Technical Analysis1

8/2/2019 Technical Analysis1

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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

1150

1200

1250

1300

1350

1400

1/4/1999

1/18/1999

2/1/1999

2/15/1999

3/1/1999

3/15/1999

3/29/1999

4/12/1999

4/26/1999

5/10/1999

5/24/1999

6/7/1999

6/21/1999


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1100

1150

1200

1250

1300

1350

1400

1/4/199

9

1/18/199

9

2/1/199

9

2/15/199

9

3/1/199

9

3/15/199

9

3/29/199

9

4/12/199

9

4/26/199

9

5/10/199

9

5/24/199

9

6/7/199

9

6/21/199

9

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

6/27/2006

7/27/2006

8/27/2006

9/27/2006

10/27/2006

11/27/2006

12/27/2006

1/27/2007

2/27/2007

3/27/2007

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

3000

3200

3400

3600

3800

4000

4200

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

Technical Analysis1

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