Technical Analysis Introduction

• Technical – looks for peaks, bottoms, trends, patterns, and other

factors affecting a stock’s price movement – makes a buy/sell decision based on those factors

• The world of technical analysis is huge• Hundreds of different patterns and indicators

investors claim to be successful

What is Technical Analysis?

• Method of evaluating securities by analyzing statistics generated by – Market activity– Past Prices– Volume

• Do not attempt to measure intrinsic value• Instead look for patterns and indicators on

charts to determine future performance

What is Technical Analysis? (Continued)

• Technicians believe that securities move in very predictable trends and patterns

• Trends continue until something happens to change the trend

• Until that change takes place, price levels are predictable

• Most agree that technical analysis is much more effective when combined with fundamental analysis

The Bar Chart

Advantage is that it show the high, low, open and close for each dayAdvantage is that it show the high, low, open and close for each day

The Bar Chart (Continued)

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

Point and Figure Chart

• Somewhat rare

• Plots day-to-day increases and declines in price.

• A rising stack of XXXX’s represents increases

• A rising stack of OOOO’s represents decreases.

• Typically used for intraday charting

Point and Figure Chart

Point and Figure Chart (continued)

• Helps to filter out less-significant price movements allowing analyst to focus on most important trends

• Used to keep track of emerging price patterns– No time dimension

• Two attributes affecting the appearance of a point & figure chart – Box size– Reversal amount

Using the Moving Average

• Shows the average value of a security’s price over a period of time– Using compared or used in conjunction with EMA

• The most commonly used averages are of 20,30,50, 100 and 200 days– The longer the time span, the less sensitive the

moving average to daily price changes– Moving averages are used to emphasize the direction

of a trend and smooth out price and volume fluctuations (“noise”).

Moving Average

1.Notice in April when 1.Notice in April when the stock price dropped the stock price dropped well below its 5-day well below its 5-day average (the green average (the green line). Bearish signalline). Bearish signal2.February it rose 2.February it rose above its 50-day above its 50-day average and continued average and continued to rise for several to rise for several weeks. Bullish signalweeks. Bullish signal3.Typically, when a 3.Typically, when a stock moves below its stock moves below its moving average it is a moving average it is a bad sign, above it is a bad sign, above it is a good signgood sign

Moving Averages (Continued)• What do the different days mean?

– 20 days - choppy line. It isn't the most accurate, but is probably the most useful for short term traders.

– 30 day - similar to 20 day but provides a bit more certainty for the trend.

– 50 day - moving averages provide a much less volatile, smooth line. This can be used to detect somewhat longer term trends.

– 100 day - similar to the 50 day, it is less volatile, and one of the most widely used for long term trends.

– 200 day - even less volatile, more of a rolling chart or smooth line. It doesn't react to quick movements in the stock price therefore it is rarely used.

Strategies for Moving Averages

• Filters– Used to increase confidence about an indicator

• No set rules or things to look out for when filtering, just whatever makes you confident enough to invest your money

• For example you might want to wait until a security crosses through its moving average and is at least 10% above the average to make sure that it is a true crossover.

– Remember, setting the percentile too high could result in "missing the boat" and buying the stock at its peak.

• Another filter is to wait a day or two after the security crosses over, this can be used to make sure that the rise in the security isn't a fluke or unsustained.

– Again, the downside is if you wait too long then you could end up missing some big profits.

Strategies for Moving Averages (Continued)

• Crossovers– Not as easy as filtering – Several different types of crossover's, but all of them

involve two or more moving averages. • In a double crossover you are looking for a situation where

the shortest MA crosses through the longer one. This is almost always considered to be a buying signal since the longer average is somewhat of a support level for the stock price.

• For extra insurance you can use a triple crossover, whereby the shortest moving average must pass through the two higher ones. This is considered to be an even stronger buying indicator.

Exponential Moving Averages (EMA)

• Calculated by applying a percentage of today's closing price to yesterday's moving average value.

• Use an exponential moving average to place more weight on recent prices.

Relative Strength Index (RSI)

• A comparison between the days a stock finishes up against the days it finishes down.

• Big tool with momentum trading• Ranges from 0 to 100

– Stock considered overbought around the 70 level– Stock considered oversold around 30

• The shorter the number of days used to calculate the more volatile

Relative Strength Index (RSI)

Money Flow Index

• Measures the strength of money flowing into and out of a stock

• Difference between money flow index and RSI is that RSI only looks at prices, Money Flow also looks at volume

• Ranges from 0 to 100– Overbought at 70– Oversold at 30

Money Flow Index

Trin statisticMeasures the expectations of groups of investors. If Trin <1 signals Bull market and

If Trin < 1 signals bear market

decliningVolume/advancingVolumedecliningNumber/advancingNumber

Trin

advancingNumber/advancingVolumedecliningNumber/decliningVolume

Trin

Put/Call ratio

• Put: option to sell

• Call: option to buy

IF #outstanding puts signals bear mkt

# outstanding calls

Credit balances in brokerage accounts

• Investors will leave credit balances when they plan to invest in the future

• As balance increases, they feel market will decline in future so they will buy

• This signals bull market

Resistance and Support• Price levels at which movement should stop and

reverse direction. – Act as floor and ceiling– Different strengths (major and minor)

• Support– Price level below the current market price at which buying

interest should be able to overcome selling pressure and thus keep the price from going any lower

• Resistance– Price level above the current market price, at which

selling pressure should be strong enough to overcome buying pressure and thus keep the price from going any higher

Resistance and SupportOne of two things can happen when stock approaches

resistance/support

• Can act as a reversal point– When price drops to a

support level, it will go back up

– When price rises to a resistance level, it will go back down

• Support/Resistance reverse roles once penetrated.– Market price falls

below a support level, then the former support level becomes a resistance level when the market later trades back up to that level

Resistance and Support

Resistance

Support

Charting Patterns

• Cup and Handle– Pattern on bar chart as short as 7 weeks or as long as

65 weeks– Cup in the shape of a U; Handle has a slight

downward drift– Right hand side of pattern has low trading volume– As the stock comes up to test old highs, the stock will

incur selling pressure by the people who bought at or near the old high

– Selling pressure will take the stock price sideways for 4 days to 4 weeks, then it takes off

Charting Patterns

Head and Shoulders

• Resembles an “M” in which a stock’s price– Rises to a peak and then declines, then– Rises above the former peak and again declines, and

then– Rises again but not the second peak and again

declines

• The first and third peaks are shoulders, and the second peak forms the head.

• Very bearish indicator

Head and Shoulders

Double Bottom

• Occurs when a stock price drops to a similar price level twice within a few weeks or months

• The double-bottom pattern resembles a “W”• Buy when the price passes the highest point in the

handle.• In a perfect double bottom, the second decline

should normally go slightly lower than the first decline to create a shakeout of jittery investors

• The middle point of the “W” should not go into new high ground.

• This is a very bullish indicator

Double Bottom