Introduction

Technical Analysis is a method of evaluating stocks by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools like indicators and oscillators to identify patterns that can suggest future activity.

Technical charting analysis is a way of gathering and processing price and volume information of a particular security by applying mathematical equations and then plotting the resulting data onto graphs in order to predict future price movements.  Unlike the fundamental analysis, where the economic, geo political factors or the financial health of a company is under scrutiny, technical analysis is only concerned with the price and trading volume of a security.  In essence, technical analysis focuses on the effect of the previous price movements while fundamental analysis studies the causes that could affect the market. A technical analyst believes that the historical performance of stocks and markets are indications of future performance.

Charting analysis involves the usage of data relating to price and trading volume that occur with respect to time. The resulting information are then used to generate visual displays that can help the investor uncover price patterns and trends.  These patterns are more commonly known as indicators and depending on the additional variables used in the mathematical formulation; the indicators can be further classified as either leading or lagging indicators. Typical leading indicators are the Williams%R, the stochastic, momentum, and the Relative Strength Index (RSI).  Typical lagging indicators are the Moving Average Convergence/Divergence (MACD), the simple and exponential moving averages, and the Chaiken Oscillator. Beyond the indicators, technical analysis also consists of the utilization of number theories such as the Fibonacci sequence calculations, the Gann numbers and the Elliot wave theory. These number theories are used

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for the most part to help forecast resistance and support levels of a security's price.

Difference between Technical and Fundamental Analysis

Technical analysis and fundamental analysis are the two main attentions in the financial markets. Mainly, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals.

Charts vs. Financial Statements

At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company’s value. In financial terms, an analyst attempts to measure a company’s fundamental value. In this approach, investment decisions are fairly easy to make - if the price of a stock trades below its intrinsic value, it’s a good investment.

Technical traders, on the other hand, believe there is no reason to analyze a company’s fundamentals because these are all accounted for in the stock’s price. Technicians believe that all the information they need about a stock can be found in its charts.

Time approach for both the technique

Fundamental analysis takes a relatively long-term approach to analyzing the market compared to technical analysis. While technical analysis can be used on a timeframe of weeks, days or even minutes, fundamental analysis often looks at data over a number of years.

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The different timeframes that these two approaches use is a result of the nature of the investing style to which they each adhere. It can take a long time for a company’s value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until the stock’s market price rises to its “correct” value. This type of investing is called value investing and assumes that the short-term market is wrong, but that the price of a particular stock will correct itself over the long run. This “long run” can represent a timeframe of as long as several years, in some cases.

Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of time. Financial statements are filed quarterly and changes in earnings per share don’t emerge on a daily basis like price and volume information. Also remember that fundamentals are the actual characteristics of a business. New management can’t implement sweeping changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term timeframe, therefore, is because the data they use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts.

Trading Versus Investing

Not only is technical analysis more short term in nature that fundamental analysis, but the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price.

Technical analysis has only recently begun to enjoy some mainstream credibility. While most analysts on Stock Exchanges focus on the fundamental side, just about any major brokerage now employs technical analysts as well.

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The field of technical analysis is based on three assumptions:

1.     The market discounts everything. 

2.     Price moves in trends. 

3.     History tends to repeat itself.

1. The Market Discounts Everything 

A major criticism of technical analysis is that it only considers price

movement, ignoring the fundamental factors of the company.

However, technical analysis assumes that, at any given time, a stock's

price reflects everything that has or could affect the company -

including fundamental factors. Technical analysts believe that the

company's fundamentals, along with broader economic factors

and market psychology, are all priced into the stock, removing the

need to actually consider these factors separately. This only leaves the

analysis of price movement, which technical theory views as a product

of the supply and demand for a particular stock in the market. 

2. Price Moves in Trends 

In technical analysis, price movements are believed to follow trends.

This means that after a trend has been established, the future price

movement is more likely to be in the same direction as the trend than

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to be against it. Most technical trading strategies are based on this

assumption.

3. History Tends To Repeat Itself 

Another important idea in technical analysis is that history tends to

repeat itself, mainly in terms of price movement. The repetitive nature

of price movements is attributed to market psychology; in other words,

market participants tend to provide a consistent reaction to similar

market stimuli over time. Technical analysis uses chart patterns to

analyze market movements and understand trends..

Dow Theory

The Dow Theory has been around for almost 100 years, yet even in todays volatile and technology-driven markets, the basic components of Dow theory still remain valid. Developed by Charles Dow, refined by William Hamilton and articulated by Robert Rhea, the Dow Theory addresses not only technical analysis and price action, but also market philosophy. Many of the ideas and comments put forth by Dow and Hamilton became axioms of Wall Street. While there are those who may think that it is different this time, a read through The Dow Theory will attest that the stock market behaves the same today as it did almost 100 years ago.

Charles Dow developed the Dow Theory from his analysis of market price action in the late 19th century. Until his death in 1902, Dow was part owner as well as editor of The Wall Street Journal. Although he never wrote a book on the subject, he did write some editorials that reflected his views on speculation and the role of the rail and industrial averages.

Basic Tenants:

1. The Average discounts everything

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Market reflects every possible knowable factor that affects overall supply and demand. All news and information is quickly incorporated into a stock price as soon as that information becomes available

2. The market has three trends

The Dow Theory leverages trend analysis to identify the overall direction of the market. The theory defines three movements:

The Primary Trend: It is the major movement of the market. This trend can last for several years. The Secondary Trend or Intermediate Trend: It serves as a correction to the primary movement, moving in the opposite direction of the primary movement.The Minor Trend: It is a corrective move within the secondary trend and is typically defined as lasting less than three weeks.

3. Major trends have three phases

Accumulation Phase– Informed buying by the most astute investor. Marks the beginning of an upward trend. This phase comes at the end of a downward trend as investors re-enter the market to buy stocks at attractive pricesPublic Participation Phase – Most technical trend followers begin to participate when prices begin to advance rapidly and business news improves. Informed investors enter the market and help to drive up stock pricesDistribution Phase – Newspaper begin to print increasingly bullish stories. It completes the cycle as savvy investors scale back their positions believing that the market is becoming over-priced.

4. The Averages must confirm each other

The Dow Theory states that a major reversal in trends is not signaled unless the major averages (Industrial and Railway) are in agreement. Without agreement in these averages, it is difficult to confirm a trend in business conditions.

5. Volume must confirm the trend

Volume should expand or increase in the direction of the major trend

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In a major uptrend, volume should increase as prices move higher and diminishes as prices fall. In case of Absence of high trading volumes, there can be a number of explanations for price changes.

6. A trend is assumed to be in effect until it gives definite signals that it has reversed

While markets might make a temporary move in one direction or the other, Dow Theory requires significant evidence to mark the end of a trend. One of the primary goals of technical analysis is to identify these reversals to react accordingly.

Random Walk Theory

The theory states that the stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement.

In short, this is the idea that stocks take a random and unpredictable path. A follower of the random walk theory believes it's impossible to outperform the market without assuming additional risk.

It states the best market strategy to follow would be a simple “Buy & Hold” strategy as opposed to any attempt to beat the market.

Critics of the theory

The illusion of randomness gradually disappears as the skill in chart reading improves. The stocks do maintain price trends over time - in other words, that it is possible to outperform the market by carefully selecting entry and exit points for equity investments.

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Types of Charts :

There are four main types of charts that are used by investors and traders depending on the information that they are seeking and their

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individual skill levels. The chart types are: the line chart, the bar chart, the candlestick chart and the point and figure chart.

1. Line Chart

The most basic of the four charts is the line chart 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. Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices. However, 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.

A line chart

2. Bar Charts

The bar chart expands on the line chart by adding several more key pieces of information to each data point. 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

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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. 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).

3. Candlestick Chart

The candlestick chart is similar to a bar chart, but it differs in the way that it is visually constructed. Similar to the bar chart, the candlestick also has a thin vertical line showing the period's trading range. 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 colours to explain what has happened during the trading period. A major problem with the candlestick colour configuration, however, is that different sites use different standards; therefore, it is important to understand the candlestick configuration used at the chart site you are working with. There are two colour 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 colour that is used to indicate an up day.

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A candlestick chart

4. Point and Figure Charts

The point and figure chart has had a long history of use dating back to the first technical traders. This type of chart reflects price movements and is not as concerned about time and volume in the formulation of the points. The point and figure chart removes the noise, or insignificant price movements, in the stock, which can distort traders' views of the price trends. These types of charts also try to neutralize the skewing effect that time has on chart analysis.

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A Point and figure chart

When first looking at a point and figure chart, you will notice a series of Xs and Os. The Xs represent upward price trends and the Os represent downward price trends. There are also numbers and letters in the chart; these represent months, and give investors an idea of the date. Each box on the chart represents the price scale, which adjusts depending on the price of the stock: the higher the stock's price the more each box represents. The other critical point of a point and figure chart is the reversal criteria. This is usually set at three but it can also be set according to the chartist's discretion. The reversal criteria set how much the price has to move away from the high or low in the price trend to create a new trend or, in other words, how much the price has to move in order for a column of Xs to become a column of Os, or vice versa. When the price trend has moved from one trend to another, it shifts to the right, signalling a trend change.

Important of Volume in Technical Analysis

Volume is simply the number of shares or contracts that trade over a given period of time, usually a day. The higher the volume, the more active the security. To determine the movement of the volume (up or down), chartists look at the volume bars that can usually be found at the bottom of any chart. Volume bars illustrate how many shares have traded per period and show trends in the same way that prices do.

Importance of Volume

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Volume is an important aspect of technical analysis because it is used to confirm trends and chart patterns. Any price movement up or down with relatively high volume is seen as a stronger, more relevant move than a similar move with weak volume. If volume is high during the day relative to the average daily volume, it is a sign that the reversal is probably for real. On the other hand, if the volume is below average, there may not be enough conviction to support a true trend reversal

Volume should move with the trend. If prices are moving in an upward trend, volume should increase (and vice versa). If the previous relationship between volume and price movements starts to deteriorate, it is usually a sign of weakness in the trend. For example, if the stock is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end.

Trends

Markets don’t generally move in a straight line in any direction. Market moves are characterized by a series of zigzags. These zigzags resemble a series of successive waves with fairly obvious peak and troughs. The direction of those peaks and troughs constitute the market trend.

A trend is really nothing more than the general direction in which a market is headed.

Types of Trend

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Trend Classifications

Along with these three trend directions, there are three trend classifications.

Primary trend

The period of this trend generally lasts over a period between 9 months to 2 years. Treat this as a reflection of investors' attitude towards the fundamentals in the business cycle. A business cycle lasts approximately over an average period of 4 years. However, as more and more people start to invest in the market, these causes bull and bear markets to last longer. Bull markets generally last longer than bear markets as it takes time to build up confidence but fear subsides

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quickly after any major negative news or event. That is why you see market prices going up slowly over a longer time frame but falling very quickly in a shorter time frame.

Intermediate trend

The period of this trend generally lasts over a period between 6 weeks to 9 months or longer but rarely shorter. Intermediate trends are countercyclical trends that interrupt the course of the primary trend price movements.

Short-term trend

The period of this trend generally lasts over a period between 2 to 4 weeks varying between longer and shorter time occasionally. Short-term trends interrupt the course of intermediate trends just like how the intermediate trends interrupt the course of the primary trend. This trend is influenced by random news events and is more difficult to identify when compared to the primary or intermediate trends.

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Trend Lines

Technical analysis is built on the assumption that prices trend. Trend Lines are an important tool in technical analysis for both trend identification and confirmation. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance. Many of the principles applicable to support and resistance levels can be applied to trend lines as well. It is important that you understand all of the concepts presented in our Support and Resistance article before you continue.

Types of Trendlines

Uptrend Line

An uptrend line has a positive slope and is formed by connecting two or more low points. The second low must be higher than the first for the line to have a positive slope. Uptrend lines act as support and indicate that net-demand (demand less supply) is increasing even as the price rises. A rising price combined with increasing demand is very bullish, and shows a strong determination on the part of the buyers. As long as prices remain above the trend line, the uptrend is considered solid and intact. A break below the uptrend line indicates that net-demand has weakened and a change in trend could be imminent.

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Downtrend Line

A downtrend line has a negative slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. Downtrend lines act as resistance, and indicate that net-supply (supply less demand) is increasing even as the price declines. A declining price combined with increasing supply is very bearish, and shows the strong resolve of the sellers. As long as prices remain below the downtrend line, the downtrend is solid and intact. A break above the downtrend line indicates that net-supply is decreasing and that a change of trend could be imminent.

Breaking of Trend Lines

Trend line breaks are counter trend trades, because they expect the price to continue in its new direction (against the previous trend). For an upward trend line (and an upward trend), a trend line break would be a short trade, where the trader sells at a price near the trend line, and then buys at a price below the trend line. For a downward trend line (and therefore a downward trend), a trend line break would be a long trade, where the trader buys at a price near the trend line, and then sells at a price above the trend line.

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Trend line breaks are not usually traded independently, but are combined with other trading information, such as price movement or volume information. For example, a complete trend line trading system might consist of a trend line break in combination with strong volume in the correct direction.

Channel Line

While the trendline is the primary tool of technical analysis, the channel line is an important secondary one. When constructing a channel line, it should be drawn absolutely parallel to the basic trendline or at minimum very close to parallel.

Importance

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A channel line is a secondary tool to the trendline. It can assist the trader in identifying areas of support or resistance. It can also help gauge whether when the trend is losing steam or accelerating.

Support and Resistance

Support:

Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards

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support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.

Resistance:

Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. The logic dictates that as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.

Role Reversal

Once a resistance or support level is broken, its role is reversed. If the price falls below a support level, that level will become resistance. If the price rises above a resistance level, it will often become support. As the price moves past a level of support or resistance, it is thought that supply and demand has shifted, causing the breached level to reverse its role. For a true reversal to occur, however, it is important that the price make a strong move through either the support or resistance.

In almost every case, a stock will have both a level of support and a level of resistance and will trade in this range as it bounces between these levels. This is most often seen when a stock is trading in a

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generally sideways manner as the price moves through successive peaks and troughs, testing resistance and support.

Chart Patterns

A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future price movements. Chartists use these patterns to identify current trends and trend reversals and to trigger buy and sell signals.

Basically there are two types of chart patterns Reversal and Continuation

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Reversal

It is a change in the direction of a price trend. On a price chart, reversals undergo a recognizable change in the price structure. An uptrend, which is a series of higher highs and higher lows, reverses into a downtrend by changing to a series of lower highs and lower lows. A downtrend, which is a series of lower highs and lower lows, reverses into an uptrend by changing to a series of higher highs and higher lows.

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It also referred to as a "trend reversal", "rally" or "correction".

Head and Shoulders Top

A bearish head & shoulders top is a powerful and reliable reversal pattern that appears as a large distribution period after a significant uptrend. Its completion signals a trend reversal. Three successive peaks characterize the pattern with the middle one being the tallest and the two outside ones being shorter and approximately equal.

The above chart illustrates the sequences of events that unfold as the pattern develops. The left shoulder is formed as just another peak and correction within a long uptrend. The stock then rallies and makes another higher high. This action, which forms the left shoulder and first half of the head is no different than what is expected with a stock in a

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typical uptrend. And at this point in time, there is no way for the trader to know that a head & shoulders is forming. The stock then begins its usual “pullback within an uptrend,” but not only does the stock trade below the left shoulder, it falls to, or close to, the same level as the previous pullback. The head has now been formed. This is the first sign that the buyers may be getting tired and the stock seems to be losing strength. A trendline, called the neckline, can be drawn between the two troughs. The stock then rallies again but is unable to eclipse its previous high. This is the second sign the uptrend may be nearing an end. A sell-off from this shorter peak (right shoulder) through the neckline would mark a successful reversal of the uptrend.

The neckline should be flat or slightly upward sloping. Downward sloping necklines do occasionally occur, but their existence indicates that weakness is slowly working itself into the stock and a large correction is probably not imminent. In this case, the trader ought to look elsewhere for trading opportunities.

Breakouts to the downside do not have the same volume or movement requirements as their bullish counterparts. In fact, when stock breaks support with a massive volume surge, it often signals that of a capitulation sell-off and the stock rebounds shortly after. The best downside breaks occur on average volume followed by the stock drifting lower for a few days on increasing volume. Psychologically, when a stock first breaks support, stockholders become concerned; many of them show a loss and some sell. As the stock trades lower, concern becomes fear and the selling accelerates. Then fear becomes panic, and people sell regardless of price. This is why there typically is a delayed volume surge with breaks to the downside.

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Head & Shoulder Bottom

Bullish head & shoulders bottoms are powerful and reliable reversal patterns that appear as large basing periods after a substantial downtrend. Its completion signals a trend reversal. Three successive troughs characterize the pattern with the middle one being the deepest and the two outside ones being shallower and approximately equal.

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TATA MOTORS

The above chart illustrates the sequence of events that unfold as the pattern develops. The left shoulder is formed as just another sell-off and bounce within a long downtrend. The stock then falls and makes another lower low. This action, which forms the left shoulder and first half of the head, is no different than what is expected with a stock in a typical downtrend. And at this point in time, there is no way for the trader to know that a head & shoulders bottom is forming. The stock then begins its usual “bounce within a downtrend,” but not only does the stock trade above the left shoulder, it rallies to, or close to, the same level as the previous bounce. The head has now been formed. This is the first sign that the selling pressure may be abating and the stock seems to be gaining strength. A trendline, called the neckline, can be drawn between the two troughs. The stock then falls again but the imbalance of supply and demand is such that the stock does not make a lower low. This is the second sign the downtrend may be nearing an end. A rally from this shallower dip (right shoulder) through the neckline with a volume surge would mark a successful reversal of the downtrend.

Like all other upside breaks, a surge in volume must accompany the breakout. Failure to accomplish this doesn't necessarily mean the pattern will be a complete failure, but a red flag is raised. Remember, a head & shoulders bottom occurs after a weak stock has been in a long downtrend. There really needs to be a massive amount of buying to reverse the downtrend.

The character and extent of the expected price movement upon breakage depends on several factors. Typically it is equal to the distance from the neckline to the extreme point of the head. But this is just a guideline. Head and shoulders is a reversal pattern, so there must be a significant move to reverse. A small move into the pattern usually results in a small rally upon break. Also, the rally tends to be the mirror image of the preceding drop. This means a quick and violent drop foreshadows a quick rally.

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Double Tops and Bottoms

This chart pattern is another well-known pattern that signals a trend reversal - it is considered to be one of the most reliable and is commonly used. These patterns are formed after a sustained trend and signal to chartists that the trend is about to reverse. The pattern is created when a price movement tests support or resistance levels twice and is unable to break through. This pattern is often used to signal intermediate and long-term trend reversals.

In the case of the double top pattern in below chart, the price movement has twice tried to move above a certain price level. After two unsuccessful attempts at pushing the price higher, the trend reverses and the price heads lower. In the case of a double bottom (shown on the right), the price movement has tried to go lower twice, but has found support each time. After the second bounce off of the support, the security enters a new trend and heads upward.

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MRPL

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Triple Top 

This bearish reversal pattern is formed when a security that is trending upward tests a similar level of resistance three times without breaking through. Each time the security tests the resistance level, it falls to a similar area of support. After the third fall to the support level, the pattern is complete when the security falls through the support; the price is then expected to move in a downward trend. 

The first step in this pattern is the creation of a new high in an uptrend that is stalled by selling pressure, which forms a level of resistance. The selling pressure causes the price to fall until it finds a level of support, as buyers move back into the security. The buying pressure sends the price back up to the area of resistance the security previously met. Again, the sellers enter the market and send the security back down to the support level. 

This up-and-down movement is repeated for the third time; but this time the buyers, after failing three times, give up on the security, and the sellers take over. Upon falling through the level of support, the security is expected to trend downward. 

This pattern can be difficult to spot in the early stages as it will initially look like a double-top pattern, which was discussed in a previous section. The most important thing here is that one waits for the price to move past the level of resistance before entering the security, as the security could actually just end up being range-bound, where it trades between the two levels for sometime. 

In the triple-top formation, each test of resistance at the upper end should be marked with declining volume at each successive peak. And again, when the price breaks below the support level, it should be accompanied by high volume. 

Once the signal is formed, the price objective is based on the size of

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the chart pattern or the price distance between the level of resistance and support.

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Triple Bottom 

This bullish reversal pattern has all of the same attributes as the triple top but signals a reversal of a downward trend. The triple-bottom pattern illustrates a security that is trading in a downtrend and attempts to fall through a level of support three times, each time moving back to a level of resistance. After the third attempt to push the price lower, the pattern is complete when the price moves above the resistance level and begins trading in an upward trend. 

This pattern begins by setting a new low in a downtrend, which is followed by a rally to a high. This sets up the range of trading for the triple-bottom pattern. After hitting the high, the price again comes under selling pressure, which sends it back down to the previous low. Buyers again move back into the security at this support level, sending the price back up again, usually tothe previous high. 

This is repeated a third time, but after failing again to move to a new low, the pattern is complete when the security moves above the resistance level to begin trading in an uptrend. 

In this pattern, volume plays a role similar to the triple top, declining at each trough as it tests the support level, which is a sign of diminishing selling pressure. Again, volume should be high on a breakout above the resistance level on the completion of the pattern. 

The price objective will also initially be calculated as the distance of the chart pattern added to the price breakout.

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Rounding Bottoms

A rounding bottom, also referred to as a saucer bottom, is a long-term reversal pattern that signals a shift from a downtrend to an uptrend. This pattern is traditionally thought to last anywhere from several months to several years. Due to the long-term look of these patterns and their components, the signal and construct of these patterns are more difficult to identify than other reversal patterns. 

The pattern should be preceded by a downtrend but will sometimes be preceded by a sideways price movement that formed after a downward trend. The start of the rounding bottom (its left side) is usually caused by a peak in the downward trend followed by a long price descent to a new long-term low.

The time distance from the initial peak to the long-term low is considered to be half the distance of the rounding bottom. This helps to give chartists an idea to as to how long the chart pattern will last or when the pattern is expected to be complete, with a breakout to the upside. For example, if the first half of the pattern is one year, then the signal will not be formed until around a year later. 

Volume is one of the most important confirming measures for this pattern where volume should be high at the initial peak (or start of the pattern) and weaken as the price movement heads toward the low. As the price moves away from the low to the price level set by the initial peak, volume should be rising. 

Breakouts in chart patterns should be accompanied by a large increase in volume, which helps to strengthen the signal formed by the breakout. Once the price moves above the peak that was established at the start of the chart pattern, the downward trend is considered to have reversed and a buy signal is formed. 

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Rounding Top

A Rounded Top is considered a bearish signal, indicating a possible reversal of the current uptrend to a new downtrend.

A Rounded Top is dome-shaped, and is sometimes referred to as an inverted bowl or a saucer top. The pattern is confirmed when the price breaks down below its moving average.

Volume

Volume can fluctuate, however volume generally appears to be concave, and follows the inverse of the price pattern. Therefore, as the price begins to ascend, volume tends to decrease. Once the top of the price pattern starts its downward turn, volume tends to increase.

Duration of the Rounded TopRounded Tops typically occur over a period of about 3 weeks, but can also be observed over several years.

Target PriceAfter a downside breakout, technical analysts may use the starting price at the left side of the dome to determine where the price may head.

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Continuation

A technical analysis pattern that suggests a trend is exhibiting a temporary diversion in behaviour, and will eventually continue on its existing trend. The symmetrical triangle charts displayed below are both exhibiting a continuation pattern. Notice how the chart extends above (below) its existing pattern.

Bullish symmetrical triangles

Bullish symmetrical triangles represent neutral periods of doubt and indecision. They are characterized by a series of higher lows and lower highs as the forces of supply and demand are nearly equal. Each rally is seen as a selling opportunity while each dip is met with buying. The pattern is typically large and takes several months or more than a year to form.

Bullish symmetrical triangles appear in uptrends and typically resolve themselves to the upside. Breakouts to the upside must be accompanied by a significant increase in volume to confirm the breakout. Failure to accomplish this doesn't automatically render the play invalid, but it does raise a yellow flag. Besides volume, the astute trader ought to look for a close above the most recent high. This price represents the previous area of selling pressure and an area where stockholders may be looking to “get out even.” It is recommended that if volume does not accompany the break, and if the stock fails to make a higher high within a reasonable amount of time, the trader should move a sell stop up to protect profits.

The expected price movement upon breakout is approximately equal to the widest part of the pattern.

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Bearish symmetrical triangles

Bearish symmetrical triangles represent neutral periods of doubt and indecision. They are characterized by a series of higher lows and lower highs as the forces of supply and demand are nearly equal. Each rally is seen as a selling opportunity while each dip is met with buying. The

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pattern is typically large and takes several months or more than a year to form.

Bearish symmetrical triangles appear in downtrends and typically resolve themselves to the downside. Breakdowns do not have the same volume or movement requirements as their opposite upside breaks. In fact, when stock breaks support with a massive volume surge, it often signals that of a capitulation sell-off and the stock rebounds shortly after. The best downside breaks occur on average volume followed by the stock drifting lower for a few days on increasing volume. Psychologically, when a stock first breaks support, stockholders become concerned; many of them show a loss and some sell. As the stock trades lower, concern becomes fear and the selling accelerates. Then fear becomes panic, and people sell regardless of price. This is why there typically is a delayed volume surge with breaks to the downside.

The expected price movement upon breakout is approximately equal to the widest part of the pattern.

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Bearish symmetrical triangles

Ascending Triangles

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Ascending triangles form in uptrends and characterized by a series of higher lows but the same highs. They have a definite bullish bias and typically form in 2 to 8 weeks. It is as if a massive sell order has been placed at the upper trendline and even though the stock is strong and in an uptrend, it takes some time to fully execute the order. Volume usually diminishes as the pattern develops. Once the overhead supply is absorbed, the stock is free to catapult higher because the lack of supply shifts the supply/demand imbalance to favor the buyers. Also, if indeed a stock is in a steady uptrend, every stockholder who bought in the prior several months will be showing a gain. Satisfied and happy stockholders rarely sell. This reality also helps to push the stock higher after the break.

Breakouts should be accompanied by a significant increase in volume. Failure to accomplish this doesn't render the breakout invalid, but a red flag is raised and appropriate stops should be employed.

There are two guidelines a trader can use to determine the extent of the rally upon breakout. The first expected price movement is approximately equal to the widest part of the pattern. The second price target is equal to the rally into the pattern. The extent of the advance will often depend on the overall market. A strong market will help greatly in achieving the more ambitious price target, but in a weak market, a trader should be happy with just a moderate advance.

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Descending Triangles

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Descending triangles form in downtrends and are characterized by a series of lower highs but the same lows. They have a definite bearish bias and typically form in 2 to 8 weeks.

It is as if a massive buy order has been placed at the lower trendline, and even though the stock is weak and in a downtrend, it takes some time to fully executes the order. Volume usually diminishes as the pattern develops. Once the underneath demand is absorbed, a big drop in the stock can occur because the lack of demand shifts the supply/demand imbalance to favour the sellers. Also, given this is a weak stock in a steady downtrend, when support is broken, every stockholder who recently established a long position in the prior several months shows a loss. So besides the large buy order being absorbed, fear now sets in and adds to the downward pressure.

Like symmetrical triangles, downside breaks do not have strict volume requirements. The best downside breaks occur on average volume followed by the stock drifting lower for a few days. Volume then ramps up as traders throw in the towel, and the stock crashes.

There are two guidelines a trader can use to determine the extent of the fall after the break. The first expected price movement is approximately equal to the widest part of the pattern. The second price target is equal to the price movement into the pattern. The drop will often depend on the overall market. A weak market will help push the stock lower, but a strong market may slow or stop the descent.

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Bullish flags

Bullish flags are small continuation patterns that represent brief pauses within an already existing uptrend. They appear flat or trade with a slight downward slant and typically occur in the middle of a large rally or immediately after a stock has broken out of a basing period.

The slight short-term downtrend against the overall uptrend is very healthy as it functions to scare off weak and emotional long positions that would otherwise slow the movement after the breakout. These longs would sell at the first sign of strength. But instead, as the stock slowly trends down, these weak stockholders sell their positions. Once enough have sold, the overhead resistance in essence is cleared and the stock can continue its ride up.

Whether a bullish flag pattern appears during a large rally or after breaking out of a consolidation period, the expected price movement upon breakout is approximately equal to the preceding move into the flag.

It is important to emphasize that for a bullish flag to truly posses great potential, it must have been preceded by a significant move on heavy volume. Like pennants, bullish flags tend to be symmetrical in that the stock movement after the breakout often mirrors the move into the pattern.

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Bearish flags

Bearish flags are small continuation patterns that represent brief pauses within an already existing downtrend. They appear flat or trade with a slight upward slant and occur in the middle of a large drop or immediately after a stock has broken down from a substantial rally.

The slight short-term uptrend against the overall downtrend is very healthy and has serves two functions.

Weak shorts that were hoping to take profits at a lower price get scared and cover their positions. This covering is partially responsible for the short-term upward slant. Once enough have covered, the underneath support in essence is lessened.

The slight uptrend also indicates that the lay public is being “suckered into” the stock as they buy what they believe to be a cheap stock.

When the buying from the lay public dries up and the weak shorts finish covering, support disappears, and the stock continues it downward movement.

Whether a bearish flag pattern appears during a large fall or after breaking down from a distribution period, the expected price movement upon breakout is approximately equal to the preceding move into the flag.

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Pennants

Pennants are small continuation patterns that represent brief pauses within an already existing trend. They are characterized by converging

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trendlines and have a definite bullish or bearish bias depending on the overall trend.

Bullish breakouts should be accompanied by a significant increase in volume with appropriate stops used if this is not seen.

Downside breaks do not have the same volume requirement as their bullish counterparts. Like other bearish breaks, there often is a delayed volume surge.

The price action prior to a wedge formation can be used as a guide in predicting the price movement upon breakout. So, for a bullish wedge in an uptrend to truly possess great potential, it must have been preceded by a significant move (i.e. if the movement into the pattern was quick and full of energy, the rally after the breakout most likely will be quick and full of energy).

The expected price movement upon breakout is approximately equal to the distance of the move into the pattern.

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Gaps

A gap in a chart is an empty space between a trading period and the following trading period. This occurs when there is a large difference in prices between two sequential trading periods. For example, if the trading range in one period is between $25 and $30 and the next trading period opens at $40, there will be a large gap on the chart between these two periods. Gap price movements can be found on bar charts and candlestick charts but will not be found on point and figure or basic line charts. Gaps generally show that something of significance has happened in the security, such as a better-than-expected earnings announcement.

There are main types of Gaps :

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Chandlestick50

The Japanese began using technical analysis to trade rice in the 17th century. While this early version of technical analysis was different from the US version initiated by Charles Dow around 1900, many of the guiding principles were very similar:

The "what" (price action) is more important than the "why" (news, earnings, and so on).All known information is reflected in the price.Buyers and sellers move markets based on expectations and emotions (fear and greed).Markets fluctuate.

The actual price may not reflect the underlying value.

According to Steve Nison, candlestick charting first appeared sometime after 1850. Much of the credit for candlestick development and charting goes to a legendary rice trader named Homma from the town of Sakata. It is likely that his original ideas were modified and refined over many years of trading eventually resulting in the system of candlestick charting that we use today.

In order to create a candlestick chart, you must have a data set that contains open, high, low and close values for each time period you want to display. The hollow or filled portion of the candlestick is called "the body" (also referred to as "the real body"). The long thin lines above and below the body represent the high/low range and are called "shadows" (also referred to as "wicks" and "tails"). The high is marked by the top of the upper shadow and the low by the bottom of the lower shadow. If the stock closes higher than its opening price, a hollow candlestick is drawn with the bottom of the body representing the opening price and the top of the body representing the closing price. If the stock closes lower than its opening price, a filled candlestick is drawn with the top of the body representing the opening price and the bottom of the body representing the closing price.

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Bullish Candlestick Patterns

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Bearish Candlestick Patterns

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Doji

Doji candlesticks have the same open and close price or at least their bodies are extremely short. A doji should have a very small body that appears as a thin line.

Doji candles suggest indecision or a struggle for turf positioning between buyers and sellers. Prices move above and below the open price during the session, but close at or very near the open price.

Neither buyers nor sellers were able to gain control and the result was essentially a draw.

There are four special types of Doji candlesticks

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Pivot Points

We often hear market analysts or experienced traders talking about an equity price nearing a certain support or resistance level, each of which is important because it represents a point at which a major price movement is expected to occur. But how do these analysts and professional traders come up with these so-called levels? One of the most common methods is using pivot points, and here we take a look at how to calculate and interpret these technical tools.

How to Calculate Pivot Points

There are several different methods for calculating pivot points, the most common of which is the five-point system. This system uses the previous day's high, low and close, along with two support levels and two resistance levels (totalling five price points) to derive a pivot point. The equations are as follows:

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Interpreting and Using Pivot Points

When calculating pivot points, the pivot point itself is the primary support/resistance. This means that the largest price movement is expected to occur at this price. The other support and resistance levels are less influential, but may still generate significant price movements. 

Pivot points can be used in two ways. The first way is for determining overall market trend: if the pivot point price is broken in an upward movement, then the market is bullish, and vice versa. Keep in mind, however, that pivot points are short-term trend indicators, useful for only one day until they need to be recalculated. The second method is to use pivot point price levels to enter and exit the markets. For example, a trader might put in a limit order to buy 100 shares if the price breaks a resistance level. Alternatively, a trader might set a stop-loss for his active trade if a support level is broken.

Conclusion

Pivot points are yet another useful tool that can be added to any trader's toolbox. It enables anyone to quickly calculate levels that are likely to cause price movement. The success of a pivot-point system, however, lies squarely on the shoulders of the trader, and on his or her ability to effectively use the pivot-point systems in conjunction with other forms of technical analysis. These other technical indicators can be anything from MACD crossovers to candlestick patterns - the greater the number of positive indications, the greater the chances for success.

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Moving Averages

An indicator frequently used in technical analysis showing the average value of a security's price over a set period. Moving averages are generally used to measure momentum and define areas of possible support and resistance.

Types of Moving Averages

There are a number of different types of moving averages that vary in the way they are calculated, but how each average is interpreted remains the same. The calculations only differ in regards to the weighting that they place on the price data, shifting from equal weighting of each price point to more weight being placed on recent data. The three most common types of moving averages are simple, linear and exponential.

Simple Moving Average (SMA)

This is the most common method used to calculate the moving average of prices. It simply takes the sum of all of the past closing prices over the time period and divides the result by the number of prices used in the calculation. For example, in a 10-day moving average, the last 10 closing prices are added together and then divided by 10. As you can see in Figure 1, a trader is able to make the average less responsive to changing prices by increasing the number of periods used in the calculation. Increasing the number of time periods in the calculation is one of the best ways to gauge the strength of the long-term trend and the likelihood that it will reverse.

Many individuals argue that the usefulness of this type of average is limited because each point in the data series has the same impact on the result regardless of where it occurs in the sequence. The critics argue that the most recent data is more important and, therefore, it should also have a higher weighting. This type of criticism has been

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one of the main factors leading to the invention of other forms of moving averages.

Exponential Moving Average (EMA)

This moving average calculation uses a smoothing factor to place a higher weight on recent data points and is regarded as much more efficient than the linear weighted average. Having an understanding of the calculation is not generally required for most traders because most charting packages do the calculation for you. The most important thing to remember about the exponential moving average is that it is more responsive to new information relative to the simple moving average. This responsiveness is one of the key factors of why this is the moving average of choice among many technical traders. As you can see in Figure 2, a 15-period EMA rises and falls faster than a 15-period SMA. This slight difference doesn’t seem like much, but it is an important factor to be aware of since it can affect returns.

Date Closing

Exponential Moving Avg.

11/6/04

72.12 Arbitrary start point 71.75

12/6/04

72.08 (0.18 x 72.08 + 0.82 x 71.75 = 71.81)

13/6/04

70.69 (0.18 x 70.69 + 0.82 x 71.81 = 71.61)

14/6/04

68.90 (0.18 x 68.90 + 0.82 x 71.61 = 71.12)

15/6/04

68.02 (0.18 x 68.02 + 0.82 x 71.12 = 70.56)

18/6/ 66.88 (0.18 x 66.88 + 0.82 x 70.56 =

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04 69.90)

19/6/04

67.32 (0.18 x 67.32 + 0.82 x 69.90 = 69.44)

20/6/04

69.41 (0.18 x 69.41 + 0.82 x 69.44 = 69.43)

21/6/04

69.84 (0.18 x 69.84 + 0.82 x 69.43 = 69.51)

22/6/04

68.83 (0.18 x 68.83 + 0.82 x 69.51 = 69.38)

Moving Average Envelopes

Moving Average Envelopes are percentage-based envelopes set above and below a moving average. The moving average, which forms the base for this indicator, can be a simple or exponential moving average. Each envelope is then set the same percentage above or below the moving average. This creates parallel bands that follow price action.

A surge above the upper envelope shows extraordinary strength, while a plunge below the lower envelope shows extraordinary weakness. Such strong moves can signal the end of one trend and the beginning of another.

Calculation

Calculation for Moving Average Envelopes is straight-forward. First, choose a simple moving average or exponential moving average. Simple moving averages weight each data point (price) equally. Exponential moving averages put more weight on recent prices and have less lag. Second, select the number of time periods for the moving average. Third, set the percentage for the envelopes. A 20-day moving average with a 2.5% envelope would show the following two lines:

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Upper Envelope: 20-day SMA + (20-day SMA x .025)

Lower Envelope: 20-day SMA - (20-day SMA x .025)

Bollinger Bands

Developed by John Bollinger, Bollinger Bands  are volatility bands placed above and below a moving average. Volatility is based on the standard deviation, which changes a volatility increase and decreases. The bands automatically widen when volatility increases and narrow when volatility decreases. This dynamic nature of Bollinger Bands also means they can be used on different securities with the standard settings.

Middle Band = 20-day simple moving average (SMA)Upper Band = 20-day SMA + (20-day standard deviation of price x 2) Lower Band = 20-day SMA - (20-day standard deviation of price x 2)

Bollinger Bands consist of a middle band with two outer bands. The middle band is a simple moving average that is usually set at 20 periods. A simple moving average is used because a simple moving

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average is also used in the standard deviation formula. The look-back period for the standard deviation is the same as for the simple moving average. The outer bands are usually set 2 standard deviations above and below the middle band.

NTPC

Indicators and Oscillators

Indicator

Statistics used to measure current conditions as well as to forecast financial or economic trends. Indicators are used extensively in technical analysis to predict changes in stock trends or price patterns. In fundamental analysis, economic indicators that quantify current economic and industry conditions are used to provide insight into the future profitability potential of public companies

Oscillator

It is a technical analysis tool that is banded between two extreme values and built with the results from a trend indicator for discovering

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short-term overbought or oversold conditions. As the value of the oscillator approaches the upper extreme value the asset is deemed to be overbought, and as it approaches the lower extreme it is deemed to be oversold.

Relative Strength Index

The RSI was developed by J. Welles Wilder, Jr. & presented in his 1978 book, New Concepts in Technical Trading Systems.

The formula is:- RSI = 100 – 100 1 + RS

where RS = Avg of x days up closesAvg of x days down closes

The shorter the time period, the more sensitive the oscillator becomes. RSI works best when the fluctuations reach the upper & lower extremes.

RSI helps to signal overbought and oversold conditions in a security. The indicator is plotted in a range between zero and 100. A reading above 70 is used to suggest that a security is overbought, while a reading below 30 is used to suggest that it is oversold. This indicator helps traders to identify whether a security’s price has been unreasonably pushed to current levels and whether a reversal may be on the way.

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Rate of change (ROC)

It is a technical indicator that measures the percentage change between the most recent price and the price "n" periods in the past. It is calculated by using the following formula:

(Closing Price Today - Closing Price "n" Periods Ago) / Closing Price "n" Periods Ago

ROC is classed as a price momentum indicator or a velocity indicator because it measures the rate of change or the strength of momentum of change

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.

Commodity Channel Index (CCI)

Introduction

Developed by Donald Lambert and featured in Commodities magazine in 1980, the Commodity Channel Index (CCI) is a versatile indicator that can be used to identify a new trend or warn of extreme conditions. CCI is relatively high when prices are far above their average. CCI is relatively low when prices are far below their average. In this manner, CCI can be used to identify overbought and oversold levels.

Calculation

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The example below is based on a 20-period Commodity Channel Index (CCI) calculation. The number of CCI periods is also used for the calculations of the simple moving average and Mean Deviation.

CCI = (Typical Price - 20-period SMA of TP) / (.015 x Mean Deviation)

Typical Price (TP) = (High + Low + Close)/3

Constant = .015

Interpretation

CCI measures the difference between a security's price change and its average price change. High positive readings indicate that prices are well above their average, which is a show of strength. Low negative readings indicate that prices are well below their average, which is a show of weakness.

The Commodity Channel Index (CCI) can be used as either a coincident or leading indicator. As a coincident indicator, surges above +100 reflect strong price action that can signal the start of an uptrend. Plunges below -100 reflect weak price action that can signal the start of an uptrend.

Overbought/Oversold

The definition of overbought or oversold varies for the Commodity Channel Index (CCI). ±100 may work in a trading range, but more extreme levels are needed for other situations. ±200 is a much harder level to reach and more representative of a true extreme. Selection of overbought/oversold levels also depends on the volatility of the underlying security.

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Moving Average Convergence

The moving average convergence divergence (MACD) is one of the most well-known and used indicators in technical analysis. This indicator is comprised of two exponential moving averages, which help to measure momentum in the security. The MACD is simply the difference between these two moving averages plotted against a centerline. The centerline is the point at which the two moving averages are equal. Along with the MACD and the centerline, an exponential moving average of the MACD itself is plotted on the chart. The idea behind this momentum indicator is to measure short-term

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momentum compared to longer term momentum to help signal the current direction of momentum.

MACD= shorter term moving average - longer term moving average

When the MACD is positive, it signals that the shorter term moving average is above the longer term moving average and suggests upward momentum. The opposite holds true when the MACD is negative - this signals that the shorter term is below the longer and suggest downward momentum. When the MACD line crosses over the centerline, it signals a crossing in the moving averages. The most common moving average values used in the calculation are the 26-day and 12-day exponential moving averages. The signal line is commonly created by using a nine-day exponential moving average of the MACD values. These values can be adjusted to meet the needs of the technician and the security. For more volatile securities, shorter term averages are used while less volatile securities should have longer averages.As you can see in Figure 2, one of the most common buy signals is generated when the MACD crosses above the signal line (blue dotted line), while sell signals often occur when the MACD crosses below the signal.

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Bibliography

Book:

John J. Murphy

Websites :

www.moneycontrol.com

www.investopedia.com

www.stockcharts.com

www.leavittbrothers.com/education

www.icharts.in

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