TECHNICAL ANALYSIS

Link for technical charts

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hnical
Chapter Objectives
To know the concept of technical analysis

To understand the Dow theory

To find out the support and resistance level

To comprehend the indicators and oscillators

To explain the chart form of price analysis

 Technical Analysis Vs. Fundamental Analysis
1. Fundamental analysts analyses financial strength of corporate, growth of
sales, earnings and profitability.
 The technical analysts mainly focus the attention on the past history of prices.
2. Fundamental analysts estimate the intrinsic value of the shares.
 Technical analysts mainly predict the short term price movement.
3. Fundamentalists are of the opinion that supply and demand for stocks
depend on the underlying factors.
 Technicians opine that they can forecast supply and demand by studying the prices
and volume of trading.
 Technical Analysis Vs. Fundamental Analysis
4. Fundamental analysis is aimed at identifying scrips for investment and it
tries to find out intrinsic value of shares.
 The technical analysis is aimed at finding the right time for investment.
Technical Analysis
Technical analysis is a tool or a method for forecasting the future
direction of prices through the study of past market data, mainly
prices and volume.
A process of identifying trend and trend reversals at an earlier stage
to formulate the buying and selling strategy.
Technical analyst study the relationship between price-volume and
supply-demand for the overall market and the individual stock,
investor psychology, money flow etc.,.
Assumptions
The market value of the scrip is determined by the interaction of
supply and demand.
The market discounts everything.

The market always moves in trend.

History repeats itself. It is true to the stock market also.

Origin of Technical Analysis
Technical analysis is based on the doctrine given by Charles H. Dow in
1884, in the Wall Street Journal.
A. J. Nelson, a close friend of Charles Dow formalised the Dow theory
for economic forecasting.
Analysts used charts of individual stocks and moving averages in the
early 1920s.
Benefits and Limitations of Technical Analysis
Benefits Limitations

• Technical analysis is able to • At times, different

tell us when to enter or exit indicators or tools give
using patterns. confusing/contradictory
• It gives insights in to signals.
demand and supply • By ignoring fundamental
situation and volume analysis, long term wealth
trends. building become difficult as
• It can be done on any technical analysis find its
difficult to project long
commodity and for any
term targets.
time period just by studying
charts.
How to use Technical analysis on Fundamental Data
• Plotting fundamental information, rather than just looking
at table stuffed with the data, may give a unique perspective
and help us to spot trends we did not notice before.
• P/E ratio charts, P/BV charts and dividend yield charts – how
well these are rising or falling – will give investors an idea
about whether investors are getting overly bullish or
cautious about a particular stock.
Dow Theory
Dow developed his theory to explain the movement of the indices of
Dow Jones Averages.
The theory is based on certain hypothesis:
 No single individual or buyer can influence the major trend of the market.
Market discounts every thing.
The theory is not infallible.
According to Dow theory the trend is divided into
Primary
Intermediate/Secondary
Short term/Minor
Primary, Secondary and
Minor Trends
Primary Trend
 The security price trend may be either increasing or decreasing.

 When the market exhibits the increasing trend, it is called ‘bull market’ and when
it exhibits a decreasing trend it is called ‘bear market’.

 Raising trend line

 Flat Trend line
 Falling trend line
Bull Market
The bull market shows three clear-cut peaks.
Each peak is higher than the previous peak.
The bottoms are also higher than the previous
bottoms.
Bull market
Y
T3

T2 Speculation
phase
P
R B2
I T1
Good corporate
C earnings
E
Revival B1
of market
confidence
phase-1
X
Days
Bear Market
The market exhibits falling trend.
The peaks are lower than the previous peaks.
The bottoms are also lower than the previous bottoms.
Y Bear market

Loss of hope (phase-1)

P T1
R Recession in business (phase-2)
I
C T2
B1
E
Distress selling
(phase-3)
B2
B3

X
Days
The Secondary Trend
The secondary trend or the intermediate trend moves against the
main trend and leads to correction.
The correction would be 33% to 66% of the earlier fall or increase.

Compared to the time taken for the primary trend, secondary trend is
swift and quicker.
Minor Trends
Minor trends or tertiary moves are called random wriggles.

They are simply the daily price fluctuations.

Minor trend tries to correct the secondary trend movement.

Support and Resistance Level
In the support level, the fall in the price may be halted for the time
being or it may result even in price reversal.
In this level, the demand for the particular scrip is expected.
In the resistance level, the supply of scrip would be greater than the
demand.
Further rise in price is prevented.
Selling pressure is greater and the increase in price is halted for the time
being.
Support and Resistance Level
Pivot Points
• It is a price level that is used by traders as a
possible indicator of market movement.
• When the price of an asset is trading above the
pivot point, it indicates the day is bullish or
positive.
• When the price of an asset is trading below the
pivot point, it indicates the day is bearish or
negative.
• The indicator typically includes four additional
levels: S1, S2, R1, and R2. These stand for
support one and two, and resistance one and
two.
Pivot Points
• Pivot point = (High + Low+ Close)/3
• First level support and resistance
• R1 = 2*PP- Low
• S1 = 2*PP- High
• Second level support and resistance
• R2 = PP + (High –low)
• S2 = PP-(High – Low)
• Third level support and resistance
• R3= High+2(PP-low)
• S3 = Low -2(High-PP)
Q1
• Wipro Ltd., Open, High, low and closing price on 19.11.2024 are 556,
569.8, 554.7, 562.
Elliot Wave Theory
Elliot Wave theory
• Ralph Nelson Elliott developed the Elliott Wave Theory in the 1930s.
• Elliott believed that stock markets, generally thought to behave in a
somewhat random and chaotic manner, in fact, traded in repetitive
patterns.
Elliot Wave theory
• The Elliott Wave Theory is a form of technical analysis that looks for
recurrent long-term price patterns related to persistent changes in
investor sentiment and psychology.
• The theory identifies impulse waves that set up a pattern and
corrective waves that oppose the larger trend.
• Each set of waves is nested within a larger set of waves that adhere
to the same impulse or corrective pattern, which is described as a
fractal approach to investing.
Elliot Wave theory
• The Elliott Wave Theory is interpreted as follows:
• Five waves move in the direction of the main trend, followed by three
waves in a correction (totaling a 5-3 move). This 5-3 move then becomes two
subdivisions of the next higher wave move.
• The underlying 5-3 pattern remains constant, though the time span of each
wave may vary.
Elliot Wave Theory
Elliot Wave theory
• Waves 1, 2, 3, 4 and 5 form an impulse, and waves A, B and C form a
correction. The five-wave impulse, in turn, forms wave 1 at the next-
largest degree, and the three-wave correction forms wave 2 at the
next-largest degree.
• The corrective wave normally has three distinct price movements –
two in the direction of the main correction (A and C) and one against
it (B).
Volume of TradeIndicators
Volume expands along with the bull market and narrows down in the
bear market.
Technical analyst use volume as an excellent method of confirming
the trend.
Breadth of the Market
The net difference between the number of stock advanced and
declined during the same period is the breadth of the market.
A cumulative index of net differences measures the market breadth.
Short sales
This is a technical indicator also known as short interest.
It refers to the selling of shares that are not owned.
They show the general situations.
ODD Lot trading
Moving Average
The word moving means that the body of data moves ahead to
include the recent observation.
The moving average indicates the underlying trend in the scrip.
For identifying short-term trend, 10 to 30 days moving averages are
used.
In the case of medium-term trend 50 to 125 days are adopted.
To identify long-term trend 200 days moving average is used.
Moving Averages
• Simple Moving Average
• Exponential Moving Average
• Moving Average Convergence and Divergence (MACD Oscillator)
MACD
• The Moving Average Convergence/Divergence indicator
is a momentum oscillator primarily used to trade trends.
Although it is an oscillator, it is not typically used to
identify over bought or oversold conditions. It appears
on the chart as two lines which oscillate without
boundaries. The crossover of the two lines give trading
signals similar to a two moving average system
MACD Calculation
• An approximated MACD can be calculated by
subtracting the value of a 26 period Exponential Moving
Average (EMA) from a 12 period EMA. The shorter EMA
is constantly converging toward, and diverging away
from, the longer EMA. This causes MACD to oscillate
around the zero level. A signal line is created with a 9
period EMA of the MACD line.
MACD
Oscillators
Oscillator shows the share price movement across a reference point
from one extreme to another. The momentum indicates:
Overbought and oversold conditions of the scrip or the market.
Signaling the possible trend reversal.
Rise or decline in the momentum.
Relative Strength Index (RSI)
RSI was developed by Wells Wilder.
Identifies the inherent technical strength and
weakness of a particular scrip or market. RSI can be
calculated for a scrip by adopting the following
formula
 100 
100  
 1  Rs 
RSI =
Average gain per day
Average loss per day
Rs =

If the share price is falling and RSI is rising, a divergence is

said to have occurred.
Divergence indicates the turning point of the market.
RSI
Rate of Change (ROC)
ROC measures the rate of change between the
current price and the price ‘n’ number of days in the
past.
ROC helps to find out the overbought and oversold
positions in a scrip.
ROC can be calculated by two methods.
In the first method current closing price is expressed as a
percentage of the 12 days or weeks in past.
In the second method, the percentage variation between
the current price and the price 12 days in the past is
calculated.
ROC
Bollineger Band
• A Bollinger Band® is a technical analysis tool defined by a set of
trendlines. They are plotted as two standard deviations, both
positively and negatively, away from a simple moving average (SMA)
of a security's price and can be adjusted to user preferences.
• Bollinger Bands® was developed by technical trader John Bollinger
and designed to give investors a higher probability of identifying
when an asset is oversold or overbought.
Charts
Charts are graphic presentations of the stock prices. These also have
the following uses:
Spots the current trend for buying and selling
Indicates the probable future action of the market by projection
Shows the past historic movement
Indicates the important areas of support and resistance

Bar Charts
The bar chart is the simplest and most commonly
used tool of a technical analyst.
A dot is entered to represent the highest price at
which the stock is traded on the day, week or month.
Another dot is entered to indicate the lowest price on
that particular date.
A line is drawn to connect both the points.
A horizontal nub is drawn to mark the closing price.

Line Chart
Japanese Candle Stick Chart
Line chart
Candle Stick Chart
Point and Figure Charts
These charts are one-dimensional and there is no indication of time
or volume.
The price changes in relation to previous prices are shown.
The change of price direction can be interpreted.
Some inherent disadvantages are:
They do not show the intra-day price movement.
Only whole numbers are taken into consideration, resulting in loss of
information regarding minor fluctuations.
Volume is not mentioned in the chart.
P&F Chart
Candle Stick
Chart Patterns
V Formation
Tops and bottoms
Double top and bottom
Head and shoulders
Inverted head and shoulders
Triangles
Chart Patterns
Chart Patterns -Triangles
The triangle formation is easy to identify and popular in technical
analysis.
The different triangles are:
Symmetrical
Ascending
Descending—inverted
Chart Patterns- Head and Shoulders
Head and shoulders
•A head and shoulders pattern is used in technical analysis. It is
a specific chart formation that predicts a bullish-to-bearish trend
reversal. The pattern appears as a baseline with three peaks,
where the outside two are close in height, and the middle is
highest.
•The head and shoulders pattern forms when a stock's price
rises to a peak and then declines back to the base of the prior
up-move. Then, the price rises above the previous peak to form
the "head" and then declines back to the original base. Finally,
the stock price peaks again at about the level of the first peak of
the formation before falling back down.
Chart Patterns - Inverted Head and Shoulders
Inverse Head and shoulders
• The inverse head and shoulders chart pattern is a
bullish chart formation that signals a potential reversal
of a downtrend. It is the opposite of the head and
shoulders chart pattern, which is a bearish formation.
Stop loss order
• A stop-loss order is an order placed with a broker to buy or sell a
specific stock once the stock reaches a certain price. A stop-loss is
designed to limit an investor's loss on a security position. For
example, setting a stop-loss order for 10% below the price at which
you bought the stock will limit your loss to 10%
• A stop-loss order is a trading trigger placed on a stock that
automates the selling of the stock from a portfolio if the stock
reaches a specified low. Investors can automatically set stop-loss
orders through brokerage accounts and typically do not require
exorbitant additional trading costs.
Stop-limit order
• Stop-limit orders are a conditional trade that combine the features
of a stop loss with those of a limit order to mitigate risk.
• Stop-limit orders enable traders to have precise control over when
the order should be filled, but they are not guaranteed to be
executed.
• The stop price dictates the price whether the order is triggered, then
the limit price dictates the price at which the order is filled.
Risk / Reward Ratio
• The risk/reward ratio helps investors manage their risk of losing
money on trades. Even if a trader has some profitable trades, they
will lose money over time if their win rate is below 50%. The
risk/reward ratio measures the difference between a trade entry
point to a stop-loss and a sell or take-profit order. Comparing these
two provides the ratio of profit to loss, or reward to risk.
Problem 1:
• A trader purchases 100 shares of XYZ Company at $20 and places a
stop-loss order at $15 to ensure that losses will not exceed $500.
Also, assume that this trader believes that the price of XYZ will reach
$30 in the next few months.
• What is his risk/reward ratio?
• If he wishes to have a risk/reward ratio of 1:5, what should be his
stop loss price and target price?
• (a) In this case, the trader is willing to risk $5 per share to make an
expected return of $10 per share after closing the position. Since the
trader stands to make double the amount that they have risked,
they would be said to have a 1:2 risk/reward ratio on that particular
trade.
• suppose an investor set a stop-loss order at $18, instead of $15, and
they continued to target a $30 profit-taking exit,he will have a risk/
reward ratio of 1:5
 Tools for Judging Undervaluation or
Overvaluation

• PBV-ROE Matrix

• Growth-Duration Matrix

•
• Quality at a Reasonable Price (VRE)

• PEG: Growth at a Reasonable Price

 PBV-ROE Matrix

Overvalued High ROE

HIGH Low ROE High PBV
High PBV
PBV Ratio
Low ROE Undervalued
LOW Low PBV High ROE
Low PBV

LOW HIGH
ROE
 Growth-Duration Matrix

Promises of
High Undervalued
growth

Expected 5-Yr
EPS Growth
Dividend
Low Overvalued
cows

Low High
Duration (1/Dividend Yield)
 Expectations Risk Index (ERI)

Developed by Al Rappaport, the ERI reflects the risk in

realising the expectations embedded in the current market
price

Proportion of stock Ratio of expected future

ERI = price depending on X growth to recent growth
expected future growth (Acceleration ratio)
 Quality at a Reasonable Price
Determining whether a stock is overvalued or undervalued is often difficult. To deal
with this issue, some value investors use a metric called the value of ROE or VRE for
short.
The VRE is defined as the return on equity (ROE) percentage divided by the
PE(price-earning) ratio. For example, if a company has an expected ROE of 18
percent and a PE ratio of 15, its VRE is 1.2 (18/15).
According to value investors who use VRE:
• A stock is considered overvalued if the VRE is less than 1.
• A stock is worthy of being considered for investment, if the VRE is greater than
1.
• A stock represents a very attractive investment proposition if the VRE > 2
• A stock represents an extremely attractive investment proposition if the VRE > 3
 PEG: Growth at a Reasonable Price

What price should one pay for growth? To answer this difficult
question, Peter Lynch, the legendary mutual fund manager,
developed the so-called PE-to-growth ratio, or PEG ratio. The PEG
ratio is simply the PE ratio divided by the expected EPS growth rate
(in percent). For example, if a company has a PE ratio of 20 and its
EPS is expected to grow at 25 percent, its PEG ratio is 0.8 (20/25).
 PEG: Growth at a Reasonable Price
Proponents of PEG ratio believe that:
A PEG of 1 or more suggests that the stock is fully valued.
• A PEG of less than 1 implies that the stock is worthy of being considered for
investment.
• A PEG of less than 0.5 means that the stock possibly is a very attractive
investment proposition.
• A PEG of less than 0.33 suggests that the stock is an unusually attractive
investment proposition.
Thus, the lower the PEG ratio, the greater the investment attractiveness of the
stock. Growth-at-a-reasonable price (GARP) investors generally shun stocks with PEG
ratios significantly greater than 1.
PEG ratio
• The price/earnings to growth ratio (PEG ratio) is a stock's
price-to-earnings (P/E) ratio divided by the growth rate of its
earnings for a specified time period.
• The PEG ratio is used to determine a stock's value while also
factoring in the company's expected earnings growth, and it is
thought to provide a more complete picture than the more standard
P/E ratio.
• In general, a good PEG ratio has a value lower than 1.0.
PEG ratios greater than 1.0 are generally considered
unfavorable, suggesting a stock is overvalued.
Meanwhile, PEG ratios lower than 1.0 are considered
better, indicating a stock is relatively undervalued.
Enterprise value
• EV tells investors or interested parties a company's value and how
much another company would need if it wanted to purchase that
company.
EBITDA
EV/EBIDTA
• EV calculates a company's total value or assessed
worth, while EBITDA measures a company's overall
financial performance and profitability.
• Typically, when evaluating a company, an EV/EBITDA
value below 10 is seen as healthy.
• It's ideal for analysts and investors looking to compare companies
within the same industry.
PB Ratio
• The price-to-book ratio, or P/B ratio, is a financial ratio used
to compare a company's current market value to its book value
(where book value is the value of all assets minus liabilities
owned by a company)