technical analysis
TRANSCRIPT
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DEFINITION:Technical Analysis is the study of: PRICE. VOLUME. OPEN INTEREST.It is the study of market action through the help of charts and other technical indicatorsso as to forecast the trend.
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ASSUMPTIONS:Current Price of an underlying asset
discounts all information.
Price always moves in trends.
History repeats often.
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DIFFERENCES:FUNDAMENTAL ANALYSIS TECHNICAL ANALYSIS
1. TIME CONSUMING. 1. QUICK STUDY.
2. STUDY OF CAUSE. 2. STUDY OF EFFECT.
3. INTRINSIC VALUE. 3. STUDY OF CHARTS.
4. INCLUDES ECONOMIC, INDUSTRY AND COMPANY ANALYSIS.
5. APPLIED FOR FEW MARKETS UNDER STUDY.
4. PRICE, VOLUME AND OPEN INTEREST ANALYSIS.
5. CAN BE APPLIED TO ANY MARKET AND INSTRUMENT.
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DIFFERENCES IN APPLICABILITY:Technical analysis as applied to stockMarkets is same to even derivative
markets.However the following things shall be
kept In mind:Pricing Structure.Time period.Margin requirements.Timing is everything in futures
market, where buy and hold strategy does not work.
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DOW THEORY: Ideas of Charles Dow, propounded by
NELSON and William P Hamilton. Assumptions of Dow theory:a) The Market indices (Averages) discounts
everything.b) Individual securities generally move
along with the market trend.c) The market has 3 trends, namely:1. Primary Trend. (Major trend).2. Secondary Trend. (Intermediate trend).3. Minor Trend. (Short term trend).
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STUDY OF VARIOUS TRENDS:1. THE PRIMARY OR MAJOR TREND:
Dow compares the major trend to a TIDE, where a major uptrend is represented by patterns of rising peaks and troughs and a downtrend is characterized by lower peaks and troughs.
A MAJOR TREND LASTS FOR MORE THAN AN YEAR OR SEVERAL YEARS.
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PRIMARY TREND:A Bull market is represented by an
Uptrend in the Primary trend and a Bear market is represented by a Downtrend in the Primary Market.
They represent extreme and extensive movements on either side with atleast a 20% change in the price.
A long term investor is concerned only with primary trend reversal and will try to catch the bull or bear market early.
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STUDY OF VARIOUS TRENDS:2. THE SECONDARY OR INTERMEDIATE
TREND: DOW compares the intermediate trend to waves that makeup tides and they
represents correction in the Primary trend.
AN INTERMEDIATE TREND GENERALLY LASTS FOR THREE WEEKS TO THREE MONTHS. THESE INTERMEDIARY CORRECTIONS GENERALLY RETRACES 1/3 OR 1/2 OR 2/3 OF THE PREVIOUS MOVE.
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STUDY OF VARIOUS TRENDS:3. THE MINOR OR SHORT TERM TREND: DOW compares the minor or short term trend to ripples on the waves. Minor trend represents fluctuations in the intermediate trends.
A MINOR TREND GENERALLY LASTS FOR LESS THAN THREE WEEKS.
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FOCUS ON MAJOR TRENDS:Dow suggests to focus on the big picture i.e. to focus on the MAJOR TREND.The major trend consists of three phases Namely:a) ACCUMULATION PHASE.b) PUBLIC PARTICIPATION PHASE.c) DISTRIBUTION PHASE.
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Primary Trend:Accumulation stage is generally caught only
by farsighted investors, technical traders catch the Public participation phase and markets have said to have reached the distribution phase when markets boil with financial good news making the front page. It is also indicated by high speculation stage with cats and dog shares moving with high volumes and price without fundamental backing.
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VOLUME MUST CONFIRM THE TREND!!!
According to DOW, Volume must confirm Uptrend by expanding as Price moves Higher and diminishes with decrease in Price.In a Downtrend, Volume should expand as Price drops and diminish as they rally.
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A trend is said to be at effect until it gives definite signals that it has reversed:
A trend in motion continues to be in motion until any external force causes it to change direction.
Various technical tools help the analyst to identify signals of trend reversals.
A trend before reversing, slows down and then changes direction.
Volume confirmation of a trends direction reversal is to be considered.
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CRITICISMS OF DOW THEORY:
Dow theory generally misses 20% to 25% of a move before generating a signal.
Use of closing prices (Line charts).
Signals in Dow theory are generally generated during the second phase of the uptrend.
It was primarily used as an indicator of Economy which was substituted to stocks and other underlying assets.
Subjectivity and difficulty in distinguishing the various phases of trends.
An investor is more concerned on his investments, rather than just depending upon the movements in market returns.
It may not help a trader following intermediate trend.
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CHART CONSTRUCTION:
Price and Volume data are generally studied by using graphical representations called charts.
Different types of charts include;
a) LINE CHARTS.
b) BAR CHARTS.
c) CANDLE STICKS.
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OPEN INTEREST:
Open Interest is the total number of outstanding future contract that are held by the market participants at the end of the day.
Open interest is the number of outstanding contracts held by the longs or the shorts and not the total of the both.
Generally Volume and Open interests will be small at the early stages of futures contract life and expands as it reaches the maturity period and again drop during close to expiration stage.
For trading purpose, avoid stocks with lower volumes and lower open interest.
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TREND ANALYSIS:
“ALWAYS TRADE IN THE DIRECTION OF THE TREND”
“TREND IS YOUR FRIEND”
“NEVER BUCK THE TREND”
It is the direction of the PEAKS and TROUGHS that constitutes market trend.
A Trend is simply the indicator of the direction of the market.
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TYPES OF TREND:
AN UPTREND.
Series of successive higher peaks and troughs.
A DOWN TREND.
Series of declining peaks and troughs.
SIDEWAYS TREND.
Series of Horizontal peaks and troughs.
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TREND STRATEGY:
In an Uptrend, go LONG (BULLISH).
In a Downtrend, go SHORT (BEARISH).
In a Sideways trend, DO NOTHING.
Trend is classified into 3 categories based on their time period:
a) Major Trend.
b) Intermediate Trend.
c) Minor Trend.
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SUPPORT AND RESISTANCE:
SUPPORT:
It is an area or level on the chart where buying interest is sufficiently strong to overcome selling pressure i.e. Demand > Supply. In short, the troughs or reaction lows are called as Support.
For an Uptrend to continue, each successive lows, (Supports) must be greater than the preceding low.
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SUPPORT AND RESISTANCE:
RESISTANCE:
It is an area or level on the chart where Selling pressure is sufficiently strong enough to overcome buying interest i.e. Supply > Demand. In short, the peaks or reaction highs are called as Resistance.
For an Uptrend to continue, each successive highs, (Resistances) must be greater than the preceding highs.
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SUPPORT AND RESISTANCE:
CAUTION:
If the corrective dip in an uptrend comes all the way to previous low or breaches it, it is an early signal of reversal of a trend (downward move) or beginning of sideway movement.
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SUPPORT AND RESISTANCE:
BETTER CONFIRMATION:
More the trading that takes place in the Support or Resistance area, more significant it becomes.
Amount of time spent in the support or resistance area is a sign of better confirmation.
Volume also acts as a pivotal point in determination of better future prices and confirms better the support or resistance levels.
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SUPPORT AND RESISTANCE:
Support becomes resistance and vice versa if a Support level is penetrated (Broken out) with a significant margin and similarly in case of a break out of resistance levels.
In an uptrend, previous resistance levels which have been broken by a significant margin become supports.
In a downtrend, violated support levels becomes resistance levels on subsequent bounces.
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TREND LINES: It is a simple but very valuable technical tool.
Uptrend:
It is a straight line drawn from left to right
along with every successive lows.
Downtrend:
It is a straight line drawn from left to right.
along with every successive highs.
AN UPTREND OR A DOWNTREND SHALL BE
CONFIRMED BY JOINING OF ATLEAST
3POINTS.
Days low or highs shall be considered for drawing a trend line.
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TREND LINES: Trendline shall include all price action.
Trendline break on a closing basis is considered more valid than on intraday basis.
Valid trend line break is generally considered with a limit of 3% to 5% from the neckline.
Deciding the levels of tolerance is left to the risk levels of the investor.
A minimum 2day close below or above the trend line break is also generally considered.
Few of them even consider a weekly break of trend line as a valid signal.
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FAN PRINCIPLE:
Sometimes after the violation of an uptrend line, prices will decline a bit before rallying back to the bottom of the old uptrend line, which is now acting as the resistance.
The breaking of the 3rd trend line in an UPTREND signals the reversal of the trend. Generally the broken trend line 1 and 2 becomes the Resistance levels.
The breaking of the 3rd trend line in a DOWNTREND signals the reversal of the trend. Generally the broken trend line 1 and 2 becomes the Support levels.
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CHANNEL LINES:
Channel line also called as Return line is an area between two parallel lines i.e. the basic trendline and the channel line drawn parallel to the basic trendline.
Generally on an Upward trendline, supports form the basic trendline and the resistance the upper channel.
Confirmation of an existence of channel is proved by the price action within the two parallel lines.
Failure to reach the channel line in an upward trend is an early signal of beginning of weakness.
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CHANNEL LINES:
Once a breakout occurs from an existing price channel, prices usually travel a distance equal to the width of the channel from the point at which trend line is broken.
Out of the 2 trendlines constituting a channel, the basic trendline is by far the most important and reliable one.
The Channel line is a secondary use of the trendline technique.
The failure to reach the upper end of the channel line is an early warning that the lower line (Basic trend line) may be broken in the near future.
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PERCENTAGE RETRACEMENT LINES: After a particular move, Prices generally retrace a portion of the previous move, before resuming the trend in the original direction.
These counter trend moves are called as retracements and are generally to the extent of 50% of the previous move.
Besides 50% retracements, there are minimum (1/3) and maximum (2/3) retracements too.
Percentage retracements are applicable to all types of trends.
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PERCENTAGE RETRACEMENT LINES: If the prior trend is to be maintained, 66.67% or 2/3 retracement is a critical point not to be breached.
66.67% retracement is low risk area to buy in an uptrend or to sell on a downtrend.
If prices move beyond the 66.67% retracement, then the odds favour a trend reversal rather than just a retracement. The move in such situations usually retrace 100% of the previous trend.
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SIGNIFICANT REVERSAL DAYS:REVERSAL DAYS ARE MORE KEENLY WATCHED ON WEEKLY AS WELL AS MONTHLY CHARTS.
CHARTISTS GIVE MORE SIGNIFICANCE TO WEEKLY CHART REVERSAL THAN DAILY CHART REVERSAL AND MORE SIGNIFICANCE TO MONTHLY THAN WEEKLY.
VOLUME CONFIRMATION ON A REVERSAL DAY IS ALSO SEEN FOR BETTER PREDICTIONS.
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GAPS: It is the area on the bar chart where no trading has taken
place.
UPSIDE GAPS are gaps opened due to Open price being
greater than the previous days high and that upside gap
opened are not filled in during the day.
DOWN SIDE GAPS are gaps opened due to days high
price being below the previous days low.
Upside gaps are signs of Market strength whereas
Downside gaps are signs of market weakness.
Gaps on weekly and monthly charts are considered more
significant to that of gaps on a daily chart.
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TYPES OF GAPS:BREAK AWAY GAPS.BREAK AWAY GAPS.
RUNAWAY GAPS.RUNAWAY GAPS.
EXHAUSTION GAPS.EXHAUSTION GAPS.
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BREAKAWAY GAPS:
It usually occurs at the end of an important price pattern and signifies beginning of an important market move.
The breaking of an important RESISTANCE or SUPPORT through a breakaway gap is a solid confirmation of a beginning of a major and steep up move or a downward move.
Break away gaps usually occur with heavy volumes.
Break away gaps are generally not filled.
Break away gaps on the upside acts as an support and on a downtrend acts as resistance.
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RUNAWAY GAPS:
It is also called as Measuring gaps which usually occurs at the midway of a major move.
It is a signal of markets moving effortlessly with comfortable volumes.
It signifies the continuation of the major move which started with the Breakaway gap.
It is also used to set up price targets.
Run away gaps are also not filled.
Run away gaps on the upside acts as an support and on a downtrend acts as resistance.
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EXHAUSTION GAPS:
It usually occurs at the END of a major move.
An analyst should expect runaway gaps after break away and Exhaustion gap after Run away gaps.
It signifies the END of the major move which started with the Breakaway gap and continued with a Run away gap.
It is used to exit positions on the either side.
Exhaustion gaps are generally filled.
Exhaustion gaps on the upside or downside acts as the neckline and breach of the same is a strong signal of reversal.
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ISLAND REVERSAL:
It occurs after an exhaustion gap, generally with a time period of 2 days or weeks.
An Exhaustion gap to the upside followed by a breakaway gap to the downside completes the ISLAND REVERSAL PATTERN and indicates reversal of trend.
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CHART PATTERNS:
It is a formation that appears on a price chart that can be classified into different categories which have future predictive value.
Chart Patterns can be classified into 2 broad categories, namely:
a) Reversal Patterns.
b) Continuation Patterns.
Volume plays a very important role in confirming the above pattern formations and future predictions.
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REVERSAL PATTERNS:
HEAD AND SHOULDER:
There shall exist a prior Uptrend before the formation of an Head and Shoulder pattern.
The peak of the head shall be higher than the peaks of the either shoulders.
Generally peaks are with heavy volumes and troughs with lighter volumes.
Generally rally into the newer highs is on lighter volumes in comparison with the previous highs rally.
Breach of neckline which forms the support line is important.
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REVERSAL PATTERNS:
Breach of neckline is considered on the closing basis and not on intraday basis.
Volume should increase on the breaking of the neckline.
3% to 5% breach below the neckline is also considered for better confirmation.
Usually a Return move develops which is a bounce back to the bottom of the neckline (support) breached, now acting as a stiff Resistance.
If the initial breaking of the neckline is on heavy volumes, the probability of bounce back or the return move is less and vice versa.
After the breach of neckline, prices should not re-cross the neckline again, if crossed it is a failure pattern.
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HEAD AND SHOULDER:
MEASURING IMPLICATIONS:
Price Objective is based on the Height of the Pattern.
The distance from the top of the head to the neckline (Vertical line) is the expected price downtrend from the point of breach of the neckline.
The above Price objective is a minimum target and the maximum price target might be the retracement of the full previous move. (100% RETRACEMENT OF PREVIOUS MOVE)
½ and 2/3 retracements of previous move can also be considered for the price targets to adjust.
Gaps, Previous trends break, Previous supports and resistances shall also be considered while fixing the price target.
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INVERSE HEAD AND SHOULDER:
It is a mirror image of the Head and Shoulder top Pattern.
The volume from the head should see heavier volumes and a burst of volumes in breaking of the neckline.
Return move back to the neckline acting as support line is seen more often in a inverse pattern rather on top pattern.
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INVERSE HEAD AND SHOULDER:
MEASURING IMPLICATIONS:
Price Objective is based on the Height of the Pattern.
The distance from the top of the inverted head to the neckline (Vertical line) is the expected price upside from the point of breach of the neckline.
The above Price objective is a minimum target and the maximum price target might be the retracement of the full previous move. (100% RETRACEMENT OF PREVIOUS MOVE)
½ and 2/3 retracements of previous move can also be considered for the price targets to adjust.
Gaps, Previous trends break, Previous supports and resistances shall also be considered while fixing the price target.
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COMPLEX HEAD AND SHOULDER PATTERNS:
It is a variation of Head and Shoulder Pattern which are rarely found.
These are patterns where 2heads may appear along with a right and a left shoulder.
It can also be a double left and a double right shoulder.
They have the same forecasting implications to that of Normal Head and shoulder pattern.
A lot of anticipatory buying takes place during the formation of the right shoulder and aggressive traders take positions before the confirmation of the pattern itself.
If the initial positions prove right, additional positions can be added at the breach of neckline.
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CAUTION: HEAD AND SHOULDER PATTERN CAN HEAD AND SHOULDER PATTERN CAN
ALSO ACT AS A CONSOLIDATION ALSO ACT AS A CONSOLIDATION PATTERN, RATHER THAN REVERSAL PATTERN, RATHER THAN REVERSAL PATTERN.PATTERN.
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TRIPLE TOPS AND BOTTOMS:
It is a slight variation of Head and Shoulder pattern which is very rare as a chart pattern.
The three Peaks or Troughs in the Triple Top or a Triple bottom formation is at the same level.
Volumes tend to decline with each successive peaks and increase at the breakout point.
The measuring technique and the return move is same as that of the Head and Shoulder Pattern.
A Triple bottom is a mirror image of triple top.
Study of previous trend before the formation of a triple top or a triple bottom is crucial.
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DOUBLE TOPS AND BOTTOMS:
It is a common reversal chart pattern found very frequently.
This pattern must have two peaks at about the same level.
Volumes is generally low on the second peak and picks up on the break of the neckline.
The measuring technique and the return move is same as that of the Head and Shoulder Pattern.
A Double bottom is a mirror image of double top.
Study of previous trend before the formation of a double top or a double bottom is crucial.
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DOUBLE TOPS AND BOTTOMS:
A double top is commonly referred to as “M” formation and a double bottom as “W” formation.
A normal pull back from a previous peak before the resumption of the uptrend should not be studied as Double top formation. (Till the breach of neckline, the double top formation is not complete)
The longer the time period between the peaks or bottoms and greater the height, more reliable is the chart pattern.
Generally Valid Double tops and bottoms should at least have a months gap between the two peaks or troughs.
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VARIATIONS FROM THE IDEAL PATTERNS:
Use of filters by traders to deal with variations in chart patterns.
On occasions the second peak will not reach the levels of first peak.
Most chartists want a close beyond the previous resistance on a closing basis and not on intra day basis.
Percentage penetration criteria of 3% to 5% is also considered.
The two day penetration rule is also used as a time filter.
A Friday close beyond the previous peak is also considered.
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SAUCERS AND SPIKES:
It is also called as rounding bottoms.
It is a very slow and gradual turn from down to side ways and then to an uptrend.
Longer they last, more significant they are.
Spikes are “V” patterns that happens very quickly with little or no transition period.
They usually occur in markets which so over extended, that a sudden piece of adverse news will turn the trend abruptly without giving signals of slowing down or a turn in trend.
Volumes is the only tool that can help in predicting a “Spike”.
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CONTINUATION PATTERNS:
It is an indication of a sideways price action, which is a pause in the prevailing trend and the next move will be in the same direction of the trend which preceded the formation.
Continuation patterns are generally of a shorter duration in comparison to that of reversal patterns.
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TRIANGLES:
Triangle patterns are generally considered as Continuation patterns even though sometimes they act as Reversal Patterns.
There are 3 types of triangles, namely:
a)SYMMETRICAL TRIANGLES.
b)ASCENDING TRIANGLES.
c)DESCENDING TRIANGLES.
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SYMMETRICAL TRIANGLES: Symmetric Triangles are also called as “COILS”
These triangles show 2 Converging trend lines, the Upper line descending and the Lower line ascending.
The Vertical line measuring the height of the pattern is referred to as “BASE”. (AB)
The point of intersection of the above 2 trend lines is called as the “APEX”. (C)
A close outside either of the trend lines, completes the pattern.
B
A
C
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ASCENDING TRIANGLES: It is similar to that of a Symmetric Triangle with a rising
lower line except for the flat or horizontal Upper line.
The Vertical line measuring the height of the pattern is referred to as “BASE”.
The point of intersection of the above 2 trend lines is called as the “APEX”.
A close outside either of the trend lines, completes the pattern.
This is generally a “Bullish Pattern”.
B
AC
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DESCENDING TRIANGLES: It is similar to that of a Symmetric Triangle with a
declining Upper line except for the flat or horizontal Down line.
The Vertical line measuring the height of the pattern is referred to as “BASE”.
The point of intersection of the above 2 trend lines is called as the “APEX”.
A close outside either of the trend lines, completes the pattern.
This is generally a “Bearish Pattern”.
B
A
C
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TRIANGLES:
A Symmetric triangle pattern is a continuation pattern which represents pause in the existing trend after which the previous trend continues.
The study of previous trend before the formation of a triangle is highly significant for accurate interpretation.
If the previous trend were to be an uptrend, the implications of symmetric triangle is bullish and if it were to be a down trend, it would have bearish implications.
A triangle should have minimum 4 reversal points i.e. each trend line must be touched at least twice. Few of them also have 6 reversal points.
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MEASUREMENT OF TRIANGLES:
As a general rule prices should break out in the direction of the Prior Trend somewhere between 2/3 to 3/4 of the Horizontal width of the triangle.
Horizontal width is the distance between the BASE at the left of the pattern to the APEX at the right of the pattern.
If prices remain within the triangle beyond the 3/4 point, then the triangle loses its significance and prices may reach to the APEX point.
Trend reversal is given by closing penetration of one of the trendlines.
Return move is rarely found in Triangles, and the broken line acts as Support in an up trend and resistance in a down trend.
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TRIANGLES:
Volume should diminish as the price swings narrow within the triangle.
Volume should pick up noticeably at the penetration point.
Measurement of symmetrical triangles are based on the Height of the BASE or by drawing a parallel line upward from the top of the BASE, parallel to the lower line.
B
A
C
D
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VOLUME PATTERNS ON TRIANGLES:
In an Ascending Triangle pattern, volumes tend to increase on bounces and contracts on dips.
In a Descending Triangle, Volumes should be heavier on the downside and lighter during the bounces.
A Triangle is considered to be an intermediate continuation pattern which generally take a month to 3months for its formation.
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BROADENING PATTERNS:
It is an inverted triangle or triangle turned backwards.
A Broadening pattern should not show a converging trend line Pattern.
Volume tend to behave the opposite way as to a triangle wherein it tends to expand along with the wider price swings.
It usually occurs at market tops which shows three successive higher peaks and two declining troughs.
The violation of the second trough completes the formation of the Broadening pattern.
An Expanding pattern is generally a bearish signal as it appears at the market top.
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B
A
C
D
F
E
BROADENING PATTERNS:
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FLAGS AND PENNANTS PATTERNS:
They represent brief pauses in Dynamic market moves.
It is preceded by a sharp or straight line move before its formation.
A Flag usually occurs after a sharp move and represent pause in the trend. The flag should slope against the trend.
Volume should dry up on the formation and burst on the breakout.
A Flag generally occurs near the midpoint of a move.
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FLAGS AND PENNANTS PATTERNS:
Both patterns are relatively short term and should be completed within 1 to 3 weeks.
It can also form on a down trend (Inverted flag and pennant) signifying continuation of the previous trend.
Both patterns occur about the midpoint of the previous up move or down move signifying half the previous way remaining from the breakout.
Both patterns take less time to form in a down trend.
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FLAGS AND PENNANTS PATTERNS:
A Pennant represents the formation of a small symmetric triangle preceded by a sharp up move.
Volume should be light on the formation and burst on the breakout.
A Pennant is identified by 2 Converging trend lines.
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On Balance Volume (OBV):
If Prices are on the downtrend with a flat or raising OBV, it is a signal of bullishness and if Prices are on the upside with a flat or falling OBV, is a signal of bearishness.
A big spike in the OBV line indicates some big news, and unless it is sustained by further accumulation on the higher levels, it should be studied as “Doubtful move”.
OBV can be considered as an indicator of insider information.
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1. OBV.2. MFI.3. MOVING AVERAGE.4. BOLLINGER BANDS.5. 4 WEEK RULE.6. OSCILLATORS.7. CCI8. RSI9. STOCASTICS10. MACD11. ACCUMULATION – DISTRIBUTION12. ATR.13. WILLIAMS % R.14. WILLIAMS A/D15. CHAIKIN OSCILLATORS
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MOVING AVERAGES:
It is a simple trend analysis technique which averages out the prices for a particular period of time.
In short it is a Curving Trend line which helps in identifying the beginning of a new trend line or end of a old trend line.
It is only an indicator tool and not a leading tool. It only reacts and never anticipates.
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MOVING AVERAGES:
Moving averages lag the market price action and smoothens the noise in price action.
Shorter term Moving Averages are more sensitive to price action in comparison to longer duration moving averages.
Moving averages can be Simple or Weighted or Exponential Moving averages.
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Oscillators:
Crossing of Zero line is considered as a trading signal where crossing above the zero line is a buy signal and below the zero line is a sell signal.
Oscillators signals should not be used against the basic price trend. i.e. buy positions should be initiated on crossing above the zero line only if the market trend is up and vice-versa.
Similarly Short positions should be initiated only if the crossing below the zero line is complemented with a basic down trend in prices.
AN OSCILLATOR IS A LEADING INDICATOR WHICH TURNS EARLY TO THAT OF THE PRICE LINE.
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Oscillators:
The upper and lower boundary limits can be fixed based on the previous momentum history.
There are 3 types of Oscillators:
1. Momentum Oscillators. (V-Vx)
2. Rate of change Oscillators. (V/Vx)
3. Moving Average Oscillators. (Histogram)
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RELATIVE STRENGTH INDEX:
RSI technique was developed by J.Welles Wilder.
It is the most popular and trusted Oscillator tool used by most of the traders, which smoothens the noise found in most of the other Oscillator tools.
RSI = 100 – 100 / (1+RS)
RS = Average of x days UP close Average of x days DOWN close
14days is popularly used for the calculation of RSI and 14weeks in case of a Weekly chart being used. However variations of 14 days are also used. Shorter the time period, more sensitive the oscillator becomes and wider is its amplitude.
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RELATIVE STRENGTH INDEX:
RSI works best at the extreme points of the band.
5,7 and 9 days are used as variations of the shorter time period RSI and 21 or 28 days is used for the longer time duration.
The 14 days RSI becomes Over bought above 70 and oversold below 30.
The study of chart patterns are equally applicable to even RSI as they are drawn to regular price charts.
RSI – PRICE Divergence:
If prices are rising or flat and RSI is decreasing, look for turn down in prices. If prices are declining or flat and RSI is increasing, expect prices to move higher.
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Negative Divergence:
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Over Bought and Over Sold Situation:
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Top Failure Swing:
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Bottom Failure Swing:
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STOCHASTICS:
It is based on the observation that as price increases, closing price will be closer to day’s high on an uptrend and on a downtrend, closing price will be closer to day’s low.
%K line and %D line are the two lines used in Stochastics.
Stochastic observes where the most recent closing price is in relation to the price range for a chosen time period. (14days is generally used)
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Accumulation-Distribution Pattern:
It is a variation of On balancing Volume which attempts to confirm changes in prices by comparing the volumes associated with it.
It is a momentum indicator which associates changes in Price and Volume.
The indicator is based on the premise that more the volume that accompanies a price move, more significant is the move.
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Accumulation-Distribution Pattern:
Σ {(C - L) – (H – C)} * Volume
(H – L)Where:
C = Close.
L = Low.
H = High.
The nearer the close is to the high’s of the day, more volume is added to the cumulative total and vice-versa.
If the close is exactly between the days high and low, then nothing is added or deducted to the cumulative total.
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Accumulation-Distribution Pattern:
When security is being accumulated, the A/D moves up and when the security is being distributed, the A/D moves downwards.
When a Negative Divergence occurs between Price and A/D pattern, Price will usually change to confirm the A/D.
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ELLIOTT THEORY:
Proposed by Ralph Nelson Elliott, Wave theory was improvised by Charles J Collins.
Elliot was very much influenced by the Dow theory.
Through constant observations and nature of markets, Elliott concluded that the movements of stocks can be predicted by observing repetitive patterns of waves.
There are 3 basic tenants of Elliott wave theory:
a)Pattern.
b)Ratio.
c)Time.
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BAR CHARTS VS CANDLE STICKS Studies market psychology much faster and
easier than bar charts. A candles extended real body demonstrate definite bullishness or bearishness. However a small real body indicates indecision or a tug of war between the bulls and the bears with no definite winner.
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INTRODUCTION Candle Sticks predict the strong psychology of
the markets, its emotions and future expectations.
“What is important in market fluctuations are not the events themselves, but the HUMAN REACTIONS to these events”.
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INTRODUCTION The use of Candle Stick charts originated in
JAPAN when RICE was the medium of exchange.
Munehisa Homma is considered as the father of Candle Sticks.
“NEVER PLACE A TRADE WITH A CANDLE SIGNAL WITHOUT CONSIDERING THE RISK-REWARD RATIO OF THE POTENT TRADE”
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LIMITATIONSThey need a Close to confirm the Candle
Signal.They don’t give PRICE TARGETS.Candle Patterns cannot be used in isolation to
effect trades.Cannot be used on tick charts.
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DEFINTIONSREAL BODY:
It is the rectangle portion of the Candle that represents the range between the Opening and Closing Price.
WHITE (GREEN) REAL BODY:It represents Close being higher than Open.
BLACK (RED) REAL BODY:It represents Close being lower than Open.
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DEFINTIONSSHADOW:
It is the Vertical line that extends above and below the real body called as Upper and Lower Shadows.The Top of the Upper shadow is the sessions high and the Bottom being the sessions low.
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DEFINTIONSSHAVEN HEAD AND BOTTOM:
If the Close is at the High’s of the session, it has no upper shadow and hence it has a “Shaven Head”.
If the Close is at the Low’s of the session, it has no lower shadow and hence it has a “Shaven Bottom”.The top of the upper shadow and the bottom of the lower shadow represents the high’s and low’s of the session, whether the real body is White (Green) or Black (Red).
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TIME FRAMELike BARS, each CANDLE represents action
for a specific time frame. On a daily chart, each candle represents price action for a day, on a weekly chart for a week and on a 15 minute intra day chart, a 15 minute unit of time.
A Long body (either Green or Red) indicate strong market participation, whereas a Small body indicates no market participation.
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SIGNALSEXAMPLE OF A CANDLEA Long Green real body indicate, extremely
POSITIVE or BULLISH sentiments as the close is many points above its open and near to its day high.
A Long Red real body indicate, extremely NEGATIVE or BEARISH sentiments as the close is many points below its open and near to its day low.
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SIGNALSThe upper shadow indicates that the day’s
high could not be maintained by the Bull’s because of selling pressure at higher levels or lack of buying interest at higher levels.
The lower shadow indicates that the Buying came at lower levels to support the stock price not to go further below.
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SIGNALSThey believe that the first hour of the day sets the tone of the day’s market.
“It is said that the amateur opens the market and the professional closes it”.
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STUDY OF SINGLE CANDLESSPINNING TOPS:
It refers to a Candle (either Green or Red) with a Small Real Body. Spinning Tops may have Upper and Lower Shadows or none at all.A Spinning Top indicate that Bulls and Bears are battling it out in a tug of war with neither the bulls nor bears being able to take dominant control.
Spinning top helps a trader to cover old positions and not to initiate new positions.
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STUDY OF SINGLE CANDLESSPINNING TOPS:
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STUDY OF SINGLE CANDLESHIGH WAVE CANDLES:
They also have diminutive real body (either green or red) like spinning top but also longer upper and lower shadows. The Upper and Lower shadows need not be of same size, but should be substantially long. High wave candles indicate outright CONFUSION in the minds of bulls and bears.
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TREND ANALYSIS THRU SPINNING TOPS AND HIGH WAVE CANDLES
UPTREND:In an Uptrend supported by long green
real body, small real body (either green or red) exerts caution on the long side.
Spinning tops are warnings not to follow this market on the long side and are more powerful in a market which are becoming over extended and are nearing resistance levels. A trend shift or reversal may be in the offering.
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TREND ANALYSIS THRU SPINNING TOPS AND HIGH WAVE CANDLES
SIDEWAYS TREND:In a Sideways trend or a Box Range,
Spinning Tops and High Wave candles have no implications of trend reversal or shift. It indicates markets simply resting before it breaks up or down from the price range.
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TREND ANALYSIS THRU SPINNING TOPS AND HIGH WAVE CANDLES
DOWN TREND:In an Down trend supported by long red
real body, small real body (either green or red) exerts caution on the short side.
Spinning tops are warnings not to follow this market on the short side and are more powerful in a market which are becoming over sold and are nearing Support levels. A trend shift or reversal may be in the offering.
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HAMMER AND HANGING MANThe Hammer and Hanging man candles
have small real body (whether green or red) and should have long single sided shadow.
An HAMMER appears on a down trend at or near the bottom which suggests that the market is hammering out a base.
An HANGING MAN appears on an uptrend at or near the top which suggests that the market is creating a top. One must wait for a close under the Hanging man’s real body before becoming BEARISH.
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SHOOTING STARA Shooting Star is a top reversal line just
like the Hanging man. A Shooting Star displays a long upper shadow and its small real body is at or near the lows of the session.
A Shooting Star shows trouble overhead. Because of the Shooting Stars long bearish upper shadow, we don’t need any confirmation like the Hanging man.
A Shooting Star is a bearish reversal signal and it must appear during a rally (Uptrend).
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HAMMER, HANGING MAN AND SHOOTING STAR
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STAR PATTERN:
A Star is a small real body that gaps away from the long real body preceding it in an uptrend or downtrend. The 3rd candle should also gap away from that of the Star’s real body, leaving the star’s real body isolated.
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STAR PATTERN: Star patterns are of 2 types:1. Morning Star:
It is a bottom reversal pattern which is a bullish signal. It is a pattern followed by a prior down trend and a long red candle develops confirming the control of bears being intact is followed by a small real body (Green or red) gapping down and a gap up green long real body completes the morning star pattern.
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STAR PATTERN:1. Evening Star:
It is a top reversal pattern which is a bearish signal. It is a pattern followed by a prior up trend and a long green candle develops confirming the control of bulls being intact is followed by a small real body (Green or red) gapping up and a gap down red long real body completes the evening star pattern.
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STAR PATTERNS:
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Morning or Evening Doji Stars:
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MORNING STAR PATTERN
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EVENING STAR PATTERN
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THE TWEEZER PATTERN:Tweezers represents two or more candle
lines with matching highs or lows.The tweezer top occurs in a rising
market and a tweezer bottom in a falling market.
Generally the first candle in a tweezer will be a long real body and the second being a small real body.
A Tweezer too is a strong reversal pattern.
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THE TWEEZER PATTERN:Tweezers are generally of less importance to short term traders and it is more powerful on a long term chart for indicating reversal signals.
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THE TWEEZER PATTERN:
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THE THREE BLACK CROWS:It appears in the context of high price levels and a matured uptrend.
It is also called as three winged crows.
It consists of three consecutive red candles that should close at or near their lows.
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THE THREE BLACK CROWS:The appearance of three black crows on a weekly chart is an early signal of reversal of long term trend and it should be even confirmed by other technical indicators for a better confirmation.
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BLACK CROWS ON WEEKLY CHARTS
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THE THREE WHITE SOLDIERS:It is a Continuation pattern where consecutive three long green candles appear, signaling strength in the previous uptrend.
Each green candle should close at or near its high.
Each candle should open within or close to the prior candles real body.
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THE THREE WHITE SOLDIERS:The previous trend is not critical for the above pattern.
The soldiers may begin an upward rise out of a downside reversal or may emerge during a rally.
The three white soldiers indicate positive momentum ahead.
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THE THREE WHITE SOLDIERS:
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THE THREE WHITE SOLDIERS:The three white soldiers should necessarily not be studied as a buy signal since overbought markets generally consolidate or retrace after prolonged price rises.
Thus the best entry point may be considered after a pull back to the support levels.
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THE WINDOW PATTERNS:They are also called as Disjointed candles which are continuation patterns.
They are synonymous with that of western technical patterns known as gaps.
A Window is a price zone where no trade takes place. It is called as PRICE VACCUM.
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THE WINDOW PATTERNS:RAISING WINDOW:A Raising window appears with a price vacuum between the prior candles high and the current sessions low.
A Raising window is a Bullish signal and hence long positions can be initiated with it. It indicates Bulls being in control willing to pay high.
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THE WINDOW PATTERNS:FALLING WINDOW:A Falling window appears with a price
vacuum between the prior candles low and the current sessions high.
A Falling window is a Bearish signal and hence short positions can be initiated with it. It indicates bears driving the markets down with no competition from the bulls.
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THE WINDOW PATTERNS:oAs windows are Continuation patterns, it is advisable to trade in the direction of the window.
oIt is wrong to study the gap of real bodies as windows. It should be the gaps of shadows and price vacuum should be created for a window to occur.