1. Technical analysis
Ref:
-- Technical Analysis of Stock Trends by Robert D. Edwards, John
Magee, and W. H. C. Bassetti
-- Dow Theory for the 21st
Century: Technical Indicators to
improving your investment results by Jack Schannep

2. Introduction
 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.

3. The Potential Rewards
 This chart, from Norman Fosbeck, shows how market timing
can benefit your returns. The only problem is that you have to
be very good at it.
Alternative Market Strategies (1964 to 1984)
Strategy Avg. Annual Gain $10,000 Grows To
Buyand Hold 11.46% 87,500$
Avoid Bear Markets 21.48% 489,700$
Longand Short Major Swings 27.99% 1,391,200$
Longand Short Every5% Swing 93.18% 5,240,000,000$

4. The Potential Rewards
 This chart, from Barron’s, shows the benefit of being smart
enough to miss the worst 5 days of the year between Feb 1966
and Oct 2001.
Source: “The Truth About Timing,” by Jacqueline Doherty, Barron’s (November 5, 2001)

5. Agenda
 Charting Stocks
• Bar Charts and Japanese Candlestick Charts
• Point and Figure Charts
 Major Chart Patterns
 Price-based Indicators
 Volume-based Indicators
 Dow Theory
 Elliot Wave

6. What is Technical Analysis?
 The study of market dynamics by evaluating the market’s own
actions
• Figuring out what others think of a stock based on the history
of prices (CHARTing)
• Assumes a degree of market efficiency

7. What do Technicals offer?
 A sense of current markets:
• Where are the markets going?
 A verification on fundamental analysis
• Enable to spot good bargains based on how certain set of
fundamentals are valued in the market.

8. Charting the Market
 Chartists use bar charts, candlestick, or point and figure charts
to look for patterns which may indicate future price
movements.
 They also analyze volume and other psychological indicators
(breadth of the market, % of bulls vs % of bears, put/call ratio,
etc.).
 Strict chartists don’t care about fundamentals at all.

9. Drawing Bar (OHLC) Charts
 Each bar is composed of 4
elements:
• Open
• High
• Low
• Close
 Note that the candlestick
body is empty (white) on up
days, and filled (some
color) on down days
 Ref. Incrediblecharts.com
for a sample charts
Open
Close
High
Low
Standard
BarChart
Japanese
Candlestick
Open
Close
High
Low
Standard
BarChart
Japanese
Candlestick

10. Types of Charts: Bar Charts
 This is a bar (open, high, low, close or OHLC) chart of AMAT
from early July to mid October 2001.

11. Types of Charts: Japanese Candlesticks
 This is a Japanese Candlestick (open, high, low, close) chart of
AMAT from early July to mid October 2001

12. 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 3-point
reversal.
X
X
X
X
X
O
O
X
X
X
X
O
O
O
O

13. Three Basic Functions of Technical Analysis
1. Trends
• Where is the market going?
1. Reversals
• Tops and Bottoms
Congestion/Confusion/Uncertainty

14. Trends
 Is the market going up or down?
• How do peaks and bottoms align?
•Increasing Bull Trend, Decreasing Bear Trend
• Channels
•Combination of trend lines at the top and bottom

15. MONSANTO Co. (chemicals) (May 2007-June 2008)

16. BAC (March 2008-Feb 2009)

17. Reversals Patterns
 When will the market change?
• Gaps, 1-day moves
• Double Top and Double Bottom
• Flags and Pennants
• Head-and-Shoulders and Reverse Head-and-Shoulders

18. Gaps
 A gap is an area on a price chart in which there were no trades.
 Normally gap occurs between the closing price of one day and the
opening price of the next day. Gaps normally appear more frequently
on daily charts than on weekly or monthly charts
 Gaps on price charts indicate that something important has happened
to the fundamentals or the psychology of the market participants that
accompanies this market movement.
 Gaps can be subdivided into four basic categories:
• Common gaps,
• Breakaway gaps,
• Runaway gaps,
• Exhaustion gaps.

25. Sample Charts
International Business Machines (IBM)

26. Goldman Sachs (GC)

27. ABB Ltd

28. Double Top (Bearish Reversal)
 The Double Top Reversal is a bearish reversal pattern. The pattern can
be identified when two consecutive peaks that are roughly equal are
made with a moderate trough in-between
 The classic Double top formation indicate atleast an intermediate
reversal, if not long term, from bullish to bearish trend.
 Many a times potential Double Top Reversals can form during a long
term uptrend, but the reversal can not be confirmed until the key
support is broken.

30. Double Bottom (Bullish Reversal)
 The Double Bottom Reversal is a bullish reversal pattern. The pattern
can be identified when two consecutive troughs that are roughly equal
are made with a moderate peak in-between.
 The classic Double bottom formation indicate an intermediate or a
long term reversal, from bearish to bullish trend.
 Many a times potential Double Bottom Reversals can form during a
long term down trend, but the reversal can not be confirmed until the
key resistance is broken.

32. Flags and Pennants
 Flag : A flag is a small rectangle pattern that slopes against the
previous trend. If the previous move was up, then the flag would slope
down and vice versa. The sharp advance or decline that form a Flag is
always fueled by expansion of volumes, hence indicating the
continuance of the trend.
 Pennant: A pennant is a small symmetrical triangle that begins wide
and converges as the pattern matures. The slope is usually neutral.
Pennant formation is also supported by expansion of volumes.
 Duration: Flags and pennants are short-term patterns that can last
from 1 to 12 weeks. some consider 8 weeks as a time frame for
formation of a reliable pattern. Ideally, these patterns will form
between 1 and 4 weeks.
 Break: For a flag or pennant, a break above resistance /support signals
that the previous trend of advance /decline has resumed.

33. Flags and Pennants
 Flagpole: The flagpole is the distance from the first resistance or
support break to the high or low of the flag/pennant. The sharp advance
(or decline) that forms the flagpole should break a trend line or
resistance/support level. A line extending up from this break to the high
of the flag/pennant forms the flagpole.
 Targets: The length of the flagpole can be applied to the resistance
break or support break of the flag/pennant to estimate the advance or
decline.

36. Head and Shoulders
 The Head and Shoulders reversal pattern is formed with a
precedence of up trend.
 It is made up of a three successive peaks called
• A left shoulder,
• A head,
• A right shoulder, and a neckline.
• Other parts playing a role in the pattern formation are
volume, the breakout, price target and support turned
resistance.
 The Competition of H&S pattern indicate an onset of bearish
trend
 Where as the inverse H&S pattern is formed on a preceding
down trend. Competition of this pattern indicates an onset of
bullish trend

40. Congestion/Confusion/Uncertainty
 When is the market deciding what direction to move?
 Markets move within a narrow range under confusion/uncertainty
causing congestion in price movements (narrow range)

41. Teva Pharmaceutical Industries Limited (TEVA)

42. Exxon Mobil Corporation (XOM)

43. Support and Resistance
 What prices will people be willing to buy and sell?
• Support - “Buying (actual or potential) in sufficient volume to
halt a downtrend in prices for an appreciable period”
• Resistance - “Selling (actual or potential) in sufficient volume
to satisfy all bids”
•Stops prices from increasing
• Fibonacci retracements and extensions are used to identify
support and resistance levels and also as indicatiors for
reversals.

44. Green Mountain Coffee Roasters (GMCR)

45. Fibonacci Retracement/ Extensions
 Retracement levels suggested by Fibonacci sequence indicates potential
trend reversals, resistance and support levels.
 Different retracement levels are 61.8% (deeper), 50%, 38.2%
(moderate) and 23.6% (shallow).
 Note Retracement levels are not hard reversal points they only serve as
alert zones for potential reversals. The retracement levels are to be used
in combination with other technical tools like momentum oscillators ,
chaikin money flow (CMF), gaps, trend lines etc.
 Fibonacci extension is calculated when the price retraces more than
100% of the prior move. It works well when stocks are at new highs or
new lows – with no obvious support or resistance levels on the chart.
 The two common Fibonacci ratios used for calculating extensions are
1.618 and 1.272.

48. Basic Technical Tools
 Trend Lines
 Moving Averages
 Price Patterns
 Indicators
 Cycles

49. 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.

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

51. Simple Moving Averages
 A moving average is
simply the average price
(usually the closing price)
over the last N periods.
 They are used to smooth
out fluctuations of less
than N periods.
 This chart shows MSFT
with a 10-day moving
average. Note how the
moving average shows
much less volatility than
the daily stock price.
MSFTDailyPriceswith10-dayMA
9/23/93to9/21/94
30
35
40
45
50
55
60
1 21 41 61 81 101 121 141 161 181 201 221 241
Date
Price

52. Price Patterns
 Technicians look for many patterns in the historical time series
of prices.
 These patterns are reputed to provide information regarding the
size and timing of subsequent price moves.
 But don’t forget that the EMH says these patterns are illusions,
and have no real meaning. In fact, they can be seen in a
randomly generated price series.

53. 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.
Head
Head
LeftShoulder
LeftShoulder
RightShoulder
RightShoulder
Neckline
Neckline
H&STop
H&SBottom

54. 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.
Target
DoubleTop
DoubleBottom
Target

55. Triangles
 Triangles are continuation
formations.
 Three flavors:
• Ascending
• Descending
• Symmetrical
 Typically, triangles should
break out about half to
three-quarters of the way
through the formation.
Ascending
Descending
Symmetrical
Symmetrical

56. Rounded Tops & Bottoms
 Rounding formations are
characterized by a slow
reversal of trend.
RoundingTop
Rounding
Bottom

57. Broadening Formations
 These formations are like
reverse triangles.
 These formations usually
signal a reversal of the
trend.
BroadeningTops
BroadeningBottoms

58. Technical Indicators
 There are, literally, hundreds of technical indicators used to
generate buy and sell signals.
 A few of them are :
• Moving Average Convergence/Divergence (MACD)
• Relative Strength Index (RSI)
• On Balance Volume (OBV)
• Bollinger Bands

59. MACD
 MACD was developed by Gerald Appel as a way to keep track
of a moving average crossover system.
 Appel defined MACD as the difference between a 12-day and
26-day moving average. A 9-day moving average of this
difference is used to generate signals.
 One can look for signal line crossovers, centerline crossovers
and divergences to generate signals.
 When this signal line goes from negative to positive, a buy
signal is generated.
 When the signal line goes from positive to negative, a sell
signal is generated.
 MACD is best used in choppy (trendless) markets, and is
subject to whipsaws (in and out rapidly with little or no profit).

61. 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 / average price changes on down days.
 The most important thing to understand about RSI is that a level above
70 indicates a stock is overbought, and a level below 30 indicates that it
is oversold (it can range from 0 to 100).
 Also, realize that stocks can remain overbought or oversold for long
periods of time, so RSI alone isn’t always a great timing tool.

62. Oversold
Overbought

63. On Balance Volume (OBV)
 On Balance Volume was developed by Joseph Granville, one of
the most famous technicians of the 1960’s and 1970’s.
 OBV is calculated by adding volume on up days, and
subtracting volume on down days. A running total is kept.
 Granville believed that “volume leads price.”
 To use OBV, you generally look for OBV to show a change in
trend (a divergence from the price trend).
 If the stock is in an uptrend but OBV turns down, then that can
be taken as a signal that the price trend may soon reverse.

65. Bollinger Bands
 Bollinger bands were created by John Bollinger (former FNN
technical analyst, and regular guest on CNBC).
 These are used to identify M-Tops and W-Bottoms or to determine the
strength of the trend.
 Bollinger Bands are two volatility bands (Std. deviations) placed
above and below a moving average of the closing price.
 A buy signal is given when the stock price closes below the lower
band, and a sell signal is given when the stock price closes above the
upper band.
 When the bands contract, that is a signal that a big move is coming,
but it is impossible to say if it will be up or down.
 It appears that the buy signals by BB are far more reliable than the sell
signals.

69. Dow Theory
 This theory was first stated by Charles Henry 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 (industrial average) must be
confirmed by a trend change in the DJTA (transportation
average) in order to generate a valid signal.

70. Tenets of Dow Theory
 The Markets have three trends:
• Uptrend
• down trend
• correction
 Trends Have 3 Phases
• Accumulation Phase
• Public participation Phase
• The excess Phase and hence one c
 The Markets Discount All news
• (EHM Holds good and hence one can beat the market only by timing it
 Averages must confirm to each other
 Trends Must be confirmed by volumes
 Trends exist until definitive signals prove they have ended

71. Dow Theory Trends
 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 shorter-term departures
from the primary trend (weeks to months)
 Day to day fluctuations
• Not significant in Dow Theory

72. Dow Theory Trends

73. Does Dow Theory Work?
 According to Martin Pring, 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.

74. Elliot Wave Principle
 R.N. Elliot formulated this idea in a series of articles in
Financial World in 1939.
 Elliot believed that the market has a rhythmic regularity that
can be used to predict future prices.
 The Elliot Wave Principle is based on a repeating 8-wave cycle,
and each cycle is made up of similar shorter-term cycles (“Big
fleas have little fleas upon their backs to bite 'em - little fleas
have smaller fleas and so on ad infinitem”).
 Elliot Wave adherents also make extensive use of the Fibonacci
series.

75. The Elliot Wave Principle
1
2
3
4
5
A
B
C

76. Does Elliot Wave Work?
 Who knows? One of the biggest problems with Elliot Wave is
that no two practitioners seem to agree on the wave count, and
therefore on the prediction of what’s to come.
 Robert Prechter (the most famous EW practitioner) made
several astoundingly correct predictions in the 1980’s, but
hasn’t been so prescient since (he no longer gets much press
attention).
 For example, in 1985 he predicted that the market would peak
in 1987 (correct), but he thought it would peak at 3686 (± 100
points).
 The DJIA actually peaked on 25 August 1987 at 2722.42, more
than 960 points lower.

77. Happy Investing