TECHNICAL ANALYSIS

Objective

Technical Analysis involves analyzing historical price charts to

anticipate price movements in financial assets. This topic covers
basic concepts of reading charts and understanding of different
types of charts. Detailed explanation of Dow and Elliot Wave
theory has been covered which form the basis of technical
analysis.
 Agenda
Technical Analysis
• Assumptions
• Fundamental vs. Technical Analysis
• Charts
• Trends
• Channels
• Supports/ Resistance
• Pivot Points
• Waves
 Dow Theory
 Elliot wave
 Fibonacci Retracement
 GANN angle
 Technical Analysis
• TA studies supply and demand in a market in an attempt to
determine what direction, or trend, will continue in the future
• It attempts to understand the emotions in the market by
studying the market itself, as opposed to its components
• Relies on past market data
 Price
 Open Interest
 Volume
 Time
• Can be applied to any market
 TA: Assumptions
• The market discounts everything
 All Information is accounted by the market
 Rational and irrational thoughts of the participants are taken in the
price of security
• Price moves in trends
 Trend once established, will move in that direction rather than
against
• History tends to repeat itself
 Price movement previously happened can happen again
 Why TA works ?

• Self Fulfilling Prophecy

 All chart followers do the same thing and follow same indicators
 Too many traders making same decisions affect the markets

• It’s a Science
 Papers published establish validity of TA
 It depicts a psychology of the market
 Components
• Price: is the quantity of payment or compensation given from one party
to another in return for goods or services
• Volume is the number of contracts traded in a given period of time
 Used to confirm trends and chart patterns
 Volume moves with the trend
 Price is preceded by volume
• Open Interest is total number of derivative contracts, that have not been
settled in the previous time period for a specific underlying security
• Time period for which the market is analyzed
Technical vs. Fundamental Analysis
• Charts vs. Financial Statements
• Time Horizon: Short term vs. Long Term
• Trading vs. Investing
• TA: Looks for Support and Resistance
• FA: Looks for Overvalued or Undervalued securities
• Use of both to improve results
 Charts
• Graphical representation of price, volume, OI among others
against time
• Time Scale
 X-axis or Bottom axis
 Intra Day(1min, 5min, 1hourly), Daily, Weekly, Monthly
• Price Scale
 Y-axis or Right hand Axis
 Linear or logarithmic
• Displays historical prices of securities
 Line Chart
• Represents only the closing prices over a set period of time
• Line is formed by connecting the closing prices over the time
frame
 Bar Chart
• A bar chart or bar graph is a chart with rectangular bars
with lengths proportional to the values that they represent
• Price vs Time
• High
• Low
• Open
• Close
 Candlestick Charts
• Candlestick chart is similar to a bar chart
• Difference comes in the formation of a wide bar on the
vertical line, which illustrates the difference between the
open and close
• Rely heavily on the use of colors
 Close > Open => Green or white or Blank
 Close < Open => Red or black or filled
 Trend
• Trend is the general direction in which a security or market is
headed
• An uptrend is classified as a series of higher highs and higher
lows, while a downtrend is one of lower lows and lower highs

• A downtrend occurs when each successive peak and trough is

lower than the ones found earlier in the trend
• A sideways or horizontal trend happens when there is little
movement up or down in the peaks and troughs
Trends: Example
Types of Trend (Time)
 Support and Resistance
• Support is the price level through which a stock or market seldom falls
(Blue arrows)
• Resistance, on the other hand, is the price level that a stock or market
seldom surpasses (Red arrows)
• Logic
 Market psychology and
 Supply and demand
• Role Reversal
 Support acts as resistance once it is broken
• Generally, its not a specific price, but a small range of prices
• Round numbers like 10, 50, 100 and 1,000 act as psychological levels
Support and Resistance
 Channels
• The channel is a corridor, within which the price chart is
moving, limited by the support line below and the resistance
line above
• Types
 bull - ascending channel
 bear - descending channel
 flat or range (trendless)
• Rules
 The longer price is moving within the channel, the higher probability
that it will break it
 It is better to play in the direction of the main trend
Channel: Example
 Dow Theory
• Derived from 255 Wall Street Journal editorials written
by Charles H. Dow (1851–1902)
• Has been in existence and practiced for more than 100 years
• Published in The Wall Street Journal. Traders still apply its
components
 Tenets of Dow Theory
• The market has three movements
 “Main movement", primary movement or major trend may last from
less than a year to several years
 “Medium swing", secondary reaction or intermediate reaction may
last from ten days to three months and generally retraces from 33%
to 66% of the primary price change
 “Short swing" or minor movement varies with opinion from hours to
a month or more
 Tenets of Dow Theory
• Market trends have three phases
 Accumulation phase : period when investors are actively buying
(selling) stock against the general opinion of the market. Stock
price does not change much
 Public participation phase: period with rapid price change occurs.
Trend followers and other technically oriented investors
participate
 Distribution phase: period with rampant speculation. At this point,
investors begin to distribute their holdings to the market
 Tenets of Dow Theory
• The stock market discounts all news
 Quickly incorporates any news which occurs in market
• Stock market averages must confirm each other
 All sectors must move in same direction at same time
• Trends are confirmed by volume
 Price move at low volume is false movement
• Trends exist until definitive signals prove that they have
ended
 Market noise doesn’t have significant effect
Dow Theory
Dow Theory Example
 Elliot Wave
• Ralph Nelson Elliott(1871–1948), a professional accountant,
developed the concept in the 1930s
• Market prices unfold in specific patterns
• Collective investor psychology (or crowd psychology) moves from
optimism to pessimism and back again in a natural sequence
• Five waves and three waves at all degrees of trend
• Waves 1, 3, and 5 are "motive" waves, and each motive wave itself
subdivides in five waves
• Waves 2 and 4 are "corrective" waves, and subdivide in three waves
• Motive waves always move with the trend, while corrective waves move
against it
Wave
 Types of Waves
• Grand supercycle: multi-century
• Supercycle: multi-decade (about 40-70 years)
• Cycle: one year to several years (or even several decades
under an Elliott Extension)
• Primary: a few months to a couple of years
• Intermediate: weeks to months
• Minor: weeks
• Minute: days
• Minuette: hours
• Subminuette: minutes
 Wave Characteristic
• Wave 1
 Rarely obvious at its inception
 First wave of a new bull market begins, the fundamental news is
almost universally negative
 Volume might increase a bit as prices rise
• Wave 2
 Wave two corrects wave one
 The news is still bad
 Bearish sentiment quickly builds
 Some positive signs appear for those who are looking
 Volume should be lower during wave two than during wave one
 Prices usually do not retrace more than 61.8%
 Wave Characteristic
• Wave 3:
 Wave three is usually the largest and most powerful wave in a trend
 News is now positive and fundamental analysts start to raise earnings estimates
 Prices rise quickly, corrections are short-lived and shallow
 Anyone looking to "get in on a pullback" will likely miss the boat
 Midpoint, "the crowd" will often join the new bullish trend
 Wave three often extends wave one by a ratio of 1.618:1
• Wave 4:
 Typically corrective
 Prices may sideways for an extended period
 Retraces less than 38.2% of wave three
 Volume is well below than that of wave three
 Good place to buy a pull back
 Fourth waves are often frustrating because of their lack of progress in the larger trend
 Wave Characteristic
• Wave 5
 Final leg in the direction of the dominant trend
 News is almost universally positive and everyone is bullish
 Many average investors finally buy in, right before the top
 Volume is often lower in wave five than in wave three
 Momentum indicators start to show divergences
 At the end of a major bull market, bears may very well be ridiculed
• Wave A
 Corrections are typically harder to identify than impulse moves
 Fundamental news is usually still positive
 Analysts see the drop as a correction in a still-active bull market
 Some technical indicators that accompany wave A include
o increased volume
o rising implied volatility in the options markets and
o possibly a turn higher in open interest in related futures markets
 Wave Characteristic
• Wave B
 Prices reverse higher
 Many see as a resumption of the now long-gone bull market
 Right shoulder of a head and shoulders reversal pattern
 The volume during wave B should be lower than in wave A
 Fundamentals are probably no longer improving, but they most likely have not
yet turned negative
• Wave C
 Prices move impulsively lower in five waves
 Volume picks up, and by the third leg of wave C, almost everyone realizes that
a bear market is firmly entrenched
 Wave C is typically at least as large as wave A and often extends to 1.618 times
wave A or beyond
 Three rules:
• Wave 2 always retraces less than 100% of wave 1
• Wave 3 cannot be the shortest of the three impulse waves,
namely waves 1, 3 and 5
• Wave 4 does not overlap with the price territory of wave 1, except
in the rare case of a diagonal triangle

• Common guideline
 waves 2 and 4 will often take alternate forms
 a sharp move in wave 2, for example, will suggest a mild move
in wave 4
 Corrective wave patterns unfold in forms known as zigzags, flats,
or triangles. In turn these corrective patterns can come together
to form more complex corrections
Example
5,13,21 WAVE COUNT
Wave within Wave
 Pivot Points
• Pivot Points are those price levels based on
 Previous day OHLC to act as
 Levels of support and resistance for next day
• Most widely used formula for calculating pivot points:
 R2 = P + (H - L) = P + (R1 - S1)
 R1 = (P x 2) – L
 P = (H + L + C) / 3
 S1 = (P x 2) – H
 S2 = P - (H - L) = P - (R1 - S1)
 Gann Angle
• The Gann Angles are named after W. D. Gann, a 20th century market theorist
• The legitimacy of Gann's techniques has been seriously questioned
• Most important angle Gann called the 1x1 or the 45° angle
• Other important angles were the 2x1, the 3x1, the 4x1, the 8x1, and the 16x1
• When the angles are drawn in a group, they are often called a Gann fan
• Angles may either be drawn ascending from price bottoms, as just described, or
descending from price tops
• When the trend is up and the price stays in the space above an ascending angle
without breaking below it, the market is strong
• When the trend is down and the price remains below a descending angle without
breaking above it, the market is weak
• The market shows its relative strength or weakness according to the angle it is
above or below
• When an up trending price reverses and breaks under an ascending angle
 The tendency of the price is to go to the next nearest angle below it
Example Gann Fan
 Fibonacci Retracement

• The four basic Fibonacci retracement levels are calculated as

23.8%, 38.2% 50.0% and 61.8% of the impulse
• 0.0% is considered to be the start of the move or impulse,
while 100.0% is the high point of the move
• Trading is done on the basis of Levels
Example