technical analysis

Meaning:
• Study of market generated data like price and volume
to determine the future direction of price movement.
• A study of past or historical price and volume

movement so as to predict the future stocks price
behavior.
• Forecasting techniques that utilize historical share price
data.
Vipin k, Asst Prof. VJIM

2

• Technical analysts believe that past patterns of market action

will recur in the future and that past patterns can be used for
predictive purposes.

• Some of the tools used by chartists to measure supply and
demand and to forecast security prices are the Dow theory
chart, odd-lot theory, confidence index, breadth-of-market

indicators, relative-strength analysis, and trading-volume
data.

3

Assumptions/basic principles/premises of technical analysis
 Market prices are determined by the interactions of supply and
demand forces.

 Supply and demand are influenced by variety of factors, both
rational and irrational. Includes fundamentals as well as
psychological factors.

 Shift in demand & supply bring about changes in trends.
 Shift in demand & supply detected with the help of charts of
market action.
 Analysis of past market data can be used to predict the future price
behavior.


4

• Charles .H. Dow
• Editor of wall street journal, in USA

• Popularly known as Theory of Technical
analysis

9

According to Charles .H. Dow
• “ The market is always considered as having

three movements, all going at the same time. The
first is the narrow movement from day to day.
The second is the short swing, running from
two weeks to a month or more; the third is the
main movement covering at least four years in

its duration”

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• The Dow theory is used to indicate reversals and trends in
the market as a whole or in individual securities.
• According to the theory, there are three movements going
on in the markets at all times:
1. daily fluctuations (the narrow movement from
day-to-day)
2. secondary movements (short-run movements over
two weeks to a month or more)
3. primary trends, major movements covering at
least four years in duration

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• Dow formulated a hypothesis is that the stock
market does not move on a random basis but

is influenced by three distinctive cyclical
trends that guides its direction.

1) Primary / main movements
2) Secondary reaction / correction movement

3) Minor / narrow movements

12

According to Dow theory
• Price movements in the market can be identified by
means of line chart.
• In the line chart, closing price of shares or the closing
value of the market index may be plotted against the
corresponding trading day.
• The charts helps in identifying the primary, secondary
and minor movements.

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* Primary or main movements /trend
• Long range cycle that carries the entire market up or
down long term trend in the market.
* Secondary reaction or correction movement/trend
• These are the opposite direction to the primary

movements
• Only for a short period
• Eg:- when the market is moving upward continuously, this
upward movement will be interrupted by downward
movement of short duration.

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Minor or Narrow movements/trend


Day today fluctuations in the market



Not significant & have no analytical value



Very short duration


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• Primary movements – Tides
• Secondary/ correction movements – Waves

• Minor/ Narrow movements – Ripples


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• Trend is the direction of movement.
• Share price can either increase, decrease or
remain in flat.
• The three directions :


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• Share price do not rise or fall in a straight line.

• Every rise or fall in price experience a counter moves

• Share price move in a zigzag manner.


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Trend lines
• Straight line drawn connecting either the top or
bottom of the price movement
• To draw a trend line, the technical analyst
should have at lest two tops or bottoms.


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(1) Rising/up trend


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(2) Falling/down trend


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(3) Flat trend


23

Trend Reversal
• Changes in the direction of trend is referred to as

trend reversal.
• A share that exhibits a rising trend may start to move
narrowly or fall after some times, this change in the
direction of movement represent trend reversal.
• Technical analyst tries to identify the trend reversal at

an early stage so as to trade profitably.

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• When the trend begins to rise the technical analyst
would recommend purchase of the shares.
• When the trend begins to fall, sale is indicated.

• During a flat trend the investor should stay away
from the market.


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Trend Reversal


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• Ralph Elliot
• Theory was formulated in 1934
• After analyzing 75 years of stock market price
movements and charts.
• According to this theory – market movement was

quite orderly and followed a patter of waves.

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According to this theory
• The market moves in waves
(A wave is a movement of the stock price from one change in
the direction to the next change in the same direction.
Depending on the demand & supply pressure waves are
generated)


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According to this theory
• A movement in a particular direction can be

represented by five distinctive waves.
• Of these five waves, three waves are in the direction
of the movement & are called impulse waves.
• Two waves are against the direction of the movement
& are termed as corrective waves or reaction waves


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Graph


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Graph


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Graph


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• Waves 1,3 & 5 are the impulsive waves
• 2 & 4 are the corrective waves
• The wave 1 is upwards and wave 2 correct the wave

1.
• Waves 3 & 5 are impulsive and 4 corrects wave 3


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• Correction involves correcting the earlier rise
• Wave 2 would correct the rise of wave 1

• Wave 4 would correct the rise of wave 3 & after the
completion of wave 5, there would come a correction
which would be labeled ABC
• This correction would be in three waves in which the
waves ‘A & C’ will be against the trend and wave ‘B’

will be along the trend.

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• The ABC correction following the fifth wave would
correct the entire rise from the starting of wave 1 to the
end of the fifth wave.
• One complete cycle consist of waves made up of two
distinctive phases, bullish & bearish. One full cycle
of waves is completed after the termination of 8 waves
movement, there will be a fresh cycle started.
• The theory is used for predicting the future price
changes & in deciding the timing of investment.

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Support and

Level

• Support and resistance define natural
boundaries for rising and falling prices.


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Support Level
• Level that the technical analyst believes a
stock price will not fall below. Some times
called “Floor”.


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Resistance Level
• Opposite of support level.
• Technical analyst believe that stock price will
not exceed.


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Breakout
• The security price moves out of the previous
trading range (breaching the resistance or support
level)


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• Term used to study the advance and decline that have occurred
in the stock market.
• Advance means – Number of shares whose prices have
increased from the previous day’s trading.
• Decline means – Number of shares whose prices have fallen

from the previous day’s trading.
• The net difference between the number of stock advanced
& declined during the same period is the breadth of the
market.
• A cumulative index of net differences measure the market

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Day

advance

decline

Net

Breadth

21-02-12

1486

774

712

712

22-02-12

1310

966

344

1056

23-02-12

898

1225

-327

729

24-02-12

1108

1091

17

746

25-02-12

931

1279

-348

398


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• Line Chart
• Bar Charts

• Candlestick Charts


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Line Chart
 The most basic of the four charts – because it represents only the closing
prices over a set period of time.
 The line is formed by connecting the closing prices over the time frame.
 Do not provide visual information of the trading range for the individual
points such as the high, low and opening prices.

 The closing price is often considered to be the most important price in
stock data compared to the high and low for the day and this is why it is
the only value used in line charts.

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Line Chart


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Bar Charts
•

The chart is made up of a series of vertical lines that represent

each data point. This vertical line represents the high and low for
the trading period, along with the closing price.
• The close and open are represented on the vertical line by a
horizontal dash.
• The opening price on a bar chart is illustrated by the dash that is
located on the left side of the vertical bar.
• Conversely, the close is represented by the dash on the right.

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Bar Charts
• Generally, if the left dash (open) is lower than the right

dash (close) then the bar will be shaded black,
representing an up period for the stock, which means it
has gained value.

• A bar that is colored red signals that the stock has gone
down in value over that period. When this is the case, the
dash on the right (close) is lower than the dash on the left

(open).

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Bar Charts


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Candlestick Charts
•

Similar to a bar chart, but it differs in the way that it is visually constructed.

•

The difference comes in the formation of a wide bar on the vertical line, which illustrates the

difference between the open and close. And, like bar charts, candlesticks also rely heavily on
the use of colors to explain what has happened during the trading period.
•

There are two color constructs for days up and one for days that the price falls.

•

When the price of the stock is up and closes above the opening trade, the candlestick will
usually be white or clear.

•

If the stock has traded down for the period, then the candlestick will usually be red or black,
depending on the site.

•

If the stock's price has closed above the previous day's close but below the day's open, the
candlestick will be black or filled with the color that is used to indicate an up day

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Candlestick Charts


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• Mathematical indicators calculated with the help of
the closing price data.
• Helps to identify overbought and over sold conditions
of the scrip.
• Helps to identify possibility of trend reversal.


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• RSI (Relative Strength Index)
• ROC (Rate of Change Indicator)
• MACD (Moving Average Convergence/Divergence)


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(Relative Strength Index)

RSI = 100 – 100
(1+RS)
RS = Average gain per day
Average loss per day

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• Most commonly used time period for the calculation of RSI

is 14 days.
• RSI value ranging from 0 – 100
• RSI value above

70 are considered to denote overbought

condition.
• RSI value below

30

considered to denote oversold

condition.

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ROC (Rate of Change Indicator)
• ROC measures the rate of change of the
current price as compared to the price a certain
number of days or weeks back.

• ROC =

Current price
price ‘n’ period ago


- 1

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ROC (Rate of Change Indicator)
• Value may be +ve,-ve or zero
• When the ROC line is above the zero line, the price
is rising & when it is below zero line ,the price is

falling.


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MACD (Moving Average Convergence Divergence)
• Short term & long term exponential moving average
are calculated with the help of closing price data.
• A 12 day & 48 day exponential moving average are

popular combination
• Difference between short term & long term EMA
represent MACD


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• MACD line (blue line): difference between the 12 and 26 days EMAs

• signal (red line): 9 day EMA of the blue line
• histogram (bar graph): difference between the blue and red lines

Mathematically:
• MACD = [stockPrices,12]EMA - [stockPrices,26]EMA
• signal = [MACD,9]EMA
• histogram = MACD – signal


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• Shares are generally sold in a lot of hundreds
• Shares are sold in smaller lots fewer than 100 are called odd lot.
•

Buyers & sellers of odd lots are called odd lotters.

• Odd lot purchases to odd lot sales ( purchase %) is the odd lot index.
( Odd lot purchases divided by odd lot sales)
• Increases the odd lot purchases results in an increase in the index.(selling
leads to fall the index)

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• Basic assumption of technical analyst is that price trends

occur in an orderly manner & not random.
• Random walk theory gained popularity in 1973 when
Burton Malkiel wrote "A Random Walk Down Wall

Street", a book that is now regarded as an investment
classic.
• Theory that states that the past movement or direction
of the price of a stock or overall market cannot be used
to predict its future movement.

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• Random walk theory states that market price evolve at random and do
not follow any regular pattern.

• According to this theory future stock price are

completely independent of past stock prices.
• The Random Walk Hypothesis is a financial theory stating that stock

market prices evolve according to a random walk and thus the prices of
the stock market cannot be predicted by analyzing the past stock prices.

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 Market is supreme and no investor or group can influence it.
 Stock price discount all information quickly.

 Markets are efficient and that the flow of information is free
and unbiased.
 All investors have free access to the same information and

nobody has superior knowledge or expertise.
 Market quickly adjusts itself to any deviations from
equilibrium level due to the operations of free forces of
demand and supply.
Vipin k, Asst or insider information.
 Nobody has better knowledge Prof. VJIM

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• Hypothesis states that the capital

market is efficient in processing

information.
• Efficient capital market is one in which security prices equal their
intrinsic value at all time, and where most securities are correctly priced.
• According to Elton and Gruber,” when some one refers to efficient capital
markets, they mean that securities prices fully reflect all available
information”

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Forms of market efficiency
• There are three forms of the efficient market hypothesis
• The "Weak" form asserts that all past market prices and data are fully
reflected in securities prices. In other words, technical analysis is of no
use.
• The "Semi strong" form asserts that all publicly available information
is fully reflected in securities prices. In other words, fundamental
analysis is of no use.
• The "Strong" form asserts that all information is fully reflected in
securities prices. In other words, even insider information is of no use.

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•

In this diagram, the circles
represent

the

amount

of All historical prices and returns

information that each form of the
Strong Form

EMH includes.
•

Note that the weak form covers

Semi-Strong

the least amount of information,

and the strong form covers all

Weak Form

information.
•

Also note that each successive
form includes the previous ones.

All information, public and
private


All public information
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• Information is free and quick to flow
• All investors have the same access to information.
• Every investor has access to lending and borrowing at the same rate.
• Market absorbs the information quickly and the market responds to
new technology, new trends, change the tastes, etc efficiently and
quickly.

• Investors are rational and behave in a cost effective competitive
manner for optimization of returns

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