Technical analysis

Technical analysis is the attempt to forecast stock prices on the basis of market-derived data. Technicians (also known as quantitative analysts or chartists) usually look at price, volume and psychological indicators over time. They are looking for trends and patterns in the data that indicate future price movements.

Underlying Assumptions of Technical Analysis

1. The market value of any scrip is determined solely by the interaction of supply and demand 2. The market discounts everything

Underlying Assumptions of Technical Analysis

3. The market always move in trend 4. In the rising market investors psychology have up beats and they purchase the shares in greater volumes. At the same time in down trend they may be very eager to get out of the market by selling.

Dow Theory
This theory was first stated by Charles Dow in a series of columns in the WSJ between 1900 and 1902. Dow (and later Hamilton and Rhea) believed that market trends forecast trends in the economy. A change in the trend of the DJIA must be confirmed by a trend change in the DJTA in order to generate a valid signal.

Hypothesis
The first hypothesis is that no single individual or buyer can influence the major trend of the market. The second hypothesis is that the market discounts everything. The third hypothesis is that the theory is not infallible. It is not a tool to beat the market but provides a way to understand it better.

Dow Theory Trends (1)

Primary Trend
Called the tide by Dow, this is the trend that defines the long-term direction (up to several years). Others have called this a secular bull or bear market.

Secondary Trend
Called the waves by Dow, this is shorterterm departures from the primary trend (weeks to months)

Day to day fluctuations

Not significant in Dow Theory

Dow Theory Trends (2)

Typical Stock Market Cycle

Stock Price Declining Trend Channel Peak Flat Trend Channel Sell Point Rising Trend Channel Declining Buy Point Trend Trough Channel

Buy Point Trough

Does Dow Theory Work?

According to the theory, if you had invested $44 in 1897 and followed all buy and sell signals, by 1981 you would have accumulated about $18,000. If you had simply invested $44 and held that portfolio, by 1981 you would have accumulated about $960.

Support & Resistance

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

Breakout

Support

Resistance

Indicators
Volume of trade The breath of the market Short sales Odd lot trading Moving average

Volume of trade
Larger rise in price or larger fall in price leads to larger increase in volume. Larger volume with rise in price is called bull market and the larger volume with fall in price indicates bear market.

Breath of the market

Advances: The number of shares whose price have increases from the previous days trading. Declines: It indicates the number of shares whose prices have fallen from the previous day trading. In a bull market , a bearish signal is given when the A/D line slopes down while the BSE sensex is rising.

Short sales
Selling of shares that are not owned. When the demand for a particular share increases, the outstanding short positions also increase and it indicates further rise of prices. Short sales of a particular month is selected and compared with the average daily volume of the preceding month. If the ratio is less than 1 market is said to be weak or overbought and a decline can be expected. Value above 1 indicates bullish trend.

Odd lot trading

Shares sold in smaller lots fewer than 100 are called odd lot. odd lot purchases to odd lot sales is the odd lot index. The increase in the odd lot purchases results in an increase in the index. Relatively more selling leads to fall in the index.

Moving average
The moving averages are used to study the movement of the market as well as the individual scrip price. It indicates the underlying trend in the scrip. For identifying short term trend, 10 day to 30 day moving averages are used. In the case of medium trend 50 day to 125 day are adopted 200 day moving average is used to identify the long term trend.

Relative Strength Index (RSI)

RSI was developed by Welles Wilder as an oscillator to gauge overbought/oversold levels. RSI is a rescaled measure of the ratio of average price changes on up days to average price changes on down days. The RSI crosses seventy there may be downturn and it is time to sell. If the RSI falls below thiry it is time to pick up the scrip.

Charts
The graphic presentation of the data It helps to find out the trend of the price without any difficulty. Spots the current trend for buying and selling Shows the historic movement Indicates the important areas of support and resistance.

Drawing Point & Figure Charts

Point & Figure charts are independent of time. An X represents an up move. An O represents a down move. The Box Size is the number of points needed to make an X or O. The Reversal is the price change needed to recognize a change in direction. Typically, P&F charts use a 1-point box and a 3point reversal.

X X X XO X XO XO O XO O X

Trend Lines
There are three basic kinds of trends:
An Up trend where prices are generally increasing. A Down trend where prices are generally decreasing. A Trading Range.

Head and Shoulders

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

Left Shoulder

Right Shoulder

Neckline

H&S Bottom
Neckline

Left Shoulder

Right Shoulder

Head

Double Tops and Bottoms

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

Target Target

Double Bottom

Triangles
Triangles are continuation formations. Three flavors:
Ascending Descending Symmetrical
Ascending

Symmetrical Symmetrical

Typically, triangles should break out about half to threequarters of the way through the formation.

Descending

Flags and pennants

Flag pattern commonly seen on the price charts. These patterns emerge before a fall or rise in the value of scrip's. These patterns show the market corrections of the overbought or oversold situations. The time taken form these patterns is quick.

Pennants
It looks like symmetrical triangle. There are bullish and bearish pennant. In the bullish pennant the lower tops form the upper trend line. The lower trend line connects the rising bottoms. In the bearish trend the upward trend line is falling and the lower trend line is rising.

The Bar Chart

The Bar Chart (Continued)

Some of the most popular type of charts Advantage is that it show the high, low, open and close for each day

Candle Stick Charting

Candle Stick Charting (Continued)

Been around for hundreds of years Often referred to as Japanese Candles because the Japanese would use them to analyze the price of rice contracts Similar to bar chart, but uses color to show if stock was up (green) or down (red) over the day More than 20 patterns are used by technicians for candlestick charting. Some of the most popular include the following.

Candle Stick Charting (Continued)

Candle Stick Charting (Continued)

Green is an example of a bullish pattern, the stock opened at (or near) its low and closed near its high Red is an example of a bearish pattern. The stock opened at (or near) its high and dropped substantially to close near its low

Candle Stick Charting (Continued)

Top example is called a hammer and is a bullish pattern only if it occurs after the stock price has dropped for several days.
Theory is that pattern indicates a reversal

Bottom is an example of a star, typically indicating a reversal and/or indecision.

Technical analysis Vs fundamental analysis

FA analysts analyses the stock based on the goals of the investor FA they try to find out the long term value of the shares to buy and hold. FA forecasts of supply and demand depend on various factors TA mainly focus the attention on the past history of prices. TA mainly predict the short term price movement. TA forecast supply and demand for stock by studying prices and volume of trading.