Technical analysis - By Sohan Khatri

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Technical Analysis
A peek into the world of psychology and charts
By: Sohan Babu Khatri
CEO- Three H Management
Director- Grand Bank Nepal Ltd.
Director – Strategic Center for Disaster Risk Reduction
Adjuct Faculty - Ace Institute of Management
Adjunct Faculty – Kathmandu College of Management
Session Delivered For:
Nepal Derivative Exchange
(NDEX)
Organized by:
Management Association of
Nepal (MAN)

Types of Analysis
Types of Analysis
Fundamental Technical Random

Fundamental Analysis
• Find out the basics and fundamentals behind
the value/price of the security
• Fundamental analysis involves economic,
industry, and company analysis that lead to
valuation
• Finding out intrinsic value on the basis of
fundamentals
• Comparing intrinsic value with the market value
• Taking Buy/Sell/Hold decision on the basis of
difference between intrinsic and market value.

Technical Analysis
• Method of evaluating securities by analyzing
statistics generated by
– Market activity
– Past Prices
– Volume
• Technical analysis involves the development of
trading rules based on past price and volume data
for individual securities and the overall capital
market.
• Doesn’t attempt to measure intrinsic value
• Instead look for patterns and indicators on charts to
determine future performance

……….
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

……….
• Most agree that technical analysis is much more
effective when combined with fundamental analysis
• Technical analysis is, perhaps, the oldest form of
security analysis. It is believed that the first technical
analysis occurred in 17th century Japan, where analysts
used charts to plot price changes in rice.
• Indeed, many present-day Japanese analysts still rely on
technical analysis to forecast prices in their stock
exchange, which is the second largest in the world. In
the United States, technical analysis has been used for
more than 100 years

…….
• Technical analysis assumes that market
psychology influences trading in a way that
enables predicting when the price will rise or
fall.
• Technical analysis works best when market
has some form of inefficiency.

Assumptions of Tech. Analysis
• The market value of any good or service is determined solely
by the interaction of supply and demand.
• Supply and demand are governed by numerous rational and
irrational factors. Included in these factors are those
economic variables relied on by the fundamental analyst as
well as opinions, moods, and guesses. The market weighs all
these factors continually and automatically.
• Disregarding minor fluctuations, the prices for individual
securities and the overall value of the market tend to move in
trends, which persist for appreciable lengths of time.
• Prevailing trends change in reaction to shifts in supply and
demand relationships. These shifts, no matter why they
occur, can be detected sooner or later in the action of the
market itself

Technical Analysis and Price Equilibrium
Technical analysts look for the beginning of a movement from one equilibrium value
to a new equilibrium value. Technical analysts do not attempt to predict the new
equilibrium value. They look for the start of a change so that they can get on the
bandwagon early and benefit from the move to the new equilibrium by buying if the
trend is up or selling if the trend is down.

Efficient Market
• An efficient capital market is one in which
security prices adjust rapidly to the arrival of
new information and, therefore, the current
prices of securities reflect all information
about the security.
• To be absolutely correct, this is referred to as
an informationally efficient market.

Efficient Market Hypothesis (EMH)

MARKET EFFICIENCY AND
SECURITY SELECTION
LEVEL OF APPROACH TECHNICAL FUNDAMENTAL RANDOM
EFFICIENCY ANALYSIS ANALYSIS SELECTION
INEFFICIENCY BEST POOR POOR
WEAK-FORM POOR BEST POOR
EFFICIENCY
SEMI-STRONG-FORM
EFFICIENCY POOR GOOD FAIR
STRONG-FORM
EFFICIENCY POOR FAIR BEST

Challenges of Technical Analysis
• Challenges to basic assumptions
– Empirical tests of Efficient Market Hypothesis
(EMH) show that prices do not move in trends
• Challenges to technical trading rules
– Rules that worked in the past may not be
repeated
– Patterns may become self-fulfilling prophecies
– A successful rule will gain followers and become
less successful
– Rules all require subjective judgment

Advantages of Technical Analysis
• Unlike fundamental analysis, technical analysis is not
heavily dependent on financial accounting
statements
– Problems with accounting statements:
• Lack information needed by security analysts
• Many psychological and other non-quantifiable factors do not
show up in financial statements
• Fundamental analyst must process new information
and quickly determine a new intrinsic value, but
technical analyst merely has to recognize a
movement to a new equilibrium
• Technicians trade when a move to a new equilibrium
is underway but a fundamental analyst finds
undervalued securities that may not adjust to
“correct” prices as quickly

Primary and Secondary Trend
Primary Trend
Called “the tide” by Dow, this is the trend that defines the long-term direction
(up to several years). Others have called this a “secular” bull or bear market.
Secondary Trend
Called “the waves” by Dow, this is shorter-term departures from the primary
trend (weeks to months)

Trend Duration
• Trend duration is also made up of three time
periods; major, intermediate and minor.
• The major trend will have a duration of six to
eight months or longer and is best illustrated by
weekly and monthly bar charts.
• Within the major trend significant corrections or
reversals of trend will be present; these would
be intermediate and minor trends within the
major trend.
• The intermediate trend lasts from three weeks
to three months, and the minor trend is anything
less, from two to three weeks in duration.

Price, Volume and Open Interest
Price Volume Open Interest Interpretation
Rising Rising Rising Market is Strong
Rising Falling Falling
Market is
Weakening
Falling Rising Rising Market is Weak
Falling Falling Falling
Market is
Strengthening

The Elliot Wave Principle
1
2
3
4
5
A
B
C
Elliot believed that the market has a rhythmic regularity that can be used
to predict future prices.
The Elliot Wave Principle is based on a repeating 8-wave cycle, and each
cycle is made up of similar shorter-term cycles (“Big fleas have little fleas
upon their backs to bite 'em - little fleas have smaller fleas and so on ad
infinitem”).

Basic Types of Charts (OHLC)
• Bar Chart
• Line Chart
• Candle Stick Chart
• Point and Figure Chart

Bar Chart
Bar Charts
A bar chart also shows closing prices,
while simultaneously showing opening
prices, as well as the highs and lows.
Advantage is that it show the
high, low, open and close for each
day

Drawing Point & Figure Charts
• Point & Figure charts are
independent of time.
• An X represents an up move.
• An O represents a down move.
• The Box Size is the number of
points needed to make an X or O.
• The Reversal is the price change
needed to recognize a change in
direction.
• Typically, P&F charts use a 1-point
box and a 3-point reversal.
X
X
X
X
X
O
O
X
X
X
X
O
O
O
O
• Typically used for intraday charting
• If used for multi-day study, only closing prices will be
used

Technical analysis - By Sohan Khatri

Line Chart
A simple line chart draws a line from one closing price to the
next closing price.

Support and Resistance
• Support and resistance are tools used by technicians
to help them identify and follow price trends.
Horizontal lines are drawn on the bar chart to indicate
areas of support and resistance.
• The troughs or reaction lows on a price chart are
identified as support. Support is an area on the chart
where buying pressure overtakes selling pressure
and the market reacts higher.
• Usually support is identified by a previous reaction
low or trough on the bar chart.
• Resistance is an area on the chart where selling
pressure overtakes buying pressure and the market
reacts lower. A resistance level is identified by a
previous price high or peak on the bar chart.

Support and Resistance
Support and resistance is one of the most widely
used concepts in trading. Strangely enough,
everyone seems to have their own idea on how you
should measure support and resistance.

Support and Resistance…..
• Support and resistance lines
indicate likely ends of
trends.
• Resistance results from the
inability to surpass prior
highs.
• Support results from the
inability to break below to
prior lows.
• What was support becomes
resistance, and vice-versa.
Support Resistance
Breakout

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.
• This chart shows a 10-day
moving average. Note how the
moving average shows much
less volatility than the daily
stock price.
30
35
40
45
50
55
60
1 21 41 61 81 101 121 141 161 181 201 221 241
Price
Date
MSFT Daily Prices with 10-day MA
9/23/93 to 9/21/94

Head and Shoulders
• This formation is
characterized by two
small peaks on either
side of a larger peak.
• This is a reversal
pattern, meaning that it
signifies a change in the
trend.
Head
Head
Left Shoulder
Left Shoulder
Right Shoulder
Right Shoulder
Neckline
Neckline
H&S Top
H&S Bottom

Head & Shoulders Example
Sell Signal
Minimum Target Price
Based on measurement rule

Double Tops and Bottoms
• These formations are similar
to the H&S formations, but
there is no head.
• These are reversal patterns
with the same measuring
implications as the H&S.
Target
Double Top
Double Bottom
Target

Triangles
• Triangles are
continuation
formations.
• Three flavors:
– Ascending
– Descending
– Symmetrical
• Typically, triangles
should break out about
half to three-quarters of
the way through the
formation.
Ascending
Descending
Symmetrical
Symmetrical

Rounded Tops & Bottoms
• Rounding formations
are characterized by a
slow reversal of trend.
Rounding Top
Rounding
Bottom

Broadening Formations
• These formations are
like reverse triangles.
• These formations
usually signal a
reversal of the trend.
Broadening Tops
Broadening Bottoms

Example
What could you have known,
and when could you have known it?

DJIA Oct 2000 to Oct 2001 Example
Double bottom
Gap, should get
filled
Nov to Mar
Trading range
Descending
triangles

Candlestick
• Japanese Candlestick charting and analysis is one of the
most effective methodologies in the universe of technical
analysis. Japanese Candlestick analysis is a highly
effective, but under-used investment decision-making
technique. Yet few people understand the ramifications or
significance of the signals that are clearly and reliably
displayed.
• Popularized by Sokuta Honma, Japanese Rice Trader during
mid 1700s.
• Developed over 400-year period
• Steve Neson is credited with introducing them into the US
markets

The purpose of candlestick charting is strictly
to serve as a visual aid. The advantages of
candlestick charting are:
• Candlesticks are easy to interpret, and are a
good place for a beginner to start figuring out
chart analysis.
• Candlesticks are easy to use.
• Candlesticks and candlestick patterns have
cool names such as the shooting star, which
helps you to remember what the pattern
means.
• Candlesticks are good at identifying
marketing turning points – reversals from an
uptrend to a downtrend or a downtrend to an
uptrend.

Formation of Candlestick
There are two types of Candlestick, Bullish
& Bearish
• Bullish Candlestick formed when market
close above the opening price.
• Bearish Candlestick formed when market
close below the opening price.

A Long Day and Short Day
A long day represents a large price move
from open to close. Long represents the
length of the candle body.
Short days can be interpreted by the
same analytical process of the long
candles.

Some Candlestick
Patterns
and
Indicators

Marubozu
White Marubozu
In Japanese, Marubozu means close cropped or
close-cut. This is an extremely strong pattern. It
opens on the low and immediately heads up. It
continues upward until it closes, on its high. it is
often the first part of a bullish continuation
pattern.
Black Marubozu
It is often identified in a bearish continuation A
long black candle could represent the final sell off,
making it an "alert" to a bullish reversal.

Closing Marubozu
A Closing Marubozu has no shadow at it's closing end.
A white body will not have a shadow at the top. A
black body will not have a shadow at the bottom. In
both cases, these are strong signals corresponding to
the direction that they each represent.
Opening Marubozu
The Opening Marubozu has no shadows extending
from the open price of the body. A white body would
not have a shadow at the bottom end , the black
candle would not have a shadow at it's top end.
Though these are strong signals, they are not as
strong as the Closing Marubozu.

Spinning Top
Spinning Tops are depicted with small bodies
relative to the shadows. This demonstrates
some indecision on the part of the bulls and the
bears.
Doji
The Doji is one of the most important
signals in candlestick analysis. It is formed
when the open and the close are the same
or very near the same.
Interpretation is that the bulls and the bears
are conflicting.

Morning Star
The Morning Star is a bottom reversal signal. Like
the morning star, the planet Mercury, it foretells
the sunrise, or the rising prices. The pattern
consists of a three day signal.
Evening Star
The Evening Star is the exact opposite of the
morning star. The evening star, the planet
Venus, occurs just before the darkness sets in.
The evening star is found at the end of the
uptrend.
Shooting Star
A Shooting Star sends a warning that the top is
near. It got its name by looking like a shooting
star.
The Shooting Star Formation, at the bottom of a
trend, is a bullish signal. It is known as an
inverted hammer. It is important to wait for the
bullish verification.

The hammer is a bullish reversal pattern that
forms during a downtrend.
It is named because the market is hammering out
a bottom.
When price is falling, hammers signal that the
bottom is near and price will start rising again.
The long lower shadow indicates that sellers
pushed prices lower, but buyers were able to
overcome this selling pressure and closed near the
open.
Hammer

Leading VS. Lagging Indicators
• A leading indicator gives a buy signal before the new trend
or reversal occurs (oscillators are leading indicators.)
Example: Stochastic, parabolic SAR, and the Relative
Strength Index(RSI)
• A lagging indicator gives a signal after the trend has started
and basically informs you “ hey buddy”. Pay attention, the
trend has started, you’re missing the boat.”
(momentum indicators are lagging indicators also called
Trend following Indicators)
Example: Moving Average, MACD

Relative Strength Index (RSI)
• Relative Strength Index (RSI) is a
momentum oscillator that measures the
speed and change of price movements.
• RSI oscillates between zero and 100.
Traditionally, and according to Wilder, RSI is
considered overbought when above 70 and
oversold when below 30.
• Signals can also be generated by looking for
divergences, failure swings and centerline
crossovers. RSI can also be used to identify
the general trend.

RSI
Relative Strength index (
RSI) identifies overbought
and oversold conditions in
the oscillator
Is a price- following
oscillator
Scaled from 0 to 100-
readings over indicate
overbought and below
indicates underbought
Period-9 days and 14 days

RSI Example Chart
OversoldOverbought

Parabolic SAR
Parabolic Stop And Reversal (SAR)
A Parabolic SAR places dots, or points, on a chart that indicate potential
reversals in price movement
Basically, when the dots are below the candles, it is a buy signal; and when
the dots are above the candles, it is a sell signal.
You DON’T want to use this tool in a choppy market where the price
movement is sideways.
It only gives bullish and bearish signals

Stochastic
Measures overbought and oversold conditions in the market.
2 lines are similar to the MACD lines in the sense that one line
is scaled from 0 to 100
When the stochastic lines are above (The red dotted line in
the chart above), then it means the market is overbought .
When the stochastic lines are below ( the blue dotted line),
then it means that the market is oversold.

Bollinger Bands
• Bollinger bands are used to measure a market’s volatility.
• When the market is quiet, the bands squeez; and when the
market is LOUD, the bands expand
The Bollinger Bounce:
• A strategy that relies on the notion that price tends to always
return to the middle of the Bollinger Bands
• You buy when the price hits the lower Bollinger band
• You sell the price hits the upper Bollinger band
• Best used in raging markets

Bollinger Bands Example Chart
Sell signal
Buy signals
Sometimes, the buy
signals just keep coming and
you can go broke!

Moving Average
• A “simple moving average (SMA) is calculated by
adding the instrument prices for the most recent “n”
time periods and then dividing by “n”
• Crossover trading-two SMAs are plotted and the
shorter period is used as the signal line. If is shorter
period crosses over the longer period from below to
above, then it is considered bullish and a buy
opportunity. Conversely, if shorter period crosses over
the longer period form above, then it is considered
bearish and a sell opportunity.
• Effective period are 5,10, 20,50 and for support and
resistance 50,200

MACD
The MACD turns two trend-following indicators, moving
averages, into a momentum oscillator by subtracting the
longer moving average from the shorter moving average.
As a result, the MACD offers the best of both worlds: trend
following and momentum. The MACD fluctuates above and
below the zero line as the moving averages converge, cross
and diverge.
Traders can look for signal line crossovers, centerline
crossovers and divergences to generate signals. Because the
MACD is unbounded, it is not particularly useful for identifying
overbought and oversold levels.

……..
Used to identify buy and sell signal. When MACD crosses
above the signal line, it may be time for the longs to enter
the market, whereas when a cross below the signal line
occurs, it may be time for the shorts to enter the market.
If you look at our original chart, you can see that as the
two moving averages separate, the histogram, gets
bigger. This is called divergence, because the faster
moving average is diverging or moving away from the
slower moving average.
As the moving averages get closer to each other, the
histogram gets smaller. This is called convergence
because the faster moving average or getting closer to the
slower moving average.

………
• The MACD Line oscillates above and below the zero
line, which is also known as the centerline. These
crossovers signal that the 12-day EMA has crossed the 26-
day EMA.
• The direction, of course, depends on the direction of the
moving average cross. Positive MACD indicates that the
12-day EMA is above the 26-day EMA.
• Positive values increase as the shorter EMA diverges
further from the longer EMA. This means upside
momentum is increasing.
• Negative MACD values indicates that the 12-day EMA is
below the 26-day EMA. Negative values increase as the
shorter EMA diverges further below the longer EMA. This
means downside momentum is increasing.

Pivot Points
• Pivot Points use the prior period's high, low
and close to formulate future support and
resistance.
• In this regard, Pivot Points are predictive or
leading indicators.
• There are at least five different versions of
Pivot Points.
• Major ones are Standard Pivot Points,
Demark Pivot Points and Fibonacci Pivot
Points.

……..
• At the beginning of the trading day, floor traders
would look at the previous day's high, low and
close to calculate a Pivot Point for the current
trading day.
• With this Pivot Point as the base, further
calculations were used to set support 1, support
2, resistance 1 and resistance 2.
• These levels would then be used to assist their
trading throughout the day.

………
• Support and Resistance levels are areas
at which the direction of price movement
can possibly change.
• Pivot points are especially useful to short-
term trader who are looking to take
advantages of small price movements.

Which Time Frame to Use
Trading time frames are usually categorized into
three types:
• Long-term
• Short-term or swing
• Intraday or day-trading
Which one is better?
It depends on your
personality!

Time
frame
Description Advantages Disadvantages
Long-term Long-term traders will
usually refer to daily and
weekly charts. The
weekly charts will
establish the longer term
perspective and assist in
placing entries in the
shorter term daily. Trades
usually from a few weeks
to many months,
sometimes years.
Don’t have to watch
markets intraday
Fewer transactions
means less paying of
spreads
Large swings which require
large stops
Usually 1 or 2 good trades a
year so patience is required
Bigger account needed to
ride longer term swings
Frequent losing months
Short-term Short-term traders use
hourly time frames and
hold trades for several
hours to a week.
More opportunities for
trades
Less chance of losing
months
Less reliance on one or
two trades a year to make
money
Transaction costs will be
higher (more spreads to pay)
Overnight risk becomes a
factor
Intraday Intraday traders use
minute charts such as 1-
minute or 5-minute.
Trades are held intraday
and exited by market
close.
Lots of trading
opportunities
Less chance of losing
months
No overnight risk
Transaction costs will be
much higher (more spreads
to pay)
Mentally more difficult due to
frequency of trading
Profits are limited by needing
to exit at the end of the day.

On Balance Volume
• On Balance Volume was developed by Joseph
Granville, one of the most famous technicians of the
1960’s and 1970’s.
• OBV is calculated by adding volume on up
days, and subtracting volume on down days. A
running total is kept.
• Granville believed that “volume leads price.”
• To use OBV, you generally look for OBV to show a
change in trend (a divergence from the price trend).
• If the stock is in an uptrend, but OBV turns
down, that is a signal that the price trend may soon
reverse.

OBV Example Chart
Divergence, OBV failed
OBV confirms
trend change
but doesn’t
lead

Reasons for several traders suffering
from losses
• No planning
• No patience(investors’psychology)
• Not following the trends
• Hot news
• Lack of time
• Not using money management
technique(investors’ psychology)
• Not using stops(investors’psychology)
• Overtrading (investors’psychology)
• Continuous buy/sell

• Buy and Sell on Confidence
• Buy only Liquid Stocks and Liquid Markets
• Don’t buy or sell on Hot Tips
• Do not Dollar Cost Average
• No one wins 100 % of the Time
• Always use Stops
• I don’t have Time
• Be patient and let time be your Friend
• Learn from your Mistakes
• Know how to short Stocks
• Follow the Rules

Best guidelines for trading
• Robert Deel’s 16 Rules of Investology (A
successful trader, 20 years of experience ; He is an internationally
recognized trading expert, and has trained groups of traders Throughout the
U.S., Europe, Asia, and Canada. He is the author of Trading the Plan and
The Strategic Electronic Day Trader. He is also the President and CEO of
Tradingschool.com, a school that trains Individual and professional traders
from all over the world.
• Trade with a Plan
• Screen your trade
• Always Look at a Chart
• Stay With a Trend
• Use Money Management Techniques

THE END

Technical analysis - By Sohan Khatri

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