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Technical Analysis

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33 views17 pages

Technical Analysis

Uploaded by

Muhammad Junaid
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Technical Analysis

https://www.investopedia.com/terms/t/technical-analysis-of-stocks-and-trends.asp
Technical Analysis
• Technical analysis attempts to predict future price movements,
providing traders with the information needed to make a profit.
• Traders apply technical analysis tools to charts in order to identify
entry and exit points for potential trades.
• An underlying assumption of technical analysis is that the market has
processed all available information and that it is reflected in the price
chart.
Forms of Technical Analysis

Chart Patterns

Technical Analysis

Technical (Statistical)
Indicators
Chart Patterns
Chart patterns are a subjective form of technical analysis where
technicians attempt to identify areas of support and resistance on a chart
by looking at specific patterns. These patterns, underpinned by
psychological factors, are designed to predict where prices are headed,
following a breakout or breakdown from a specific price point and time.
For example, an ascending triangle chart pattern is a bullish chart
pattern that shows a key area of resistance. A breakout from this
resistance could lead to a significant, high-volume move higher.
Technical Indicators
Technical indicators are a statistical form of technical analysis where
technicians apply various mathematical formulas to prices and volumes.
The most common technical indicators are moving averages, which
smooth price data to help make it easier to spot trends. More complex
technical indicators include the moving average convergence-
divergence (MACD), which looks at the interplay between several
moving averages. Many trading systems are based on technical
indicators since they can be quantitatively calculated.
Limitations of Technical Analysis
Technical analysis has the same limitation of any strategy based on particular
trade triggers. The chart can be misinterpreted. The formation may be predicated
on low volume. The periods being used for the moving averages may be too long
or too short for the type of trade you are looking to make. Leaving those aside, the
technical analysis of stocks and trends has a fascinating limitation unique to itself.
As more technical analysis strategies, tools and techniques become widely
adopted, these have a material impact on the price action. For example, are those
three black crows forming because the priced in information is justifying a bearish
reversal or because traders universally agree that they should be followed by a
bearish reversal and bring that about by taking up short positions? Although this is
an interesting question, a true technical analyst doesn't actually care as long as the
trading model continues to work.
Key Technical Analysis Concepts
• Dow Theory • Overbought
• Support and Resistance Basics • Oversold
• Support (Support Level) • Relative Strength
• Resistance (Resistance Level) • Candlestick
• Trend • Volume
• Pullback • Gap
• Breakout
• Reversal
Dow Theory
Dow believed that the stock market as a whole was a reliable measure of overall business
conditions within the economy and that by analyzing the overall market, one could accurately
gauge those conditions and identify the direction of major market trends and the likely direction
of individual stocks.
How the Dow Theory Works
There are six main components to the Dow theory.
1. The Market Discounts Everything
The Dow theory operates on the efficient markets hypothesis (EMH), which states that asset
prices incorporate all available information. In other words, this approach is the antithesis of
behavioral economics.
Earnings potential, competitive advantage, management competence—all of these factors and
more are priced into the market, even if not every individual knows all or any of these details.
In more strict readings of this theory, even future events are discounted in the form of risk.
How the Dow Theory Works
There are six main components to the Dow theory.

1. The Market Discounts Everything


The Dow theory operates on the efficient markets hypothesis (EMH),
which states that asset prices incorporate all available information. In
other words, this approach is the antithesis of behavioral economics.
Earnings potential, competitive advantage, management competence—
all of these factors and more are priced into the market, even if not
every individual knows all or any of these details. In more strict
readings of this theory, even future events are discounted in the form of
risk.
How the Dow Theory Works
There are six main components to the Dow theory.

2. There Are Three Primary Kinds of Market Trends


Markets experience primary trends which last a year or more, such as a
bull or bear market. Within these broader trends, they experience
secondary trends, often working against the primary trend, such as a
pullback within a bull market or a rally within a bear market; these
secondary trends last from three weeks to three months. Finally, there
are minor trends lasting less than three weeks, which are largely noise.
How the Dow Theory Works
There are six main components to the Dow theory.

3. Primary Trends Have Three Phases


A primary trend will pass through three phases, according to the Dow
theory. In a bull market, these are the accumulation phase, the public
participation (or big move) phase, and the excess phase. In a bear
market, they are called the distribution phase, the public participation
phase, and the panic (or despair) phase.
How the Dow Theory Works
There are six main components to the Dow theory.

4. Indices Must Confirm Each Other


In order for a trend to be established, Dow postulated indices or market averages must
confirm each other. This means that the signals that occur on one index must match or
correspond with the signals on the other. If one index, such as the Dow Jones
Industrial Average, is confirming a new primary uptrend, but another index remains in
a primary downward trend, traders should not assume that a new trend has begun.
Dow used the two indices he and his partners invented, the Dow Jones Industrial
Average (DJIA) and the Dow Jones Transportation Average (DJTA), on the
assumption that if business conditions were, in fact, healthy, as a rise in the DJIA
might suggest, the railroads would be profiting from moving the freight this business
activity required. If asset prices were rising but the railroads were suffering, the trend
would likely not be sustainable. The converse also applies: if railroads are profiting
but the market is in a downturn, there is no clear trend.
How the Dow Theory Works
There are six main components to the Dow theory.

5. Volume Must Confirm the Trend


Volume should increase if the price is moving in the direction of the
primary trend and decrease if it is moving against it. Low volume
signals a weakness in the trend. For example, in a bull market, the
volume should increase as the price is rising, and fall during secondary
pullbacks. If in this example the volume picks up during a pullback, it
could be a sign that the trend is reversing as more market participants
turn bearish.
How the Dow Theory Works
There are six main components to the Dow theory.

6. Trends Persist Until a Clear Reversal Occurs


Reversals in primary trends can be confused with secondary trends. It is
difficult to determine whether an upswing in a bear market is a reversal
or a short-lived rally to be followed by still lower lows, and the Dow
theory advocates caution, insisting that a possible reversal be confirmed.
Support and Resistance Basics
• Technical analysts use support and resistance levels to identify price points
on a chart where the probabilities favor a pause or reversal of a prevailing
trend.
• Support occurs where a downtrend is expected to pause due to a
concentration of demand.
• Resistance occurs where an uptrend is expected to pause temporarily, due to
a concentration of supply.
• Market psychology plays a major role as traders and investors remember the
past and react to changing conditions to anticipate future market movement.
• Support and resistance areas can be identified on charts using trendlines and
moving averages
Support and Resistance
• Support and resistance levels are one of the key concepts used by technical analysts and form
the basis of a wide variety of technical analysis tools. The basics of support and resistance
consist of a support level, which can be thought of as the floor under trading prices, and a
resistance level, which can be thought of as the ceiling. Prices fall and test the support level,
which will either "hold," and the price will bounce back up, or the support level will be
violated, and the price will drop through the support and likely continue lower to the next
support level.
• Determining future levels of support can drastically improve the returns of a short-term
investing strategy because it gives traders an accurate picture of what price levels should prop
up the price of a given security in the event of a correction. Conversely, foreseeing a level of
resistance can be advantageous because this is a price level that could potentially harm a long
position, signifying an area where investors have a high willingness to sell the security. As
mentioned above, there are several different methods to choose when looking to identify
support/resistance, but regardless of the method, the interpretation remains the same—it
prevents the price of an underlying asset from moving in a certain direction.

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