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Technical Analysis
The stock market or any market may or may not
reflect what its true value is. It however always
reflects investors perception of the value.
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What the technical analyst beliefs
Security prices and volumes move in trends
Past is an indicator of the future
Market price reflects all the different investor opinions about a security
Shortcomings of fundamental Analysis
Accounting policies may vary from company to company thus makingcomparison difficult.
Full information may not be available to the analyst.
Non-quantifiable factors may not show up in the financial statements(perceptions)
Economic analysis, then industry and then company analysis.too much
hard work
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Third party opinion
Prices do not move in trends (efficient markets)
If a rule exists then it would be fully exploited making its use less profitable
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Technical Analysis Tools
Dow Theory
Patterns
Head & Shoulders
Triangle
Double tops/bottoms
Others
Charts
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Others
Relative strength Analysis
Moving Averages
Momentum Tools
RSI (Relative Strength Index)
MACD (Moving Average Convergence Divergence)
Elliott Wave theory
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Dow TheoryThe Dow theory is a method that attempts to interpret and signal changesin the stock market direction.
The Dow theory identifies three forces:
a primary direction or trend,
a secondary reaction or trend, and
daily fluctuations
Purpose: to signal changes in the primary direction
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However, if a departure in one is followed by a departure in the other, this is viewed
is confirmation that the trend has changed.
Must monitor two indexes:Dow Jones Industrial AverageDow Jones Transportation Average
If ONE index departs from the primary direction, this is not a signal.
Importance of volume
Ratio of upside-downside volume
Price movements are not very important unless they are confirmed by
volume.
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Typical Stock Market Cycle
StockPrice
Indicate the primary & secondary trend in this
Primary Trend
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CHARTS
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Charts
Line Charts: formed by joining the closing prices of a security against the date
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1100
1150
1200
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Bar Charts: formed by joining the high and low prices for a given day. The closingprice is indicated as a tick on this line.
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Point-and-figure chartsattempt to show only major price moves and their direction.
The point and figure chart maker decides what price move is major.
That is, it could be Rs.2, Rs.5, or any other level.
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A major up-move is marked with an X
A major down-move is marked with an O
Start a new column when there is a direction change.
Buy and sell signals are generated when new highs or new lows are reached.
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50
48 X46 X
44 X
42 X
40 X
38 X X
36 X O X
34 X O X
32 X O
30 O
DATE1
DATE2
DATE3
DATE4
DATE5
DATE6
DATE7
DATE8
DATE9
DATE10
30 32 34 36 38 36 36 34 32 32
DATE11 DATE12 DATE13 DATE14 DATE15 DATE16 DATE17 DATE18 DATE19
30 34 36 38 40 42 44 46 48
For the following sequence of prices draw the point and figure chart
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Patterns
Head & Shoulders
When the stock price pierces the neckline after the right shoulder is
finished, it is time to sell.
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Inverse Head & Shoulders
When the stock price pierces the neckline after the right shoulder is
finished, it is time to buy.
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Target
Double Top
Double Bottom
Target
Double Top/Double bottoms
Indicates the resistance and support level forthe stock.
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Ascending
Descending
Symmetrical
Symmetrical
Triangles
Three formations, namely:
Ascending: The top part of the triangle appears flat, while the bottompart of the triangle has an upward slant.Indicates bullish trend
Descending: Unlike the
ascending triangle, thistime the bottom part of thetriangle appears flat. Thetop part of the triangle hasa downward slant.Indicates bearish trend.
Symmetrical: Symmetricaltriangles can be characterized asareas of indecision.
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Relative Strength Analysis
Relative strength chartsmeasure the performance of one investment relative toanother (most of the time between security and the market index).
IndexMarket
stocktheofice
Strengthlative
Pr
Re
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0.46
0.48
0.5
0.52
0.54
0.56
0.58
0.6
1-Aug-06 12-Oct-06 22-Dec-06 9-Mar-07
0
500
1000
1500
2000
2500
3000
Infy
RSI
Rising RSC means that the stock is doing better
RSC generally reverses ahead of stock prices.
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Support & Resistance levels
A breakout occurs when a stock (or the market) passes through either asupport or a resistance level.
A support levelis a price or level below which a stock or the market as a whole isunlikely to go,
Resistance levelis a price or level above which a stock or the market as a wholeis unlikely to rise.
Resistance and support areas are usually viewed as psychological barriers
Bargain hunters help support the lower level.
Profit takers resist the upper level.
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http://en.wikipedia.org/wiki/Image:PaychexSupportResistanceChart.JPG -
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Moving Averages
Moving average chartsare average daily prices or index levels, calculated using afixed number of previous days prices or levels, updated each day.
Because daily price fluctuations are smoothed out, these charts are used to
identify trends.
2500260027002800290030003100
320033003400350036003700380039004000410042004300
4400
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30 Day MA
60 day MA
Price
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Example: Suppose the technical trader calculates a 30-day and a 60-day movingaverage of a stock price.
If the 30-day crosses the 60-day from above, it is a bearish signaltime tosell.
If the 30-day crosses the 60-day from below, it is a bullish signaltime to buy.
When the shorter-term moving average line is consistently above the longer-termline, it is considered a bullish signal
Lags the price trend.
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Weighted Moving Average:As against simple moving average where all theobservations are given similar weights, here the more recent observations aregiven higher weights than the older observations. The weights decrease
arithmetically.
1...)1(
....)1( )1(1
nn
PPnnPWMA
nMMM
To compute n-day moving average at time M use the following formula:
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Exponential Moving average: It also weighs the more recent observationsheavily, only the method of weighing differs. The weights decreaseexponentially.
The formula for the weighting of the current trading day's value is 2 / (n+1),where "n" is the number of days in the moving average. The result of thisweighting is then added to the previous exponential moving average calculation.
OEMAOEMAxActualIndeNEMA )(
).()1(
2
daysofnothedenotesnnwhere
So for 100-day EMA n is 100
The starting point for OEMA is OSMA
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Day Index
1 3335.8
2 3370.4
3 3385.95
4 3401.1
5 3425.7
6 3430.35
7 3413.9
8 3435.45
9 3476.85
10 3473.75
Given the 100-day SMA at day 1 is 3227.89, compute the 100-day EMAfor the other dates
EMA
3227.889
3230.711
3233.785
3237.098
3240.832
3244.585
3247.938
3251.651
3256.111
3260.42
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100-day EPM, SPM Vs the Actual
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3400
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4400
0 20 40 60 80 100 120 140 160
EMA
Actual
SMA
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Momentum Strategies
Relative Strength Index
Measures the relative internal strength of the stock against itself.
)1(
100100 RSRSI
closesdowndaysnofAverage
closesupdaysnofAverageRSwhere
'
'
RSI approaching 70 indicates overbought (overvalued) position while RSIapproaching 30 indicates oversold (undervalued) position.
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3-Apr-06 3142.151 4-Apr-06 3152.7
2 5-Apr-06 3114.75
3 7-Apr-06 3167
4 10-Apr-06 3189.3
5 12-Apr-06 3075.65
6 13-Apr-06 3018.85
7 17-Apr-06 3229.95
8 18-Apr-06 3336
9 19-Apr-06 3278.8
10 20-Apr-06 3276.6
u
d
u
u
d
d
u
u
d
d
Up Avg3152.7
0
3167
3189.3
0
0
3229.95
3336
0
0
1607.495
Down Avg0
3114.75
0
0
3075.65
3018.85
0
0
3278.8
3276.6
1576.465
Relative Strength=1607.50/1576.47 =1.02
RSI=50.49