TECHNICAL ANALYSIS
Dr. Vanishree M.R.
Associate Professor
School of Business and Management
CHRIST (Deemed to be University)
Concept
Technical analysis is the study of past market data to
forecast the direction of future price movements. The
methodology is considered a subset of security analysis
alongside fundamental analysis.
The theory behind the validity of technical analysis is the
notion that the collective actions – buying and selling – of
all the participants in the market accurately reflect all
relevant information pertaining to a traded security, and
therefore, continually assign a fair market value to
the security.
Candlesticks
Candlestick charting is the most commonly used
method of showing price movement on a chart. A
candlestick is formed from the price action during a
single time period for any time frame.
Each candlestick on an hourly chart shows the price
action for one hour, while each candlestick on a 4-hour
chart shows the price action during each 4-hour time
period.
History
The Japanese began using technical analysis to trade
rice in the 17th century.
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.
Formation
✔ 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.
Compared to traditional bar charts, many traders
consider candlestick charts more visually appealing and
easier to interpret.
Each candlestick provides a simple, visually appealing
picture of price action; a trader can instantly compare
the relationship between the open and close as well as
the high and low.
The relationship between the open and close is
considered vital information and forms the essence of
candlesticks. Hollow candlesticks, where the close is
greater than the open, indicate buying
pressure. Filled candlesticks, where the close is less
than the open, indicate selling pressure.
Long Versus Short Bodies
Generally speaking, the longer the body is, the more
intense the buying or selling pressure. Conversely, short
candlesticks indicate little price movement and
represent consolidation.
• Long white candlesticks
show strong buying
pressure
• Long black candlesticks
show strong selling
pressure
Marubozu
Even more potent long candlesticks are the Marubozu
brothers, Black and White. Marubozu do not have upper
or lower shadows and the high and low are represented
by the open or close.
A White Marubozu forms when the open equals the low
and the close equals the high. This indicates that buyers
controlled the price action from the first trade to the last
trade.
Black Marubozu form when the open equals the high
and the close equals the low. This indicates that sellers
controlled the price action from the first trade to the last
trade.
Doji
Doji represent an important type of candlestick,
providing information both on their own and as
components of a number of important patterns.
Doji form when a security's open and close are virtually
equal. The length of the upper and lower shadows can
vary, with the resulting candlestick looking like a cross,
inverted cross or plus sign.
Alone, Doji are neutral patterns. Any bullish or bearish
bias is based on preceding price action and future
confirmation.
Ideally, but not necessarily, the open
and close should be equal. While a
Doji with an equal open and close
would be considered more robust, it is
more important to capture the essence
of the candlestick.
Doji convey a sense of indecision or
tug-of-war between buyers and
sellers.
Prices move above and below the
opening level during the session, but
close at or near the opening level.
Dragonfly and Gravestone Doji
Dragonfly Doji
Dragonfly Doji form when the
open, high and close are equal and
the low creates a long lower
shadow. The resulting candlestick
looks like a “T” due to the lack of
an upper shadow.
Dragonfly Doji indicate that sellers dominated trading
and drove prices lower during the session. By the end
of the session, buyers resurfaced and pushed prices
back to the opening level and the session high.
Gravestone Doji form when the open, low and close are
equal and the high creates a long upper shadow. The
resulting candlestick looks like an upside down “T” due
to the lack of a lower shadow.
Gravestone Doji indicate that buyers dominated trading
and drove prices higher during the session. However, by
the end of the session, sellers resurfaced and pushed
prices back to the opening level and the session low.
Bulls Versus Bears
A candlestick depicts the battle between Bulls (buyers)
and Bears (sellers) over a given period of time.
An analogy to this battle can be made between two
football teams, which we can also call the Bulls and the
Bears.
The bottom (intra-session low) of the candlestick
represents a touchdown for the Bears and the top
(intra-session high) a touchdown for the Bulls. The
closer the close is to the high, the closer the Bulls are to
a touchdown.
The closer the close is to the low, the closer the Bears
are to a touchdown. While there are many variations,
following picture have been narrowed the field to 6
types of games (or candlesticks):
1. Long white candlesticks indicate that
the Bulls controlled the ball (trading)
for most of the game.
2. Long black candlesticks indicate that
the Bears controlled the ball (trading)
for most of the game.
3. Small candlesticks indicate that neither team could move the
ball and prices finished about where they started.
4. A long lower shadow indicates that the Bears controlled the
ball for part of the game, but lost control by the end and the
Bulls made an impressive comeback.
5. A long upper shadow indicates that the Bulls controlled the
ball for part of the game, but lost control by the end and the
Bears made an impressive comeback.
6. A long upper and lower shadow indicates that the both the
Bears and the Bulls had their moments during the game, but
neither could put the other away, resulting in a standoff.
Moving Average Analysis
Moving averages are the most common indicator in technical
analysis. The moving average itself may also be the most
important indicator, as it serves as the foundation of countless
others, such as the Moving Average Convergence Divergence
(MACD).
A moving average is calculated by taking into account the most
recent n observations.
This average can be used with any price including the High, Low,
Open, or Close, and can be applied to other indicators too. A
moving average smoothens a data series, which is very important
in a volatile market as it helps to identify significant trends.
Types of Moving Average
• Simple Moving Average (SMA)
• Exponential Moving Average (EMA)
SMA is the easiest moving average to construct. It is
simply the average price over the specified period. The
average is called "moving" because it is plotted on the
chart bar by bar, forming a line that moves along the
chart as the average value changes. SMA is simply the
mean, or average, of the stock price values over the
specified period.
• EMA is preferred among some traders. Unlike the
SMA, it possesses multiplying factors that give more
weight to more recent data points than prior data
points.
• As a result, the EMA will react more quickly to price
action. This can give a trader an earlier signal relative
to an SMA.
• EMAs tend to be more common among day traders,
who trade in and out of positions quickly, as they
change more quickly with price
• Moving average is calculated by adding the closing
price of the security for a number of time periods and
then dividing this total by the number of time periods.
• Short-term averages respond quickly to changes in the
price of the underlying, while long-term averages are
slow to react.
• EMA: {Close - EMA(previous day)} x multiplier +
EMA(previous day).
Moving average-interpretation:
A buy signal is produced when the shorter-term
average crosses from below to above the longer-term
average. Conversely, a sell signal is issued when the
shorter-term average crosses from above to below the
longer-term average.
Example:
Sum of five most
Trading recent closing
Day Closing Price prices MA (5 days)
1 260.00
2 256.50
3 245.00
4 260.00
5 264.50 1286.00 257.2
6 250.00 1276.00 255.2
7 259.50 1279.00 255.8
8 255.00 1289.00 257.8
9 250.00 1279.00 255.8
10 262.50 1277.00 255.4
MACD
A variation of the moving average is the moving
average convergence divergence. It involves comparing
a short- term moving average, say a 50 day moving
average, with a long term moving average, say a 200
day moving average.
If the short-term moving average is consistently higher
than the long-term moving average, it is a bullish signal;
if the short-term moving average is consistently lower
than the long-term moving average, it is a bearish
signal.
Relative Strength Analysis
The RSA is based on the assumption that prices of some
securities rise rapidly during the bull phase but fall
slowly during the bear phase in relation to the market as
a whole.
Technical analysts – calculates rate of return and
classifies securities that have earned superior historical
returns as having relative strength.
• RSI =100 – (100/1+RS)
Average gain per day
• RS = ---------------------------
Average loss per day
Example - RSI:
Day Price Gain Loss
1 300 - -
2 304 4 -
3 319 15 -
4 317 - 2
5 319 2 -
6 333 14 -
7 331 - 2
8 332 1 -
9 348 16 -
10 346 - 2
52/6 =8.67 6/3 =2
RSI =100-(100/1+4.335)
= 81.26
ROC (Rate of Change)
• The Rate of Change (ROC) is a simple technical indicator
that shows the percentage difference between the current
price and the price n periods ago.
• ROC = (Close - Close N periods ago) / Close N periods
ago * 100
• ROC is an oscillator that fluctuates above and below the
zero line. When the price rises, the ROC moves up and
when the price declines, the ROC falls.
.
• Oscillators indicate the market momentum or scrip
momentum. It shows the share price movement across
a reference point from one extreme to another.
• Change in the price should be correlated with the
change in the momentum.
Example - ROC
Day Price ROC
1 235.2 -
2 232.85 -
3 236.65 -
4 234.2 -
5 231.7 -
6 244.75 -
7 257.95 -
8 254.9 8.38
9 249.85 7.3
10 244.6 3.36
11 234.05 -.06
12 234.25 1.1
13 235.8 -3.66
14 232.7 -9.79
Technical analysis Vs. Fundamental
analysis
• Fundamental analysts study the financial strength of
corporate, earnings etc., Technical analysts focus on
past history of prices.
• Fundamental analysts estimate the intrinsic value of
shares and take the buy/sell decisions. Technical
analysts predict the short term price movement.
• Fundamental analysts opine that the supply and
demand cannot be predicted since it depend on other
factors. Technical analysts opinion that it can be
predicted.
