technical analysis which is not concerned about why
markets have moved in the way they have. Technical analysis asks, ‘If markets have
moved as can be seen from the charts, can we predict the way it will move in the
future?’
In this chapter, we present a comprehensive view of the technical analysis para-
digm. We will look at the evidence on the use of technical analysis by profession-
als and research on the profitability of technical analysis. The empirical evidence
on technical analysis lends support to the widespread use of technical analysis by
Introduction to technical analysis 3
professionals. With this we also place technical analysis in the context of the Effi-
cient Market Hypothesis (EMH). To aid our understanding of technical analysis,
and its effective use, we wrap up this chapter with a discussion on the financial
market infrastructure required for trading.
1.2 Evidence on the use of technical analysis

If you are a novice to trading or a student, you may have googled the term tech-
nical analysis and been flummoxed at the number of web resources available on
the subject: from books and articles to blogs, forums, and websites. If you are a
trader (retail or institutional), you must have had countless strategies discussed
and shared by peers on technical trading. And you know that technical analysis is
incredibly popular amongst traders, which is presumably also the reason you are
reading this book.
Is there a fascination that professional traders have for technical analysis? Yes
indeed, technical analysis remains an ‘obstinate passion’ (Menkhoff and Taylor,
2007) for trading professionals. One of the most intriguing areas of mainstream
finance is that this popularity of technical analyses among practitioners is despite
technical analysis not being anchored to any underlying economic or financial
theory (Hsu, Taylor, and Wang, 2016).
How important is technical analysis to traders? Allen and Taylor (1990) pre-
sented some of the earliest evidence on the use of technical analysis by profes-
sionals, in this case chief forex dealers in the London market. The paper showed
that chartism, or use of technical charts by market participants for forecasting,
dominated the short-term horizon predictions. Of respondents, 90% used charts
for forecasts for the short-term (intra-day to one-week) horizon. While for long-
term (one- and three-month) forecasts, the inclination to use fundamental analysis
increased, only 30% of respondents were depending ‘on pure fundamentals’. The
paper presented compelling evidence of the complementarity between technical
and fundamental analysis in the minds of traders.
While the evidence on the use of technical analysis brought forth interest in
why technical analysis can work, to which we will come later on, a series of studies
followed, lending support to the extensive use of technical analysis amongst traders
(Menkhoff and Taylor, 2007, 2010; Cheung, Chinn, and Marsh, 2004, Cheung
and Chinn, 2001; Oberlechner, 2001; Cheung and Wong, 2000; Hsu et al., 2016).
Cheung and Chinn (2001) reported that, in a survey of US dealers, technical trad-
ing best describes 30% of trading behaviour, a slightly greater proportion than
that attributed to fundamental analysis (25%), followed by customer-order-driven
(22%) or ‘jobbing’2 (23%).
Gehrig and Menkhoff (2006), in a survey covering forex dealers and fund man-
agers, showed that technical analysis has gained traction over time, being most
important in forex dealing and second in fund management. The recent evidence
on the use of technical analysis suggests that this trend has continued. Menkhoff
(2010) shows in a survey of 692 fund managers in five countries that not only do a
majority of them use technical analysis but that at a forecasting horizon of weeks,
technical analysis is also the most important form of analysis and considered more
important than fundamental analysis.
Technical analysis seems to largely dominate over fundamental analysis in shorter
trading horizons (Allen and Taylor, 1990; Cheung and Chinn, 2001; Gehrig and
Menkhoff, 2006; Menkhoff, 2010). Gehrig and Menkhoff (2006) show that charts
are used for shorter-term forecasting horizons while flows dominate at the shortest
term and fundamentals at a longer horizon. Cheung and Wong (2000), in a survey
covering the forex market in Hong Kong, Tokyo, and Singapore, report 40% of the
respondents saying that technical trading is the major factor determining exchange
rates in the medium run. This study contends that short-run exchange rate dynam-
ics depend on a host of non-fundamental forces in addition to technical trading
(bandwagon effects, overreaction to news, and excessive speculation).
Traders hardly neglect the fundamental factors even when following technicals
staunchly. In fact, technical and fundamental analysis may be more complementary
than initially thought (Cheung et al., 2004; Cheung and Wong, 2000; Gehrig and
Menkhoff, 2006). Cheung et al. (2004), covering the UK-based dealers, iterated
that there was little evidence of a systematic difference of opinion between chartists
and fundamentalists. Gehrig and Menkhoff (2006) point out that professionals rely
on both fundamental and technical analysis, in addition to flow analysis. Cheung
and Wong (2000) argue for combining fundamentals and non-fundamentals in a
unified model for both short-run and long-run exchange rate dynamics. In the
present global economic system with integration in financial markets, news events
often have a destabilizing impact on the financial markets. An awareness of what
goes on behind the chart movement is crucial even when trading on the basis of
technicals alone. While fundamentals and technicals have different approaches to
understanding market movement, for the trader, the use of both is concerned with
how to predict future prices.
1.3 Technical analysis profitability and the efficient

market paradigm
The extensive evidence on the use of technical trading by professionals is not sur-
prising given the compelling evidence for the profitability of technical analysis. In
one of the major empirical studies on profitability of technical analysis indicators,
Brock, Lakonishok, and LeBaron (1992) showed, using technical analysis based on
filter techniques, that profit can be generated substantially in excess of buy-and-
hold returns. Other studies confirmed that technical analysis served as an important
tool in the hands of market practitioners in enabling effective trading decisions
(Pinches, 1970; Menkhoff and Taylor, 2007; Surajaras and Sweeney, 1992; Menk-
hoff and Schlumberger, 1995; Neely, Weller, and Dittmar, 1997; LeBaron, 1999;
Saacke, 2002). In a recent study, Hsu et al. (2016) used daily data from over 45 years
for 30 developed and emerging market currencies to examine the profitability of
more than 21,000 technical trading rules in the foreign exchange market. They
find evidence of substantial predictability and excess profitability in both developed

and emerging currencies when measured against a variety of performance metrics.
The evidence on the profitability of technical analysis challenges the basis of the
EMH. Are financial markets efficient? The debate over the efficient market para-
digm is one of the most interesting deliberations in financial economics. The seeds
of efficiency paradigm were sown in Paul Samuelson’s analysis of random walk in
1965, but it is Fama’s seminal paper in 1970 which formalized the paradigm with its
theoretical and empirical evidence, iterating that the efficient market model, ‘but
with a few exceptions[,] . . . stands up well’ (Fama, 1970). In Fama’s construct,
an efficient market is a market in which prices always ‘fully reflect’ all available
information.
However, as evidence on stock market anomalies grew (Dimson and Mussavian,
1998), it became hard to believe that the anomalies are exceptions and prices do
indeed reflect ‘all information’. Soon the evidence on long-term mispricing in
equity markets, one of the strongest coming from De Bondt and Thaler in 1985,
challenged the core of the efficient market hypothesis. While the debate on the
efficiency of financial markets has continued for almost half a century now (see
the discussion in Fama and Thaler, 2016), stock market bubbles noted in the last
20 years add weight to the fact that stock prices do indeed ‘diverge to a significant
degree from their intrinsic value’ (Thaler, 2014).
If markets are efficient, prices at any given point of time, correctly estimate the
intrinsic value of an asset based on all information available till that point in time. If,
with new information coming, the changes in prices behave in a random manner
or are distributed independently as a random variable (Pinches, 1970; Meese and
Rogoff, 1983), the forecasting of future prices is largely ruled out. With random
walk holding in the financial markets, any technical analysis strategy cannot out-
perform a buy-and-hold strategy. Indeed, if markets are fully efficient, technical
analysis would be redundant. The evidence on the financial market being far from
efficient and the profitability of technical analysis may indeed be deeply connected.
1.4 What explains the profitability of technical analysis?3

What lies behind this evidence on the profitability of technical analysis? Menk-
hoff and Taylor (2007) point to the belief among traders that technical analysis
can represent changes in market psychology and provide information about ‘non-
fundamental influence’. If fundamental factors cannot reflect changes or swings in
sentiment, prices will not reflect all information. Prices may be overreacting or
underreacting to new information in the market. Gehrig and Menkhoff (2006)
show that market participants using technical trading are more concerned and
indeed better versed with the psychological influences that dominate the foreign
exchange market. Technical analysis is able to address these psychological forces
providing value to traders and investors.
Furthermore, financial markets may be characterized by limited arbitrage which
can explain why prices ‘diverge far from fundamental value’ (Shleifer and Vishny,
1997). Shleifer and Vishny (Ibid) point out that as arbitrage requires capital, it entails
risk. With arbitrage being conducted by specialized professionals with resources of
outside investors (referred to as ‘performance-based arbitrage’), it would be difficult
to take ‘extreme’ positions which lead to a situation of ‘limited arbitrage’. With
prices swaying away from fundamental value, technical analysis is better placed to
understand market movement.
In the context of technical analysis profitability, the role of central bank interven-
tions also needs to be considered. Central banks frequently intervene in forex markets
to curb volatility (Roy Trivedi, 2019), and a host of studies show that the presence
of intervention is strongly associated with profits from technical analysis indicators
(Silber, 1994; Szakmary and Mathur, 1997; Neely, 1998; Roy Trivedi, 2020a). The
analysis of Bundesbank interventions with high-frequency data (Frenkel and Stadt-
mann, 2004) and daily data (Neely and Weller, 2001) shows technical trading rules
are most profitable on the day before interventions take place. Neely (Ibid) points out
that official interventions are usually during periods of sharp market movement, that
is when markets are trending, which also makes technical analysis profitable. Again,
central bank intervention may increase market volatility in shorter horizons (Roy
Trivedi, 2019), and the presence of market volatility may, in turn, contribute to the
creation of trends. Central bank intervention in that case would introduce noticeable
trends into the exchange rate movement, making it possible for market participants
to gain from trading (LeBaron, 1999; Saacke, 2002; Roy Trivedi, Ibid).
The discussion of the profitability of technical analysis in the presence of central
bank intervention helps to underline an important aspect of technical analysis. The
success of technical analysis indicators in this environment comes from the ability
to effectively use trend creation. As Menkhoff (2010) points out, economic pro-
cesses need time to unfold and technical analysis may be a ‘proper instrument’ to
anticipate price development in the sense of Hellwig (1982).
Prechter (2016)4 opines that technical analysis essentially rejects the idea of mar-
ket shocks and reaction to news as determining the movement of the market. In
fact, for technical analysts, the ideas of shocks and discounting and over- or under-
reaction to news are intimately related to the impact-and-response view of market
pricing embraced by the random walk theorists and practitioners of fundamental
analysis (Prechter, 2016). Prechter challenges each one of those concepts and argues
that stock market fluctuations express changes in social mood, which is active and
internally regulated rather than reactive to external forces. According to him, the
socionomic theory offers the only internally and externally consistent basis for the
technical analysis profession: if markets were priced rationally on external factors,
technical analysis would be impossible; if markets are priced non-rationally accord-
ing to patterned waves of social mood, technical analysis – which investigates senti-
ment, momentum, volume, and price behaviour – is valid analysis (Prechter, 2016).
Thus, technical analysis profitability, backed as it is by evidence, has links to
the essentials underlying technical analysis paradigms – the ability to gauge market
sentiments and social moods. The understanding of trend generation that tech-
nical analysis brings is indeed a hallmark of technical trading. As we discuss in
later chapters, trend generation and reversal are central to most technical analysis
approaches. Effective trading indeed starts from understanding the trend, which
shall remain the focus through the rest of the book.
1.5 Financial markets: the trader’s playground
1.5.1 Functions of financial markets

Before we take up the core of technical trading, let us briefly consider the trading
infrastructure in financial markets. An understanding of this infrastructure is essen-
tial before we can effectively apply the technical analysis skill. Financial markets are
the trader’s playground. It is where traders can test their skills against others to make
profits. In this section, we take you through the maze of markets, picking up pieces
to have a comprehensive view of the trading infrastructure of financial markets.
We focus here only on those aspects of financial market infrastructure essential for
understanding trading, as a comprehensive discussion on financial markets is out-
side the purview of this book.
Financial markets are where financial assets trade. They exist to enable the
smooth flow of financial capital5 between those who save and those who need
access to financial capital. Financial intermediation is one of the crucial pro-
ductive activities in an economy by which funds are channelled from lenders
to borrowers. Financial intermediation involves an institutional unit incurring
liabilities on its own account for the purpose of acquiring financial assets by
engaging in financial transactions on the market (OECD, 2019). Economic liter-
ature supports a strong positive correlation between long-run economic growth
and financial intermediation as also between long-run growth and stock market
development (Levine, 2005; Demirgüç-Kunt and Levine, 1995; Levine and Zer-
vos, 1996).
What do financial markets do?

Mobilization of savings: Mobilization or pooling of savings is the most crucial
function of financial intermediaries (Levine, 2005). Intermediaries perform the
costly task of pooling the savings of diverse savers for investment. To ensure sav-
ers are interested in the process, transaction costs must be low, and contractual
arrangements should exist to reinforce the trust of savers in the intermediary. Thus,
mobilization may involve multiple bilateral contracts between productive units rais-
ing capital and agents with surplus funds. The joint-stock company (where many
individuals invest in a new legal entity, the firm) represents a prime example of
multiple bilateral mobilizations (Levine, Ibid).
Reducing the cost of external finance to firms: Financial intermediaries reduce
the cost of external finance to firms. It is not surprising, therefore, that industrial
sectors requiring external finance develop disproportionately faster in countries
with more-developed financial markets (Rajan and Zingales, 1998).
Provision of information: Information provision and production are important

functions of intermediaries. Financial intermediaries affect economic growth by
lowering information costs and sifting capital towards more efficient investment
opportunities. Intermediaries play an important role in collecting and analysing
information which, in turn, facilitate the transfer of funds to the areas of highest
social return (Greenwood and Jovanovic, 1990). Financial intermediaries, includ-
ing credit bureaus, financial newspapers, check guarantee services, investment
bankers, and accounting firms, are created to produce information on firms and
sell this information to savers (Ramakrishnan and Thakor, 1984).
Provision of liquidity: Financial intermediaries help individuals to reduce the
risk associated with their liquidity needs (Bencivenga and Smith, 1991). Finan-
cial intermediation prevents the misallocations of invested capital due to liquidity
needs.
1.5.2 Types of financial markets

Finance thus acts as the lubricant for the rest of the economy, and financial mar-
kets offer the playground for the valuation of financial assets. These financial assets
include stocks (equity), bonds (debt), commodities, currencies, and derivatives.
While the microstructures of the different financial markets differ, they share cer-
tain characteristics with reference to trading. Broadly, financial markets are catego-
rized into the following types:
Money markets: These markets are for the short-term debt securities with
maturity of a year or less. The assets traded in this market include Treasury
bills, commercial papers, and certificates of deposits. They embody liquidity
with both low risk and return.
Capital markets: Markets for securities with maturity of more than one year is
called capital markets. Capital markets include markets for long-term debt
securities and stocks.
Long-term debt securities (bonds) are issued by both governments and corporates.
Investors in bonds get coupon payments (interest income) at regular intervals and
principal at maturity. The secondary market for debt securities gives liquidity to
the owners of these securities as the assets can be bought and sold any time before
maturity. Debt instruments characterize low risk and return.
Stocks represent equity ownership in companies that issue stocks or shares via
the primary market. Equity owners get a part of profits as dividends but are ranked
below debt holders for residual claims. This means that if for some reason the
company goes out of business, debt holders would be paid first and then equity
holders would have claims to the residual assets. Equity holders have a claim on a
company’s assets but only when the other liabilities of the company are paid for.
Equity holders nevertheless are looking for a maximization of shareholder wealth
and therefore expect management to work towards that goal. Voting rights are
given to the owners of common shares and provide shareholders with the opportu-
nity to participate in major corporate governance decisions such as the election of
the company’s board of directors. The secondary market provides an opportunity
for equity holders to trade their stocks, leading to capital gains (or losses) (Box 1.1).
BOX 1.1 TYPES AND CHARACTERISTICS OF

EQUITY SECURITIES
Common stock/ordinary shares represent the final residual claims on assets on

liquidation. Common stockholders have voting rights and receive dividends.
Preference shares (or preferred stocks) rank above common shares for
payment of dividends and the distribution of the company’s net assets if liq-
uidated. However, unless specifically allowed at issuance, preference share-
holders may not have any voting rights.
Equity shares with deferential rights are issued with disproportionate
rights with regard to crucial issues, including voting and dividends.
Private equity securities are equity securities issued via non-public offer-
ings or private placements to select entities and therefore are not listed on
public exchanges.
Foreign exchange market: This is the market for the purchase and sale of cur-
rencies. It is one of the most vibrant financial markets, with a huge turnover and
liquidity. While all commodities are bought and sold with money as the numer-
aire, for the currency market one currency is used to value the other. Forex mar-
kets cater to the end users who need foreign currency for business (exporters and
importers), travel, education, or investment. Additionally, currencies are traded by
both institutional and retail entities to make profits from the appreciation or depre-
ciation of the currencies. The main participants in the foreign exchange market are
retail clients (end users), commercial banks (who take buy/sell orders from their
retail clients and buy/sell currencies on their own accounts, known as proprietary
trading), foreign exchange brokers (who help dealers to find counterparties, lower-
ing transaction costs), and, finally, the central bank (which maintains the exchange
rate regime of the country, as also acts as the custodian of the foreign exchange
reserves) (Box 1.2).
BOX 1.2 FOREX QUOTE
Every forex transaction involves a currency pair, and the forex price (or
exchange rate) is the price of one currency in terms of the other. Of the two
currencies in the pair, one is called the base currency and the other, the quot-
ing currency. The base currency is the currency that is priced and quoting
currency is the currency that prices the base currency, thus acting as money.
Thus, a currency quote is essentially the price of the base currency in units of
quoting currency.
In the book, we will refer to all currencies by their International Organiza-
tion for Standardization (ISO) codes. USD (United States dollar) is the ISO
code for the currency of the United States. The ISO codes of currencies featur-
ing in this book appear in the list of abbreviations. Conventionally, in writ-
ing a currency pair, the base currency is always written first. Thus, GBP/USD
means GBP (Great Britain pound) is the base currency and USD is the quoting
currency.
Commodity markets: Commodity markets are for the purchase and sale of
homogeneous primary commodities as opposed to manufactured products, includ-
ing precious metals (gold, silver), natural resources (oil, gas, metals or minerals),
animal products, and so on. Commodities can be traded directly or indirectly
(through the derivative markets). While investments in commodity markets is done
to diversify the portfolio, the evidence on commodity exposures increasing portfo-
lio returns is mixed (Baker et al., 2018).
Derivative markets: The markets for derivatives involve contractual agreements
which derive their value from an underlying. Financial assets that have been used as
an underlying include equities or equity index, fixed-income instruments, foreign
currencies, commodities, credit events, and other derivative securities. The value
of the derivative contract is derived from the corresponding equity prices, inter-
est rates, exchange rates, commodity prices, and the probabilities of certain credit
events (Bank of International Settlements, 2012).
In this book, we discuss technical analysis with examples from the equity and
foreign exchange markets only. While technical analysis is equally applicable to
bond, commodity, and derivatives markets, the unique features of these markets
require a separate study for the application of technical analysis in these markets
which is beyond the scope of this book.
1.5.3 Infrastructure of trading
While the primary market for financial assets leads to the creation of financial
assets, the secondary market facilitates buyers and sellers to trade in such assets.
Secondary markets therefore provide liquidity and enable price discovery. The
infrastructure of the market allows trading to happen. While the infrastructure of
different financial markets differs, the underlying structure common to all financial
markets is discussed here.
1.5.3.1 Intermediaries
Brokers and dealers

The distinction between brokers and dealers is a crucial one. While foreign
exchange markets have both dealers and brokers, the equity market is a broker-
driven market.
Brokers are agents who fill orders for their clients by bringing together buyers
and sellers. However, they do not trade with their clients or take positions them-
selves. Brokers try to find counterparties who would take the other side of their
clients’ orders, which reduces the client’s costs of finding counterparties for trading
(Fuhrmann and Lamba, 2011).
Dealers act as counterparties to their clients (Fuhrmann and Lamba, Ibid). Deal-
ers thus provide liquidity to the market by trading with their clients and taking
positions on their own books. Dealers try to reverse the positions taken for provid-
ing clients with liquidity by trading with another client on the other side of the
market. Profits are made when they buy at prices that on average are lower than
the prices at which they sell. Thus, dealers provide liquidity by connecting buyers
and sellers who have come to the financial market at different points in time while
brokers connect buyers and sellers at the same point in time.
While dealers can act as brokers and brokers can deal with their clients (broker–
dealer), a conflict of interest arises with respect to how they fill their customers’
orders. Brokers should try to get the best price for their customers’ orders, that
is the lowest price for a buy order and highest for a sell order. However, a dealer
would want the highest buy price while selling to their clients and the lowest sell
price for buying from their clients. A special category of dealers is primary deal-
ers, with whom central banks trade (in bills, notes, and bonds) when conducting
monetary policy.
Exchanges
Historically, exchanges were physical places (floor or pit) where traders met to
arrange their trades. With the development of communication and technology, the
need for a physical place to conduct and arrange for trades is redundant. Advances
in communication and technology have allowed exchanges to completely automate
their trading systems (Harris, 2002). Exchanges, like brokers, arrange trades based
on the orders’ brokers and dealers submit to them. However, exchanges, unlike
brokers, regulate the behaviour of members in relation to the trades conducted in
their exchange (Fuhrmann and Lamba, 2011).
Clearing-houses
Clearing-houses arrange for final settlement of trades for their members, facilitat-
ing the process of transferring money from the buyer to the seller while transferring
securities from the seller to the buyer. For the smooth operation of the clearing
process, members need to have adequate capital. Margins and limits are imposed
by the clearing-houses on the aggregate net (buy minus sell) quantities that their
members can settle. Non-member brokers and dealers must arrange to have a
clearing-house member settle their trades (Fuhrmann and Lamba, 2011).
Strong settlement systems in financial markets address counterparty risk and
ensure liquidity because it enhances the number of counterparties with whom a
trader can safely arrange a trade. Clearing and settlement systems follow a hierarchy,
of which, at the first tier, brokers and dealers guarantee settlement of the trades for
their retail and institutional customers. The clearing-house members guarantee set-
tlement of the trades of their customers at the second tier. At the third and topmost
tier, clearing-houses guarantee settlement of all trades presented to them by their
members, even when a clearing-house member fails to settle a trade. In the case of
a failure on part of a clearing-house member, the clearing-house settles the trade
using its own capital (Fuhrmann and Lamba, 2011).
In the clearing and settlement process, two more entities play a vital role: clear-
ing banks, responsible for making funds available for net payment obligation credit/
debit, and depositories, responsible for making securities available for net security
obligation credit/debit. Depositories hold securities on behalf of their clients in
electronic or dematerialized form, just as a bank holds cash for the customer as a
deposit. Dematerialization of securities helps to address risks arising from the theft,
loss, or mutilation of physical certificates.
1.5.3.2 Positions
A position in an asset is the quantity of a financial instrument owned or owed by an
entity. Long positions are assets owned by an entity while short positions represent
assets which are sold, even though they are not owned. Long positions are profit-
able when there is an increase in price. Short positions are profitable when there is
a decrease in the prices of the assets as short sellers can then repurchase the assets
at lower prices.
It is important to note here that for long positions, the profits are unlimited,
while losses are limited. For a short position, the losses are unlimited while profits
are limited. For example, let us suppose you have bought a security for Rs 100
(long position) and hope to gain from its price rise. The price can go up to any
level, so theoretically your profits are unlimited, while the minimum it can fall to is
zero, in which case, the loss would be 100%. In case, you have sold a security you
did not have at Rs 100 (short position), you expect its price to fall. If it falls to zero,
the profits would be 100%, but again, it can rise up to any level in which case you
would face unlimited losses.
1.5.3.3 Orders
Orders are instructions used by the buyers and sellers to communicate with the
brokers, exchanges, and dealers for transacting traders. To trade, we must specify
the financial instrument that we want to trade, the amount we want to trade, and
the position to be taken. These instructions are classified into execution instruc-
tions, validity instructions, and clearing instructions (Fuhrmann and Lamba, 2011).
Execution instructions specify to the broker or dealer or exchange ‘how to fill the
order’, validity instructions specify to the broker or dealer or exchange ‘when the
order may be filled’, and clearing instructions indicate the specifications on the ‘final
settlement of the trade’ (Fuhrmann and Lamba, Ibid).
Execution instructions
Market orders tell the broker or exchange to obtain the best price immediately
available when filling the order. While filling market orders, the broker or exchange
will try to get the best price immediately available. This means that the actual trans-
acted price may not be the same that the trader was looking for while putting the
trade, especially for a fast-moving market. For a volatile market, this means that the
buy (sell) price may be higher (lower) than expected.
Limit orders also give the same instruction but with stipulations. In the case of
a buy-limit order, the stipulation is to not accept a price higher than the specified
limit price. In the case of a sell-limit order, the stipulation is not to accept a price
lower than a specified limit price when selling. Limit orders therefore may not
get executed if prices move quickly in the opposite direction to that expected by
trader.
Limit orders are said to be aggressively priced if they are given closer to the
market price (and therefore likely to trade) and less aggressively if priced otherwise.
The highest bid in the market is the best bid, and the lowest ask in the market is
the best offer. The difference between the bid and the offer is the market bid–ask
spread (Box 1.3). An increase in the bid–ask spread is taken as an indicator of
increased volatility in the financial markets (Fleming and Remolona, 1999).
BOX 1.3 MACROECONOMIC NEWS

ANNOUNCEMENTS AND FINANCIAL MARKET
VOLATILITY
Bid–ask spreads are seen as indicators of market volatility in economic litera-

ture. Macroeconomic announcements have the greatest impact on market
volatility (in the form of the bid–ask spreads) in the shortest time frames
(Fleming and Remolona, 1999). In microstructure theory, bid–ask spreads
represent inventory carrying costs, order-processing costs, and asymmet-
ric information costs (Bessembinder, 1994). Inventory carrying costs arise
because the act of market making imposes on interbank dealers the need to
either maintain liquidity in terms of currencies themselves or provide liquidity
to counterparties by trading at given rates immediately (Bessembinder, Ibid).
Asymmetric information reflects the widening of spreads as participants face

more ‘informed’ traders. The presence of a more informed trader with insider
information will lead to a rise in bid–ask spreads by existing participants to
protect against the lack of information (Fleming and Remolona, 1999). The
order-processing costs reflect the time and money spent in processing a trade,
including trading, clearing and settlements fees, and back-office costs, typi-
cally small in foreign exchange markets (Galati, 2000).
Execution instructions may also specify conditions on size. All-or-nothing

orders can only trade if their entire size offered for trade can be traded. Traders can
similarly specify minimum-fill sizes (minimum-fill orders).
Exposure instructions tell the broker whether and to what extent the order’s
details would be exposed to the counterparty. Hidden orders are not known to
counterparties (but exposed to the brokers or exchanges that fill the order). Hid-
den orders are used when traders are in the market with a big volume and want
the information to be hidden from counterparties, as it is possible that the market
may move against them if the size of the order is known to counterparties. Iceberg
orders (or display-specific size) have a specific portion displayed to the counterparty.
Validity instructions
Validity instructions indicate when an order may be filled. A day order is valid for
the trading day on which it is submitted and expires if not filled by end of trading
day. Good-till-cancelled orders are valid till cancelled by the trader. Immediate-
or-cancel orders (or ‘fill-or-kill’ orders) are good only for immediate execution by
the broker or exchange; otherwise, they are cancelled immediately. Good-on-close
orders become valid at the close of trading.
Stop orders are validity instructions which become effective when the price
reaches a certain threshold. The buy-stop order becomes activated when the price
rises above a certain threshold, and a sell-stop order becomes activated when the
price falls below a threshold. Traders frequently use stop orders to contain their
losses, hence the name ‘stop-loss’ order. For example, let us suppose a trader has
taken a long position at Rs 100 and expect prices to rise. If the market moves in
the other direction, she may want to quit the position and minimize the loss. In
this case, she will put a stop-loss sell order at, say, 98. If the price starts to fall, the
moment it falls below 98, the order to sell becomes valid and is executed at the best
possible price. Similarly, if the trader has short sold at Rs 100, she may want to put
a buy-order stop loss at 110, which implies that if the price goes above 110, the buy
order would be immediately executed at the best possible price.
Stop-loss orders may be market or limit orders. For a stop-loss market order,
once the stop condition is valid, the broker should try to get the best possible price
immediately available. As it happens with the market order, there is no certainty

for the trader of getting that particular price. If the trader is not willing to accept
a buy or sell order at a price above or below a certain limit, a limit order may be
put with the stop loss. In the preceding example, for the buy order, let us suppose
the limit is put at 111 and stop at 110. This tells the broker that above 110, the
buy–stop-loss order is activated, and therefore, the broker should try to get the best
possible buy price but not exceeding 111. Similarly, for the sell order, the limit is
put at 97 and stop loss at 98. This tells the broker that below 98, the sell–stop-loss
order is activated; therefore, the broker should try to get the best possible buy price
but not less than 97.
Clearing instructions
Clearing instructions guide on the final clearing and settlement of trades, including
indicating which entity is responsible for clearing and settling the trade. The clear-
ing function decides what members are due to deliver and what members are due
to receive on the settlement date. Settlement is a two-way process which involves
a transfer of funds and securities on the settlement date. The entity responsible for
clearance is the customer’s broker in the case of retail trades and a custodian or another
broker in the case of institutional trades (Fuhrmann and Lamba, Ibid, NSE, 2020).
In this chapter, we have presented a snippet view of the financial markets, focus-
ing on the structure of financial markets which enable the trading process. We have
discussed the academic viewpoint on technical analysis profitability and what can
explain technical analysis being an effective tool for the trading process. The idea
of trend generation as central to technical analysis is carried forward in the next
chapter. The success of technical analysis indicators, we recognize, comes from the
ability to reflect the sentiment in the market and thereby recognize trend creation.
The basic premise of technical analysis is that market move in trends which can
be recognized through suitable indicators and utilized for trading. Throughout the
remainder of the book, we will see that the different technical analysis approaches
presented give differing thought processes for understanding this basic tenet of
trend generation in the market. Chapter 2 takes up the building blocks of technical
analysis, its basic assumptions, and, finally, trend analysis, the cornerstone of techni-
cal analysis theory.
1.6 Key takeaways
1 Financial markets allow the smooth flow of financial capital between those
who save and those who need finance.
2 Money markets are for the short-term debt securities with maturity of a year
or less.
3 Capital markets are for securities with maturity of more than one year.
4 A foreign exchange market is a market for the purchase and sale of currencies,
with one currency being priced in terms on another.
5 Commodity markets are the markets for the purchase and sale of homogenous
primary commodities as opposed to manufactured products.
6 Derivative markets are for contractual agreements which derive their value
from an underlying (a stock, bond, currency, and commodity).
7 Financial intermediaries mobilize savings, reduce the cost of external finance
to firms, lower information costs, and provide liquidity in the economy.
8 The primary market for the financial assets leads to the creation of these assets,
while the secondary market help buyers and sellers to trade in these financial
assets.
9 The infrastructure of financial markets includes the intermediaries (who facili-
tate the trading, clearing, and settlement of securities), positions (which reflect
the quantity of financial instrument owned or owed by an entity), and orders
(which represents communications between traders and intermediaries).
10 Traders commonly use fundamental analysis and/or technical analysis to fore-
cast the future market movement.
11 Technical analysis is the methodological study of charts and price movement
to forecast prices.
12 Empirical studies have confirmed that technical analysis is an important tool
for market practitioners, enabling effective trading decisions.
Notes
1 The title of the book by Mohamed A. El-Erian (2016) on the global financial system and
the role of the central banks is also a fitting adage for the fascination of our times with
trading and use of technical analysis in the financial markets
2 ‘Jobbing’ refers to the use of continuous buy and sell orders by traders in order to make
substantial profits in ‘small increments’ (Cheung and Chinn, 2001).
3 We are grateful to Dr. Lukas Menkhoff for his viewpoints which form the basis of the
arguments presented in this section.
4 We are grateful to Robert Prechter for his inputs on why technical analysis is better
placed to gauge market sentiments.
5 See Perez (2002) and Roy Trivedi and Bhattacharya (2018) for a discussion on the demar-
cation between production and financial capital and its implications.
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3 Nifty 50 is the National Stock Exchange’s (NSE’s) diversified 50 stock index accounting
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most recent price movement.
1 Italics in original. Shiller, R. J. (2016). Irrational exuberance (3rd ed., p. 2). Princeton, NJ:
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2 An MACD histogram is denoted as MACD Forest in the Eikon, Refinitiv charting
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EFFECTIVE TRADING IN

FINANCIAL MARKETS USING

• Presenting in-depth coverage of technical analysis tools (including trade set-ups)

‘This book is an amazing toolkit to understand trading/investing as a data-driven

Smita Roy Trivedi and

List of figures xii

1 Introduction to technical analysis 1

2 Basic principles of technical analysis 17

3 Classical reversal and continuation patterns 44

4 Candlesticks patterns and their use in trading strategies 67

4.2.3 Doji candlesticks 71

5 Moving averages and their use for trading strategies 94

6 Momentum indicators and stochastics 113

7 Volatility and volume indicators 135

8 Elliott Wave Principles 150

9 Time cycles 185

10 Introduction to backtesting and algorithmic trading 203

2.1 GBP/USD movement, 2015–2019 (monthly chart). Created

3.1 Head and Shoulders pattern 45

4.5 Candles with long shadows 72

2.1 Price data for point and figure chart 22

AMA Adaptive moving average

Structure of the book and resources

Smita Roy Trivedi

The Only Game in Town.

1.1 Technical analysis and trading in the financial

1.2 Evidence on the use of technical analysis

1.3 Technical analysis profitability and the efficient

find evidence of substantial predictability and excess profitability in both developed

1.4 What explains the profitability of technical analysis?3

1.5 Financial markets: the trader’s playground

1.5.1 Functions of financial markets

What do financial markets do?

Provision of information: Information provision and production are important

1.5.2 Types of financial markets

BOX 1.1 TYPES AND CHARACTERISTICS OF

Common stock/ordinary shares represent the final residual claims on assets on

BOX 1.2 FOREX QUOTE

Brokers and dealers

BOX 1.3 MACROECONOMIC NEWS

Bid–ask spreads are seen as indicators of market volatility in economic litera-

Asymmetric information reflects the widening of spreads as participants face

Execution instructions may also specify conditions on size. All-or-nothing

immediately available. As it happens with the market order, there is no certainty

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List of figures xii

1 Introduction to technical analysis 1

2 Basic principles of technical analysis 17

3 Classical reversal and continuation patterns 44

4 Candlesticks patterns and their use in trading strategies 67

5 Moving averages and their use for trading strategies 94

6 Momentum indicators and stochastics 113

7 Volatility and volume indicators 135

8 Elliott Wave Principles 150

9 Time cycles 185

10 Introduction to backtesting and algorithmic trading 203

3.1 Head and Shoulders pattern 45

4.5 Candles with long shadows 72

2.1 Price data for point and figure chart 22

1.1 Technical analysis and trading in the financial

1.2 Evidence on the use of technical analysis

1.3 Technical analysis profitability and the efficient

1.4 What explains the profitability of technical analysis?3

1.5 Financial markets: the trader’s playground

1.5.1 Functions of financial markets

1.5.2 Types of financial markets