Technical Analysis

Dr. Pankaj K Agarwal

 What is Technical Analysis
• Technical Analysis can be defined as an art and
science of forecasting future prices based on
an examination of the past price movements
• Also known as Charting
• Makes use of Prices, Volumes and Open
Interest data.
• It is an examination of demand and supply.
 Basis of Technical Analysis
• Price and Market Discount Everything.
• Price movements are not random but follow
some trend
• “What” is more important than “Why”
• History repeats itself
• Pareto Principle (Markets are 80%
Psychological and 20% Logical)
 Aspects of Technical Analysis
• Helps decide When to enter/exit whereas
fundamental analysis helps decide What.
 Weaknesses
• Analyst Bias
• Open to Interpretation
• Too Late
• Always Another Level
• Peculiarities
• Controlling Risk More Important Than Profits
 What is a Chart?
• It’s a graphical method of showing where
stock prices have been in the past.
• A chart gives us a complete picture of a stock’s
price history over a period of an hour, day,
week, month or many years.
• Time on X-axis and Prices/Volumes on Y-axis
 Basic Technical Charts
• Line Chart

• Bar Chart

• Candlestick
Bar Chart
 Candlesticks

*In NSE software, black candlestick is Red and White is Blue.

Candlesticks
Candlestick Patterns Examples
 Some More Candlestick Patterns
• Hammer
• Hanging Man
• Shooting Star- Signals End of an Uptrend
• Bullish Harami
• Bearish Harami
• Doji
 Hammer and Hanging Man

Example: Nifty 50
 Hammer
1. The lower shadow should be at least two times the
length of the body.
2. There should be no upper shadow or a very small
upper shadow.
3. The real body is at the upper end of the trading range.
The color of the body is not important although a white
body should have slightly more bullish implications.
4. The following day needs to confirm the Hammer
signal with a strong bullish day.
 Hanging Man
• The hanging man appears during an uptrend,
and its real body can be either black or white.
• While it signifies a potential top reversal, it
requires confirmation during the next trading
session.
• The hanging man usually has little or no upper
shadow.
 Shooting Star
1. The upper shadow should be at
least two times the length of the body.
2. Prices gap open after an uptrend.
3. A small real body is formed near the
lower part of the price range. The
color of the body is not important
although a black body should have
slightly more bearish implications.
4. The lower shadow is virtually non-
existent.
5.The following day needs to confirm
the Shooting Star signal with a black
candle or better yet, a gap down with
a lower close.
Example: L & T 29-09-2016 to 29-09-2017
Bullish Harami
• The Harami is a commonly observed
phenomenon. The pattern is composed
of a two candle formation in a down-
trending market. The color first candle
is the same as that of current trend.
• The first body in the pattern is longer
than the second one. The open and the
close occur inside the open and the
close of the previous day. Its presence
indicates that the trend is over.
• The Harami (meaning “pregnant” in
Japanese) Candlestick Pattern is a
reversal pattern. The pattern consists
of two Candlesticks. The first candle is
black in color and a continuation of
 Bearish Harami
• Bearish Harami is a two
candlestick pattern composed
of small black real body
contained within a prior
relatively long white real body.
• The body of the first candle is
the same color as that of the
current trend. The open and
the close occur inside the open
and the close of the previous
day.
• Its presence indicates that the
trend is over.
Example: CIPLA 29-09-2016 to 29-09-2019
 Doji
• Doji stars are patterns with
the same open and close
price. It’s a significant
reversal indicator.
• A Doji star at the top is a
warning that the uptrend is
about to change. This is
especially true after a long
white candlestick in an
uptrend.
• Doji can occur at bottoms
also signaling reversal.
Example: Bajaj Finance 29-09-16 to 29-09-2019
 Pattern Study
• Support
– It is a point where one can expect more buyers
than sellers

• Resistance
– It is a point where one can expect more sellers
than buyers
Support Level
Resistance Level
 Support and Resistance-Reasons
• Bulls Vs Bears

• New Levels

• Zones
Resistance and Support Zones
Interchange of Resistance and Support
Why Resistance and Support Are Important

• Market has a memory

Head and Shoulder
• Normally coupled with
volume increases with
falls than rises
• Support often becomes
resistance
Inverted Head and Shoulder
Example:SBI
Double Tops and Bottoms
Double Top
Double Bottom
 Technical Indicators
• A Technical indicator is a mathematical
formula applied to the security’s price, volume
or open interest. The result is a value that is
used to anticipate future changes in prices
• Examples:
– Moving Averages
– Oscillators (MACD and RSI)
 Purpose of Indicators
• To Alert

• To Confirm

• To Predict
 Important Points in Using Indicators
• What is the indicator saying about the price action of a
security?

• Is the price action getting stronger? Is it getting weaker?

• Is the indication being supported by Charts?

• It is a good idea to focus on 2-3 complementary

indicators
 Leading and Lagging Indicators
• Leading Indicators:
– Early signals for entry and exit.
– Example: Momentum, RSI, William%R
•Lagging Indicators
• Good for Confirmation
•Examples: Moving Averages, MACD
 Moving Averages
• Simple Moving Averages (SMA)
Equal weight to all past values

• Exponential Moving Averages (EMA)

– More weight to recent values
EMA (current) = ((Price (current) - EMA (prev)) x (Multiplier) + EMA (prev)
Multiplier= 2/(Time Period +1)
Interpretation
If price has broken the MA, a trend is confirmed.
 Simple or Exponential?
• Often there is no difference
• However, SMA has a lag and EMA is quicker
• For shorter trading horizons, EMA appears
better.
• SMA suits better for long-term trend spotting
• However, it works differently for different
securities
• It is a choice between sensitivity and reliability
 Shorter or Longer?
• Shorter more sensitive but generate early
signals.

• However, Longer ones are more reliable

• Popular lengths are 21, 50, 89, 150 and 200

days as well as 10, 30 and 40 weeks.
 Use of Moving Averages
• Trend identification/confirmation
(Direction, Location and Crossovers)
• Support and resistance level
identification/confirmation
• Trading systems
False Signals in Moving Averages
 Important

• 200-day Moving Averages are often used to

examine Indices.
 Oscillators
• This is a class of indicators that measure momentum.
Examples: Relative Strength, Rate of Change, William
%R

• Momentum refers to rate of change. Momentum

measures the rate at which prices rise or fall and is
based on the principle that prices usually rise at the
fastest pace well ahead of their peak, and decline at
their greatest speed before their trough.
• Momentum often provides leading signals
 Oscillator
• An oscillator is an indicator that moves back and
forth across a reference line or between
prescribed upper and lower limits. When an
oscillator reaches a new high, it shows that an
uptrend is gaining speed and is likely to continue.
When an oscillator traces a lower peak, it means
that the trend has stopped accelerating and a
reversal can be expected from there, much like a
car slowing down to make a U-Turn
 Relative Strength Index
• The Relative Strength Index (RSI) measures the price of a
security against its past performance in order to determine its
internal strength (in an attempt to quantify the security price
momentum).
• "A popular method of analyzing the RSI is to look for a
divergence in which the security is making a new high, but the
RSI is failing to surpass its previous high. This divergence is an
indication of an impending reversal. When the RSI then turns
down and falls below its most recent trough, it is said to have
completed a failure swing; The failure swing is considered a
confirmation of the impending reversal.”
• RSI= 100-100/(1+RS), where RS is ratio of up closes and down
closes
Relative Strength Index

Days Closing Prices

0 120.00
1 119.00
2 128.75
3 125.80
4 127.25
 Application of RSI
• Overbought and Oversold Positions: Overbought refers to
exhaustion of buying and oversold refers to exhaustion of
selling.
• RSI >= 80 implies overbought position
• RSI <= 20 implies oversold position
• RSI is a leading indicator
Trading Rules
• Go long when the indicator moves from below to above the
oversold line.
• Go short when the indicator moves from above to below the
overbought line
M
 RSI and Divergence
Strong Divergence Moderate Divergence
 Moving Average Convergence Divergence
(MACD)
• Created by Gerald Appel in the late 1970s. The
MACD indicator is basically a refinement of the
two moving averages system and measures the
distance between the two moving average lines.
• It is constructed by taking the difference or the
ratio of short-term and the long-term moving
average
• MACD is usually a co-incident indicator
 Understanding MACD
• The MACD comprises two lines, the fast line and the slow or signal
line. These are easy to identify as the slow line will be the
smoother of the two.
Procedure
• Step1. Calculate a 12 period exponential moving average of the
close price.
• Step2. Calculate a 26 period exponential moving average of the
close price.
• Step3. Subtract the 26 period moving average from the 12 period
moving average. This is the fast MACD line.
• Step4. Calculate a 9 period exponential moving average of the fast
MACD line calculated above. This is the slow or signal MACD line.
 Interpreting MACD
1. Crossovers: The basic MACD trading rule is to sell when the
MACD falls below its signal line. Similarly, a buy signal occurs
when the MACD rises above its signal line. It is also popular to
buy/sell when the MACD goes above/below zero.
2. Centre Line Crossover
A bullish centerline crossover occurs when MACD moves above
the zero line and into positive territory. This is a clear indication
that momentum has changed from negative to positive or from
bearish to bullish. After a positive divergence and bullish moving
average crossover, the centerline crossover can act as a
confirmation signal. Of the three signals, moving average
crossover are probably the second most common signals.
 Interpreting MACD
A bearish center-line crossover occurs when MACD
moves below zero and into negative territory. This is
a clear indication that momentum has changed
from positive to negative or from bullish to bearish.
The center-line crossover can act as an independent
signal, or confirm a prior signal such as a moving
average crossover or negative divergence. Once
MACD crosses into negative territory, momentum,
at least for the short term, has turned bearish.
 The Dow Theory
• Propounded in 1900, gave birth to technical
analysis
• Initially attempted to describe, not predict
• Robert Rhea (1932) attempted to formalize
and tried prediction
• It assumes stocks follow market trend and
prices are a barometer of business conditions
 The Dow Theory-Basic Tenets
– The Market Discounts Everything
– The Market Has Three Movements
– Primary Trend
– Secondary Reaction (33%-66% Lasting 1-3 Months)
– Minor Movements
– All
Indices Must Conform
–Volume Must Confirm
–Sideways Market is a Substitute for Secondary
Trend
–Closing Price is Most Sacred
The Dow Theory
The Dow Theory-Basic Tenets
Price Action Determines The Trend

Source: www.zerodha.com
 The Dow Theory-Basic Tenets
• 3% or a higher fall in dividend yield indicates
maturity of the bull market, and a 6% or a
higher rise in the dividend yield is said to be
the end of a bear market.
Caution in Using Technical Analysis
• No rule succeeds forever
• If a golden rule existed, it would not
be shared
• If it is shared, it will cease to be a
golden rule as returns will vanish
soon
• Market Efficiency (EMH)