Technical Analysis
Meaning
⚫ Fundamental analysis is a method of evaluating securities by
attempting to estimate the intrinsic value of a stock.
Fundamental analysts study everything from the overall
economy and industry conditions to the financial condition and
management of companies. It enables them to predict a stock’s
price movement in the long run.
⚫ Technical analysis is the evaluation of securities by means of
studying statistics generated by market activity, such as past
prices and volume. Technical analysts do not attempt to
measure a security's intrinsic value but instead use stock
charts to identify patterns and trends that may suggest where a
stock price will go in the near future.
Contd….
⚫ Unlike fundamental analysts, technical analysts don't care
whether a stock is undervalued - the only thing that matters is
a security's past trading data and what information this data
can provide about where the security might move in the near
future.
⚫ Technical Analysis is the forecasting of future financial price
movements based on an examination of past price
movements. Like weather forecasting, technical analysis does
not result in absolute predictions about the future. Instead,
technical analysis can help investors anticipate what is "likely"
to happen to prices over time. Technical analysis uses a wide
variety of charts that show price over time.
Basic Tenets of Technical Analysis
1. The price of a security is determined by the demand and
supply forces operating in a market.
2. Prices tend to move in trends over long term. This long
term trend sets the direction of market prices.
3. Price fluctuation reflect logical and emotional forces.
4. Price movements, whatever their cause, once in force
persist for some period of time and can be detected.
5. The trends in security prices may reverse due to shift in
demand and supply
Contd…
6. The changes in demand and supply can be predicted well in
advance with the help of charts and technical tools.
Hence the task of a Technical analyst is to:
i. Identify the trend and
ii. Recognize when one trend comes to an end and prices start
moving in the opposite direction.
Trading Rules
Credit Balance Theory
• According to Credit Balance Theory, the level of credit
(cash) balance in investors’ trading or brokerage account is
a good tool to forecast market trend.
• Investor with large cash balance in trading account is more
likely to buy securities in near future.
• More and more investors sitting on positive credit (cash)
balance will create demand for shares which would result
in increase in share prices.
• Therefore, Credit Balance Theory proposes that high credit
balance indicates a lurking bullish trend in future as cash
represents potential purchasing power.
Trading Rules
⚫
Trading Rules
• This ratio will always be below 1 because yield of top rated
bonds cannot exceed those on low grade bonds.
• Higher values of confidence index suggest bullish nature of
the market.
Trading Rules
Filter rules
• A technical analyst sets trading rules based on the
magnitude of percentage changes in market price of the
share.
• For instance, he would buy a certain share if it falls by 2%
on a trading day, while sell the other if it rises by say, 10%.
• Such set price parameters are called as filter rules.
• Filter rules are generally based on price momentum
Trading Rules
Market Breadth Analysis
• Market breadth is the spread between the number of
stocks that advance and decline in price.
• For example if on a particular day 300 stocks advance in
prices while 200 stocks decline in prices, then market
breadth will be 300 – 200 = 100.
• One can calculate cumulative breadth and if it is
increasing, it signals a bullish market and vice versa.
Day Advances Decline Market Cumulative
Breadth Breadth
1 300 200 100 100
2 350 220 130 230
3 300 50 250 480
4 320 170 150 630
5 270 160 110 740
In the above table cumulative breadth is
continuously rising and hence it suggests the
presence of Bullish market in future as per Market
breadth analysis
Trading Rules
⚫
Trading Rules
• Advance decline ratio greater than 1 (Positive market
breadth) denotes more stocks in the index have shown
positive price movement whereas advance decline ratio
less than 1 (Negative market breadth) implies more stocks
had negative price movement in the index.
Charts
⚫ A price chart displays the price of a particular stock over a
time series.
⚫ The Y-axis represents the price of the stock, and the
X-axis the time scale.
⚫ A charting tool plots the prices of the stock from left to right
across the X-axis, with the most recent being plotted at the
furthest right.
⚫ It provides a visual assistance to the technical analyst in
detecting evolving and changing patterns of price
behaviour.
Charts
⚫ On a particular day, the price of a share varies many times.
It is difficult to plot all the prices prevailing for a particular
stock on a particular day. Therefore generally the following
four prices are of interest to an investor-
⚫ Open price: Open price is the price at which the trading on
a share starts on a particular day.
⚫ High price: High price is the highest price at which the
share has been traded on a particular day.
⚫ Low price: Low price is the lowest price at which the share
has been traded on a particular day.
⚫ Close price: Close price is the price at which trading on a
share closes on a particular day
Types of Charts
Charts
Advanced
Basic
Interactive
Charts
Charts
Bar Chart of
Candlestick
Line Chart Bar Chart Prices with
Chart
Volume
Contd…
⚫ A line chart is the most basic and simplest type of
stock charts that are used in technical analysis.
⚫ The line chart is also called a close-only chart as it
plots the closing price of the underlying security, with
a line connecting the dots depicting the close price in
different time periods.
⚫ In a line chart the price data for the underlying
security is plotted on a graph with the time plotted
from left to right along the horizontal axis, or the x-axis
and price levels plotted from the bottom up along the
vertical axis, or the y-axis.
Contd…
⚫ The uncluttered simplicity of the line chart is its greatest
strength as it provides a clean, easily recognizable, visual
display of the price movement. This makes it an ideal tool
for use in identifying trend lines and certain chart patterns.
⚫ However, the line chart does not indicate the highs and
lows and, hence, they do not indicate the price range for
the session. Despite this, line charts were the charting
technique favored by Charles Dow who was only
interested in the level at which the price closed. This, Dow
felt, is the most important price data of the session or
trading period as it determined that period's unrealized
profit or loss.
Bar Chart
Bar Chart
⚫ A ‘Bar chart’ shows high, low and closing prices of a stock
every day.
⚫ Open price of a day is generally equal to the close price of
the previous day. Hence it is generally not shown on a bar
chart. But if required one can also show open price of the
share in a bar chart.
⚫ On a bar chart, X axis shows time while Y axis shows
stock prices.
⚫ The length of the bar shows the range of price i.e. the
highest price minus lowest price, in a particular day and
hence if bar lengths increase overtime, it may be regarded
as a signal of increasing stock volatility.
⚫ One bar is placed every day and closing and opening
prices may be depicted with some signs such as – or X.
Price and Volume Chart
Price and Volume Chart
⚫ Price –volume chart shows the high, low and close price of
a share along with its volume in the same chart.
⚫ In this chart time is plotted on the X-axis and volume on left
side of the y-axis and price on right side of y- axis
⚫ The utility of this chart is that it provides information about
the volume of trading regarding that share besides
showing the relevant prices.
Contd…
⚫ According to Steve Nison, candlestick charting first
appeared sometime after 1850. Much of the credit for
candlestick development and charting goes to a
legendary rice trader named Homma from the town of
Sakata.
⚫ Candle stick depicts the open, high, low and closing
price for each time period.
⚫ The hollow or filled portion of the candlestick is called
“the body” (also referred to as “the real body”).
⚫ The long thin lines above and below the body
represent the high/low range and are called
“shadows” (also referred to as “wicks” and “tails”).
⚫ The high is marked by the top of the upper shadow
and the low by the bottom of the lower shadow.
Contd…
⚫ If the stock closes higher than its opening price, a
white or green candlestick is drawn with the bottom of
the body representing the opening price and the top of
the body representing the closing price. This type of
candle stick indicates buying pressure.
⚫ If the stock closes lower than its opening price, a
black or red candlestick is drawn with the top of the
body representing the opening price and the bottom of
the body representing the closing price. This type of
candle stick indicates selling pressure.
Advanced Interactive Charts
⚫ These are stock charts drawn with the help of
advanced charting softwares.
⚫ Prominent features of such charts are:
Multiple indicators like MACD, Bollinger bands, RSI,
volume oscilator, regression line, etc. can be used
simultaneously on the same chart using Advanced
Interactive Charts.
Moreover, interactive charts are like drawing boards
where analyst can mark values, dates, events, symbols,
etc. using advanced chart tools.
Advanced interactive charts can be saved, captured as
a picture or shared.
They also provide an option to change chart type (bar,
line, candlestick) as per analyst’s needs.
Tools of Technical Analysis- DOW Theory
⚫ Charles Dow, the grandfather of technical analysis,
propounded what is popularly known as Dow theory.
⚫ It is based on the following assumptions:
Stock market does not move on random basis rather there are set
trends which can detect the direction of market movement.
No single individual or buyer can influence the major trend of the
market. However, an individual investor can affect the daily price
movement by buying or selling huge quantum of particular scrip.
Market discounts every thing.
Contd…
⚫ According to this theory in any type of market; whether
bullish or bearish, three trends are simultaneously at
work - the primary trend, the intermediate trend and the
minor trend.
Primary Trend
⚫ According to Dow Theory, primary trend is the long term
trend which lasts for a period of more than one year.
⚫ Dow determined that a primary trend will generally last
between one and three years but could vary in some
instances.
⚫ In Dow Theory, the primary trend is the most important
one to determine. This is because this trend indicates the
overall direction of the movements in stock prices.
⚫ If primary trend is upward then bull market is in operation
whereas if primary trend is downward then the market is
bearish.
⚫ The primary trend will also impact the secondary and minor
trends within the market.
Secondary, or Intermediate Trend
⚫ In Dow Theory, a primary trend is the main direction in which
the market is moving. Conversely, a secondary trend moves in
the opposite direction of the primary trend, or as a correction to
the primary trend.
⚫ For example, an upward primary trend will be composed of
secondary downward trends. This is the movement from a
consecutively higher high to a consecutively lower high. In a
primary downward trend the secondary trend will be an upward
move, or a rally. This is the movement from a consecutively
lower low to a consecutively higher low.
Contd….
⚫ In general, a secondary, or intermediate, trend typically lasts
between three weeks and three months, while the retracement
of the secondary trend generally ranges between one-third to
two-thirds of the primary trend's movement. For example, if the
primary upward trend moved the stock index from 10,000 to
12,500 (2,500 points), the secondary trend would be expected
to send the stock index down at least 833 points (one-third of
2,500).
Minor Trend
⚫ Minor trends are just like the ripples in the market.
⚫ They are simply the daily price fluctuations.
⚫ Minor trend tries to correct the secondary price
movement.
⚫ It is better for the investor to concentrate on the
primary or secondary trends than on the minor
trends.
Bull Market Prediction
⚫ As per Dow theory a bull market is in operation when
successive high points are higher than the previous high
and successive low points are also higher than the
previous low point as shown in the figure below.
Bull Market Prediction
⚫ The intermediate trend is the period of decline in
this bull market. Therefore during bull market, it is
good time to buy during secondary corrections i.e.
the periods of decline which do not last for long.
By doing so the investor would be able to buy at
low prices and in the long term he can expect
increase in stock prices due to bull market.
⚫ Minor trends are day to day fluctuations in stock
market index and are of no use in deciding about
the investment
Bear Market Prediction
⚫ As per Dow theory a bull market is in operation when
successive high points are lower than the previous lows
and successive low points are also lower than the previous
low point as shown in the figure below.
Bear Market Prediction
⚫ The intermediate trend is the period of increasing
price in this bear market. Here also it is termed as
Secondary correction. Therefore in a bear market, the
right time to sell is during the periods of intermediate
corrections.
Moving Average
⚫ The stock prices do not rise or fall in a straight line.
⚫ The upward or downward movements are interrupted
by counter moves.
⚫ Smoothening the data makes it is easier to identify the
underlying trend.
⚫ A moving average is a technical indicator that
technical analysts use to determine the direction of a
trend by reducing the impact of unexpected price
spikes.
⚫ Moving average can be of two types
⚫ Simple moving average: It is the average of
most recent ‘n’ stock prices.
Moving Average
Calculation of five-day moving average for ABC Corp
Day Price Average
Feb 4 255 -
6 261 -
7 269 266.2
8 273 270.8
11 273 272.8
12 278 273.2
13 271 274.0
14 271 273.8
Moving Average
⚫ It can be computed for different types of prices, i.e., high,
low, open, and close.
⚫ Exponential Moving Average (EMA): It is calculated
using the following mathematical formula:
EMA = Pt * k + EMAy* (1 –k)
Where, Pt = Stock price today
EMAy = Exponential moving average yesterday
K = 2 / (N + 1)
N = number of days in EMA calculation
• Moving average is a lagging indicator which means it
does not predict new trends, rather it helps to identify
the existing trend. In other words it cannot predict
future price movement.
Moving Average
⚫ Moving average line is the line obtained by plotting
the moving average on the y-axis and the dates on
the x-axis.
⚫ The direction of the moving average line indicates
trend.
⚫ A 200-day moving average line may be used to
identify the direction of long-term trend.
⚫ A 60-day moving average line can be used to discern
the direction of the intermediate term trend.
⚫ A 10-day moving average line can be used to discern
the direction of the short term trend.
Moving Average
The buy and sell signals provided by the moving
average analysis are as follows:
Using one moving average:
When the price of a stock crosses its moving
average from below to up it is a buy signal.
When the price of a stock crosses its moving
average from up to down it is a sell signal.
Moving Average
Moving Average
Using two moving averages:
When a shorter term moving average crosses over a
longer term moving average from below, it
generates a buying signal.
⚫ When a shorter term moving average crosses
over a
longer term moving average from above, a sell
signal is generated.
Moving Average
Moving Average Convergence
Divergence (MACD)
⚫ It is the difference between a short term exponential
moving average and a long term exponential moving
average.
⚫ The 12-day and 26-day moving averages are
commonly used for calculating MACD.
⚫ The Signal line is a 9-day EMA of the MACD line
itself, and it acts as a trigger for buy or sell signals.
⚫ When the MACD line crosses the signal line from
below, it is typically a buy signal.
⚫ When the MACD line crosses the signal line from
above, it is considered as a sell signal.
Moving Average Convergence
Divergence (MACD)