Introduction to technical analysis

Introduction To TechnicalIntroduction To Technical
AnalysisAnalysis
Christopher M. Quigley,Christopher M. Quigley,
B.Sc., M.I.I. (Grad.), M.A., QFA.B.Sc., M.I.I. (Grad.), M.A., QFA.
Qualified Financial Adviser.Qualified Financial Adviser.
www.Wealthbuilder.iewww.Wealthbuilder.ie
cmqesquire@gmail.comcmqesquire@gmail.com

““Price action is the most insightful dataPrice action is the most insightful data
available because it is judgement backedavailable because it is judgement backed
by money.”by money.”

Introduction To Technical AnalysisIntroduction To Technical Analysis
 SeminarSeminar Outline:Outline:
 General IntroductionGeneral Introduction
 Dow TheoryDow Theory
 Charting Basics:Charting Basics:
Line ChartsLine Charts
Bar ChartsBar Charts
Candlestick ChartsCandlestick Charts
SupportSupport
ResistanceResistance
Trend LinesTrend Lines
Price ChannelsPrice Channels

 Seminar Outline (Continued):Seminar Outline (Continued):
 Charting Patterns:Charting Patterns:
Falling WedgeFalling Wedge
Rising WedgeRising Wedge
Flag/PennantFlag/Pennant
Double Top/BottomDouble Top/Bottom
Head & Shoulder Top/BottomHead & Shoulder Top/Bottom
Ascending/Descending TriangleAscending/Descending Triangle
 Technical Indicators:Technical Indicators:
Moving AveragesMoving Averages
À/D LineÀ/D Line
Indicators:Indicators: MACDMACD
Indicators:Indicators: Stochasics OscillatorStochasics Oscillator
Indicators:Indicators: Bollinger BandsBollinger Bands

 Seminar Outline (Continued):Seminar Outline (Continued):
 Technical Analysis Application:Technical Analysis Application:
Trade ExamplesTrade Examples

General IntroductionGeneral Introduction
 Technical Analysis Is A Tool To Gain Insight Into Market Price Behaviour And SoTechnical Analysis Is A Tool To Gain Insight Into Market Price Behaviour And So
Enable You To More Profitably Judge Investment Entry And Exit PointsEnable You To More Profitably Judge Investment Entry And Exit Points
 In Essence Technical Analysis, Correctly Used, Will Motivate Investment Action ThatIn Essence Technical Analysis, Correctly Used, Will Motivate Investment Action That
Brings A Higher Probability Of Success Than Through The Use Of Pure RandomBrings A Higher Probability Of Success Than Through The Use Of Pure Random
ChoiceChoice
 Dow Theory When Fully Comprehended, Demonstrates That The Market Is NotDow Theory When Fully Comprehended, Demonstrates That The Market Is Not
RandomRandom
 This Theory Has Proved Itself Over 100 YearsThis Theory Has Proved Itself Over 100 Years
 The Hypothesis Works Because Price Action Is A Result Of Human DecisionsThe Hypothesis Works Because Price Action Is A Result Of Human Decisions
 Historical Observation Indicates That Price Conditions Change But Human NatureHistorical Observation Indicates That Price Conditions Change But Human Nature
Does NotDoes Not
 Thus Technical Analysis Is Basically A Type Of Behavioural or Social ScienceThus Technical Analysis Is Basically A Type Of Behavioural or Social Science
 Such Study Cannot Predict The Future, Else There Would Be No Market, (For TheSuch Study Cannot Predict The Future, Else There Would Be No Market, (For The
Market Is A “Zero Sum Game”) But It Can Be A GuideMarket Is A “Zero Sum Game”) But It Can Be A Guide
 In My Experience Use Of Too Many Technicals Leads To” Paralysis By Analysis”.In My Experience Use Of Too Many Technicals Leads To” Paralysis By Analysis”.
Thus I Advise The Use Of Some Indicators But Not Too ManyThus I Advise The Use Of Some Indicators But Not Too Many
 My Favourite Analysis Indicators Are: Moving Averages, MACD, Stochastics, PriceMy Favourite Analysis Indicators Are: Moving Averages, MACD, Stochastics, Price
(Candlestick Format) And The A/D Line(Candlestick Format) And The A/D Line
 In Addition Volume Bars, Bollinger Bands and The ADX Line Can Be UsefulIn Addition Volume Bars, Bollinger Bands and The ADX Line Can Be Useful

 You will not excel at investment doingYou will not excel at investment doing
actions by roteactions by rote
 Ideally you must understand what you areIdeally you must understand what you are
doing and why you are doing itdoing and why you are doing it
 You must begin to think for yourselfYou must begin to think for yourself

 Thus we must ask are the marketsThus we must ask are the markets
understandable and logical or are theyunderstandable and logical or are they
random and chaoticrandom and chaotic

 It is out contention that the markets areIt is out contention that the markets are
logical and to support this thesis we willlogical and to support this thesis we will
review Dow Theory (Elliott Wave Theoryreview Dow Theory (Elliott Wave Theory
supports the same view from a differentsupports the same view from a different
perspective).perspective).

 Dow Theory was developed by Charles DowDow Theory was developed by Charles Dow
and William Hamilton in the early 1900’sand William Hamilton in the early 1900’s
 They both sought a system that wouldThey both sought a system that would
assist successful investmentassist successful investment
 As part of the process Charles DowAs part of the process Charles Dow
pioneered the use of the Dow Transportpioneered the use of the Dow Transport
index and the Dow Industrial indexindex and the Dow Industrial index

 Why these indices?Why these indices?
 They wanted to gain a unique insight intoThey wanted to gain a unique insight into
how the economy was operating becausehow the economy was operating because
they realised that the market was merely athey realised that the market was merely a
perception of economic conditionsperception of economic conditions

 Case in point let us use General Motors asCase in point let us use General Motors as
an examplean example
 If orders for cars were previously flat butIf orders for cars were previously flat but
then began to increase demand for steelthen began to increase demand for steel
would risewould rise
 This steel would need to be shippedThis steel would need to be shipped
 Thus from a base pattern shipping activityThus from a base pattern shipping activity
would spike up and load factors on railwaywould spike up and load factors on railway
lines would rise, increasing turnoverlines would rise, increasing turnover

 Thus Dow perceived rail or transport activityThus Dow perceived rail or transport activity
as an early or LEADING INDICATORas an early or LEADING INDICATOR
 As the cars that were produced from theAs the cars that were produced from the
steel were sold the sales figures wouldsteel were sold the sales figures would
show up in the profits of GMshow up in the profits of GM

 The Dow industrials would improve inThe Dow industrials would improve in
performanceperformance
 Thus the industrials were a CONFIRMINGThus the industrials were a CONFIRMING
indicatorindicator

 Dow and Hamilton in their writings wereDow and Hamilton in their writings were
among the first to coin the terms Bull andamong the first to coin the terms Bull and
Bear marketsBear markets
 BBUULL = BLL = BUUYY
 BBEEAR = SAR = SEELLLL

 With the system Charles Dow developedWith the system Charles Dow developed
certain rules:certain rules:
 There can be three trends at play in theThere can be three trends at play in the
market at any timemarket at any time

 Trends:Trends:
 Primary TrendPrimary Trend
 Secondary or Reactionary or CorrectiveSecondary or Reactionary or Corrective
TrendTrend
 Minor or Speculative TrendMinor or Speculative Trend

 Primary TrendPrimary Trend
 This main trend can last for 2-3 years or forThis main trend can last for 2-3 years or for
many decadesmany decades
 Once it is identified it is assumed to be inOnce it is identified it is assumed to be in
place until otherwise disprovedplace until otherwise disproved
 Superior investment success involvesSuperior investment success involves
knowing this trend and knowing how to workknowing this trend and knowing how to work
with itwith it

 Secondary TrendSecondary Trend
 This movement is a reaction against theThis movement is a reaction against the
main trend and is often tricky to distinguishmain trend and is often tricky to distinguish
 Very often such movements turn out to beVery often such movements turn out to be
“sucker” rallies or pullbacks“sucker” rallies or pullbacks
 This trend can last for a few days to manyThis trend can last for a few days to many
monthsmonths

 Minor TrendMinor Trend
 This movement is mainly speculative andThis movement is mainly speculative and
can be ignored from an investor point ofcan be ignored from an investor point of
viewview
 It can last for a few days and weeksIt can last for a few days and weeks

 Each major trend has 3 phases:Each major trend has 3 phases:
 Bull Trend:Bull Trend:
 AccumulationAccumulation
 Public ParticipationPublic Participation
 DistributionDistribution
 Bear Trend:Bear Trend:
 DistributionDistribution
 Public ParticipationPublic Participation
 AccumulationAccumulation

Dow TheoryDow Theory
AssumptionsAssumptions

Dow Theory AssumptionsDow Theory Assumptions
 The Averages Discount EverythingThe Averages Discount Everything
 This means that all free knowledge andThis means that all free knowledge and
news is discounted in the market price atnews is discounted in the market price at
any timeany time
 Thus if you know how to read the marketThus if you know how to read the market
you will comprehend all that there is to knowyou will comprehend all that there is to know

 Manipulation Of The Market Is ImpossibleManipulation Of The Market Is Impossible
 Because the main market is so big andBecause the main market is so big and
broad no one group can control it alone,broad no one group can control it alone,
thus price movement is based on thethus price movement is based on the
perception of economic factorsperception of economic factors

 To Have A Valid Dow Signal Both The DowTo Have A Valid Dow Signal Both The Dow
Transport Index And The Dow IndustrialTransport Index And The Dow Industrial
Index Must ConfirmIndex Must Confirm
 This is perhaps the most important of theThis is perhaps the most important of the
Dow Theory rules. History has shown thatDow Theory rules. History has shown that
there can be many false movements ofthere can be many false movements of
either index but confirmation by both greatlyeither index but confirmation by both greatly
improves the reliability and use of the theoryimproves the reliability and use of the theory

 Trend must be confirmed by volumeTrend must be confirmed by volume

Dow Theory ApplicationDow Theory Application
 A BULL TREND IS SIGNALED BYA BULL TREND IS SIGNALED BY HIGHERHIGHER
HIGHSHIGHS ANDAND HIGHER LOWSHIGHER LOWS

 A BEAR TREND IS SIGNALED BYA BEAR TREND IS SIGNALED BY LOWERLOWER
HIGHSHIGHS AndAnd LOWER LOWSLOWER LOWS

 There is always a main or primary trend inThere is always a main or primary trend in
operation and the successful investor needsoperation and the successful investor needs
to know how to recognise the signatures ofto know how to recognise the signatures of
these trendsthese trends

 Dow and Hamilton believed that the trendDow and Hamilton believed that the trend
was your friendwas your friend
 That the probability of investment successThat the probability of investment success
was greatly improved if you knew what thewas greatly improved if you knew what the
trend was and invested with ittrend was and invested with it
 They understood that theThey understood that the SENTIMENTSENTIMENT ofof
investors moved the market and that it wasinvestors moved the market and that it was
unwise to fight this sentimentunwise to fight this sentiment

 Never invest if the trend cannot be identifiedNever invest if the trend cannot be identified
 Until the trend is apparent and congruent itUntil the trend is apparent and congruent it
is best to stay out of the market on theis best to stay out of the market on the
sidelines in cash because in such casessidelines in cash because in such cases
there is above average riskthere is above average risk
 Dow and Hamilton only advised investmentDow and Hamilton only advised investment
for the big movesfor the big moves

 The theory accepts that the stock marketThe theory accepts that the stock market
values equities through subjective sentimentvalues equities through subjective sentiment
 In a bull market stocks thus may becomeIn a bull market stocks thus may become
overvaluedovervalued
 In a bear market equities may becomeIn a bear market equities may become
undervaluedundervalued
 Therefore the seasoned investor works withTherefore the seasoned investor works with
such sentimentsuch sentiment

 We will now quickly review examples of theWe will now quickly review examples of the
theory in actiontheory in action
 Example 1. 1998-2000 Tech CrashExample 1. 1998-2000 Tech Crash
 Example 2.Example 2. 2003 Post Iraq War Rally2003 Post Iraq War Rally
 Example 3.Example 3. 2007 Sub-Prime Bust2007 Sub-Prime Bust

2000 Tech Crash2000 Tech Crash
Dow 20Dow 20
&&
Dow 30Dow 30

 2000 Tech crash observations2000 Tech crash observations
 Even though the Dow 30 moved to higherEven though the Dow 30 moved to higher
highs in the 1highs in the 1stst
Qtr. Of 1999 the confirmationQtr. Of 1999 the confirmation
failed with the Dow 20 in the second Qtr. Offailed with the Dow 20 in the second Qtr. Of
1999.1999.
 This failure was a warning to seasonedThis failure was a warning to seasoned
investorsinvestors
 Both averages collapsed in the 3Both averages collapsed in the 3rdrd
. Qtr. Of. Qtr. Of
20012001

2003 Iraq War Rally2003 Iraq War Rally
Dow 20Dow 20
&&
Dow 30Dow 30

2003 Iraq War Rally Observations2003 Iraq War Rally Observations
 The Dow 30 moved to higher highs In the 2The Dow 30 moved to higher highs In the 2ndnd
Qtr. Of 2003Qtr. Of 2003
 This price action was confirmed by the DowThis price action was confirmed by the Dow
20 towards the end of the 220 towards the end of the 2ndnd
Qtr. Also.Qtr. Also.
 Both indices exploded hard in the 3Both indices exploded hard in the 3rdrd
. Qtr. Qtr
20032003

2007 Sub-Prime Bust2007 Sub-Prime Bust
Dow 20Dow 20
&&
Dow 30Dow 30

2007 Sub-Prime Bust Observations2007 Sub-Prime Bust Observations
 Lower highs and lower lows were indicatedLower highs and lower lows were indicated
by the Dow 30 towards the last Qtr. Of 2007by the Dow 30 towards the last Qtr. Of 2007
 This was confirmed by the Dow 20This was confirmed by the Dow 20
 An attempted rally by the Dow 20 in theAn attempted rally by the Dow 20 in the
second Qtr. Of 2008 was not confirmed bysecond Qtr. Of 2008 was not confirmed by
the Dow 30the Dow 30
 Both indices collapsed in the 3Both indices collapsed in the 3rdrd
. Quarter of. Quarter of
20082008

Charting BasicsCharting Basics

 A technical analysis chart is basically aA technical analysis chart is basically a
graph with price annotated on the left andgraph with price annotated on the left and
time on the bottomtime on the bottom
 Its purpose is to analyse past price changesIts purpose is to analyse past price changes
to try to predict future price movement withto try to predict future price movement with
a higher degree of probability than randoma higher degree of probability than random
guessguess

 There are three types of chart:There are three types of chart:
 Line ChartLine Chart
 Bar ChartBar Chart
 Candlestick ChartCandlestick Chart

 Line Chart:Line Chart:
 A Line chart simply graphs the Closing priceA Line chart simply graphs the Closing price
of an instrumentof an instrument

 Bar Chart:Bar Chart:
 This chart gives you the high, low, open (leftThis chart gives you the high, low, open (left
tick) and closing (right tick) prices.tick) and closing (right tick) prices.

 Candlestick Chart:Candlestick Chart:
 Japanese Candlestick charts are one of theJapanese Candlestick charts are one of the
oldest type of charts used for priceoldest type of charts used for price
prediction. They date back to the 1700s,prediction. They date back to the 1700s,
when they were used for predicting ricewhen they were used for predicting rice
prices.prices.

 Candlestick Chart:Candlestick Chart:
 The Candlestick format shows the full rangeThe Candlestick format shows the full range
of price movement i.e. high, low, open andof price movement i.e. high, low, open and
close in a more graphic manner than on theclose in a more graphic manner than on the
Bar chart . Thus we more easily get a senseBar chart . Thus we more easily get a sense
of market sentiment behind price changes.of market sentiment behind price changes.

Price: Candlestick Format ExamplesPrice: Candlestick Format Examples

 Price Support & Resistance:Price Support & Resistance:
 Support is the price level at which demand isSupport is the price level at which demand is
thought to be strong enough to prevent the pricethought to be strong enough to prevent the price
from declining further. The logic dictates that asfrom declining further. The logic dictates that as
the price declines towards support and getsthe price declines towards support and gets
cheaper, buyers become more inclined to buy andcheaper, buyers become more inclined to buy and
sellers become less inclined to sell. By the timesellers become less inclined to sell. By the time
the price reaches the support level, it is believedthe price reaches the support level, it is believed
that demand will overcome supply and prevent thethat demand will overcome supply and prevent the
price from falling below support.price from falling below support.

 Resistance is the price level at which selling isResistance is the price level at which selling is
thought to be strong enough to prevent the pricethought to be strong enough to prevent the price
from rising further.from rising further.

 Trend Lines & Price ChannelsTrend Lines & Price Channels

 Trend Lines:Trend Lines:
 Technical analysis is built on the assumption thatTechnical analysis is built on the assumption that
prices trend. Trend Lines are an important tool inprices trend. Trend Lines are an important tool in
technical analysis for both trend identification andtechnical analysis for both trend identification and
confirmation. A trend line is a straight line thatconfirmation. A trend line is a straight line that
connects two or more price points and thenconnects two or more price points and then
extends into the future to act as a line of supportextends into the future to act as a line of support
or resistance.or resistance.

 Price Channel:Price Channel:
 A price channel is a continuation patternA price channel is a continuation pattern
that slopes up or down and is bound by anthat slopes up or down and is bound by an
upper and lower trend line. The upper trendupper and lower trend line. The upper trend
line marks resistance and the lower trendline marks resistance and the lower trend
line marks support.line marks support.

 Price Channels:Price Channels:
 Main Trend Line:Main Trend Line: It takes at least two points to draw the main trendIt takes at least two points to draw the main trend
line. This line sets the tone for the trend and the slope.line. This line sets the tone for the trend and the slope.
 Channel Line:Channel Line: The line drawn parallel to the main trend line is calledThe line drawn parallel to the main trend line is called
the channel line. Ideally, the channel line will be based off of twothe channel line. Ideally, the channel line will be based off of two
reaction highs or lows.reaction highs or lows.

Charting PatternsCharting Patterns

 Falling Wedge:Falling Wedge:
 The falling wedge is a bullish pattern that beginsThe falling wedge is a bullish pattern that begins
wide at the top and contracts as prices movewide at the top and contracts as prices move
lower. This price action forms a cone that slopeslower. This price action forms a cone that slopes
down as the reaction highs and reaction lowsdown as the reaction highs and reaction lows
converge.converge.

 Rising Wedge:Rising Wedge:
 The rising wedge is a bearish pattern thatThe rising wedge is a bearish pattern that
begins wide at the bottom and contracts asbegins wide at the bottom and contracts as
prices move higher and the trading rangeprices move higher and the trading range
narrows.narrows.

 Flag/Pennant:Flag/Pennant:
 Flags and Pennants are short-termFlags and Pennants are short-term
continuation patterns that mark a smallcontinuation patterns that mark a small
consolidation before the previous moveconsolidation before the previous move
resumes. These patterns are usuallyresumes. These patterns are usually
preceded by a sharp advance or declinepreceded by a sharp advance or decline
with heavy volume, and mark a mid-point ofwith heavy volume, and mark a mid-point of
the movethe move

 Double Top:Double Top:
 The Double Top Reversal is a bearishThe Double Top Reversal is a bearish
reversal pattern.reversal pattern.

 Double Bottom:Double Bottom:
 The Double Bottom Reversal is a bullishThe Double Bottom Reversal is a bullish
reversal pattern.reversal pattern.

 Head & Shoulders Top:Head & Shoulders Top:
 A Head and Shoulders reversal pattern forms afterA Head and Shoulders reversal pattern forms after
an uptrend, and its completion marks a trendan uptrend, and its completion marks a trend
reversal. The pattern contains three successivereversal. The pattern contains three successive
peaks with the middle peak (head) being thepeaks with the middle peak (head) being the
highest and the two outside peaks (shoulders)highest and the two outside peaks (shoulders)
being low and roughly equal. The reaction lows ofbeing low and roughly equal. The reaction lows of
each peak can be connected to form support, or aeach peak can be connected to form support, or a
neckline.neckline.

 Head & Shoulders Bottom:Head & Shoulders Bottom:
 As a major reversal pattern, the Head andAs a major reversal pattern, the Head and
Shoulders Bottom forms after a downtrend, and itsShoulders Bottom forms after a downtrend, and its
completion marks a change in trend. The patterncompletion marks a change in trend. The pattern
contains three successive troughs with the middlecontains three successive troughs with the middle
trough (head) being the deepest and the twotrough (head) being the deepest and the two
outside troughs (shoulders) being shallower.outside troughs (shoulders) being shallower.
Ideally, the two shoulders would be equal in heightIdeally, the two shoulders would be equal in height
and width. The reaction highs in the middle of theand width. The reaction highs in the middle of the
pattern can be connected to form resistance, or apattern can be connected to form resistance, or a
neckline.neckline.

 Ascending Traingle:Ascending Traingle:
 The ascending triangle is a bullish formation thatThe ascending triangle is a bullish formation that
usually forms during an uptrend as a continuationusually forms during an uptrend as a continuation
pattern.pattern.

 Descending TriangleDescending Triangle
 The descending triangle is a bearish formation thatThe descending triangle is a bearish formation that
usually forms during a downtrend as ausually forms during a downtrend as a
continuation pattern.continuation pattern.

 Moving Averages:Moving Averages:
 Moving averages smooth the price data to form a trendMoving averages smooth the price data to form a trend
following indicator. They do not predict price direction, butfollowing indicator. They do not predict price direction, but
rather define the current direction with a lag. Movingrather define the current direction with a lag. Moving
averages lag because they are based on past prices.averages lag because they are based on past prices.
Despite this lag, moving averages help smooth price actionDespite this lag, moving averages help smooth price action
and filter out the noise. They also form the building blocksand filter out the noise. They also form the building blocks
for many other technical indicators and overlays, such asfor many other technical indicators and overlays, such as
Bollinger Bands and MACD. The two most popular types ofBollinger Bands and MACD. The two most popular types of
moving averages are themoving averages are the Simple Moving Average (SMA)Simple Moving Average (SMA)
and theand the Exponential Moving Average (EMA)Exponential Moving Average (EMA). These. These
moving averages can be used to identify the direction ofmoving averages can be used to identify the direction of
the trend or define potential support and resistance levels.the trend or define potential support and resistance levels.

 Moving Averages notes:Moving Averages notes:
 Used to smooth out price actionUsed to smooth out price action
 The longer the average timeline used the slower theThe longer the average timeline used the slower the
response time to trend change, thus there is a trade-offresponse time to trend change, thus there is a trade-off
 Used to identify trend direction, support and resistanceUsed to identify trend direction, support and resistance
 SimpleSimple moving average weights all time data points equallymoving average weights all time data points equally
 ExponentialExponential moving average givers higher weight to latestmoving average givers higher weight to latest
data points, thus it is slightly more sensitivedata points, thus it is slightly more sensitive

Bull:Bull: DMA = SupportDMA = Support
Bear:Bear: DMA = ResistanceDMA = Resistance

 Moving Averages: Advance/Decline Line (A/D Line):Moving Averages: Advance/Decline Line (A/D Line):
 The Advance Decline Line (AD Line) is a breadth indicator based onThe Advance Decline Line (AD Line) is a breadth indicator based on
Net Advances, which is the number of advancing stocks less theNet Advances, which is the number of advancing stocks less the
number of declining stocks.number of declining stocks.

 A/D Line behaviour in action:A/D Line behaviour in action:
 1.1. 2000 Tech Crash2000 Tech Crash
 2.2. 2003 Iraq War Rally2003 Iraq War Rally
 3.3. 2007 Sub-Prime Bust2007 Sub-Prime Bust

 Indicators: MACDIndicators: MACD
 Developed by Gerald Appel in the late seventies, Moving AverageDeveloped by Gerald Appel in the late seventies, Moving Average
Convergence-Divergence (MACD) is one of the simplest and mostConvergence-Divergence (MACD) is one of the simplest and most
effective momentum indicators available. MACD turns two trend-effective momentum indicators available. MACD turns two trend-
following indicators, moving averages, into a momentum oscillator byfollowing indicators, moving averages, into a momentum oscillator by
subtracting the longer moving average from the shorter movingsubtracting the longer moving average from the shorter moving
average. As a result, MACD offers the best of both worlds: trendaverage. As a result, MACD offers the best of both worlds: trend
following and momentum.following and momentum.
 Settings: 12 – 26 – 9Settings: 12 – 26 – 9
 Format: HistogramFormat: Histogram

 Indicators: Stochastics OscillatorIndicators: Stochastics Oscillator
 Developed by George C. Lane in the late 1950s, the StochasticDeveloped by George C. Lane in the late 1950s, the Stochastic
Oscillator is a momentum indicator that shows the location of the closeOscillator is a momentum indicator that shows the location of the close
relative to the high-low range over a set number of periods. Accordingrelative to the high-low range over a set number of periods. According
to an interview with Lane, the Stochastic Oscillator "doesn't followto an interview with Lane, the Stochastic Oscillator "doesn't follow
price, it doesn't follow volume or anything like that. It follows the speedprice, it doesn't follow volume or anything like that. It follows the speed
or the momentum of price. As a rule, the momentum changes directionor the momentum of price. As a rule, the momentum changes direction
before price."before price."
 Settings: 14-3-3 and 28-7-7Settings: 14-3-3 and 28-7-7

 The major insight that Lane had with stochasticsThe major insight that Lane had with stochastics
was that in a bull move prices tend to close to thewas that in a bull move prices tend to close to the
top of the range and in bear moves prices tend totop of the range and in bear moves prices tend to
close near the bottom of the price rangeclose near the bottom of the price range
 He also observed that momentum tends to changeHe also observed that momentum tends to change
before price.before price.

 Indicators: Bollinger BandsIndicators: Bollinger Bands
 Developed by John Bollinger, Bollinger Bands are volatilityDeveloped by John Bollinger, Bollinger Bands are volatility
bands placed above and below a moving average. Volatilitybands placed above and below a moving average. Volatility
is based on the standard deviation, which changes ais based on the standard deviation, which changes a
volatility increase and decreases. The bands automaticallyvolatility increase and decreases. The bands automatically
widen when volatility increases and narrow when volatilitywiden when volatility increases and narrow when volatility
decreases.decreases.
 Setting: Normally use the 20 DMA as the centre lineSetting: Normally use the 20 DMA as the centre line

Bollinger Bands consist of a middle band with twoBollinger Bands consist of a middle band with two
outer bands. The middle band is a simple movingouter bands. The middle band is a simple moving
average that is usually set at 20 periods. A simpleaverage that is usually set at 20 periods. A simple
moving average is used because a simple movingmoving average is used because a simple moving
average is also used in the standard deviationaverage is also used in the standard deviation
formula. The look-back period for the standardformula. The look-back period for the standard
deviation is the same as for the simple movingdeviation is the same as for the simple moving
average. The outer bands are usually set 2average. The outer bands are usually set 2
standard deviations above and below the middlestandard deviations above and below the middle
band.band.

 Wide Bollinger Bands indicate markets withWide Bollinger Bands indicate markets with
high volatility and strong trendhigh volatility and strong trend
 Narrow contracted Bollinger Bands indicateNarrow contracted Bollinger Bands indicate
low volatility and range bound marketslow volatility and range bound markets
 Bollinger Bands work well in conjunctionBollinger Bands work well in conjunction
with momentum indicators like Wilder’swith momentum indicators like Wilder’s
Stochastics and MACD.Stochastics and MACD.
 Trading Triggers would be multi tops, multiTrading Triggers would be multi tops, multi
bottoms and line breakouts.bottoms and line breakouts.

 McClellan Oscillator
 Developed by Sherman and Marian McClellan, the
McClellan Oscillator is a breadth indicator derived from Net
Advances, which is the number of advancing issues less
the number of declining issues.
 Subtracting the 39-day exponential moving average of Net
Advances from the 19-day exponential moving average of
Net Advances forms the oscillator. As the formula reveals,
the McClellan Oscillator is a momentum indicator that
works similar to MACD. McClellan Oscillator signals can be
generated with breadth thrusts, centerline crossovers and
divergences.

 McClennan Oscillator: Interpretation
 Think of the McClellan Oscillator as the MACD for the AD Line, which is a cumulative
measure of Net Advances. Just as MACD puts momentum into the price plot of a stock,
the McClellan Oscillator puts momentum into the AD Line. The McClellan Oscillator is
positive when the 19-day EMA (shorter moving average) is above the 39-day (longer
moving average) EMA. This signals that advances are gaining the upper hand.
Conversely, the indicator is negative when the 19-day EMA is below the 39-day EMA.
 This signals that declining issues are dominating. Signals typical for MACD apply to the
McClellan Oscillator. First, the McClellan Oscillator generally favors the bulls when
positive and the bears when negative. Second, chartists can look for bullish and bearish
divergences to anticipate reversals. Third, chartists can look for breadth thrusts to signal
the start of an extended move.

 McClellan Summation Index
 Introduction
 Developed by Sherman and Marian McClellan, the McClellan Summation Index is a
breadth indicator derived the McClellan Oscillator, which is a breadth indicator based on
Net Advances (advancing issues less declining issues).
 The Summation Index is simply a running total of the McClellan Oscillator values. Even
though it is called a Summation Index, the indicator is really an oscillator that fluctuates
above and below the zero line. As such, signals can be derived from bullish/bearish
divergences, directional movement and centerline crossovers. A moving average can
also be applied to identify upturns and downturns.

 McClennan Summation: Interpretation
 The Summation Index rises when the McClellan Oscillator is positive and falls when the
McClellan Oscillator is negative. Extended positive numbers in the McClellan Oscillator
cause the Summation Index to trend higher. Conversely, extended negative readings
cause the Summation Index to trend lower.
 Because of its cumulative nature, the Summation Index is a slower version of the
McClellan Oscillator. The index crosses the zero line fewer times, forms divergences less
often and produces fewer signals in general. Whereas the McClellan Oscillator can be
used for short-term and medium-term timing, the Summation Index is generally used for
medium-term and long-term timing.

..
 Volatility Index (VIX)Volatility Index (VIX)
 IntroductionIntroduction
 The volatility indices measure the implied volatility for a basket of put and call optionsThe volatility indices measure the implied volatility for a basket of put and call options
related to a specific index or ETF. The most popular is the CBOE Volatility Index ($VIX),related to a specific index or ETF. The most popular is the CBOE Volatility Index ($VIX),
which measures the implied volatility for a basket of out-of-the-money put and callwhich measures the implied volatility for a basket of out-of-the-money put and call
options for the S&P 500. Specifically, the VIX is designed to measure the expected 30-options for the S&P 500. Specifically, the VIX is designed to measure the expected 30-
day volatility for the S&P 500. The Chicago Board Options Exchange (CBOE) calculatesday volatility for the S&P 500. The Chicago Board Options Exchange (CBOE) calculates
volatility indices for a number of different ETFs and indices. These include the Goldvolatility indices for a number of different ETFs and indices. These include the Gold
SPDR, the USO Oil Fund, the Euro Currency Trust, the Dow Industrials, the S&P 500SPDR, the USO Oil Fund, the Euro Currency Trust, the Dow Industrials, the S&P 500
and the Nasdaq 100. This article will focus on using the VIX. Chartists can use the VIXand the Nasdaq 100. This article will focus on using the VIX. Chartists can use the VIX
and other volatility indices to measure sentiment and look for sentiment extremes thatand other volatility indices to measure sentiment and look for sentiment extremes that
can foreshadow reversals.can foreshadow reversals.

 VIV: Volatility IndexVIV: Volatility Index
 InterpretationInterpretation
 Typically, the VIX has an inverse relationship to the stock market. VIX advances whenTypically, the VIX has an inverse relationship to the stock market. VIX advances when
stocks decline and declines when stocks advance. It seems that volatility would bestocks decline and declines when stocks advance. It seems that volatility would be
immune to market direction, but the stock market has a bullish bias overall. A rising stockimmune to market direction, but the stock market has a bullish bias overall. A rising stock
market is viewed as less risky, while a declining stock market carries more risk. Themarket is viewed as less risky, while a declining stock market carries more risk. The
higher the perceived risk, the higher the implied volatility. Hence, this implied volatility ishigher the perceived risk, the higher the implied volatility. Hence, this implied volatility is
very susceptible to directional movement. A down swing or extended decline increasesvery susceptible to directional movement. A down swing or extended decline increases
the demand forthe demand for put optionsput options, which in turn increases put prices and the implied volatility., which in turn increases put prices and the implied volatility.
Puts are bought as a hedge against long positions or as a directional bet. This is whyPuts are bought as a hedge against long positions or as a directional bet. This is why
many analysts consider the VIX a coincident indicator. It moves when stocks move, notmany analysts consider the VIX a coincident indicator. It moves when stocks move, not
independently of stocks. In fact, VIX can be used as a trend-confirming indicator becauseindependently of stocks. In fact, VIX can be used as a trend-confirming indicator because
it often trends in the opposite direction of the stock market. Despite a tendency to trend,it often trends in the opposite direction of the stock market. Despite a tendency to trend,
the VIX can also trade in ranges that mark sentiment extremes. These extremes can bethe VIX can also trade in ranges that mark sentiment extremes. These extremes can be
identified to anticipate stock marketidentified to anticipate stock market

CRDN: June, 2005CRDN: June, 2005

 Trade Examples:Trade Examples:
 Momentum Swing Trades:Momentum Swing Trades:

AAPL: Aug, 2007AAPL: Aug, 2007

 Trade ExamplesTrade Examples
 Momentum BreakoutMomentum Breakout

 Silver Ultra ETF: AGQSilver Ultra ETF: AGQ

 Netflix : NFLXNetflix : NFLX

Introduction to technical analysis

Introduction to technical analysis

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