notes on technical analysis

8/3/2019 Notes on Technical Analysis

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Notes on Technical Analysis

1. General Term1.1. Definition of trend period

Long term trend - ~1 yearMid term trend - ~1 qtr

Short term trend - ~1 mth

1.2. Support and Resistance Line

Support line - the min of a trend

Resistance line - the max of a trend

To break through support or resistance line required large volume. Thus do not

place order directly at resistance or support level.

One standard clich in trading is price range is 80% of the time.

2. Candle stick plot

2.1. Cup and handle. A bullish continuation price pattern in which the upward trend haspaused but will continue in an upward direction once the pattern is confirmed.

2.2. Double or Triple Tops and Bottoms. Double or Triple Tops and Bottom arereversal price pattern. Though Triple Tops and Bottom are less prevalent.


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2.3. Engulfing Pattern. Engulfing pattern is a Trend reversal pattern.

2.4. Evening Star. An evening star is a top reversal pattern that is very easy toidentify because the last candle in the pattern opens below the previous day's smallreal body, which can be either red or green and closes deep into the real body of thetrading range of the candle two days prior. This will be confirmed if the next day isanother down session.

2.5. Flag and Pennant. Flag and Pennant are short-term (one to three weeks)continuation price patterns that are formed when there is a sharp price movementfollowed by a generally sideways price movement. This pattern is then completedupon another sharp price movement in the same direction as the move that startedthe trend.


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2.6. Falling three methods. A very bearish price pattern. Look closely and you can seethat a new high is not formed from the high set on the first day.

2.7. Gap. A gap in a bar/candle stick chart is an empty space between a trading periodand the following trading period. This occurs when there is a large difference inprices between two sequential trading periods. Gaps generally show that somethingof significance has happened in the security, such as a better-than-expectedearnings announcement.

Gap can be classified into four group:

Breakaway gaps are those that occur at the end of a price pattern and signalthe beginning of a new trend.

Exhaustion gaps occur near the end of a price pattern and signal a finalattempt to hit new highs or lows.

Common gaps are those that cannot be placed in a price pattern - they simplyrepresent an area where the price has "gapped".

Continuation gaps occur in the middle of a price pattern and signal a rush ofbuyers or sellers who share a common belief in the underlying stock's futuredirection.

When someone says that a gap has been "filled", that means that the price hasmoved back to the original pre-gap level. These fills are quite common and occur asa result of the following: Irrational Exuberance: The initial spike may have been overly optimistic or

pessimistic, therefore inviting a correction.

Technical Resistance: When a price moves up or down sharply, it doesn't leavebehind any support or resistance.

Price Pattern: Price patterns are used to classify gaps; as a result, they can alsotell you if a gap will be filled or not. Exhaustion gaps are typically the most likelyto be filled because they signal the end of a price trend, while continuation andbreakaway gaps are significantly less likely to be filled since they are used toconfirm the direction of the current trend.


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When gaps are filled within the same trading day on which they occur, this isreferred to as fading.

Key things you will want to remember when trading gaps: Once a stock has started to fill the gap, it will rarely stop, because there is often

no immediate support or resistance.

Exhaustion gaps and continuation gaps predict the price moving in two differentdirections - be sure that you correctly classify the gap you are going to play. Retail investors are the ones who usually exhibit irrational exuberance; however,

institutional investors may play along to help their portfolios - so be careful whenusing this indicator, and make sure to wait for the price to start to break beforetaking a position.

Be sure to watch the volume. High volume should be present in breakaway gaps,while low volume should occur in exhaustion gaps.

2.8. Hammer. A bullish price pattern that occur when a stock or commodity opens downand the price drops throughout the session only to come back near the openingprice at close. It comes from the action of "hammering" out a bottom.

2.9. Hanging man. A bearish price pattern that develops after a rally. Hanging men thatappear after a long rally should be noted and acted upon. If a trading range for thehanging day is above the entire trading range of the previous day, a "gap" day maybe indicated.


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2.10. Harami. A trend reversal pattern.

2.11. Harami Cross. A trend reversal pattern.

2.12. Head and shoulder. A reversal price pattern that when formed, signals thatthe security is likely to move against the previous trend. It has four main parts: twoshoulders, a head and a neckline. Also, each individual head and shoulder iscomprised of a high and a low.


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"Throwback" move occurs when the price breaks through the neckline, setting anew high or low (depending on the pattern), followed by a retreat back to theneckline. This move back to the neckline is considered to be a test of the pattern andthe newly reversed support or resistance. The successful test of this new level of

support or resistance helps to strengthen the pattern and its suggested newdirection. So, it's important to wait for the pattern to test out and not sell out tooquickly - before the pattern makes its bigger moves.

Market psychology behind Head and Shoulder As price falls from the market high (head), sellers have begun to enter the market

and there is less aggressive buying. As the neckline is approached, many people who bought in the final wave higher

or bought on the rally in the right shoulder are now proven wrong and facinglarge losses it is this large group which now will exit positions driving the pricetowards the profit target.

The stop above the right shoulder is logical because the trend has shifteddownwards the right shoulder is a lower high than the head - and therefore theright shoulder is unlikely to be broken until an uptrend resumes.

The profit target assumes that those who are wrong or purchased the security ata poor time will be forced to exit their positions, thus creating a reversal of similarmagnitude to the topping pattern which just occurred.

The neckline is the point at which many traders are experiencing pain and will beforced to exit positions, thus pushing the price towards the price target.


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2.13. Mat Hold. A bullish price trend. Note day two to foursee the issue falling offslightly but not trading outside the range of the long white day on day one

2.14. Rising Three Methods. A very bullish price trend. Note day two to four stillstay within the price range of the long white day (day one in the pattern).

2.15. Rounding Bottom. Also referred to as a Saucer Bottom, is a long-term

(several months to several years) trend reversal pattern that signals a shift from adownward trend to an upward trend.

2.16. Separating Lines. A continuous price pattern. The key to the second day isthat the issue has the same opening price as day one.

2.17. Triangle. These chart patterns are considered to last anywhere from a coupleof weeks to several months.


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The symmetrical triangle in is a pattern in which two trendlines converge towardeach other. This pattern is neutral in that a breakout to the upside or downside is aconfirmation of a trend in that direction.

In an ascending triangle, the upper trendline is flat, while the bottom trendline isupward sloping. This is generally thought of as a bullish pattern in which chartistslook for an upside breakout.

In a descending triangle, the lower trendline is flat and the upper trendline isdescending. This is generally seen as a bearish pattern where chartists look for adownside breakout.

2.18. Wedge. Can be either a continuation or reversal pattern that last three to sixmonths. It is similar to a symmetrical triangle except that the wedge pattern slantsin an upward (Bearish) or downward direction (Bullish).


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3. Noise Free Candle Stick plot3.1. Heikin-Ashi Technique. Instead of using the open-high-low-close (OHLC) bars like

standard candlestick charts, the Heikin-Ashi technique uses a modified formula:

Close = (Open+High+Low+Close)/4Open = [Open (previous bar) + Close (previous bar)]/2

High = Max (High,Open,Close)Low = Min (Low,Open, Close)

Interpretation

Positive candles (blue) containing no wicks: There is strong uptrendmomentum in the session and it will likely continue. Here, the trader will have ahands-off approach to profits while strongly considering adding on to the position.

Positive candles (blue) containing shadows or wicks: Strength continues tosupport the price action higher. At this point, with upside potential still present,the investor will likely consider the notion of adding to the overall position.

A smaller candle body with longer wicks: Similar to the doji candlestickformation, this candle suggests a near-term turnaround in the overall trend.Signaling indecision, market participants are likely to wait for further directional

bias before pushing the market one way or the other. Traders following on thesignal will likely prefer confirmation before initiating any positions. Negative candles (red) containing shadows or wicks: Weakness or negativemomentum is supporting the price action lower in the market. As a result, traderswill want to begin exiting initial long positions or selling positions at this point.

Negative candles (red) containing no shadows or wicks: Selling momentum isstrong and will likely support a move lower in the overall decline. As a result, thetrader would do well to add to existing short holdings.

4. Indicator

Indicators are used in two main ways: to confirm price movement and the quality ofchart patterns, and to form buy and sell signals.

Indicators are classifies as leading or lagging and bounded or no-bounded. A leadingindicator is thought to be the strongest during periods of sideways or non-trendingtrading ranges, while the lagging indicators are still useful during trending periods.

The ones that are bound within a range are called oscillators - these are the mostcommon type of indicators. Oscillator indicators have a range, for example between zeroand 100, and signal periods where the security is overbought (near 100) or oversold(near zero). Non-bounded indicators still form buy and sell signals along with displayingstrength or weakness, but they vary in the way they do this.

The two main ways that indicators are used to form buy and sell signals in technicalanalysis is through crossovers and divergence.

Crossover When the price moves through a moving average and when it moves through moving

average crossovers e.g. long and short terms. The most common time frames that are used when creating moving averages are the

200-day, 100-day, 50-day, 20-day and 10-day. The 200-day average is thought to bea good measure of a trading year, a 100-day average of a half a year, a 50-dayaverage of a quarter of a year, a 20-day average of a month and 10-day average oftwo weeks.


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When a short-term average is above a longer-term average, the trend is up. On theother hand, a long-term average above a shorter-term average signals a downwardmovement in the trend.

Divergence

Traders make transaction decisions by identifying situations of divergence, where theprice of a stock and a set of relevant indicators are moving in opposite directions.

Class A bearish divergences occur when prices rise to a new high but the oscillator canonly muster a high that is lower than exhibited on a previous rally. Class A bearishdivergences often signal a sharp and significant reversal toward a downtrend. Class Abullish divergences occur when prices reach a new low but an oscillator reaches a higherbottom than it reached during its previous decline. Class A bullish divergences are oftenthe best signals of an impending sharp rally.

Class B bearish divergences are illustrated by prices making a double top, with anoscillator tracing a lower second top. Class B bullish divergences occur when prices tracea double bottom, with an oscillator tracing a higher second bottom.

Class C bearish divergences occur when prices rise to a new high but an indicator stopsat the very same level it reached during the previous rally. Class C bullish divergencesoccur when prices fall to a new low while the indicator traces a double bottom. Class Cdivergences are most indicative of market stagnation - bulls and bears are becomingneither stronger nor weaker.

Class B and C represent choppy market action and should be ignored.

4.1. Accumulation/Distribution Line. Non-bounded Volume indicators thatmeasures money flows in a security. This indicator attempts to measure the ratio ofbuying to selling by comparing the price movement of a period to the volume of thatperiod.

Acc/Dist = ((Close - Low) - (High - Close)) / (High - Low) * Period's Volume

If a security has an accumulation/distribution line that is trending upward, it is a signthat there is more buying than selling.4.2. Average Directional Index (ADX). ADX is a bounded indicator that is usedto measure the momentum of a current trend. The ADX is a combination of two pricemovement measures: the positive directional indicator (+DI) and the negativedirectional indicator (-DI). The +DI measures the strength of the upward trend whilethe -DI measures the strength of the downward trend. These two measures are alsoplotted along with the ADX line. Measured on a scale between zero and 100, readingsbelow 20 signal a weak trend while readings above 40 signal a strong trend.

4.3. Aroon. A unbounded trending indicator used to measure whether a security isin an uptrend or downtrend and the magnitude of that trend. The indicator is alsoused to predict when a new trend is beginning. The indicator is comprised of twolines, "Aroon up" line and "Aroon down" line. The Aroon up line measures the amountof time it has been since the highest price during the time period. The Aroon downline, on the other hand, measures the amount of time since the lowest price duringthe time period.

Aroon Oscillator. Plot the difference between the Aroon up and down lines bysubtracting the two lines. This line is then plotted between a range of -100 and 100.


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The centreline at zero in the oscillator is considered to be a major signal linedetermining the trend. The higher the value of the oscillator from the centrelinepoint, the more upward strength there is in the security; the lower the oscillator'svalue is from the centreline, the more downward pressure. A trend reversal issignalled when the oscillator crosses through the centreline. Divergence is also usedin the oscillator to predict trend reversals. A reversal warning is formed when the

oscillator and the price trend are moving in an opposite direction.

4.4. Bollinger Band. Bollinger bands consist of a centre line and two pricechannels above (overbrought) and below it(over sold). The centre line isan exponential moving average; the price channels are the standard deviations ofthe stock being studied. The bands will expand and contract as the price action of anissue becomes volatile (expansion) or becomes bound into a tight trading pattern(contraction).

BOLU = MA(TP, n) + m * SD[TP, n]BOLD = MA(TP, n) - m * SD[TP, n]

BOLU = Upper Bollinger BandBOLD = Lower Bollinger Bandn = Smoothing Periodm = Number of Standard Deviations (SD)SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3

Bandwidth = [Upper Bolling Band (20 period) - Lower Bolling Band (20 period)] /SMA(20 period)

The squeeze relies on the premise that stocks fluctuate between periods of highvolatility, followed by low volatility. Equities that are at six-month low levels ofvolatility, as demonstrated by the narrow distance between Bollinger Bands,generally demonstrate explosive breakouts.

By generating two sets of Bollinger bands - one set using the parameter of"1 standard deviation" and the other using the typical setting of "2 standarddeviation" - we can look at price in a whole new way.

4.5. Moving Average Convergence Divergence (MACD). MACD is amomentum indicator. It is the difference between a short term EMA and a long termEMA plotted against a centreline. The centreline is the point at which the two movingaverages are equal.

When the MACD is positive, it signals that the shorter term moving average is abovethe longer term moving average and suggests upward momentum. The oppositeholds true when the MACD is negative - this signals that the shorter term is below thelonger and suggest downward momentum. When the MACD line crosses over thecentreline, it signals a crossing in the moving averages.

The most common moving average values used in the calculation are the 26 day and12 day exponential moving averages for long term & 18 day and 7 day for shortterm.

Along with the MACD and the centreline, an EMA of the average MACD for 9 periodsis plotted on the chart. This EMA is known as the trigger line. Together with theMACD, it is used to indicate when the momentum is shifting.


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The basic bullish signal (buy sign) occurs when the MACD line crosses above thetrigger line, and the basic bearish signal (sell sign) is generated when the MACDcrosses below the trigger line.

Disadvantages of MACD1. Severe whipsaw effect in both trending and range bound markets, because

relatively small movements can cause the indicator to change directions quickly.2. Inability to make comparisons between different securities.

MACD histogram. The histogram is plotted on the centreline and represented bybars. Each bar is the difference between the MACD and the trigger signal. The higherthe bars are in either direction, the more momentum behind the direction in whichthe bars point.

4.6. Money flow index

4.7. Relative Strength Index (RSI). RSI helps to signal overbought and oversoldconditions in a security.

RSI = 100(RS/RS + 1)

RS = Average of x day up closes / x day down closes

The indicator is plotted in a range between zero and 100. A reading above 70 is usedto suggest that a security is overbought, while a reading below 30 is used to suggestthat it is oversold. This indicator helps traders to identify whether a security price hasbeen unreasonably pushed to current levels and whether a reversal may be on theway. The standard calculation for RSI uses 14 trading days as the basis, which can beadjusted to meet the needs of the user.

4.8. On-Balance Volume (OBV). It is used to reflect movements in volume. TheOBV is calculated by taking the total volume for the trading period and assigning it apositive or negative value depending on whether the price is up or down during thetrading period. When price is up during the trading period, the volume is assigned apositive value, while a negative value is assigned when the price is down for theperiod. The positive or negative volume total for the period is then added to a totalthat is accumulated from the start of the measure. It is important to focus on thetrend in the OBV - this is more important than the actual value of the OBV measure.

The idea behind the OBV measure is that volume is thought to precede pricemovements. If volume is decreasing when the price of a security is rising then it is asign of increased selling pressure, which if continued, will send the price of a securitylower. The opposite is true with increasing volume on up days, which is a sign ofbuying pressure. If the OBV is moving in the same direction as the existing trend, it isa signal that the strength of the trend remains. When the OBV starts to move againstthe trend, it is a signal that the existing trend is weakening and may reverse.

4.9. Parabolic SAR. A.k.a. stop and reversal system. Parabolic SAR is amomentum indicator. A dot placed below the price is deemed to be a bullish signal,causing traders to expect the momentum to remain in the upward direction.Conversely, a dot placed above the prices is used to illustrate that the bears are incontrol and that the momentum is likely to remain downward.

The indicator works extremely well when a stock is trending, but it can lead to manyfalse signals when the price moves sideways or is trading in a choppy market.


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4.10. Stochastic Oscillator. The idea behind this indicator is that in an uptrend,the price should be closing near the highs of the trading range, signalling upwardmomentum in the security. In downtrends, the price should be closing near the lowsof the trading range, signalling downward momentum. The stochastic oscillator isplotted within a range of zero and 100 and signals overbought conditions above 80

and oversold conditions below 20.

The stochastic oscillator contains two lines. The first line is the %K, which isessentially the raw measure used to formulate the idea of momentum behind theoscillator. The second line is the %D, which is simply a moving average of the %K.

The %D line is considered to be the more important of the two lines as it is seen toproduce better signals. Note %D is the slower of the two.

There are three versions of the stochastic oscillator fast(basic), slow and full.

Fast:

%K = 100[(C Lclose)/(H L)]

C = the most recent closing priceL = the low of the previous trading sessionsH = the highest price traded during the same period.

%D = 3 period of the moving average of %K

Slow:%K = 3 periods of the moving average of fast %K%D = n period of the moving average of slow %K

The stochastic oscillator generally uses the past 14 trading periods in its calculationbut can be adjusted to meet the needs of the user.

The main signal that is formed by this oscillator is when the %K line crosses the %Dline. A bullish signal is formed when the %K breaks through the %D in an upwarddirection. A bearish signal is formed when the %K falls through the %D in adownward direction.

If the security is moving in an upward direction and the %D is moving in a downwarddirection this is a bearish sign. A bullish sign is formed when the %D is movingupward when the security is moving downward. If this divergence is happening whenthe %D is in an overbought (above 80) or an oversold (below 20) position on theoscillator the signal formed is much stronger. However, the signal is not consideredcomplete until the %K line crosses the %D line in the opposite direction of the pricetrend.

notes on technical analysis

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