Technical analysis

Technical analysis
 Technical analysis is the process of analyzing a security's
historical prices in an effort to determine probable future
prices.
 This is done by comparing current price action (i.e., current
expectations) with comparable historical price action to predict a
reasonable outcome.
 A technical analyst therefore concentrates on the movement of
share prices. He claims that by examining past share price
movements future share prices can be accurately predicted.
 Technical analysis is the name given to forecasting techniques
that utilise historical share price data.
 The rationale behind technical analysis is that share price
behaviour repeats itself over time and analysts attempts to
derive methods to predict this repetition.
 Assumptions of Technical analysis
 Interactions of supply and demand determine
the market value of the scrip. The market
discounts everything. The price of the security
quoted represents the hopes, fears and inside
information of the market players.
 The market always moves in trend. The price
may create pattern too. The trend may be either
increasing or decreasing. It continues for some
time and then reverses.
 It is said history repeats itself and this is also true
to the stock market.
Technical analysis vs fundamental analysis:
 Technical analysis try to predict short term price movement whereas fundamental
analysis try to establish long term values.
 The focus of technical analysis is mainly on internal market data, particularly price
and volume data whereas the focus of fundamental analysis is on the factors
relating to economy, industry and the company.
 Speculators who want to make quick money mostly use results of technical
analysis whereas investors who invest on long term basis use results of
fundamental analysis.
 Fundamental analysis involves compilation and analysis of huge amount of data
and is therefore complex, time consuming, and tedious in nature. On the other
hand technical analysis is simple and quick method on forecasting behaviour of
stock prices.
 According to technical analysts their method is far superior than fundamental
analysis because fundamental analysis is based on financial statements which
themselves are plagued by certain deficiencies like subjectivity
 Fundamental analysis is long term approach. Technical analysts feel that their own
techniques and charts are quicker and superior to fundamental analysis.
 Charting as a Technical tool
 Charts are simply graphical representations of a series of prices over time.
 For example, a chart might show a stock’s price movement over a one-year period
where each point represents an individual day’s closing price. Or, a chart might
show a commodity’s price movement over a period of just one hour with each point
representing one second.
 The clues are provided by the history of stock’s price movement as recorded on
chart.
 In essence the chartists contend that a study of a stock’s behaviour not only tells
where a stock has been but also where it is going.
 Chart represents a key activity in technical analysis becoz graphical representation is
the very basis of technical analysis. It is the security prices that are charted.
 The prices are plotted on XY graph where x axis represents the trading days and Y
axis denotes prices.
 The time scale refers to the range of dates that appear at the bottom of the chart,
which can vary from seconds to decades. The most frequently used time scales
are intraday, daily, weekly, monthly, quarterly, and yearly. 
 Types of charts
 Line chart:
• In this chart the closing prices of a share are plotted on XY graph on day
to day basis.
 On line chart, the closing prices of successive time periods are connected
by a line with no notice taken of the highs and lows of stock prices for
each time period.
 The line is formed by connecting the closing prices for each period over
the timeframe.
 A line chart can give the reader a fairly good idea of where the price of an
asset has traveled over a given time frame. Since the closing prices are
often seen as the most important ones to keep track of, it is not difficult
to see why line charts have become so popular. 
 Bar charts:
 Bar charts expand upon the line chart by adding the open, high, low, and close –
or the daily price range.

 A bar chart is a style of chart used by some technical analysts on which the top of
the vertical line indicates the highest price a security is traded at during the day,
and the bottom represents the lowest price. The closing price is displayed on the
right side of the bar, and the opening price is shown on the left side of the bar.

 A single bar represents one day of trading. These are the most popular type of
charts used in technical analysis.
• Candle stick charts:
• The Japanese candlestick chart shows the highest price, the lowest price, opening price
and closing price of shares on day to day basis.
 Such charts show a stock open, close, high and low in a modified three dimensional format.
The vertical axis shows stock price while the horizontal reflect the passage of time.
 The key difference between a daily candlestick chart and bar chart are the white and black
candles augmenting the daily trading range lines.
 If the opening price exceeds the closing price (stock is down for the day), the body of
candle is black.
 When the stock is up (the close price exceeds the open) the candle is clear.
 White candle represents stock advances, with black candles representing declines.
 White candlestick indicates a bullish trend while black candlestick indicate bearish trend.
 Days where the open and closing prices are the same will not have any wide body or
rectangle at all.
 The difference is a wider bar or rectangle that represents the difference between the
opening and closing prices.
 Point and figure chart
 On a PFC only a significant price changes are recorded. For
example for a stock that has a price in the range say Rs 30 to
Rs50, price changes of one rupee or more only may be posted.
 Using a one point scale (this means price is recorded only when
the change in price is one rupee).
 When the price of ABC stock rises by one rupee over the
preciously recorded price, an X is recorded to reflect the increase.
 When the price of ABC stock falls by one rupee over the
previously recorded price, an O is recorded to reflect the
decrease
 When the direction of price change reverses( a decline after
previous increase or a rise after previous declines) the price is
recorded in the next column to the right.
 Dow Theory
• Whatever is generally being accepted today as
technical analysis has its roots in the Dow theory.
• Charles Dow formulated a hypothesis that stock
market does not move on random basis but is
influenced by three distinct cyclical trends that guide
its direction.
• Acc to Dow Theory market has three movements and
these movements are simultaneous in nature. These
are primary movements, secondary movements and
minor movements.
• The primary movement is the long range cycle that carries the entire
market up or down. This is the long term trend in the market.
• The secondary reactions act as a restraining force on the primary
movement and last only for a short while. These are also known as
corrections.
• For example when the market is moving upwards continiously this
upward movement will be interrupted by downward movements of
short durations. These are secondary reactions.
• The third movements in the market is the minor movements which
are day to day fluctuations in the market. The minor movements are
not significant and have no analytical value as they are of very short
duration.
• The three movements are compared to tides, waves and ripples.
 Trend
• A trend is really nothing more than the general direction in
which a security or market is headed.
• A trend can be defined as the direction in which the market is
moving. Up trend is the upward movement and downtrend is
the downward movement of stock prices or of the market as
measured by an average or index over a period of time, usually
longer than six months.
• Trend reversals: The change in the direction of trend is referred
to as trend reversal. A share that exhibits a rising trend may
start to move narrowly or fall after sometime. This change in
the direction of movement represents a trend reversal.
 Trends
 Trend lines are lines that are drawn to identify
such trends and extend them into the future.
These lines typically connect the peaks of
advances and bottoms of declines. Sometimes,
an intermediate trend that extends horizontally
is seen.
 Bullish Trend
• If the succession of peaks and troughs occurs at increasingly higher prices,
then the market is clearly up trend. This trend is bullish indicating a good
time to buy securities.
• In the first phase the prices would advance with the revival of confidence in
the future of business. The future prospects of business in general would be
perceived to be promising. This will prompt investors to buy shares of
companies.
• During the second phase, prices would advance due to improvements in
corporate earnings.
• In the third phase, prices advance due to inflation and speculation . Thus,
during the bull market, the line chart would exhibit the formation of three
peaks.
• Each peak would be followed by a bottom, each peak would be higher than
previous peak, each successive bottom would be higher than previous
bottom.
• The formation of higher bottoms and higher tops indicate bullish trends.
 Bearish Trend
 The bear market is also characterised by three phases.
 In the first phase, prices begin to fall due to abandonment of hopes.
Investors begin to sell their shares.
 In the second phase, companies start reporting lower profits and
lower dividends. This causes further fall in prices due to increased
selling pressure.
 In the final phase, prices fall still further due to distress selling.
 A bearish market would be indicated by the formation of lower tops
and lower bottoms.
 Trend Lengths
• In addition to their direction, trends can be classified in terms of
their length. Most traders consider trends short-term, intermediate-
term, or long-term.
 Long-term trends occur over a timeframe of longer than one year;
 Intermediate-term trends occur over one to three months;
 Short-term trends occur over less than one month.
 In other words, long-term trends consist of a series of intermediate-
term trends which consist of a series of short-term trends.
 Support and Resistance
• Support and resistance are the next major concept after
understanding the concept of a trend. You’ll often hear
technical analysts talk about the ongoing battle between
bulls and bears, or the struggle between buyers (demand)
and sellers (supply).
• Support levels are where demand is perceived to be strong
enough to prevent the price from falling further, while
Resistance levels are prices where selling is thought to be
strong enough to prevent prices from rising higher.
 Support
 Support and resistance are price levels at which the
downtrend or uptrend in price movements is reversed.
 Support occurs when price is falling but bounces back
or reverses direction every time it reaches at particular
level.
 When all these low points are connected by horizontal
line, it forms the support line. In other words support
level is the price level at which sufficient buying
pressure is exerted to halt the fall in prices.
 Resistance
 Resistance occurs when the share price move upwards. The price
may bounce back every time it reaches a particular level.
 The horizontal line joining these tops forms the resistance level.
 Thus resistance level is the price level where sufficient selling
pressure is exerted to halt the ongoing rise in the price of share.
 If the scrip were to break the support level and move downwards,
it has bearish implications signalling the possibility of further fall in
prices.
 Similarly, if the scrip were to penetrate the resistance level it
would be indicative of bullish trend or further rise in prices.
 Importance of Support and Resistance
• Support and resistance levels are a critical part of trend
analysis because it can be used to make specific trading
decisions and identify when a trend is about to reverse.
• For example, a trader might identify an upcoming
support level and decide to start buying the stock as it
approaches knowing that it will likely rebound higher.
These levels both test and confirm trends and should be
closely monitored by anyone using technical analysis. As
long as the price remains between these two levels, the
trend is likely to continue in the prevailing direction.
 Chart patterns
 When a trader looks at a price chart of a stock it can
appear to be completely random movements. This is often
true and, yet, within those price movements are patterns.
 Chart patterns are geometric shapes found in the price
data that can help a trader understand the price action, as
well make predictions about where the price is likely to go. 
 Continuation patterns
• Continuation patterns, when they occur,
indicate that a price trend is likely to continue.
Continuation pattern: signals that a trend will
continue once the pattern is complete.
• These patterns are formed during side way
movements of share prices and are called
continuation pattern because they indicate a
continuation of the trend prevailing before the
formation of the pattern.
 Triangles
 Triangles are the most popular among continuation
pattern.
 Triangles are formed when price movements result in
two or more consecutive descending tops and two or
more consecutive ascending bottoms.
 The triangle becomes apparent on the chart when
consecutive tops are joined by a straightline and
consecutive bottoms are joined by another straight line.
 The two straight lines are upper trend line and lower
trend line respectively.
 Flags
Flags are a pause in the trend, where the price
becomes confined in a small price range between
parallel lines. This pause in the middle of a trend
gives the pattern a flag like appearance
 The volume of trading is expected to fall during the
formation of the flag and again pick up on breaking
out from the pattern.
• Pennants
Pennants are similar to a triangle, yet smaller;
pennants are generally created by only several
bars.
• The pennant formation looks like a symmetrical
triangle. The upper trendline formed by
connecting the tops stooping downwards,
whereas the lower trendline formed by
connecting the bottoms rises upwards.
 Rectangles
• Rectangles
Often there will be pauses in a trend, where
the price action moves sideways, bound
between parallel support
and resistance lines. Rectangles, also known as
trading ranges, can last for short periods or
many years. 
 Reversal Patterns
 Reversal Pattern: signals that a prior trend will
reverse upon completion of the pattern.
 Price movements exhibit uptrends and
downtrends. The trend reverse direction after a
period of time. These reversals can be identified
with the help of certain chart formations that
typically occur during these trend reversals. Thus
reversal patterns are chart formations that tend
to signal a change in direction of earlier trend.
 Head and Shoulder Formation
 The Head and Shoulders is a reversal chart pattern that indicates a likely reversal of
the trend once it’s completed.
 A Head and Shoulder Top is characterized by three peaks with the middle peak being
the highest peak (head) and the two others being lower and roughly equal (shoulders).
 The first hump known as left shoulder is formed when the prices reach the top under
strong buying impulse. Then trading volume becomes less and there is short
downward swing. This is followed by another high volume advance which takes the
price to higher top known as head.
 This is followed by another reaction on less volume which takes the price down to
bottom near the earlier downswing. The third rally now occurs taking the price to
height less than the head but comparable to left shoulder. This rally leads to formation
of right shoulder.
 The lows between these peaks are connected with a trend line (neckline) that
represents the key support level to watch for a breakdown and trend reversal.
 After breaking the neckline the price is expected to decline sharply.
 Inverse Head and shoulders
• This pattern is the reverse of head and shoulders formation
and is really an inverted head and shoulder pattern.
• This occurs at the end of bear phase and consists of three
distinct bottoms.
• The inverse head and shoulders pattern is also a reversal
pattern indicative of an oncoming bullish trend.
• Inverse Head and shoulder is simply the inverse of the
Head and Shoulders Top with the neckline being a
resistance level to watch for a breakout higher.
 Double Tops
 This formation signals the end of one trend and beginning of another.
 The double top is formed when a stock price rises to a certain level, falls
rapidly, rises again to the same height or more, and turns down. It
patterns resembles the letter “M”. The double top may indicate the
onset of bear market.
 Double bottom
• In double bottom the price of the stock falls to a certain level and
increases with diminishing activity. Then it falls again to the same or to
lower price and then goes up to the higher level . The double bottom
resembles the letter ‘W’.
• Technical analysts view double bottom as a sign of a bull market.
• Rounding Bottom
 The rounding bottom formation give a bullish
signal and indicate a possible reversal of the
downward trend. They are normally elongated
and U shaped. Sometimes they are called
rounding turns, bowls or saucers
 Indicators
• Share prices do not rise or fall in straight lines.
The movements are erratic (unpredictable).
• This makes it difficult for the analyst to gauge
the underlying trend.
• An indicator is a mathematical calculation that
can be applied to a security's price and/or
volume fields. The result is a value that is used
to anticipate future changes in prices.
 Simple Moving Average
• In a simple moving average a set of averages
are calculated for a specific number of days,
each average being calculated by including a
new price and excluding an old price.
• The closing price of shares are generally used
for the calculation of moving averages.
• Moving averages are used to study the movement
of the market as well as the individual scrip price.
• They show the underlying trend in the scrip. The
period of the average determines the period of
trend that is being identified.
• To indentify a short term trend, 10-30 day moving
averages are used.
• For medium trend 50-125 day averages are used.
• For long term 200 day moving averages are used.
 Cal of five day simple moving average
Days Closing Prices Total of prices of 5 Five day MA
days

1 33 -

2 35 -

3 37.5 -

4 36 -

5 39 180.5 36.1

6 40 187.5 37.5

7 40.5 193.0 38.8

8 38.5 194.0 39.6

9 41 198.0 40.4
 Interpretation
 If the NSE or BSE index lies above the stock
moving average line, the particular stock is
seen as having a bullish trend.
 If the Sensex or Nifty is below the stock’s
moving average, a bearish market can be
expected for that particular stock.
 Exponential Moving Average
 It is calculated by using the following formula:
 EMA= (Current closing price-Prev EMA)*Factor +Previous
EMA
 Factor=2/n+1
 n= number of days for which the average to be calculated
The period of average indicates the type of trend being
identified.
For example : a five day or ten day average would
indicate the short trend, a 50 day average would indicate
medium term trend and 200 day long term trend.
 Calculating of Exponential Moving average
Days Closing price EMA
1 33 33
2 35 33.66
3 37.5 34.93
4 36 35.28
5 39 36.51
• Factor=2/n+1=2/5+1=0.33
 EMA for the first day is taken as closing price
of that day itself.
 EMA for second day= (35-33)*0.33+33=33.66
 Oscillators
• Oscillators are mathematical indicators
calculated with the help of closing price data.
They help to identify overbought and
oversold conditions and also possibility of
trend reversals. These indicators are called
oscillators because they move across
reference point.
 Moving Average Convergence and
Divergence
 MACD is an oscillator that measures the convergence and divergence between two
exponential moving averages.
 A short term exponential moving average and long term exponential moving average
are calculated with the help of closing price data.
 A 12 day and 48 day exponential moving average constitute a popular combination.
The difference between the short term EMA and Long term EMA represents MACD.
 If the value of SEMA is more than LEMA, MACD will be positive and vice-versa. If both
values are equal MACD will be zero.
 Convergence takes place when moving averages move towards each other .
Divergence takes place when short term and long term moving averages move away
from each other.
 The zero contour is the centre line and MACD line oscillates above and below this
line.
 IF MACD line crosses the zero line from above the trend is considered to have
turned bearish signally selling opportunity .
 On the other hand if MACD line moves above the zero line from below the trend is
said to have turned bullish and indicating buying opportunity.
 Rate of Change
 Rate of change indicator or ROC measures the rate
of change between current price and the price n
number of days in the past.
 ROC= Current price/Price n days ago-1
 ROC value may be positive, neg, or 0.
 The ROC values oscillates across zero line.
 When ROC is above zero line the price is rising and
when it is below the zero line price is falling.
 Ideally one should buy a share that is oversold and
sell a share that is overbought.
 Relative Strength Index
• This is a powerful indicator that signals buying
and selling opportunities.
• RSI= 100- (100/(1+RS)
• RS= Average gain per day/ Average Loss per
day
• The most commonly used time period for RSI
is 14 days.
day Closing price Change over prev Loss
day
Gain
1 130 - -

2 132 2

3 130 - 2

4 135 5 -

5 137 2 -

6 134 - 3

7 136 2 -

8 140 4 -

9 140 - -

10 142 2 -

11 139 - 3

12 141 2 -

13 145 4 -
• 14 day average gain= 25/14=1.786
• Loss=10/14= 0.714
• RS= Average gain per day/ average loss per day
• =1.786/0.714=2.50
• RSI= 100- (100/ (1+2.50)
• =100-100/3.50
• =71.42
• This is RSI for 15 day
• The RSI value range from 0 to 100.
• RSI values above 70 are considered to denote overbought condition and
values below 30 oversold.
• When RSI has crossed the 30 line from below to above and is rising a
buying opportunity is indicated.
• When it has crossed the 70 line from above to below and is falling sell
signal is indicated.