Technical Analysis

Technical Analysis Introduction

• Two major types of analysis for predicting the
performance of a company’s stock
– fundamental
– technical
• Technical
– looks for peaks, bottoms, trends, patterns, and other
factors affecting a stock’s price movement
– makes a buy/sell decision based on those factors
Technical Analysis vs. Fundamental Analysis

• Technical analysis involves the development of

trading rules based on past price and volume data for
individual stocks and the overall stock market.
• Fundamental analysis involves economic, industry,
and company analysis that lead to valuation
estimates for companies, which can then be
compared to market prices to aid in investment
decisions.
 Introduction
• Technical analysis is the attempt to forecast
stock prices on the basis of market-derived
data.
• Technicians (also known as quantitative
analysts or chartists) usually look at price,
volume and psychological indicators over time.
• They are looking for trends and patterns in the
data that indicate future price movements.
 What is Technical Analysis?
(Continued)
• Method of evaluating securities by analyzing
statistics generated by
– Market activity
– Past Prices
– Volume
• Do not attempt to measure intrinsic value
• Instead look for patterns and indicators on
charts to determine future performance
 What is Technical Analysis?
(Continued)

• Technicians believe
that securities move
in very predictable
trends and patterns
• Trends continue until
something happens
to change the trend
• Until that change
takes place, price
levels are predictable
 What is Technical Analysis?
(Continued)
• Most agree that
technical analysis is
much more effective
when combined with
fundamental analysis
 Bar Charts
Bar Charts helps us to find the trends in the
market plotting the past movements in the stock
price, based on which decisions can be made
Each bar is composed of 4 elements:
– Open
– High
– Low
– Close
Bar Charts are of two types
• Standard Bar Chart
• Japanese Candle stick
 Standard Bar Charts

example of a single day

standard bar chart
where the stock closes
higher compared to
previous day’s
Standard Bar chart
showing the stock
closes lower from
the previous day’s
close
• Standard Bar chart (open, high, low, close or OHLC)of
AMAT from early July to mid October 2001.
Japanese Candle Stick Charting
 Japanese Candle Stick Charting
(Continued)
• Been around for hundreds of years
• Often referred to as “Japanese Candles”
because the Japanese would use them to
analyze the price of rice contracts
• Similar to bar chart, but uses color to
show if stock was up (green) or down
(red) from the previous day’s close
 Japanese Candle Stick Charting
(Continued)
• Green is an example of a
bullish pattern, the stock
opened at (or near) its
low and closed near its
high
• Red is an example of a
bearish pattern. The stock
opened at (or near) its
high and dropped
substantially to close near
its low
• This is a Japanese Candlestick (open, high, low, close)
chart of AMAT from early July to mid October 2001
 Basic Technical Tools
• Trend Lines
• Moving Averages
• Price Patterns
• Technical Indicators
 Trend Lines
• There are three basic kinds
of trends:
– An Up trend where prices
are generally increasing
( Bullish market ).
– A Down trend where
prices are generally
decreasing ( Bearish
trend ).
– A Trading Range ( Flat
trend / chicken market ).
 Trendlines

• Draw a trendline through the edges of

congestion areas
• The most important feature of a trendline is
its angle
• Trendlines show the action of bulls and
bears
 Up Trend

• Connect two or more daily price

lows
–Preferably 10 days apart
• When market closes below an
uptrend line, a sell signal is
generated
Up Trend

Sell Signal
 Down Trend

• Connect two or more daily price

highs
–Preferably 10 days apart
• When market closes above a down-
trend line, a buy signal is generated
Down Trend
 Support & Resistance
• Support and resistance
lines indicate likely ends
of trends.
• Resistance results from Breakout
the inability to surpass
prior highs.
• Support results from the
inability to break below
to prior lows.
Support Resistance
 Resistance and Support
• Price levels at which movement should stop and
reverse direction.
– Act as floor and ceiling
– Different strengths (major and minor)
• Support
– Price level below the current market price at which buying
interest should be able to overcome selling pressure and
thus keep the price from going any lower
• Resistance
– Price level above the current market price, at which selling
pressure should be strong enough to overcome buying
pressure and thus keep the price from going any higher
 Resistance and Support
One of two things can happen when stock approaches resistance/support

• Support/Resistance
Can act as a reversalreverse
point roles once
penetrated.
– When price drops to a support level, it will go back
– Market
up price falls below a support level, then the
former support level becomes a resistance level
– When price rises to a resistance level, it will go
when the market later trades back up to that level
back down
Resistance and Support
Resistance

Resistance/Support

Support
 Simple Moving Averages

• A moving average is simply the average

price (usually the closing price) over the
last N periods.
• They are used to smooth out
fluctuations of less than N periods.
 Using the Moving Average
• The most commonly used averages are of
20,30,50, 100 and 200 days
– The longer the time span, the less sensitive
the moving average to daily price changes
– Moving averages are used to emphasize the
direction of a trend
Moving Average
 Moving Average (Continued)
• Notice in April when the stock price dropped well
below its 50-day average (the green line).
– Bearish signal
• February it rose above its 50-day average and
continued to rise for several weeks
– Bullish signal
• Typically, when a stock moves below its moving
average it is a bad sign, above it is a good sign
 Moving Averages (Continued)
• What do the different days mean?
– 20 days - choppy line. It isn't the most accurate, but is probably
the most useful for short term traders.
– 30 day - similar to 20 day but provides a bit more certainty for
the trend.
– 50 day - moving averages provide a much less volatile, smooth
line. This can be used to detect somewhat longer term trends.
– 100 day - similar to the 50 day, it is less volatile, and one of the
most widely used for long term trends.
– 200 day - even less volatile, more of a rolling chart or smooth
line. It doesn't react to quick movements in the stock price
therefore it is rarely used.
 Price Patterns
• Technicians look for many patterns in the
historical time series of prices.
• These patterns are reputed to provide
information regarding the size and timing of
subsequent price moves.
• Price patterns are used to find out the
reversals in the trends.
 Reversal patterns
NPC (128.000, 128.000, 127.000, 127.000, +0.000)

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35000
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21 28 7 14 21 28 4 11 25 3 16 24 30 6 13 20 27 4 11 18 25 1 8 15 22 29 5 12 19 26 3 10 17 25 31 7
March April May June July August September October November
The following are the major reversal
patterns:
• Head & Shoulder
• Double top and bottom
• Triangles
• Rounded Tops and Bottoms
 Head and Shoulders

H&S Top
• This formation is
Head
characterized by two
small peaks on either side Left Shoulder Right Shoulder

of a larger peak.
• This is a reversal pattern, Neckline

meaning that it signifies a

H&S Bottom
change in the trend.
Neckline

Left Shoulder Right Shoulder

Head
Head and Shoulders
 Double Tops and Bottoms

Double Top
• These formations are
similar to the H&S
formations, but there is
no head.
• These are reversal Target
patterns with the same Target

measuring implications as
the H&S.

Double Bottom
Double Bottom Example
 Triangles

• Triangles are continuation

formations.
• Three flavors: Ascending
– Ascending
– Descending Symmetrical
– Symmetrical
• Typically, triangles should Symmetrical
break out about half to
three-quarters of the way
through the formation. Descending
 Rounded Tops & Bottoms

• Rounding formations are

Rounding
characterized by a slow Bottom
reversal of trend.

Rounding Top
Rounded Bottom Chart Example
 Technical Indicators
• There are, literally, hundreds of technical
indicators used to generate buy and sell
signals.
• We will look at the below indicators :
– Relative Strength Index (RSI)
– Advance decline line
 Relative Strength Index
• Widely used measure of momentum in the
market
• 14 day RSI is the most common
• To calculate
– Record last 14 day price changes (closes)
– Sum the negative changes and positive changes
and divide each by 14 to create (D) down average
and (U) up average
– RSI=U/(U+D) * 100
 RSI Market Indicator
• Ranges from 0 to 100
• RSI > 70
– Market is thought to be over bought
• RSI < 30
– Market is thought to be over sold
• RSI is a rescaled measure of the ratio of
average price changes on up days to average
price changes on down days
 RSI example calculations
• Close 2.40, 2.38, 2.36, 2.38, 2.36, 2.40, 2.44,
2.42, 2.44, 2.48, 2.56, 2.48, 2.52, 2.50, 2.46
• Up .02 .04 .04 .02 .04 .08 .04
– Up sum = 28/14 =2
• Down .02 .02 .02 .02 .08 .02 .04
– Down sum = 22/14=1.57
• RSI = 2/(2+1.57) * 100 = 56
RSI Example Chart
Overbought Oversold
 Advance Decline line
• The index relating advance to decline is called the
advance decline ratio
• The Advance Decline Line (AD Line) is a breadth
indicator based on Net Advances, which is the
number of advancing stocks less the number of
declining stocks. Net Advances is positive when
advances exceed declines and negative when declines
exceed advances. The AD Line is a cumulative
measure of Net Advances. It rises when Net Advances
is positive and falls when Net Advances is negative.
Monday, March 15, 2010

One could clearly see in the chart above that even though nifty is
staying flat for last few trading sessions but advance decline line
is deteriorating consistently, indicating weakness in broader
market.
 Interpretation
• The AD Line measures the degree of
participation in an advance or a decline. An AD
Line that rises and records new highs along
with the underlying index shows strong
participation that is bullish. An AD Line that
fails to keep pace with the underlying index
and confirm new highs shows narrowing
participation
 Interpreting Advance Decline Ratio

Investors are supposed to use the following

values for estimating the trend of the market:
• A/D ratio > 1.25 bullish
• A/D ratio is between 0 and 1, bearish to
choppy market
• A/D ratio > 2 extremely bullish