basis technical analysis
TRANSCRIPT
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Fundamental or Technical Analysis?
Financial statement (Huge amount of data)
Time lag
Inadequate disclosure
Subjectivity
Confidence on market
Conceptual framework
Quick response
Fundamental analysis – the belief that every security eventually sells for its intrinsic value
Technical analysis – the belief that security prices follow recurrent, predictable patterns
Judicious blend of both approaches is required to arrive at better results
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Market Dynamics
Supply and Demand
Demand
SupplyP
rice
Quantity
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Edwards & Magee (1997) state the basic assumptions of technical analysis A security’s market value is based on supply and demand Supply and demand are based on both rational and irrational
factors Security prices tend to move in persistent trends Changes in trends occur due to shifts in supply and demand Shifts in supply and demand can be detected using charts of
market transactions Some chart patterns tend to repeat themselves
Theoretical Foundation
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History repeats itself
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Bird’s Eye View of Technical Analysis
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.
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Technical Analysis
View Points
Price Change in price reflects changes in investors attitude
Time Movement in price is a function of time
Volume Intensity of price change is reflected in volume
Breadth Price change is measured across sectors or industries
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Strengths
Can be used on almost any instrument Can be used to analyse data over a wide range of time
periods There are many charting tools and techniques The basic principle of charting is easy to understand
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Weaknesses
It is subjective ie. open to individual interpretation The past does not necessarily repeat itself It is based on probability not certainty The data used must be timely and accurate
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Volume characteristics
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Dow Theory Charles Dow (1900)
Average discounts everything Market has three movements
Primary movements (bull or bear market, “the tide”) Secondary movements (corrections, “the wave”) Minor movements (daily fluctuations, “of little importance”)
Primary trends (up & down) usually has three movements 1st results from sighted investors Increased company earnings causes 2nd move When all financial news are good the final move accompanied
by rampant speculation To signal a bull or bear trend two averages must confirm each
other Only closing prices are used A trend remains effective until a reversal has been signaled by
both averages
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Trends and movements
Dow Jones Industrial Average, January 2, 2001 to October 3, 2003
7,000
8,000
9,000
10,000
11,000
12,000
01/01 04/01 07/01 10/01 01/02 04/02 07/02 10/02 01/03 04/03 07/03 10/03
Date
Level
The primary direction is either bullish or bearish, and reflects the long-run direction of the market.
Secondary trends,
temporary departures
Corrections, reversions to the primary direction
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Chart Type
Line Chart (close only) Bar Chart Point & Figure Chart Japanese Candlestick
Plotting the past price history of a security to look for patterns that suggest shifts in the underlying supply and demand relationship or investor attitudes
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Charting Stocks
Candlesticks Bars
Bullish
Bullish
Bearish Bearish
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Neutral Patterns
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Neutral Patterns
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Reversal Patterns
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Reversal Patterns
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Reversal Patterns
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Bullish Patterns
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Bullish Patterns
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Bullish Patterns
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Bearish Patterns
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Bearish Patterns
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Bearish Patterns
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Bearish Patterns
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Reversal days
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The two-day reversal
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Point and Figure Charts, I. Point-and-figure charts attempt to show only major price moves and
their direction. The point and figure chart maker decides what price move is
major. That is, it could be $2, $5, or any other level. (Point)
A major up-move is marked with an “X” A major down-move is marked with an “O” Start a new column when there is a direction change.
Buy and sell signals are generated when new highs or new lows are reached.
Congestion area, the area between buy and sell signals—a time of market indecision concerning its trend.
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Point and Figure Charts, II.
Point & Figure Chart
Stock Price Formation
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Point and Figure Charts, III.
Technical Investors for long term investors by W Clay Allen
Further Reference
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Basic Technical Tools
Trend Lines Short term Medium trend Long term
Moving Averages Price Patterns Indicators Cycles
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Trend Lines and Channels
There are three basic kinds of trends: An Up trend where prices are
generally increasing. A Down trend where prices
are generally decreasing. A Trading Range.
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Three Stages of a Trend
Accumulation
Big Move
Excess
Distribution
Big Move
Despair
Bull Market Bear Market
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Properties of Trend Line
The greater the number of touches the more important the trend line becomes.
The angle of Trendline Extension of Trend line. Trendline with Chart patterns Spacing of the two points
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Number of Touches
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Extension of Trendline
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Incorrect Angle
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Trendline with Chart Patterns
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Spacing between 2 points
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Support & 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
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PIVOT POINT ANALYSIS FOR RESISTANCE AND SUPPORT
PIVOT POINT =( HIGH+LOW+CLOSE)/3
RESISTANCE-1=2*PIVOT POINT-LOW
SUPPORT-1=2*PIVOT POINT-HIGH
RESISTANCE-2=PIVOT POINT+(HIGH-LOW)
SUPPORT-2=PIVOT POINT-(HIGH-LOW)
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Price Patterns
Reversal pattern
Bullish reversal
Bearish reversal Continuation pattern
Usually accompanied and confirmed by volume
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Reversal pattern
Head and shoulders (Top, Bottom)
Rounding Tops and Bottoms ( Saucers)
Ascending and descending Triangles (used more as a
continuation pattern)
Double and triple Tops and Bottoms
Diamonds
Rising and falling Wedges
V formation (Spikes)
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5 Major Chart Patterns
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Head & shoulders
W
Wedge & triangles
Rounded bottom
Cup & handle
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5 Major Chart patterns (either way up)
52
Head & shoulders
W
Cup & handle
Wedge & trianglesRounded top
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Head and shoulders
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Head and Shoulders
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Rounding top and Bottom
Rounding Top
Rounding Bottom
Rounding formations are characterized by a slow reversal of
trend (they are also known as cup & handle).
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Rounded Bottom
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Cup and Handle !!!
Hard to find but worthwhile
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Triangles
Triangles are reversal as well as 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
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Triangle or Wedge
More contact points = greater reliability
Target line
Descending Triangle
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Broadening Formations
These formations are like reverse triangles.
These formations usually signal a reversal of the trend.
Broadening Tops
Broadening Bottoms
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Rising and falling Wedges
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Continuation pattern
Flags Rectangles Pennants Island Gap
Common Least important Breakaway Heavy volume Runaway Heavy volume Exhaustion an end of a trend
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Flags
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RECTANGLES
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Moving Averages
Simple moving average
Weighted moving average
Exponential moving average
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Calculation of moving averages
Day 1 2 3 4 5 6 7 8 9
Price ($) 16 17 17 10 17 18 17 17 17
5 Day SMA 15.4 15.8 15.8 15.8 17.2
Day 1 2 3 4 5
Price ($) 16 17 17 10 17
Weighting 1/15 2/15 3/15 4/15 5/15
Weighted value 1.07 2.27 3.40 2.67 5.67
5 Day WMA 15.07
Simple moving average
Weighted moving average
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Calculation of moving averages EMA(current) = ( (Price(current) - EMA(prev) ) x Multiplier) +
EMA(prev) For a percentage-based EMA, "Multiplier" is equal to the EMA's specified
percentage. For a period-based EMA, "Multiplier" is equal to 2 / N where N is the specified
number of periods.
Day Price EMA(prev) diff Diff*mult EMA1 16 - - - 152 17 15 2 0.04 15.043 19 15.04 3.96 0.079 15.1194 17 15.119 1.881 0.037 15.1565 20 15.156 4.844 0.096 16.2526 17 16.252 0.748 0.015 16.2677 21 16.267 4.733 0.095 16.3628 17 16.362 0.368 0.013 16.3759 19 16.375 2.624 0.052 16.427
multiplier for 100 days EMA = 2/100=0.02
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Relative Strength Index (RSI)
RSI was developed by Welles Wilder as an oscillator to gauge
overbought/oversold levels.
RSI is a rescaled measure of the ratio of average price changes on up days
to average price changes on down days.
The most important thing to understand about RSI is that a level above 70
indicates a stock is overbought, and a level below 30 indicates that it is
oversold (it can range from 0 to 100).
Also, realize that stocks can remain overbought or oversold for long
periods of time, so RSI alone isn’t always a great timing tool.
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RSI Example Chart
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Stochastic
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Advance analysis
On balance volume Moving average envelop Bollinger band Relative strength index Stochastic Oscillator
ROC (Rate of Change oscillator) Moving average oscillator ( MACD)
And many more
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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.
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OBV Example Chart
Divergence, OBV failed
OBV confirmstrend changebut doesn’t lead
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MACD
MACD was developed by Gerald Appel as a way to keep track of a moving average crossover system.
Appel defined MACD as the difference between a 12-day and 26-day moving average. A 9-day moving average of this difference is used to generate signals.
When this signal line goes from negative to positive, a buy signal is generated.
When the signal line goes from positive to negative, a sell signal is generated.
MACD is best used in choppy (trendless) markets, and is subject to whipsaws (in and out rapidly with little or no profit).
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MACD Example Chart
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Elliot Wave Principle (1)
R.N. Elliot formulated this idea in a series of articles in Financial World in 1939.
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.
Elliot Wave adherents also make extensive use of the Fibonacci series.
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The Elliot Wave Principle (2)
1
2
3
4
5
A
B
C
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Fibonacci Numbers
Fibonacci numbers are a series where each succeeding number is the sum of the two preceding numbers.
The first two Fibonacci numbers are defined to be 1, and then the series continues as follows: 1, 1, 2, 3, 5, 8, 13, 21…
As the numbers get larger, the ratio of the numbers approaches the Golden Mean: 1.618:1.
This ratio is found extensively in nature, and has been used in architecture since the ancient Greeks (who believed that a rectangle whose sides had the ratio of 1.618:1 was the most aesthetically pleasing).
Technical analysts use this ratio and its inverse, 0.618, extensively to provide projections of price moves.
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Too Many Others To List
There are literally hundreds of indicators and thousands of trading systems. A whole semester could easily be spent on just a handful of these. There is nothing so crazy that somebody doesn’t use it to trade. For example, many people use astrology, geometry (Gann angles), neural
networks, chaos theory, etc. There’s no doubt that each of these (and others) would have made lots of money
at one time or another. The real question is can they do it consistently? As the carneys used to say, “You pay your money, and you take your chances.”
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References (Books)
The Technical Analysis course by Thomas A Meyers The psychology of Technical Analysis by Tony Plummer The Technical Analysis of Stock Option & Future advance trading system &
techniques by William F Eng Using Technical Analysis The Basic by Clifford Pistolese Technical Analysis of Stock Trends by Robert D Edwards, John Magee Technical Analysis Explained by Martin J Pring Mathematics of Technical Analysis by Clifford J Sherry Technical Analysis Plain and Simple Technical Analysis of Financial Market by John J Murphy Technical Analysis for Long Term Investors by W Clay Allen The Midas Method of Technical Analysis by Paul Levine
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References (WWW) Nseindia Investopedia Stockcharts Smartinvesor Stockta Tradingcoach Daytrading Wilkipedia Chartsmart Deepinsight Ft Litwick (for candle stick analysis) Traders
and many more