Technical Analysis

What is Technical Analysis?

 Method of evaluating securities by analyzing the

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 to identify
patterns that can suggest future activity.
 What is Technical Analysis?

 Despite all the fancy and exotic tools it just studies

supply and demand in a market
 in an attempt to determine what direction, or trend,
will continue in the future.
 Assumptions

 The field of technical analysis is based on three

assumptions:
 The market discounts everything.
 Price moves in trends.
 History tends to repeat itself.
 The Market Discounts Everything

 Technical analysts believe that the company's

fundamentals, 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.
 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
 Most technical trading strategies are based on this
assumption.
 History Tends To Repeat Itself

 History tends to repeat itself, mainly in terms of price

movement.
 The repetitive nature of price movements is attributed
to market psychology;
 Market participants tend to provide a consistent
reaction to similar market stimuli over time.
 They illustrate patterns in price movements that often
repeat themselves.
 Fundamental Vs. Technical
Analysis
 Charts vs. Financial Statements
 Time Horizon
 Trading Versus Investing
 Can They Co-Exist?

 Fundamental analysts may use technical analysis

techniques to figure out the best time to enter into an
undervalued security.
 By timing entry into a security, the gains on the
investment can be greatly improved.
 some technical traders might look at fundamentals to
add strength to a technical signal.
 The Use Of Trend

 One of the most important concepts in technical

analysis is that of trend.
 A trend is really nothing more than the general
direction in which a security or market is headed.
 Take a look at the chart on the next slide :
Trend
Types of trends
 Trend lines

 A Trendline is a simple charting technique that adds

a line to a chart to represent the trend in the market
or a stock.
 Drawing a Trendline is as simple as drawing a
straight line that follows a general trend.
Trendline
 Channels

 A channel, or channel lines, is the addition of two

parallel trendlines that act as strong areas of support
and resistance.
 Traders will expect a given security to trade between
the two levels of support and resistance until it breaks
beyond one of the levels,
 Traders can expect a sharp move in the direction of the
break.
Channel lines
Support And Resistance
 The Importance of Support and
Resistance
 It can be used to make trading decisions and identify
when a trend is reversing.
 For example, if a trader identifies an important level
of resistance
 that has been tested several times but never
broken,
 he or she may decide to take profits as the security
moves toward this point because it is unlikely that it
will move past this level.
 Role Reversal
 Once a resistance or support level is broken, its role
may be 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.
 This phenomenon is evident on the Wal-Mart
Stores Inc.chart between 2003 and 2006. Notice
how the role of the $51 level changes from a strong
level of support to a level of resistance.
 The Importance Of Volume

 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.
 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.
 Volume should move with the trend.
 The Importance Of Volume

 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.
 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.
Head and Shoulders
 Head and Shoulders

 Both of these head and shoulders have a similar

construction in that there are four main parts
 two shoulders, a head and a neckline.

 The patterns are confirmed when the neckline is

broken, after the formation of the second
shoulder
 Head and Shoulders

 Head and shoulders is a reversal pattern

 signals the security is likely to move against
the previous trend.
 The head-and-shoulders pattern illustrates a
weakening in a trend where there is
deterioration in the peaks and troughs.
 Head and Shoulders
 The head-and-shoulders top is a signal that a
security's price is set to fall, once the pattern
is complete, and
 is usually formed at the peak of an upward
trend.
 The reverse head-and-shoulders signals that
a security's price is set to rise and
 usually forms during a downward trend
 Head and Shoulders
 In most of the examples, the neckline is flat
 In most cases, the neckline will in fact be
slanted either up or down.
 In general, a technically strong head-and-
shoulders top should have a flat or slightly
upward-trending neckline.
 For a head-and-shoulders bottom, it should be
flat or slightly downward.
Throwback
Cup and Handle
 Cup and Handle

 First, there is an upward trend before the formation

of the cup and handle.
 In general, the larger the prior trend is, the lower the
potential for a large breakout after the pattern has
been completed.
 The handle, is a relatively smaller downward move
before the security moves higher and continues the
previous trend.
 Cup and Handle
 the handle's downward movement can retrace
one-third of the gain made in the right side of
the cup.
 During this downward move, a descending
trendline can be drawn, which forms the signal
for the breakout.
 A move by the security above this descending
trendline is a signal that the prior upward trend
is set to begin.
 Cup and Handle

 As with most chart patterns, volume is vital in

the confirmation of the pattern itself and the
signal formed.
 the most important area of focus is the
breakout: the stronger the volume on the
upward breakout, the clearer the sign that the
upward trend will continue.
Double Tops and Bottoms
 Double Tops and Bottoms

 The double-top pattern is found at the peaks

of an upward trend and is a clear signal that
the preceding upward trend is weakening and
that buyers are losing interest.
 Upon completion of this pattern, the trend is
considered to be reversed and the security is
expected to move lower
 Double Tops and Bottoms

 The double bottom is formed when a downtrend

sets a new low in the price movement.
 The pattern is confirmed when the price moves
above the resistance the security faced on the
prior move up.
Triangles
 Symmetrical triangle

 The symmetrical triangle is mainly considered

to be a continuation pattern that signals a
period of consolidation in a trend followed by
a resumption of the prior trend.
 It is formed by the convergence of a
descending resistance line and an ascending
support line.
 Ascending Triangle

 The ascending triangle is a bullish pattern,

which gives an indication that the price of the
security is headed higher upon completion.
 The pattern is formed by two trendlines: a
flat trendline being a point of resistance and
an ascending trendline acting as a price
support
 Descending triangle

 The descending triangle gives a bearish signal

to chartists, suggesting that the price will
trend downward upon completion of the
pattern.
 The descending triangle is constructed with a
flat support line and a downward-sloping
resistance line.
Triple Tops and Bottoms
 Triple Top
 a security 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
 Triple Bottom

 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.
Rounding Bottom
 Rounding Bottom

 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
 Indicators And Oscillators

 Indicators are calculations based on the price and the

volume of a security that measure such things as
money flow, trends, volatility and momentum.
 Indicators are used as a secondary measure to the
actual price movements and add additional information
to the analysis of securities.
 Indicators And Oscillators
 Indicators are used in two main ways:
 to confirm price movement and the quality of
chart patterns, and
 to form buy and sell signals.
 Indicators And Oscillators
 There are also two types of indicator constructions:
 those that fall in a bounded range
 and those that do not.
 The ones that are bound within a range are called
oscillators
 For example between zero and 100, and signal
periods where the security is overbought (near 100)
or oversold (near zero).
Security
Valuation
and Selection