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PROJECT ON

TECHNICAL ANALYSIS OF EQUITIES

A PROJECT SUBMITTED IN PART COMPLETION OF

MASTERS IN FINANCIAL MANAGEMENT

DANIEL BABU P

MFM – SEM V, ROLL NO. 41

BATCH 2008 – 2011

UNDER THE GUIDANCE OF

PROF. A K PRADHAN

K J SOMAIYA OF MANAGEMENT STUDIES & RESEARCH

Vidyanagar,Vidyavihar(E). Mumbai - 400077.




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CERTIFICATE

This is to certify that the study presented by DANIEL BABU P to K J SOMAIYA

INSTITUTE OF MANAGEMENT STUDIES & RESEARCH in part

completion of MASTERS IN FINANCIAL MANAGEMENT on TECHNICAL

ANALYSIS OF EQUITIES has been done under my guidance in the year 2008 –

2011.

The Project is in the nature of Original Work that has not so far been submitted for

any other course in this Institute or any other Institute. Reference of work and relative

sources of information has been given at the end of the project.

Signature of the Candidate

(Daniel Babu P)

Forwarded through the Research Guide

Signature of the Guide

(Prof. AK Pradhan)




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DECLARATION

I Daniel Babu P, a Student of MFM SEM – V of University of Mumbai, 2008 – 2011

Batch at SIMSR do hereby declare that this project report entitled ―Technical

Analysis of Equities‖ has been carried out by me during this semester under the

guidance of Prof. A.K Pradhan as per the norms prescribed by university of

Mumbai & the same work has not been copied from any sources directly without

authenticating for the part / section that has been adopted from published / non

published work.

I further declare that the information presented in this project is true & original to the

best of my knowledge.

Date:

Place: Mumbai DANIEL BABU P




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ACKNOWLEDGEMENT

I wish to accord my sincere gratitude to the KJ Somaiya Institute of

Management Studies & Research for their Support and co–operation.

I thank Prof. AK Pradhan for his Support and Guidance, without whom the

Project would not have been possible.

Also, the support of my colleagues was indispensable as their points and

approach has helped me to achieve success in my project.

DANIEL BABU P




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Contents

EXECUTIVE SUMMARY ........................................................................................... 6

INTRODUCTION TO TECHNICAL ANALYSIS ....................................................... 7

BASICS OF TECHNICAL ANALYSIS ..................................................................... 11

CHARTS PATTERNS AND TRENDS. ..................................................................... 15

MOVING AVERAGES ............................................................................................... 25

INDICATORS AND OSCILLATORS ........................................................................ 30

OVERLAYS ................................................................................................................ 39

REAL LIFE PREDICTION AND OUTCOMES ........................................................ 44

SELECTION OF INDICATORS/OSCILLATORS/OVERLAYS .............................. 55

STEPS IN TECHNICAL ANALYSIS ........................................................................ 59

CONCLUSIONS .......................................................................................................... 62

BIBLIOGRAPHY OF REFERENCES ...................................................................... 62




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EXECUTIVE SUMMARY

The cornerstone of the technical analysis is the belief that all of the factors that

influence market price — fundamental information, political events, natural disasters,and psychological factors — are quickly discounted in market activity.

NEED FOR THE PROJECT:

Stock analysis today is a combination of both the fundamental analysis and the

technical or chart analysis. Fundamental analysis affects technical analysis. It is

important to time entry and exits, and use spreads to manage risk. In this context,

study and evaluation of various charting techniques is taken up with respect to its

application area.

OBJECTIVES :

Study of reversal and continuation chart patterns, trends, gaps, indicators,market profiling using Elliot wave theory, Fibonacci sequences etc.

Identifying the market condition and applying the appropriate indicatorand tools. Usage of multiple such tools to finalize the strategy.

Selection of tools (indicators and functions) for technical analysis. Survey and evaluation of various software tools for pointers, scaling etc,

platforms available for technical analysis.

Testing of historical charts of various companies in different sectors /segments.

METHODOLOGY :

Various indicators and functions for technical analysis were studied and suitable ones

were selected for selection of economic environment of investing (market, micro and

macro indicators). Next step involved selection of sectors and companies for

investing. For individual equity analysis Excel Add-In tool Analyzer XL was used.

For proving technical analysis Top 5 picks of the day appearing in Economic times

are taken and the tools and functions used are applied. The market movements are

followed and the success/failure reasons of the prediction are analyzed.




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INTRODUCTION TO TECHNICAL ANALYSIS

In finance, technical analysis is a security analysis discipline for forecasting the

direction of prices through the study of past market data, primarily price and volume.Technical analysis is a method of evaluating securities by analyzing the 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 charts and other

tools to identify patterns that can suggest future activity. Technical analysis can be

used on any security with historical trading data. This includes stocks, futures and

commodities, fixed-income securities, forex, etc. In fact, technical analysis is more

frequently associated with commodities and forex, where the participants are

predominantly traders.

Just as there are many investment styles on the fundamental side, there are also many

different types of technical traders. Some rely on chart patterns, others use technical

indicators and oscillators, and most use some combination of the two. In any case,

technical analysts' exclusive use of historical price and volume data is what separates

them from their fundamental counterparts. Unlike fundamental analysts, technical

analysts don't care whether a stock is undervalued - the only thing that matters is asecurity's past trading data and what information this data can provide about where

the security might move in the future.

The field of technical analysis is based on three assumptions:

1. The Market Discounts Everything

A major criticism of technical analysis is that it only considers price movement,

ignoring the fundamental factors of the company. However, technical analysisassumes that, at any given time, a stock's price reflects everything that has or could

affect the company - including fundamental factors. Technical analysts believe that

the company's fundamentals, along with broader economic factors and market

psychology, are all priced into the stock, removing the need to actually consider these

factors separately. This only leaves the analysis of price movement, which technical

theory views as a product of the supply and demand for a particular stock in the

market.




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2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that

after a trend has been established, the future price movement is more likely to be in

the same direction as the trend than to be against it. Most technical trading strategies

are based on this assumption.

3. History Tends To Repeat Itself

Another important idea in technical analysis is that history tends to repeat itself,

mainly in terms of price movement. The repetitive nature of price movements is

attributed to market psychology; in other words, market participants tend to provide a

consistent reaction to similar market stimuli over time. Technical analysis uses

chart patterns to analyze market movements and understand trends. Although many of

these charts have been used for more than 100 years, they are still believed to be

relevant because they illustrate patterns in price movements that often repeat

themselves.

Technical analysis is a methodology to assist in deciding the timing of investments,

which is very vital to make wise investment decisions. Few of the most commonly

used technical analysis methods for capital market are Japanese Candlestick, Price

Curves, Trend Lines, High Low Charts and Moving averages

Need for technical Analysis.

A logical question is: What does technical analysis do? The answer is that the ability

to recognize when a stock has reached a support or resistance level, or a shift in

perceptions takes place, can help investors know whether to use the:

• buy low, sell high approach, or • buy high, sell higher approach, or

• whether to buy the stock at all.

The ability to apply this one aspect of chart reading will reveal the market to investors

with the same impact as understanding the colours of a traffic light. Once you know

that green means go and red means stop, you will know when it is safe to buy or not.




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We’ve touched upon some of the reasons to use technical analysis, such as the lack of

data revisions, estimates and subjectivity in its inputs. But as important as it is to

know when to buy a stock it is equally, if not more, important to know when not to

buy a stock, or when to sell a stock already held. Technical analysis is the only

investment decision-making discipline that lets you know when you are wrong

sooner, rather than later, to minimize losses.

When not to use it?

Since technical analysis is based on crowd psychology and actions of the masses, it

works best when there is a crowd to analyze. That means the best analysis occurs on

liquid stocks where there are plenty of bulls and bears at work and a critical mass of money value changes hands each day. What constitutes critical mass is subjective, but

many investors use a rule of thumb of stock price above Rs.20 and average daily

trading volume above 100,000 shares. Certainly we can tinker with these parameters

as we gain experience. Technical analysis also needs relatively normal market

conditions. War, terrorism, takeovers, legislation and litigation trump support and

resistance, although it does help during these unusual conditions to know where

investors found value in the past.

Everything supports price

A diagram resembling a table is used to stock prices. The price of the stock or

commodity is the top of the table. Indicators such as momentum, sentiment, volume

and anything else we can create, are the legs of the table. Everything is there to

support the price and as long as we keep this in mind we will be properly focused on

what we are doing. The stronger the ―legs‖ the better the ―table‖ (investment).

Price is the only thing that matters at the end of the day. It is what we say when

someone asks where a stock is today and it is the only way we judge our investing

success. Price rules and it is entirely possible to analyze a chart without any of the

other supporting indicators.




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Price

The stuff you put in the bank. Clearly, this is the most important component as we

measure our success in monetary terms. It only matters if we have more money after

investing than when we started and that is measured by price.

Other parameters help in understanding the problem.

• Volume

How much money is moving. If price tells us what is going on, volume tells us how

much is going on. Chart analysis depends on liquidity and crowd psychology, so the

more shares of stock that are traded, the more reliable the analysis can be.• Momentum

How fast it got there. It is important to know how eager the crowd is to buy and sell

because if it gets over enthused it will push prices out of equilibrium. Prices that move

too far, too fast are prone to snapbacks.

• Structure

The structure of the market refers to how it got to where it is now and we understand

that by studying trends and patterns. As stocks trade, their ups and downs form

patterns on the charts. Analysis of trends and patterns help us sort it all out and give

us clear guidelines to know when a trend changes to a pattern or a pattern changes

into a trend.

• Sentiment

How people feel about the market. Contrarianism is based on the idea that the crowd

gets it wrong when bull markets are changing to bear and vice versa. The masses

seem to pile into the market just at the wrong time, but we must look at it in reverse.

Just when everyone is buying, for example, is the wrong time to own stocks. Demand

becomes exhausted and without demand, prices must stop going up, if not fall. So,

when sentiment

indicators reach extreme optimism or pessimism, the prevailing trend is likely to be

nearing its end.




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BASICS OF TECHNICAL ANALYSIS

SUPPORT & RESISTANCE

Security prices are the result of a head-to-head battle between a bull (the buyer) and a

bear (the seller). The bulls push prices higher and the bears push prices lower. The

direction prices actually move reveals who is winning the battle.

Using this analogy, consider the price action of Phillip Morris in Figure below.

During the period shown, note how each time prices fell to the $45.50 level, the bulls

(i.e., the buyers) took control and prevented prices from falling further. That means

that at the price of $45.50, buyers felt that investing in Phillip Morris was worthwhile

(and sellers were not willing to sell for less than $45.50). This type of price action is

referred to as support, because buyers are supporting the price of $45.50.

Similar to support, a "resistance" level is the point at which sellers take control of

prices and prevent them from rising higher. Consider Figure in right. Note how each

time prices neared the level of $51.50, sellers outnumbered buyers and prevented the

price from rising.

The price at which a trade takes place is the price at which a bull and bear agree to do

business. It represents the consensus of their expectations. The bulls think prices will

move higher and the bears think prices will move lower.

Support levels indicate the price where the majority of investors believe that prices

will move higher, and resistance levels indicate the price at which a majority of

investors feel prices will move lower.




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But investor expectations change with time! For a long time investors did not expect

the Dow Industrials to rise above 1,000 (as shown by the heavy resistance at 1,000 in

Figure below). Yet only a few years later, investors were willing to trade with the

Dow near 2,500.

When investor expectations change, they often do so abruptly. Note how when prices

rose above the resistance level of Hasbro Inc. in Figure 9, they did so decisively. Note

too, that the breakout above the resistance level was accompanied with a significant

increase in volume.

Once investors accepted that Hasbro could trade above $20.00, more investors were

willing to buy it at higher levels (causing both prices and volume to increase).

Similarly, sellers who would previously have sold when prices approached $20.00

also began to expect prices to move higher and were no longer willing to sell.




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The development of support and resistance levels is probably the most noticeable and

reoccurring event on price charts. The penetration of support/resistance levels can be

triggered by fundamental changes that are above or below investor expectations (e.g.,

changes in earnings, management, competition, etc) or by self-fulfilling prophecy (

investors buy as they see prices rise). The cause is not as significant as the effect--new

expectations lead to new price levels.

Figure below in left shows a breakout caused by fundamental factors. The breakout

occurred when Snapple released a higher than expected earnings report. How do we

know it was higher than expectations? By the resulting change in prices following the

report!

Other support/resistance levels are more emotional. For example, the DJIA had a

tough time changing investor expectations when it neared 3,000 (see Figure above

right).

Supply and demand

There is nothing mysterious about support and resistance--it is classic supply and

demand. Remembering "Econ 101" class, supply/demand lines show what the supply

and demand will be at a given price.

The "supply" line shows the quantity (i.e., the number of shares) that sellers are

willing to supply at a given price. When prices increase, the quantity of sellers also

increases as more investors are willing to sell at these higher prices.

The "demand" line shows the number of shares that buyers are willing to buy at a

given price. When prices increase, the quantity of buyers decreases as fewer investors

are willing to buy at higher prices.




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At any given price, a supply/demand chart shows how many buyers and sellers there

are. For example, the following chart shows that, at the price of 42-1/2, there will be

10 buyers and 25 sellers.

Support occurs at the price where the supply line touches the left side of the chart

(e.g., 27-1/2 on the above chart). Prices can't fall below this amount, because no

sellers are willing to sell at these prices. Resistance occurs at the price where the

demand line touches the left side of the chart (e.g., 47-1/2). Prices can't rise above this

amount, because there are no buyers willing to buy at these prices.

In a free market these lines are continually changing. As investor expectations change,

so do the prices buyers and sellers feel are acceptable. A breakout above a resistancelevel is evidence of an upward shift in the demand line as more buyers become willing

to buy at higher prices. Similarly, the failure of a support level shows that the supply

line has shifted downward.

The foundation of most technical analysis tools is rooted in the concept of supply and

demand. Charts of security prices give us a superb view of these forces in action.




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CHARTS PATTERNS AND TRENDS.

CHARTS

The foundation of technical analysis is the chart. In this case, a picture truly is worth a

thousand words.

Line charts

A line chart is the simplest type of chart. As shown in the chart of General Motors in

Figure below, the single line represents the security's closing price on each day. Dates

are displayed along the bottom of the chart and prices are displayed on the side(s).

A line chart's strength comes from its simplicity. Line charts are typically displayed

using a security's closing prices.

Bar charts

A bar chart displays a security's open (if available), high, low, and closing prices. Bar

charts are the most popular type of security chart. As illustrated in the bar chart in

Figure below, the top of each vertical bar represents the highest price that the security

traded during the period, and the bottom of the bar represents the lowest price that it

traded. A closing "tick" is displayed on the right side of the bar to designate the last

price that the security traded. If opening prices are available, they are signified by a

tick on the left side of the bar.




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Volume bar chart

Volume is usually displayed as a bar graph at the bottom of the chart (see Figure

below). Most analysts only monitor the relative level of volume and as such, a volume

scale is often not displayed.

Figure on left displays "zero-based" volume. This means the bottom of each volume

bar represents the value of zero. However, most analysts prefer to see volume that is

"relative adjusted" rather than zero-based. This is done by subtracting the lowest

volume that occurred during the period displayed from all of the volume bars.

Relative adjusted volume bars make it easier to see trends in volume by ignoring the

minimum daily volume. Figure on right displays the same volume information as in

the previous chart, but this volume is relative adjusted.

OHLC "Bar Charts" —

Open-High-Low-Close charts, also known as bar charts, plot the span between the

high and low prices of a trading period as a vertical line segment at the trading time,

and the open and close prices with horizontal tick marks on the range line, usually a

tick to the left for the open price and a tick to the right for the closing price.




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Candlestick chart —

Of Japanese origin and similar to OHLC, candlesticks widen and fill the intervalbetween the open and close prices to emphasize the open/close relationship. In theWest, often black or red candle bodies represent a close lower than the open, whilewhite, green or blue candles represent a close higher than the open price.

Point and figure chart —

A chart type employing numerical filters with only passing references to time, andwhich ignores time entirely in its construction.

TRENDS

A trend is the market in motion, and a pattern is the market at rest, deciding if it wants

to continue its trend or change course.

A trend is really nothing more than a somewhat uniform change in price levels over

time. For a rising, or bull trend, prices start low and through a series of fits and starts,

advances and pullbacks, move to a higher level. Some trends are smooth and have




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small wiggles within. Others are choppy and are characterized by high volatility.

Some are flat with little net gain over time, and others are steep with a sharp increase

in relatively little time.

Support and resistance levels can be penetrated by a change in investor expectations

(which results in shifts of the supply/demand lines). This type of a change is often

abrupt and "news based."

A trend represents a consistent change in prices (i.e., a change in investor

expectations). Trends differ from support/resistance levels in that trends represent

change, whereas support/resistance levels represent barriers to change.As shown in Figure below, a rising trend is defined by successively higher low-prices.

A rising trend can be thought of as a rising support level--the bulls are in control and

are pushing prices higher.

Figure below shows a falling trend. A falling trend is defined by successively

lower high-prices. A falling trend can be thought of as a falling resistance

level--the bears are in control and are pushing prices lower.




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Just as prices penetrate support and resistance levels when expectations

change, prices can penetrate rising and falling trend lines. Figure below

shows the penetration of Merck's falling trend line as investors no longer

expected lower prices.

Note in Figure below how volume increased when the trend line was

penetrated. This is an important confirmation that the previous trend is no

longer intact.

Again, volume is the key to determining the significance of the penetration of

a trend. In the above example, volume increased when the trend was

penetrated, and was weak as the bulls tried to move prices back above the

trend line.

Indicator Alert Description

TrendLong Term UpwardSloping TradingChannel

A long term (6 months) upward sloping trading channel exists with thehighs and lows ->long term very bullish

TrendIntermediate TermUpward SlopingTrading Channel

A midterm (3 months) upward sloping trading channel exists with thehighs and lows -> midterm very bullish

TrendShort Term UpwardSloping TradingChannel

A short term (1 month) upward sloping trading channel exists with thehighs and lows ->short term very bullish

TrendLong TermDownward SlopingTrading Channel

A long term (6 months) downward sloping trading channel exists withthe highs and lows ->long term very bearish

TrendIntermediate TermDownward SlopingTrading Channel

A midterm (3 months) downward sloping trading channel exists withthe highs and lows -> midterm very bearish

TrendShort TermDownward SlopingTrading Channel

A short term (1 month) downward sloping trading channel exists withthe highs and lows ->short term very bearish

TrendLong Term BullishBreakout

A long term (6 months) downward trend in the highs has been broken->Long term bullish

Trend

Intermediate Term

Bullish Breakout

A midterm (3 months) downward trend in the highs has been broken-

>Midterm bullish




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TrendShort Term BullishBreakout

A midterm (1 month) downward trend in the highs has been broken->Short term bullish

TrendLong Term BearishBreakout

A long term (6 months) upward trend in the lows has been broken->Long term very bearish

TrendIntermediate TermBearish Breakout

A midterm (3 months) upward trend in the lows has been broken->Midterm very bearish

TrendShort Term BearishBreakout

A short term (1 month) upward trend in the lows has been broken->Short term very bearish

PATTERNS.

Rectangles (Trading Ranges)

Rectangle patterns contain the up and down wiggles of a sideways moving market.

All chart patterns are derivatives of this basic trading range. Some have steady

support levels but falling resistance levels over time. Others show support and

resistance levels converging, forming a pennant shape. But no matter what the shape,

all patterns are the same in that the stock is moving sideways rather than trending

higher or lower, and breakouts above or below these patterns tell us that either

demand or supply, respectively, has taken control.

The bottom line is that patterns and trends on charts yield clues as to the relationship

between bulls and bears and when that relationship changes. We do not have to know

why it changed other than it did change, and when we can identify it we can takeappropriate action – either buy, sell or hold.

Triangles

This type of continuation pattern has converging lines of support and resistance. Many

analysts refer to triangles as ―coils‖ because the trading action gets tighter and tighter,

storing energy until the market breaks out with great force. The breakout usually, but

not always, occurs in the direction of the original trend.




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A long-term chart of Google shows a very clear series of rising bottoms and falling

tops to create a triangle shape (see Chart above). Each swing higher and lower within

the pattern is marked with increased uncertainly as both bulls and bears lose

conviction. Bulls are taking short-term profits sooner and sooner on each rally and,

conversely, bears are covering their short positions sooner on each decline. The

market is waiting for something to unleash the energy building in this coiling action

and in September 2006, Google finally got that spark. The rally from the breakout

point was swift.

FlagsThe most common of the continuation patterns is called a flag because it resembles a

flag flying on a flagpole. When a market is trending higher, it is more common for it

to slowly give back some of those gains as the bulls take some profits. Since traders

do not all do this at the same time, the market displays a small counter trend lower as

more of them take their profits. When this is over, the market generally breaks out in

the direction of the original trend as the bulls take over again.




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Goldman Sachs was participating in the broad market rally that began in March 2003

(see Chart above). In late April, it settled into a corrective decline that was relatively

shallow and orderly. Lower highs and lower lows formed the pattern and when pricesmoved above the upper border, the rally resumed. The correction was over.

REVERSAL PATTERNS

The Head and Shoulders

The head and shoulders is the best known and probably the most reliable of the

reversal patterns. A head and shoulders top is characterized by three prominent market

peaks. The middle peak, or the head, is higher than the two surrounding peaks (the

shoulders). A trend line (the neckline) is drawn below the two intervening reaction

lows. A close below the neckline completes the pattern and signals an important

market reversal (See Figure below). Price objectives or targets can be determined by

measuring the shapes of the various price patterns. The measuring technique in a

topping pattern is to measure the vertical distance from the top of the head to the

neckline and to project the distance downward from the point where the neckline is

broken. The head and shoulders bottom is the same as the top except that it is turned

upside down.




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Double and Triple Tops and Bottoms

Another one of the reversal patterns, the triple top or bottom, is a variation of the head

and shoulders. The only difference is bottom is that the three peaks or troughs in this

pattern occur at about the same level.

Triple tops or bottoms and the head and shoulders reversal pattern are interpreted in

similar fashion and mean essentially the same thing. Double tops and bottoms (also

called M’s and W’s because of their shape) show two prominent peaks or troughs

instead of three. A double top is identified by two prominent peaks. The inability of

the second peak to move above the first peak is the first sign of weakness. When

prices then decline and move under the middle trough, the double top is completed.

The measuring technique for the double top is also based on the height of the pattern.

The height of the pattern is measured and projected downward from the point where

the trough is broken. The double bottom is the mirror image of the top

Saucers and Spikes

These two patterns aren’t as common, but are seen enough to warrant discussion. The

spike top (also called a V-reversal) pictures a sudden change in trend. What

distinguishes the spike from the other reversal patterns is the absence of a transition

period, which is sideways price action on the chart constituting topping or bottoming

activity. This type of pattern marks a dramatic change in trend with little or no

warning.

The saucer, by contrast, reveals an unusually slow shift in trend. Most often seen at

bottoms, the saucer pattern represents a slow and more gradual change in trend from




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down to up. The chart picture resembles a saucer or rounding bottom — hence its

name.




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MOVING AVERAGES

Moving averages are one of the oldest and most popular technical analysis tools. This

chapter describes the basic calculation and interpretation of moving averages. A

moving average is the average price of a security at a given time. When calculating a

moving average, you specify the time span to calculate the average price (e.g., 25

days).

A "simple" moving average is calculated by adding the security's prices for the most

recent "n" time periods and then dividing by "n." For example, adding the closingprices of a security for most recent 25 days and then dividing by 25. The result is the

security's average price over the last 25 days. This calculation is done for each period

in the chart.

Since the moving average in this chart is the average price of the security over the last

25 days, it represents the consensus of investor expectations over the last 25 days. If

the security's price is above its moving average, it means that investor's current

expectations (i.e., the current price) are higher than their average expectations over the

last 25 days, and that investors are becoming increasingly bullish on the security.

Conversely, if today's price is below its moving average, it shows that current

expectations are below average expectations over the last 25 days.




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The classic interpretation of a moving average is to use it to observe changes in

prices. Investors typically buy when a security's price rises above its moving average

and sell when the price falls below its moving average.

Time periods in moving averages

"Buy" arrows were drawn on the chart in Figure below when Aflac's price rose above

its 200-day moving average; "sell" arrows were drawn when Aflac's price fell below

its 200-day moving average.

Long-term trends are often isolated using a 200-day moving average. You can also

use computer software to automatically determine the optimum number of time

periods. Ignoring commissions, higher profits are usually found using shorter moving

averages.

Merits

The merit of this type of moving average system (i.e., buying and selling when prices

penetrate their moving average) is that you will always be on the "right" side of the

market--prices cannot rise very much without the price rising above its average price.

The disadvantage is that one will always buy and sell late. If the trend doesn't last for

a significant period of time, typically twice the length of the moving average, one will

lose money.




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There are five popular types of moving averages: simple (also referred to as

arithmetic), exponential, triangular, variable, and weighted. Moving averages can be

calculated on any data series including a security's open, high, low, close, volume, or

another indicator. A moving average of another moving average is also common.

The only significant difference between the various types of moving averages is the

weight assigned to the most recent data. Simple moving averages apply equal weight

to the prices. Exponential and weighted averages apply more weight to recent prices.

Triangular averages apply more weight to prices in the middle of the time period. And

variable moving averages change the weighting based on the volatility of prices.

Exponential Moving Average

An Exponential Moving Average (EMA) takes a percentage of today's price and adds

in the prior day's exponential moving average times 1 minus that percentage. For

instance, to calculate a 10% EMA, take today's price and multiply it by 10% then add

that figure to the prior day's EMA multiplied by the remaining percent:

(today's close * .10) + (yesterday's exponential moving average * (1-.10))

Because most people think in terms of days (time periods) versus percentages, the

following formula can be used to determine the percentage to be used in the

calculation:

Exponential Percentage = 2 /(Time Periods + 1).




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For a 20 period EMA you would use 9.52% (2/(20+1)) as your percentage for the

calculation. By nature of its calculation, the EMA gives more weight to the recent

periods.

Weighted Moving Average

The theory behind a weighted moving average (WMA) is that the recent data is more

relevant than past data. Therefore, it puts more "weight" on the recent data and less

weight on the older data. To calculate it, take the number of periods to analyze and

that becomes the weight for today's price. Yesterday's price would use today's weight

-1 and so on and so forth for the number of periods. Then divide the sum of the

weighted prices by the sum of the weights.

For example, suppose we took the last five "grades" we used in our first example and

calculated a 5-period WMA. The calculation would be as follows:

Calculation of a Weighted Moving Average. The number of periods (in

this case 5) becomes the "weight" for today. The weight for the

remaining days is reduced by 1 until the last day is found. Therefore,

the most recent period gets the highest weight and the oldest periodgets the smallest. The summed weighted prices are then divided by

the sum of the weights

Comparing the EMA,WMA and Simple Moving Averages

The simple moving average gives equal weight to all data points. By nature, it is the

"true" average. The exponential and weighted moving averages give the most recent




29

data points the highest rankings or "weightings". Therefore, the simple moving

average tends to lag (by representing all data points equally) the exponential and

weighted moving averages during large price changes. However, during "normal" or

"flat" markets the differences become negligible. This is illustrated in figure below.

March 2000 Bonds with 50-day Simple, Exponential and Weighted Moving

Averages. Notice during "normal" or "flat" markets the averages tend to run

together (a). However, once the market begins to make sharp moves (b) and

(c) the EMA and WMA tends to catch up to price faster while the SimpleMoving Average tends to lag.

Which One to Use?

Deciding between the types of moving averages really becomes a matter of personal

preference. Normally when you hear talk of moving averages, in the media it

normally refers to simple moving averages. Therefore, due to widespread focus on

these numbers, it's important to give them consideration. The 50- and 200-day

(simple) moving averages are most commonly used here. As a trader, especially

during large price moves, you might consider experimenting with exponential or

weighted moving averages.




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INDICATORS AND OSCILLATORS

Indicators are calculations based on the price and the volume of a security that

measure such things as money flow, trends, volatility and momentum. Indicators areused as a secondary measure to the actual price movements and add additional

information to the analysis of securities. Indicators are used in two main ways: to

confirm price movement and the quality of chart patterns, and to form buy and sell

signals.

There are two main types of indicators: leading and lagging. A leading indicator

precedes price movements, giving them a predictive quality, while a lagging indicator

is a confirmation tool because it follows price movement. A leading indicator is

thought to be the strongest during periods of sideways or non-trending trading ranges,

while the lagging indicators are still useful during trending periods.

There are also two types of indicator constructions: those that fall in a bounded range

and those that do not. The ones that are bound within a range are called oscillators -

these are the most common type of indicators. Oscillator indicators have a range, for

example between zero and 100, and signal periods where the security is overbought

(near 100) or oversold (near zero). Non-bounded indicators form buy and sell signals

along with displaying strength or weakness, but they vary in the way they do this.

The two main ways that indicators are used to form buy and sell signals in technical

analysis is through crossovers and divergence. Crossovers are the most popular and

are reflected when either the price moves through the moving average, or when two

different moving averages cross over each other.

The second way indicators are used is through divergence, which happens when

the direction of the price trend and the direction of the indicator trend are moving

in the opposite direction. This signals to indicator users that the direction of the

price trend is weakening.

Indicators that are used in technical analysis provide an extremely useful source of

additional information. These indicators help identify momentum, trends,

volatility and various other aspects in a security to aid in the technical analysis of

trends. It is important to note that while some traders use a single indicator solely

for buy and sell signals, they are best used in conjunction with price movement,

chart patterns and other indicators.




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Indicators used in Technical Analysis

Accumulation/Distribution Line - Combines price and volume to show how money may be

flowing into or out of a stock.

Aroon - Shows whether a stock is trending or oscillating.

Average Directional Index (ADX) - Shows whether a stock is trending or oscillating.

Average True Range (ATR) - Measures a stock's volatility.

Bollinger Bands %B - Shows the relationship between price and Bollinger Bands.

Bollinger Bandwidth - Shows the distance between the upper band and the lower band. .

Commodity Channel Index (CCI) - Shows a stock's variation from its 'typical' price.

Chaikin Money Flow (CMF) - Combines price and volume to show how money may be

flowing into or out of a stock. Alternative to Accumulation/Distribution Line.

Chaikin Oscillator - Combines price and volume to show how money may be flowing into or

out of a stock. Based on Accumulation/Distribution Line.

Detrended Price Oscillator (DPO) - A price oscillator that uses a displaced moving average to

identify cycles.

Force Index - A simple price-and-volume oscillator.

MACD - A momentum oscillator based on the difference between two EMAs.

MACD-Histogram - A momentum oscillator that shows the difference between MACD and its

signal line.

Money Flow Index (MFI) - Combines a stock's 'typical' price with its volume to show how

money may be flowing into or out of the stock.

On Balance Volume (OBV) - Combines price and volume in a very simple way to show how

money may be flowing into or out of a stock.

Percentage Price Oscillator (PPO) - A percentage-based version of the MACD indicator.

Percentage Volume Oscillator (PVO) - The PPO indicator applied to volume instead of price.

Price Relative - Technical indicator that compares the performance of two stocks to each other

by dividing their price data.

Rabbitt Q-Rank - Paul Rabbit's proprietary indicator that rates a stock based on technical and

fundamental factors. Rate of Change (ROC) - Shows the speed at which a stock's price is changing.

Relative Strength Index (RSI) - Shows how strongly a stock is moving in its current direction.

Slope - Measures the rise-over-run for a linear regression.

Standard Deviation (Volatility) - A statistical measure of a stock's volatility.

Stochastic Oscillator - Shows how a stock's price is doing relative to past movements. Fast,

Slow and Full Stochastics are explained.

StochRSI - Combines Stochastics with the RSI indicator. Helps one see RSI changes more

clearly.

TRIX - A triple-smoothed moving average of price movements.




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Ultimate Oscillator - Combines long-term, mid-term and short-term moving averages into one

number.

Williams %R - Uses Stochastics to determine overbought and oversold levels.

Market Indicators

Arms Index (TRIN) - A breadth indicator derived from the AD Ratio and AD Volume Ratio.

Advance-Decline Line - A cumulative breadth indicator derived from Net Advances.

Advance-Decline Volume Line - A cumulative breadth indicator derived from Net Advancing

Volume.

Bullish Percent Index - A breadth indicator derived from the percentage of stocks on PnF buy

signals.

High-Low Index - A breadth indicator that shows new highs as a percentage of new highs plusnew lows.

McClellan Oscillator - A MACD type oscillator of Net Advances.

McClellan Summation Index - A cumulative indicator based on the McClellan Oscillator.

Net New Highs - A breadth indicator showing the difference between new highs and new

lows. Percentage, cumulative and smoothed versions can be used.

Percent Above Moving Average - A breadth oscillator that measure the percentage of stocks

above a specific moving average.

Put Call Ratio - A sentiment indicator found by dividing put volume by call volume.

Record High Percent - A 10-day moving average of the High-Low Index, which is a breadth

indicator.

Volatility Indices - Indicators of implied volatility designed to measure fear and complacency

for a range of indices and ETFs.

Important Indicators

Accumulation/Distribution Line

The accumulation/distribution line is one of the popular volume indicators that

measures money flows in a security. This indicator attempts to measure the ratio of

buying to selling by comparing the price movement of a period to the volume of that

period.




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Calculated as:

Acc/Dist = ((Close - Low) - (High - Close)) / (High - Low) * Period's Volume

This is a non-bounded indicator that simply keeps a running sum over the period of

the security. Traders look for trends in this indicator to gain insight on the amount of

purchasing compared to selling of a security. If a security has an

accumulation/distribution line that is trending upward, it is a sign that there is more

buying than selling.

Average Directional Index

The average directional index (ADX) is a trend indicator that is used to measure the

strength of a current trend. The indicator is seldom used to identify the direction of the

current trend, but can identify the momentum behind trends.

The ADX is a combination of two price movement measures: the positive directional

indicator (+DI) and the negative directional indicator (-DI). The ADX measures the

strength of a trend but not the direction. The +DI measures the strength of the upward

trend while the -DI measures the strength of the downward trend. These two measures

are also plotted along with the ADX line. Measured on a scale between zero and 100,

readings below 20 signal a weak trend while readings above 40 signal a strong trend.

Aroon

The Aroon indicator is a relatively new technical indicator that was created in 1995.

The Aroon is a trending indicator used to measure whether a security is in an uptrendor downtrend and the magnitude of that trend. The indicator is also used to predict

when a new trend is beginning.

The indicator is comprised of two lines, an "Aroon up" line (blue line) and an "Aroon

down" line (red dotted line). The Aroon up line measures the amount of time it has

been since the highest price during the time period. The Aroon down line, on the other

hand, measures the amount of time since the lowest price during the time period. The

number of periods that are used in the calculation is dependent on the time frame that

the user wants to analyze.




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Aroon Oscillator

An expansion of the Aroon is the Aroon oscillator, which simply plots the difference

between the Aroon up and down lines by subtracting the two lines. This line is then

plotted between a range of -100 and 100. The centerline at zero in the oscillator is

considered to be a major signal line determining the trend. The higher the value of the

oscillator from the centerline point, the more upward strength there is in the security;

the lower the oscillator's value is from the centerline, the more downward pressure. A

trend reversal is signaled when the oscillator crosses through the centerline. For

example, when the oscillator goes from positive to negative, a downward trend is

confirmed. Divergence is also used in the oscillator to predict trend reversals. A

reversal warning is formed when the oscillator and the price trend are moving in an

opposite direction.

The Aroon lines and Aroon oscillators are fairly simple concepts to understand but

yield powerful information about trends. This is another great indicator to add to any

technical trader's arsenal.




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Moving Average Convergence Divergence

The moving average convergence divergence (MACD) is one of the most well known

and used indicators in technical analysis. This indicator is comprised of two

exponential moving averages, which help to measure momentum in the security. The

MACD is simply the difference between these two moving averages plotted against a

centerline. The centerline is the point at which the two moving averages are equal.

Along with the MACD and the centerline, an exponential moving average of the

MACD itself is plotted on the chart. The idea behind this momentum indicator is to

measure short-term momentum compared to longer term momentum to help signal the

current direction of momentum.

MACD= shorter term moving average - longer term moving average

When the MACD is positive, it signals that the shorter term moving average is above

the longer term moving average and suggests upward momentum. The opposite holds

true when the MACD is negative - this signals that the shorter term is below the

longer and suggest downward momentum. When the MACD line crosses over the

centerline, it signals a crossing in the moving averages. The most common moving

average values used in the calculation are the 26-day and 12-day exponential moving

averages. The signal line is commonly created by using a nine-day exponential

moving average of the MACD values. These values can be adjusted to meet the needs

of the technician and the security. For more volatile securities, shorter term averages

are used while less volatile securities should have longer averages.

Another aspect to the MACD indicator that is often found on charts is the MACD

histogram. The histogram is plotted on the centerline and represented by bars. Each

bar is the difference between the MACD and the signal line or, in most cases, the

nine-day exponential moving average. The higher the bars are in either direction, the

more momentum behind the direction in which the bars point.

As you can see in Figure below, one of the most common buy signals is generated

when the MACD crosses above the signal line (blue dotted line), while sell signals

often occur when the MACD crosses below the signal.




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MACD Top Bearish DivergenceIncreasing highs but decreasing macds for last two tops->shortterm bearish

MACD top Bullish DivergenceDecreasing highs but increasing macds for last two tops->shortterm bullish

MACDBottom BullishDivergence

Decreasing lows but increasing macds for last two bottoms->shortterm bullish

MACDBottom Bearish

Divergence

Increasing lows but decreasing macds for last two bottoms->short

term bearish

MACDBullish MACD Crossoverat Center

The MACD fastline has crossed over the MACD smoothed line atcenter->short term very bullish

MACDBearish MACD Crossoverat Center

The MACD fastline has crossed below the MACD smoothed lineat center->short term very bearish

MACD Bullish MACD CrossoverThe MACD fastline has crossed over the MACD smoothed line ->short term bullish

MACDBearish MACD Crossoverat Center

The MACD fastline has crossed below the MACD smoothed line ->short term bearish

Relative Strength Index

The relative strength index (RSI) is another one of the most used and well-known

momentum indicators in technical analysis. RSI helps to signal overbought and

oversold conditions in a security. The indicator is plotted in a range between zero and

100. A reading above 70 is used to suggest that a security is overbought, while a

reading below 30 is used to suggest that it is oversold. This indicator helps traders to

identify whether a security’s price has been unreasonably pushed to current levels and

whether a reversal may be on the way.




37

The standard calculation for RSI uses 14 trading days as the basis, which can be

adjusted to meet the needs of the user. If the trading period is adjusted to use fewer

days, the RSI will be more volatile and will be used for shorter term trades.

RSI RSI Bullish Crossover RSI has crossed over 50 ->short term bullish

RSI RSI Bearish Crossover RSI has crossed below 50->short term bearish

RSIRSI Over BoughtBuried

The RSI has been above 70 for a minimum of 3 trading sessions->shortterm bullish

RSI RSI Over Sold BuriedThe RSI has been below 30 for a minimum of 3 trading sessions->shortterm bearish

RSI RSI Over Sold The RSI is above 65 but not buried->short term bearish

RSI RSI Over Bought The RSI is below 25 but not buried->short term bullish

On-Balance Volume

The on-balance volume (OBV) indicator is a well-known technical indicator that

reflect movements in volume. It is also one of the simplest volume indicators to

compute and understand.

The OBV is calculated by taking the total volume for the trading period and assigning

it a positive or negative value depending on whether the price is up or down during

the trading period. When price is up during the trading period, the volume is assigned

a positive value, while a negative value is assigned when the price is down for the

period. The positive or negative volume total for the period is then added to a total

that is accumulated from the start of the measure.

It is important to focus on the trend in the OBV - this is more important than the

actual value of the OBV measure. This measure expands on the basic volume measure

by combining volume and price movement.




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Stochastic Oscillator

The stochastic oscillator is one of the most recognized momentum indicators used in

technical analysis. The idea behind this indicator is that in an uptrend, the price should

be closing near the highs of the trading range, signaling upward momentum in the

security. In downtrends should be closing near the lows of the trading range, signaling

downward momentum, the price

The stochastic oscillator is plotted within a range of zero and 100 and signals

overbought conditions above 80 and oversold conditions below 20. The stochastic

oscillator contains two lines. The first line is the %K, which is essentially the raw

measure used to formulate the idea of momentum behind the oscillator. The second

line is the %D, which is simply a moving average of the %K. The %D line isconsidered to be the more important of the two lines as it is seen to produce better

signals. The stochastic oscillator generally uses the past 14 trading periods in its

calculation but can be adjusted to meet the needs of the user.

StochStochastic Overbought

Buried

The fast stochastic is above 80 and has averaged above 80 for the past

5 trading sessions->short term bullish

StochStochastic OversoldBuried

The fast stochastic is below 20 and has averaged below 20 for the past5 trading sessions->short term bearish

StochStochastic OverboughtReversal

The stochastic has fallen below 80 after being buried ->short termbearish

StochStochastic OversoldReversal

The stochastic has crossed above 20 after being buried ->short termbullish




39

OVERLAYS

Bollinger Bands - A chart overlay that shows the upper and lower limits of 'normal' price

movements based on the Standard Deviation of prices.

Ichimoku Clouds - A comprehensive indicator that defines support and resistance, identifies

trend direction, gauges momentum and provides trading signals.

Keltner Channels - A chart overlay that shows upper and lower limits for price movements

based on the Average True Range of prices.

Moving Averages - Chart overlays that show the 'average' value over time. Both Simple

Moving Averages (SMAs) and Exponential Moving Averages (EMAs) are explained.

Moving Average Envelopes - A chart overlay consisting of a channel formed from simple

moving averages.

Parabolic SAR - A chart overlay that shows reversal points below prices in an uptrend and

above prices in a downtrend.

Price Channels - A chart overlay that shows a channel made from the highest high and lowest

low for a given period of time.

Volume by Price - A chart overlay with a horizontal histogram showing the amount of activity

at various price levels.

Volume-weighted Average Price (VWAP) - An intraday indicator based on total dollar value of

all trades for the current day divided by the total trading volume for the current day.

ZigZag - A chart overlay that shows filtered price movements that are greater than a given

percentage.

Bollinger bands

Bollinger bands consist of a center line and two price channels (bands) above and

below it. The center line is an exponential moving average; the price channels are the

standard deviations of the stock being studied. The bands will expand and contract asthe price action of an issue becomes volatile (expansion) or becomes bound into a

tight trading pattern (contraction).

A stock may trade for long periods in a trend, albeit with some volatility from time to

time. To better see the trend, traders use the moving average to filter the price action.

This way, traders can gather important information about how the market is trading.

For example, after a sharp rise or fall in the trend, the market may consolidate, trading

in a narrow fashion and criss-crossing above and below the moving average. To better




40

monitor this behavior, traders use the price channels, which encompass the trading

activity around the trend.

We know that markets trade erratically on a daily basis even though they are still

trading in an uptrend or downtrend. Technicians use moving averages with support

and resistance lines to anticipate the price action of a stock. Upper resistance and

lower support lines are first drawn and then extrapolated to form channels within

which the trader expects prices to be contained. Some traders draw straight lines

connecting either tops or bottoms of prices to identify the upper or lower price

extremes, respectively, and then add parallel lines to define the channel within which

the prices should move. As long as prices do not move out of this channel, the trader

can be reasonably confident that prices are moving as expected.

When stock prices continually touch the upper Bollinger band, the prices are thought

to be overbought; conversely, when they continually touch the lower band, prices are

thought to be oversold, triggering a buy signal.

When using Bollinger bands, designate the upper and lower bands as price targets. If

the price deflects off the lower band and crosses above the 20-day average (the middle

line), the upper band comes to represent the upper price target. In a strong uptrend,

prices usually fluctuate between the upper band and the 20-day moving average.

When that happens, a crossing below the 20-day moving average warns of a trend

reversal to the downside.

While every strategy has its drawbacks, Bollinger bands have become one of the most

useful and commonly used tools in spotlighting extreme short-term prices in a

security. Buying when stock prices cross below the lower Bollinger band often helps

traders take advantage of oversold conditions and profit when the stock price moves

back up toward the center moving-average line.

You can see in this chart of American Express (NYSE:AXP) from the start of 2008 that for the most part,the price action was touching the lower band and the stock price fell from the $60 level in the dead of




41

winter to its March position of around $10. In a couple of instances, the price action cut through the centerline (March to May and again in July and August), but for many traders, this was certainly not a buy signalas the trend had not been broken

In the 2001 chart of Microsoft Corporation (Nasdaq:MSFT) (above), you can see the trend reversed to an uptrend in the early part of January,

but look how slow it was in showing the trend change. Before the price action crossed over the center line, the stock price had moved from $20

to $24 and then on to between $24 and $25 before some traders would have confirmation of this trend reversal.

Parabolic SAR (SAR - stop and reverse) is a method used to find trends in marketprices or securities. It may be used as a trailing stop loss based on prices tending to

stay within a parabolic curve during a strong trend.

The concept draws on the idea that time is the enemy (similar to option theory's

concept of time decay), and unless a security can continue to generate more profits

over time, it should be liquidated. The indicator generally works well in trending

markets, but provides "whipsaws" during non-trending, sideways phases; as such, it is

recommended establishing the strength and direction of the trend first through the use




42

of things such as the Average Directional Index, and then using the Parabolic SAR to

trade that trend.

A parabola below the price is generally bullish, while a parabola above is generally

bearish.




43

TECHNICAL ANALYSIS IN PRACTICE.

Above chart shows use of trends, indicators, overlays for technical analysis




44

REAL LIFE PREDICTION AND OUTCOMES

Application of technical analysis in real life situation is taken up as follows.

Predictions by technical experts were taken up from Economic time archives e-paper. Relevant technical charts were prepared using tools in websites like

www.moneycontrol.com and www.in.finance.yahoo.com as well as using the

Microsoft Excel Add In analyzer Trend Analyzer XL.

Charts are plotted using these tools till the date or range of prediction. About 25

cases were studied. The success rate of predictions was seen to be less than 50%.

This is attributed to the abnormal market reactions. Technical analysis works on

past history. It cannot take care of government policy changes in interest rates,

taxation etc. International markets and commodities also cause sudden variation in

pricing. Unexpected financial results of companies also changes trends.

Trend Analyzer in Action

http://www.moneycontrol.com/

http://www.in.finance.yahoo.com/



http://www.moneycontrol.com/




46

Date 3rd July 2010

The Axis bank case is again taken after two months when the RSI and MACD startedturning positive. This was clear buy call and the ramp up in July shows that theanalysis was correct.




47

Date 1st July 2010

From mid July onwards the scrip was trading way above 50 day EMA and this isstrong indication to buy. The ramp that followed led to nearly 33% growth.




48

Date 3nd September 2010

High volumes along with sideways consolidation for long period was the indicationfor the ramp up which turned out to be correct




49

Head and shoulder pattern formation is a good indicator which proved correct in thiscase.




50

Here we see that the stochastic oscillator provided with good buy calls in the SBI

growth line. Also the stock kept trading at levels above 200 day EMA which showsgreater demand




51

This is a 10 year chart. High volumes of SBI cause SBI shares to be overbought oroversold. This is why the RSI oscillators keep swinging above and below the 70% and30% line continuously. When the MACD rises dramatically - that is, the shortermoving average pulls away from the longer-term moving average - it is a signal thatthe security is overbought and will soon return to normal levels.




52

In the six month period the strong reversal patters are brought out by MACD and RSIalong with spurts in volume.




53

Again the huge volumes show the crowd behaviour and overbuying and selling in themarket in the 10 year period of reliance.




54

Tools Used

AnalyzerXL is a library of 165 technical analysis functions, indicators and experts in

the form of Microsoft Excel formulas. The AnalyzerXL Wizard makes it easy to

implement a new function and simplifies the creation of trading systems. It is also

easy to create charts from functions with numeric outputs - just click the Chart icon

and select the type of chart one wish to create.

Types of Functions

An indicator is used to determine the trend of a market, the strength of the market

and the direction of the market. An expert is a stock market system such as Bill

Williams' Profitunity. Expert functions produce special outputs, such as Buy/Sell

signals, trend directions and more.

Types of Outputs

All functions are categorized by the type of output they produce. There are two types

of outputs: Formulas and Values. Formulas are automatically re-calculated when

one change input data, whereas Values remain the same. With Formulas, one do not

need to re-enter range references or function parameters when one update data.

Macros

For functions that output Values, AnalyzerXL provides a macro-building feature to

improve the updating process. These macros can easily be called when one update

oner data. There are two types of macros: Local and Global. Local macros can only

be called from the workbook in which they were created, whereas Global macros can

be called from any workbook.

Key features summary:

165 technical analysis functions, indicators, and experts

Built-in charts for more accurate analysis

Macro creation and management




55

SELECTION OF INDICATORS/OSCILLATORS/OVERLAYS

A good rule of thumb is to restrict technical analysis to stocks that trade at least

100,000 shares per day so that there is a liquid market for the stock.

1) Objective: Every indicator has its own special feature and while choosing

which one to use, one should be very clear about the objective. Let’s For eg: to

identify whether the market is consolidating or trending, the Bollinger Bands is a

good choice as the width of the band will be able to tell one the answer.

But for an entry decision while scalping the market, one may need the help of

parabolic SAR. In short one need different tools for different strategy.

2) Variety: Some indicators like the Relative Strength Index (RSI), Stochastic and

Commodity Channel Index (CCI) are oscillating in nature. They are able to tell

whether the market is overbought or oversold. Therefore there is no point in

having a RSI and a CCI together in one chart as they are of the same nature.

A mix of indicators with different ability is used so that one can tell more things

from them when doing my analysis.

3) Quantity: Some traders tend to use a lot of indicators as they believe that it can

help them to have a better understanding of the market. In contrast, these traders

usually have difficulties in getting into a trade as it is very hard for all the

indicators to give them the same entry signal at the same time.

Therefore stick to a maximum of 3 indicators for trading if one is able to get the same

signal from them, one can enter my trade.

When technical tools are used judiciously, their value cannot be overstated. And every

time one apply a tool of technical analysis, one is calculating a consensus of

bullishness or bearishness among all market participants.

For example, the moving average convergence-divergence (MACD) is simply a tool

that measures shifts in consensus from bullishness to bearishness, and vice versa.

Extending the basic MACD to a deeper level, we find the MACD-histogram, which isactually a tool for determining the difference between long-term and short-term




56

consensus of value. The measure tracks the difference between the fast MACD line

(short-term consensus) and the slow signal line (longer-term consensus).

The principles of market psychology underlie each and every technical indicator, so a

good understanding of crowd behavior is crucial to the understanding of the

fundamentals of particular technical indicators. How market psychology drives these

individual tools is described below.

The Directional System

The directional system (which one can read about in Directional Movement) was

developed by J. Welles Wilder, Jr., as a means of identifying trends that are strong

enough to be valid and useful indicators for traders. Directional lines are constructedto determine whether trends are bullish or bearish: when a positive directional line is

above the negative line, bullish traders possess greater strength (and a bullish signal is

given). The opposite situation indicates bearishness. More telling is the average

directional indicator (ADX), which rises when the spread between the positive and

negative lines increases. When the ADX rises, winners are getting ever stronger, and

losers are getting weaker; furthermore, the trend is likely to continue.

Momentum and Rate of Change (RoC)

Momentum indicators measure (which one can read about in Rate of Change) changes

in mass optimism or pessimism by comparing today's consensus of value (price) to an

earlier consensus of value. Momentum and RoC are specific measures against which

actual prices are compared: when prices rise but momentum or rate of change falls, a

top is likely near. If prices reach a new high but momentum or RoC reach a lower top,

a sell signal is realized. These rules also apply in the opposite situation, when prices

fall or new lows are reached.

Smoothed Rate of Change

The smoothed rate of change compares today's exponential moving average (average

consensus) to the average consensus of some point in the past. The smoothed rate of

change is simply an enhanced version of the RoC momentum indicator - it is intended

to alleviate the RoC's potential for errors in determining the market's attitude of

bullishness or bearishness.




57

Williams %R (Wm%R)

Wm%R, a measure focusing on closing prices, compares each day's closing price to a

recent consensus range of value (range of closing prices). If, on a particular day, bulls

are able to push the market to the top of its recent range, Wm%R issues a bullish

signal; and a bearish signal is issued if bears are able to push the market to the bottom

of its range.

Stochastics

Similar to Wm%R, stochastics measure closing prices against a range. If bulls push

prices up during the day but cannot achieve a close near the top of the range,stochastic turns down and a sell signal is issued. The same also holds true if bears

push prices down but cannot achieve a close near the low, in which case a buy signal

is issued.

Relative Strength Index (RSI)

RSI measures market psychology also in a fundamentally similar way to that of

Wm%R. RSI is almost always measured with a computer, typically over a seven or

nine-day range, producing a numerical result between 0 to 100 that points to oversold

or overbought situations; the RSI therefore gives a bullish or bearish signals

respectively.

Volume

The total volume of shares traded is also an excellent way in which to ascertain the

psychology of the market. Volume is actually a measure of investors' emotional state:

while a burst of volume will cause sudden pain in losers and immediate elation in

winners, low volume will likely not result in a significant emotional response.

The longest lasting trends generally occur where emotion is the lowest. When volume

is moderate and both shorts and longs do not experience the roller coaster ride of

emotion, the trend can reasonably be expected to continue until the emotion of the

market changes. In a longer-term trend such as this, small price changes either up or

down do not precipitate much emotion, and even a series of small changes occurring




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day-after-day (enough to create a major, gradual trend) will generally not generate

severe emotional reactions. This is a classic example of how traders are lulled into a

feeling of complacency - small losses (even a series of small daily or weekly losses)

do not feel particularly devastating; but the series of small losses will, in a few weeks

or months, aggregate into one very large loss.

Volume can be interpreted to predict trend reversals. While moderate and steady

volume point to a sustained gradual trend due to the lack of emotion in the market,

falling volume may indicate that losers have finally thrown in the towel and that the

trend is near its top or bottom. Exceptionally high volume may demonstrate that a

great many losers have given up and are selling at any cost. This is true collectivepsychology at work: amateur traders and investors who are holding losing positions

typically reach their breaking point at roughly the same time. A huge burst of volume

in a declining market may indicate that even the most patient stalwarts have raised the

white flag, which is a classic signal that the bottom is high.

In the case of short selling, a market rally may serve to flush out those individuals

holding short positions, causing them to cover and subsequently push the market

higher. The same principle holds true on the flip side: when the longs give up and bail

out, the decline pulls more losers with it (even the most resilient loser reaches his

breaking point). At the most fundamental level of market volume, both short and long

losers who collectively exit their positions are the primary drivers behind significant

volume trends.

Believe it or not, the preceding indicators are only a few basic examples of how

market psychology is measured. There are a great number of additional indicators

used in trading rooms everywhere, not to mention a near-infinite selection of

variations and refinements possible.




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STEPS IN TECHNICAL ANALYSIS

Now that we have the theory and the tools, let’s look at the process of going from a

stock idea to an actual decision to buy or sell.1. Look at the trend

We want a rising trend or one that is just starting to do so.

2. Find nearby support and resistance levels

We are trying to find stocks where demand exceeds supply and new supply

is not likely to develop soon.

3. Determine if the current trend is healthy

We want prices to be above a relevant moving average, but not so far that

the stock is prone to a snapback decline as profit taking sets in.

4. Check volume and momentum indicators

We need to be sure that they are not fading as the stock price rises: A falling indicator

warns that there might be technical problems before price action sours.

5. Find out if the stock is leading a benchmark

Is the particular stock at least matching the performance of the market and its peers?

Find obvious patterns and trends

Check an indicator or two

Compare current condition to others

As has been said several times already, there are five major categories of tools in a

complete technical toolbox, and novice chartists need only to have a basic

understanding of what they do.

The three basic goals of the tools

1. Seeing where the stock is currently trading and figuring out how it got there

This is where we explore charting tools such as:

• stock trends,

•support levels (that point at which a stock is trading at which demand is thought to be

strong enough to prevent the price from declining further), and

•resistance levels (that price at which selling is thought to be strong enough to prevent

the price from rising further).




60

We’ll also try to find a pattern or a trend to help.

2. Determining the power of a trend

This is also where we can find signs of an imminent end of a trend. For that, we will

look at important technical concepts such as trading volume and momentum.

3. Making comparisons of the stock to the market, its peers in its own industry and

even to its own history

This is where we look at relative performance and moving averages. We have not

covered relative performance of a stock to its industry group yet, but it is simpleenough to cover directly here.

If we know how fast a stock is moving, how much power is behind it and how it

stacks up to the market, then we’ll gain a huge advantage over other investors looking

only at the fundamentals (such as price-to-earnings ratios, return on equity, or

earnings growth).

A solid company with a solid chart is hard to beat.

Checklist for success

In looking at a stock, here is a checklist of key technical tools. Any potential

investment should meet most, but not necessarily all, of these criteria.

Price structure

Trends and trendlines

There is no secret to finding a trend. If prices are generally rising and making higher

highs as well as higher lows, then we have a rising trend. Most charting web sites also

offer the ability to draw trendlines on the chart to clearly define the trend more

objectively. Alternatively, the old-fashioned way of printing the chart and using a

ruler and pencil works just as well. We want stocks that are in rising trends.

Support and resistance

These are terms that simply tell us what price levels are likely to bring out the buyers

(demand) or the sellers (supply), respectively. What we want to see is a current price




61

that has either just moved through resistance (demand overwhelmed supply) or one

that is far from the next resistance level.

Moving averages

Moving averages (or simply price averages) are just average prices over a user-

defined period of time, usually 50 or 200 days. They help us determine if a trend is

turning, as prices cross the averages. They also help us determine if an existing trend

is progressing in an orderly manner, or if it is accelerating in a frenzy. Clearly, we are

looking for prices to be above selected averages but not too far above them.

Relative performance

Relative performance charts simply divide the price of a stock by a relevant market

index or industry group. The theory is that we should buy strong stocks in strongsectors and this is how we find them. If the ratio is going up, then the stock is

outperforming the market or industry and is thus a strong candidate for further gains.

If the ratio is going down, then the stock is lagging and is often more vulnerable to

bad news. We are looking for stocks whose relative performance is increasing.

Volume

The number of shares traded and when those shares trade – either on days when prices

rise or when they fall – can confirm the health of a trend or warn of an impending

change. We are looking to see if buying is spreading to other investors and for

urgency for all to buy when prices start to rise. Fear of missing a good thing causes

these surges.

Momentum

We also want to know if days when the stock rises outnumber those when it falls. Are

the gains on these positive days greater than the losses on negative days? When the

losing days are bigger and more frequent than the winning days we can surmise that

the trend is weakening. We want to know if momentum is strong but not too euphoric.

Sentiment

We’ll just worry about obvious extremes in sentiment, as this portion of the analysis is

tricky even for the pros. Is everybody thinking the same thing? That’s the time to go

the other way. And as some traders will say, sometimes the best trades are the ones

that make you sick as you leave the comfort of the crowd. We want to know if

everyone is thinking the same thing.



CONCLUSIONS

Technical analysis is based on evaluation of past prices and volume traded of the

stock. Followers of technical analysis are known as chartist as they look at the pastprices of the stock and identify patterns and trends. They do so to forecast through the

charts and prices what the stock will do in the future. The methodology involves

studying the supply and demand in the market to attempt what direction or trend will

continue in the future. There are many useful tools that have been developed to help

aid in this process. Most of them are automated and freely available for use.

Technical analysis can be a very valuable tool, but it is important to realize the

benefits as well as the limitations before diving in. Lot of subjectivity is there in

reading of patterns. It cannot take care of future events. However it can give a

scientific reason for the prediction based on current and past positions. There is no

definite answer about whether technical analysis should be used as a substitute to

fundamental analysis, but many agree that it has its merits when used as a compliment

to other investing strategies.

BIBLIOGRAPHY OF REFERENCES

Books:

1. The Technical analysis Course: Thomas A Meyers. Tata McGraw Hill

2. Technical Analysis Tools: March Tinghino, Bloomberg

Websites for data and analysis:

1. http://www.stockta.com

2. http://www.analyzerxl.com

3 http://in finance yahoo com

http://www.stockta.com/


http://www.analyzerxl.com/


http://in.finance.yahoo.com/





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