Technical Analysis

Technical Analysis: Meaning

 The study of stocks’ historical prices to estimate future price
movements.

 Allows to understand the price momentum of an stock.

 Helps to decide when to buy or sell a security in shorter time frames

Reliance Price
March 2018 680
July 2018 810
August 2018 730

 Preferred tool for stock traders

 Assumptions
 The Price of security is determined by the demand and supply forces
operating in a market

 Supply and demand are influenced by the variety of factors, both

rational and irrational.

 History repeats itself: Prices tend to move in trends over long term

 Because of the persistence of trends and patterns, analysis of past

market data can be used to predict future price behavior.

 All relevant information is always priced in: Ex: RBI announces the
change in interest rate.
 Difference between Technical analysis and
fundamental analysis
Basis Technical Analysis Fundamental Analysis
Objective Seeks to predict short-term Tries to determine long-term
price movements values (intrinsic values)

Use of Data Internal market data (Price and Fundamental factors relating to
Volume Data) the economy, the industry and
the firm
Tools Trend Analysis, study of chart Accounting, financial and
patterns statistical tools and techniques

Answers to When to buy or sell? Where to invest?

Users Short-term traders Long-term investors

 TRENDS

Support Level
Resistance Level
Consolidation
Momentum
Support and Resistance Level
 Support level is that price, below which the price is not expected to fall.

 Resistance level is that Price, above which the price does not increase.
 Support and resistance levels indicate the lower and upper limit
respectively, with in which stock prices are expected to move.

 These limit may change. In a bull market levels may be revised upwards.
In bear markets these levels may be revised downward.
Consolidation
 Describes the movement of a stock's price within a support and
resistance levels.

 Consolidation is generally regarded as a period of indecision, which

ends when the price of the stock moves above or below the trading
limits.

 The consolidation pattern in price movements is broken upon a

major news release that materially affects security's performance or
the triggering of a succession of limit orders.
 Momentum
 Momentum is the rate of acceleration of a security's price – that is, the speed at
which the price is changing.

 Simply put, it refers to the rate of change in price movements for a particular
asset.

 In technical analysis, momentum is used to identify trend lines.

 Momentum tool:

➢ A trend line is drawn from the high price to the low price, or vice versa,
over a given time period.

➢ If the line is up, the trend is up and the momentum investor buys the
stock.
 Charts

 Line Chart
 Bar Chart
 Candle Chart
 Point & Figure Chart
Prices of Interest

 Open price: Price at which trading on a share starts on a particular

day

 High Price: Highest price at which share has been traded on a

particular day

 Low Price: Lowest price at which share has been traded on a

particular day

 Close Price: Price at which trading on a share closes on a particular

day
 Line Chart
❖ X axis shows time or no. of day/week

❖ Y axis shows stock Prices

❖ On chart only closing prices of stock

are shown

❖ Connected with each other

successively with straight lines

❖ Convenient to draw

❖ Does not reveal anything about the

intraday volatility of the stock prices
(shows only closing prices)
 Bar Chart
❖ Shows high, low and closing prices of
a stock every day

❖ X axis shows time and Y axis shows

price

❖ Length of the bar shows the range of

price (highest price-lowest price)

❖ If bar length of a particular stock

increasing over time, indicates
Increasing stock volatility
 Candlesticks chart
❖ Shows high and low, open and close
price

❖ If close price is lower than the open

price then box is filled with black
colour otherwise left empty

❖ An increasing dark candlesticks are

bearish indicators

❖ Chart pattern provides a bird’s eye

view as to the movement of stock
prices- both intraday and interday
 Point and Figure Chart
❖Chart made up of X and O’s.
❖X is placed for increase and O is
placed for decrease in stock price.
❖A buy signal is implied when X lines
are moving up after every O line.
❖If O lines are going down after every
X line then a sell signal is triggered.
❖Axis do not represent time or price
level, rather show the directional
movement of prices
❖Whenever there is change in price, X
or O are placed
❖The columns are changed when there
is a change in direction
Market Indicators

 Futures
 Dow Theory
 Advances and Declines
 New Highs and Low
 Odd Lot Theory
 Institutional Activity
 Moving Average Analysis
 Market Indicators
Futures

 Meaning: Futures are derivative financial contracts that obligate the parties
to transact an asset at a predetermined future date and price. Here, the buyer
must purchase or the seller must sell the underlying asset at the set price,
regardless of the current market price at the expiration date.

 The value of index futures reflects the market sentiment and can be used to
forecast market movements.

 If futures are priced higher than the underlying index it is a bullish indicator
and vice versa.
Dow Theory

 Proposed in the late nineteenth century by Charles H. Dow.

 Assumption: Stock Market does not move on random basis but

is influenced by three distinct trends that guide its general
direction.

 Trend Classification: Primary, Secondary and Minor trends

Primary Trend

 It is the Long term trend over a period lasting for more than one year.

 This trend sets the overall direction of the market

 If primary trend is upward then bull market is in operation

 If primary trend is downward then the market is bearish

Secondary Trends

 Represents adjustments to the excesses that may have occurred in the

primary movements.

 Usually last for a few months

Minor Trends

 There are the day to day fluctuations in the market

 These have little analytical value because of their short duration and
variations.
 A major upward move is said to occur when the high point of each rally is
higher than the high point of the preceding rally and the low point of each
decline is higher than the low point of the preceding decline.

 Likewise, a major downward move is said to occur when the high point of each
rally is lower than the high point of the preceding rally and the low point of each
decline is lower than the low point of the preceding decline.
Advances and Declines

 Also referred to as the breadth of the market

 Its measurement involves two steps:

1. Calculate the no. of net advances/declines on daily basis (no. of shares

advanced - no. of shares declined)

2. Obtain the breadth of the market by cumulating daily net advances/declines

Net Advances or Breadth of

Day Advances Declines
Declines Market
Mon 630 527 103 103
Tues 690 475 215 318
Wed 746 424 322 640
Thus 492 630 -138 502
Fri 366 701 -335 167
Mon 404 698 -294 -127
Utility of Breadth of Market Analysis

 Compare breadth of market with market average

 Ordinarily, breadth of market is expected to move in tandem with a

market average

 But if there is divergence i.e. market average is moving upwards,

whereas breadth of market is moving downwards, it indicated that
the market is likely to turn bearish.
New Highs and Low

 Represents the number of Stocks making new 52-week highs or lows.

 The graph of new highs/new lows is usually plotted against a

major market index

 Observe whether the new high/new low picture is confirming or diverging

from the underlying price action.

 If there is divergence i.e. market average is moving upwards, whereas new

high are moving downwards, it indicates that the market is likely to turn
bearish.
 Odd Lot Theory (Small Volume Investors)

 Based on the assumption that the small individual investor is usually

wrong and that individual investors are more likely to generate odd-lot
sales.

 It implies that small investors buy heavily just at the peak of the market
and sell in huge quantities at the bottom of the market.

 Therefore, if odd lot sales are up and small investors are selling a stock, it
is probably a good time to buy, and when odd-lot purchases are up, it may
indicate a good time to sell.
 One should trade in opposite direction of that of small investors.

 For this Odd lot ratio is calculated:

𝑶𝒅𝒅 𝒍𝒐𝒕 𝒑𝒖𝒓𝒄𝒉𝒂𝒔𝒆𝒔

Odd lot ratio= 𝑶𝒅𝒅 𝒍𝒐𝒕 𝒔𝒂𝒍𝒆𝒔

 If the ratio is greater than 1 and continuously increasing then it

implies that market will turn bearish in near future.
 Institutional Activity (Mutual Fund Liquidity)
 The indicator is developed based on the theory of contrary opinion

 If mutual fund liquidity is low, it means that mutual funds are bullish. So
contrarians argue that the market is at, or near, a peak and hence is likely to
decline

 Thus low mutual fund liquidity is considered as a bullish indicator.

 Conversely, when the mutual fund liquidity is high, it means that mutual funds are
bearish. So contrarians believe that the market is at, or near, a bottom and hence is
likely to rise.

 Thus, high mutual fund liquidity is considered as a bullish indication.

Moving Average Analysis
 Moving average can be used to analyse the movement of the entire
market as well as individual stock prices.

 To identify long term trend a 200-day moving average of daily

prices may be used

 To identify intermediate term trend, a 60-day moving average of

daily prices may be used

 To detect short term trend, a 10-day moving average of daily prices

may be used.

 Calculation 5 days moving average analysis

 Chart Title
27.5

27

26.5

26

25.5

25

24.5

24

23.5

23
1 2 3 4 5 6 7 8 9 10

Closing Price 5 day moving average

 Moving average line is compared with stock price line to identify buy or
sell signals.

1. When the market price line cuts the moving average line from below it
is a buy signal
2. If the market price line cuts the moving average line from above, it implies
that bearish trend will soon set in.
 Patterns

 Head & Shoulder

 Triangle
 Rectangle
 Flag
 Cup & Saucer
 Double Topped
 Double Bottomed
 Head & Shoulder
• Predicts a bullish-to-bearish trend reversal.
• A head and shoulders pattern is comprised of
three component parts:
1. After long bullish trends, the price rises
to a peak and subsequently declines to form
a trough.
2. The price rises again to form a second
high substantially above the initial peak and
declines again.
3. The price rises a third time, but only to
the level of the first peak, before declining
once more.
• The first and third peaks are shoulders, and
the second peak forms the head. The line
connecting the first and second troughs is
called the neckline.
 Triangle
❖ The upper and lower trendlines ultimately meet
at the apex on the right side, forming a corner.

❖ The upper trendline is formed by connecting the

highs, while the lower trendline is formed by
connecting the lows.

❖ Type of Triangles

Ascending Triangle:

• The upper trendline must be horizontal,

indicating nearly identical highs, which form a
resistance level.

• The lower trendline is rising diagonally,

indicating higher lows.
• The breakdown occurs when the price collapses through
the upper horizontal trendline as a uptrend resumes.

• The upper trendline, which was resistance, now becomes

support

Descending Triangle:

• It is an inverted version of the ascending triangle.

• The lower trendline should be horizontal, connecting near

identical lows.

• The upper trendline declines diagonally toward the apex.

• The Breakdown occurs when the price collapses through

the lower horizontal trendline.

• The lower trendline, which was support, now becomes

Symmetrical Triangle:

• It is composed of a diagonal falling upper

trendline and a diagonally rising lower
trendline.

• As the price moves toward the apex, it will

inevitably breach the upper trendline for a
breakout and uptrend on rising prices or

• breach the lower trendline forming a

breakdown and downtrend with falling
prices.
 Rectangle

The shares move in a

narrow range, hitting resistance
at the rectangle's top and finding
support at its bottom.
 Flags
❖ A flag chart pattern is detected when
a bull rally or bear phase enters into a
consolidation pattern.

❖ The consolidation phase forms the

flag for a continuing trend

❖ It is predicted that after the

consolidation phase is over, the stock
price will move in the same direction
in which they were moving before
the formation of flag pattern.
 Cup & Saucer

• A cup and handle is considered a bullish

continuation pattern and is used to
identify buying opportunities.

• Traders should place a stop buy order

slightly above the upper trend line of the
handle.
 Double Topped

• A double top is an extremely

bearish technical reversal pattern

• forms after an asset reaches a high

price two consecutive times with a
moderate decline between the two
highs.

• It is confirmed once the asset's

price falls below a support level
 Double Bottom

• The double bottom looks like the

letter "W". The twice-touched low is
considered a support level.

• The double bottom pattern always

follows a major or minor downtrend
in a particular security, and signals the
reversal and the beginning of a
potential uptrend.
Open Interest in Futures and options

 Open interest represents the total number of outstanding or yet-to-

be-settled contracts at any given point of time.

 Open Interest is an indicator often used by traders to confirm trends

and trend reversals

Price Open Interest Market

Rising Up Upward
Rising Down Weak
Declining Up Downward
Declining Down Strong
 Price action increasing in an uptrend and open interest on the rise is
interpreted as new money coming into the market, reflecting new
buyers – this is considered bullish. Now, if the price action is rising
and the open interest is on the decline, short sellers covering their
positions are causing the rally. Money is, therefore, leaving the
marketplace – this is a bearish sign.

 If prices are in a downtrend and open interest is on the

rise, chartist know that new money is coming into the market,
showing aggressive new short selling. This scenario will prove out a
continuation of a downtrend and a bearish condition.
 If the total open interest is falling off and prices are declining, the price
decline is likely being caused by disgruntled long position holders being
forced to liquidate their positions. Technicians view this scenario as a
strong position because the downtrend will end once all the sellers have
sold their positions

 When open interest is high at a market top and the price falls off
dramatically, this scenario should be considered bearish. In other terms,
this means all of the long position holders who bought near the top of the
market are now in a loss position, and their panic to sell keeps the price
action under pressure.