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Momentum indicators Momentum indicators are alternative to trend following approaches.

The momentum indicators are extremely useful in non trending market where prices fluctuate in a horizontal price band, or trading range creating a market situation where most trend following systems simply don't work that well. The momentum indicator provides the technical trader with a tool that can enable him to profit from these periodic sideways and trendless markets. Used in conjunction with price charts during trending phases the momentum indicators become an extremely valuable ally by alerting the trader to short term market extremes, commonly referred to as overbought or oversold conditions. The momentum indicators can also warn that a trend is losing momentum before that situation becomes evident in the price action itself. Interpretation of Momentum Indicators

While there are many different ways to construct momentum oscillators the actual interpretation differs very little from one another. Most indicators look very much alike. They are plotted along the bottom of the price chart and resemble a flat horizontal band. General rules for interpretation As a general rule when the momentum indicator reaches an extreme value in either the upper or lower end of the band, this suggests that the current price move may have gone too far too fast and is due for a correction or consolidation of some type. As another general rule, the trader should be buying when the indicator line is in the lower end of the band and selling in the upper end of the band. The crossing of the midpoint line is often used to generate buy signals and sell signals. Two of the most important momentum indicators are:A.) RSI - Relative Strength Index B.) MACD - Moving Average Convergence-Divergence A.) Relative Strength Index (RSI) The Relative Strength Index is a trading indicator which is intended to indicate the current and historical strength or weakness of a market based on the closing prices of completed trading periods. It assumes that prices close higher in strong market periods, and lower in weaker periods and computes this as a ratio of the number of incrementally higher closes to the incrementally lower closes. The RSI method is classified as a momentum oscillator measuring the velocity and magnitude of directional price movements (momentum is the rate of the rise or fall in price).

The RSI is presented in a graph above. It is usually plotted as lines along with two moving averages connecting the relevant values for each period. Wilder recommended a smoothing period of 14. Wilder said that when price moves up very rapidly, at some point it is considered overbought. Likewise, when price falls very rapidly at some point it is considered oversold. In either case, Wilder felt a reaction or reversal is imminent. The slope of the RSI is directly proportional to the velocity of the move. The distance traveled by the RSI is proportional to the magnitude of the move. As a result, Wilder believed that tops and bottoms are indicated when RSI goes above 70 or drops below 30. Traditionally RSI readings greater than the 70 level are considered to be in overbought territory and RSI readings lower than the 30 level are considered to be in oversold territory. In between the 30 and 70 level is considered neutral. Wilder further believed that divergence between RSI and price action is a very strong indication that a market turning point is imminent. Bearish divergence occurs when price makes a new high but the RSI makes a lower high, thus failing to confirm. Bullish divergence occurs when price makes a new low but RSI makes a higher low. Thus RSI is a very a good momentum indicator but it should be used in confirmation with other indicators to have better results. B.)Moving Average Convergence-Divergence (MACD) Developed by Gerald Appel in the late seventies, Moving Average Convergence-Divergence (MACD) is one of the simplest and most effective momentum indicators available. MACD turns two trend-following indicators (two moving averages), into a momentum oscillator by subtracting the longer moving average from the shorter moving average. As a result, MACD offers the best of both worlds: trend following and momentum. MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, centerline crossovers and divergences to generate signals. Because MACD is unbounded, it is not particular useful for identifying overbought and oversold levels. MACD is all about the convergence and divergence of the two moving averages. Convergence occurs when the moving averages move towards each other. Divergence occurs when the moving averages move away from each other. The shorter moving average (12-day) is faster and responsible for most of the MACD movement. The longer moving average (26-day) is slower and less reactive to price changes in the underlying security. Positive MACD indicates that the 12-day EMA is above the 26-day EMA. Positive values increase as the shorter EMA trades further above the longer EMA. This means upside momentum is increasing. Negative MACD indicates that the 12-day EMA is below the 26-day EMA. Negative values increase as the shorter EMA trades further below the longer EMA. This means downside momentum is increasing. There are times when MACD crosses the zero line, which is also known as the centerline. This signals that the 12-day EMA has crossed the 26-day EMA. The direction of the centerline cross, of course, depends on direction of the moving average cross. In the example below, the yellow area shows MACD in negative territory as the 12-day EMA trades below the 26-day

EMA. The initial cross occurred at the end of September (black arrow) and MACD moved further into negative territory as the 12-day EMA diverged further from the 26-day EMA. The orange area highlights a period of positive MACD, which is when the 12-day EMA was above the 26-day EMA. Notice that the 12-day EMA remained below 1 during this period (red dotted line). This means the distance between the 12-day EMA and 26-day EMA was less than 1 point, which is not a big difference

MACD is special because it brings together momentum and trend in one indicator. This means MACD will never be far removed from price action. MACD's unique blend of trend and momentum can be applied to daily, weekly or monthly charts. The standard setting for MACD is the difference between the 12 and 26-period EMAs. Chartists looking for more sensitivity may try (5, 35, and 5). Chartists looking for less sensitivity may consider (20, 50, and 10). A less sensitive MACD will still oscillate above/below zero, but the centerline crossovers and signal line crossovers will be less frequent. MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to identify levels that historically represent overbought and oversold, MACD does not have any upper or lower limits to bind its movement. MACD can continue to overextend beyond historical extremes. MACD calculates the absolute difference between two moving averages and not the percentage difference. A 20 stock may have a MACD range of -1.5 to 1.5, while a 100 stock may have a MACD range from -10 to +10. It is not possible to compare MACD for securities that vary in price. An alternative is to use the Percentage Price Oscillator (PPO), which shows the percentage difference between two moving averages

References: 1.) J. Welles Wilder, New Concepts in Technical Trading Systems, Page 89 2.) Appel, Gerald (1999). Technical Analysis Power Tools for Active Investors. Financial Times Prentice Hall. pp. 166. 3.) Murphy, John (1999). Technical Analysis of the Financial Markets. Prentice Hall Press. pp. 252-255

Rectangle a continuation pattern A Rectangle is a continuation pattern that forms as a trading range during a pause in the trend. The pattern is easily identifiable by two comparable highs and two comparable lows. The highs and lows can be connected to form two parallel lines that make up the top and bottom of a rectangle. Rectangles are sometimes referred to as trading ranges, consolidation zones or congestion areas.

Source: Stockcharts.com There are many similarities between the rectangle and the symmetrical triangle. While both are usually continuation patterns, they can also mark significant tops and bottoms. As with the symmetrical triangle, the rectangle pattern is not complete until a breakout has occurred. Sometimes clues can be found, but the direction of the breakout is usually not determinable beforehand.

Trend: To qualify as a continuation pattern, a prior trend should exist. Ideally, the trend should be a few months old and not too mature. The more mature the trend, the less chance that the pattern marks a continuation. Four Points: At least two equivalent reaction highs are required to form the upper resistance line and two equivalent reaction lows to form the lower support line. They do not have to be exactly equal, but should be within a reasonable proximity. Although not a prerequisite, it is preferable that the highs and lows alternate. Volume: As opposed to the symmetrical triangle, rectangles do not exhibit standard volume patterns. Sometimes volume will decline as the pattern develops. Other times volume will gyrate as the prices bounce between support and resistance. Rarely will volume increase as the pattern matures. If volume declines, it is best to look for an expansion on the breakout for confirmation. If volume gyrates, it is best to assess which movements (advances to resistance or declines to support) are receiving the most volume. This type of volume assessment could offer an indication on the direction of the future breakout. Duration: Rectangles can extend for a few weeks or many months. If the pattern is less than 3 weeks, it is usually considered a flag, also a continuation pattern. Ideally, rectangles will develop over a 3-month period. Generally, the longer the pattern, the more significant the breakout. A 3-month pattern might be expected to fulfill its breakout projection. However, a 6-month pattern might be expected to exceed its breakout target. Breakout Direction: The direction of the next significant move can only be determined after the breakout has occurred. As with the symmetrical triangle, rectangles are neutral patterns that are dependent on the direction of the future breakout. Volume patterns can sometimes offer clues, but there is no confirmation until an actual break above resistance or break below support. Breakout Confirmation: For a breakout to be considered valid, it should be on a closing basis. Some traders apply a filter to price (3%), time (3 days) or volume (expansion) for confirmation.

Return to Breakout: A basic tenet of technical analysis is that broken support turns into potential resistance and vise-a-versa.. Target: The estimated move is found by measuring the height of the rectangle and applying it to the breakout. Rectangles represent a trading range that pits the bulls against the bears. As the price nears support, buyers step in and push the price higher. As the price nears resistance, bears take over and force the price lower. Nimble traders sometimes play these bounces by buying near support and selling near resistance. One group (bulls or bears) will exhaust itself and a winner will emerge when there is a breakout. Again, it is important to remember that rectangles have a neutral bias. Even though clues can sometimes be gleaned from volume patterns, the actual price action depicts a market in conflict. Only until the price breaks above resistance or below support will it be clear which group has won the battle.

Source: Stockcharts.com

In the chart shown above, the price advanced to the low forties. After meeting resistance around 42, the stock settled in a trading range between 40 and 30 to form a rectangle. The prior intermediate trend was established as bullish by the advance from the high teens to the low forties. However, it was unclear at the time if this trading range would be a reversal or a continuation pattern. The horizontal resistance line at 40 can be extended back to the Feb-99 high and marked a serious resistance level.

The red resistance line at 40 was formed with three reaction highs. The first reaction high may be a bit suspect, but the second two are robust. The parallel support line at 30 was touched three times and established a solid support level. After the high at point 5 was reached, the rectangle was valid. As the pattern developed, volume fluctuated and there was no clear indication (bullish or bearish break) until mid-February. The duration of the pattern was 5 months. Due to long-term overhead resistance at 40, the pattern needed more time to consolidate before a breakout. The longer consolidation made for bigger expectations after the breakout. The breakout occurred with a large expansion in volume and a huge moved above resistance. After the breakout, there was a slight pullback to around 46, but the volume behind the advance indicated a huge breakout. Stocks do not always return to the point of breakout. The target advance of this breakout was 10 points, which was the width of the pattern. However, judging from the duration and strength of the breakout, expansion of volume and new all-time highs, it was apparent that this was no ordinary breakout. Therefore an ordinary target was useless! After an initial advance as high as 55 13/16, the stock pulled back to 46 and then moved above 70. Another trading range subsequently developed with resistance in the low 70s and support in the upper 40s. Conclusion In summary, the rectangle is a classical technical analysis pattern bounded by significant support and resistance and described by horizontal trend lines. The pattern can be traded by buying at support and selling at resistance or buying the breakout and employing the measuring principle to set a target. References: 1.) Stockcharts.com 2.) Jones, Ronald (1971) - "The golden section: A most remarkable measure". 3.) Chart-Patterns.netfirms.com

Star Reversal Patterns Reversal patterns in technical analysis signify that the prior trend is likely to change but not necessarily reverse. Compare an uptrend to a car travelling forward at 30 kmph, when the red traffic signal comes the car stops this is a reversal signal because the car is not going forward which was the prior trend and the trend has now changed to stationary (sideways). Stars are a major reversal signal. Stars have small real bodies which gap away from a large real body that precede it. The key rule to a star is that its' real body does not overlap the previous candles real body. There are several variations of the star pattern like the morning star, evening star, doji star, and shooting star. These basic patterns are the beginning of candlestick technical analysis education.

Psychology of the Candlestick Star Pattern As a star has a small real body, it represents indecision by both the bulls and the bears. While the larger trend may be strongly up or strongly down, the presence of the star indicates that the prevailing direction may have come under profit taking or that the other side has actually taken control. Remember, the previous bar should be a strong bar in the direction of the trend which indicates that the bulls (in an up trending market) or the bears (in a down trending market) are in control. This strength in direction is what makes the appearance of the star much more important as the conviction has dissipated.

Candlestick Star Variations Morning Star

The morning star candle is a bottom reversal signal that comes after an extended downtrend. This pattern is a three candle reversal setup. The first two bars are the typical star setup discussed above. The major difference with this pattern is the third candle in the formation. It is a very strong green candle, which does not have to be a gap, which closes at least half way into the first candle. The further it eats in the first bar, the more bullish the formation. Outside of morning star showing itself, look for other indications that this pattern is for real. For example, you want to see high volume in the third candle, indicating strength. It is noticed that the morning star works very well when it occurs at previous support levels. This adds that extra layer of confidence to the analysis.

Evening Star The evening star candlestick is the bearish version of the morning star. It is a top reversal pattern that occurs after a sustained up trend. The evening star also a three candle pattern with the first candle being a strongly bullish candle with good price spread. The second candle is the star while the third is red real body that closes well into the first candle. Again, as with the bullish morning star, the third candle in the evening star does not have to be in the form of a gap. Here are a couple of factors that increase the chances of this pattern succeeding:

1. 2. 3.

The real bodies of all 3 candles do not overlap on each other The third candle closes well into the first one; preferably regaining 75% of the candle Volume should lighten up on the first candle and increase on the third.

Doji Stars When a doji represents the star within the morning star and evening star, the formations are known as the morning doji star and evening doji star. A doji is a candle that lacks a real body, meaning the open and close of the bar are the same or have a very small difference. It has a strong significance after substantial advances or declines. The lack of direction that the doji illustrates can offer a potent reversal signal, especially if it is followed by a candle in the anticipated direction. Therefore, when a doji represents the star of the morning and evening star pattern, you need to take notice.

Morning doji star and Evening doji star If you think about the psychology of this setup, the first gap came in an almost exhaustive fashion. The stock was already in a strong uptrend or downtrend and then it made a gap which closed right near its open. This was the first sign that the directional pressure was fading. Now, with the third candle gapping in the opposite direction of the trend, we now have confirmation that a more significant trend reversal has taken place.

Shooting Star

Shooting star and gravestone doji The final star variation is the shooting star which occurs after a strong uptrend (or the inverted hammer that occurs after a strong move down). The shooting star has a long upper shadow with a small real body at the lower end of the candle. This pattern usually presents itself as a sign of a short term correction rather than a more potent reversal signal. The shooting star is basically tells that the market rally could not be sustained. The market opened at or near

its lows, shot up much higher and then reversed to close near the open. Ideally, the real body of the shooting star should gap away from the previous candles' real body. While it is not necessary, it adds confirmation to the validity of the impending reversal. When a shooting star forms near a resistance level, which also was created with a shooting star, a very powerful resistance level is created. As mentioned before, the shooting star is a short term topping formation and any break above the high of this candle negates the ramifications of the formation. There is one variation to the shooting star, it is known as the gravestone doji. The gravestone doji is a shooting star with virtually no real body, the open and close are exactly the same. This formation is more powerful than the typical shooting star as portends a more serious reversal.

References: 1.) Stockcharts.com 2.) Invetsopedia.com 3.) Japanese candlestick charting techniques - Steve Nison

Moving Average Envelopes A Moving Average Envelope consists of a moving average plus and minus a certain user defined percentage deviation. Moving Average Envelopes serve as an indicator of overbought or oversold conditions, visual representations of price trend, and an indicator of price breakouts. The inputs of the Moving Average Envelopes indicator are shown below: 1. Moving Average : Moving Averages smooth the price data to form a trend following indicator. They do not predict price direction, but rather define the current direction with a lag. Moving Averages lag because they are based on past prices. Despite this lag, moving averages help smooth price action and filter out the noise. The two most popular types of moving averages are the Simple Moving Average (SMA)and the Exponential Moving Average (EMA). These moving averages can be used to identify the direction of the trend or define potential support and resistance levels. A simple moving average of both the highs and the lows can also be used. (generally 20-period is used, but it varies among technical analysts; also, a person could use only the close when calculating the moving average, rather than two) 2. Upper Band: The moving average of the highs plus a user defined percentage increase (usually between 1 & 10%). 3. Lower Band: The moving average of the lows minus a user defined percentage (again, usually between 1 & 10%).

Ref: Stockscharts.com

Interpreting the Moving Average Envelopes In the chart above, the price is not trending. During non-trending phases of markets, Moving Average Envelopes make great overbought and oversold indicators. Buy when the stock price penetrates the lower envelope and closes back inside the envelope. Sell when the stock price penetrates the upper envelope and then closes back down inside the envelope.

Price Breakout Indicator Stock prices breakout when they are done consolidating in a range When prices break above the upper envelope, then buy. When prices break below the lower envelope, then sell. An illustration of an upward price breakout is shown above on the chart. On the right side, the script gapped up above the 2% price band.

Price Trend Indicator A new trend in price is usually indicated by a price breakout as outlined above with a continued price close above the upper band, for an upward price trend. A continued price close below the lower band would indicate a new downward price trend. In the chart above, after the price breakout, the closing price continued to close above the upper band; this is a good example of how a price trend begins. Soon after, the price will fall back into the Moving Average Envelopes, but the Moving Average Envelopes will be heading in a positive direction easily identifying the trend as up. Moving Average Envelopes is a helpful technical analysis tool for identifying trends and trend breakouts and identifying overbought and oversold conditions.

References: 1.) Stockcharts.com 2.) Charles Drummond on Advanced P&L, by Charles Drummond. 1980, 547 pages.

DOJI -A reversal indicator Doji is considered a very significant reversal indicator in candlesticks technical analysis. A Doji occurs when the open and close for that session are the same or very close to being same. The length of shadows can vary. The perfect doji has the same opening and closing price, yet there is flexibility to this rule. If the opening and closing price are within a few ticks of each other, the line could still be considered a doji. But how to decide whether it's a near doji day or not is very subjective and there are no rigid rules for it. One technique to identify it is based on recent market activity. If the market is at an important market junction or it is mature part of bull or bear move or there are other technical indicators sending out an alert the appearance of near doji should be treated as a doji.

Ref: Stockscharts.com The doji is a distinctive trend signal. However, the likelihood of reversal increases if subsequent candlesticks confirm the doji's reversal potential. Doji sessions are important only in market where there are not many doji. If there are many doji on a particular chart, one should not view the emergence of a new doji in that particular market as a meaningful development

Doji at Tops Doji are valued for their ability to call market tops. This is especially true after a long white candlestick in an uptrend. The reason for the doji's negative implications in uptrend is because a doji represents indecision. Yet, as good doji are at calling tops, they tend to loose reversal potential in downtrends. The reason may be that a doji reflects a balance between buying and selling forces. With ambivalent market participants, the market could fall due to its own weight. Because of this doji requires more confirmation to signal bottom than they do a top.

Ref: Stockscharts.com Types of Dojis- Mostly three kinds of Dojis appear:1. Long legged doji or the rickshaw man This kind of doji has very long upper and lower shadows or very long legs. This is very important doji at tops. If the opening and closing price or the real body is near the center the line is referred to as rickshaw man. To the Japanese, a very long upper body or lower shadows represent a candlestick that has lost its sense of direction.

Ref: Stockscharts.com 2. Gravestone doji This is yet another distinctive doji. It develops when the opening and the closing prices are at the low of the day. While it can sometimes be found at market bottoms, its forte is in calling tops. As shown in the figure

below the shape of the gravestone doji makes its name appropriate. The gravestone doji represents the graves of those bulls and bears who have died defending their territory

Ref: Stockscharts.com 3. Simple doji or near day doji It is the most simplest of doji which has very close opening and closing prices or very near opening or closing prices. Doji as support and resistance Doji is very significant in calling tops and bottoms it can also sometimes turn into support or resistance zones. As shown in the figure 1 below the lower shadow of the doji became a resistance level. The rickshaw man on March 21 in figure 2 gave a clue that the previous uptrend could be reversing. A doji occurring a few hours later give more proof for this outlook. These two doji became a significant resistance area as shown in the figure.

Ref: Stockscharts.com

Ref: Stockscharts.com Conclusion- Doji is of utmost importance in candlesticks studies and are significant in reversal patterns. They are very useful in calling market tops thus they should be treated with utmost care in identifying trend reversal.

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References: 1.) Candlestick patterns - by Steve Nison 2.) Stockcharts.com 3.) Investopedia.com

Reversal signal -The Engulfing pattern Reversal patterns in technical analysis signify that the prior trend is likely to change but not necessarily reverse. Compare an uptrend to a car travelling forward at 30 kmph, when the red traffic signal comes the car stops this is a reversal signal because the car is not going forward which was the prior trend and the trend has now changed to stationary (sideways).Most of the candlesticks reversal signals are single candlestick pattern but Engulfing pattern is a multiple candlestick pattern. The engulfing pattern is a major reversal signal with two opposite colour real bodies composing this pattern. The Engulfing pattern can be of two typesBullish Engulfing PatternIn this pattern the market is in a downtrend, and then a white bullish real body wraps around or engulfs the prior periods black real body. This shows buying pressure has overwhelmed selling pressure.

Source: Stockcharts.com Bearish Engulfing PatternIn a bearish Engulfing pattern market is trending higher and the white real body is engulfed by a black body and it is the signal for a top reversal. These shows the bears have taken over from the bulls.

Source: Stockcharts.com There are three important criteria's for engulfing pattern1.) The market has to be in a clearly definable uptrend or downtrend, even if the trend is short term. 2.) Two candlesticks comprise the Engulfing pattern. The second real body must engulf the prior real body (it need not engulf the shadows). 3.) The second real body of the Engulfing pattern should be the opposite colour of the first real body. The exception to this rule is if the first real body the Engulfing pattern is so small it is almost a doge (very small real body). Thus after a downtrend a tiny white real body could be a bottom reversal.

Some factors that would increase the likelihood that an Engulfing pattern would be an important reversal indicator would be:-

If the first day of the engulfing pattern has a very small real body and the second day has a very long real body. This would reflect a dissemination of the prior trends force and then increase in force behind the new move. If the Engulfing pattern appears after a protracted or very fast move. A protracted trend increases the chance that potential buyers are already long. In this instance, there may be less of a supply of new longs in order to keep the market moving up. A fast move makes the market overextended and vulnerable to profit taking. If there is heavy volume on the second real body of the Engulfing pattern. If the second day of the Engulfing pattern engulfs more than one real body.

Source: Stockcharts.com The chart above shows the perfect example of Engulfing pattern. The rally began with bullish Engulfing pattern and got concluded with the bearish Engulfing pattern in July than again a bullish pattern occurred in September. Thus Engulfing pattern is an important reversal indicator but it should be used in conjunction with other indicators like volume to have accurate idea of the reversal. References: 1.) Stockcharts.com 2.) Invetsopedia.com

Windows - A Candle stick continuation pattern Most candlesticks signals are trend reversals. There is however a group of candlestick patterns which are continuation indicators. As the Japanese say "there are times to buy, times to sell, and times to rest". Many of these continuation patterns imply a time of rest a breather before market presumes it prior trend. One of the most important continuation pattern is windows. Windows Japanese commonly refer to gap as window. A window is a gap between a prior and the current session's price extremes. The diagram below shows open window in an uptrend and a window in a downtrend showing no activity between the previous day lower shadow and current day upper shadow

Source: www.candlecharts.com It is said by Japanese technicians to go in the direction of the window. Windows also become support and resistance areas. Thus a window in a rally implies a further price rise. Windows also acts as a floor in a pull back. If the pull back closes the window and selling pressure continues after the closing of the window then it means that the prior uptrend is broken or violated. Likewise in a downtrend any up price movement will be given resistance by the window and if the resistance is broken or the window is closed it means that the downtrend is broken. Traditional technical analysis asserts that corrections go back to the window. In other words the test of an open window is likely. Thus in an uptrend one can use pullbacks up to windows as buying zone but longs should be vacated and even shorts should be considered if selling pressure continues after closing the window. 1. In the diagram below we can see window 1 and 2 amid a rally which started with bullish engulfing pattern. A bearish shooting star arose after window 2, a day after this shooting star market opened lower and closed this window but the pull back was up to that point of window 2 only and there was no selling pressure after that so the market bounced back. Window 3 was also formed acting as a support to the uptrend.

Source: www.candlecharts.com

The Japanese believe that a window from a congestion zone or a new high deserve special attention. So far the focus has been on the use of windows as support or resistance zones but there is a third use also. A window especially if it made with small black candlestick from a low price congestion area can mean a meaningful upside breakout. The figure below demonstrates this fact, there was large congestion area but after the window was formed it gave a breakout and acted as support on many occasions.

Source: www.candlecharts.com Thus in the end we can say that window is an effective continuation pattern and can become important resistance or support zone. If windows are used with other indicators like volumes they can provide important insights and room to earn huge returns.

References: 1.) Japanese candlestick charting techniques - Steve Nison 2.) www.candlecharts.com

BOLLINGER BANDS- Telling you when to buy and when to sell. Imagine having Aladdins magic lamp, and having the genie guide you through the chaos of buying and selling in capital markets! On a more realistic note, it would really be a boon if somebody or something can give intimation about when to buy and when to sell, when are the tops forming and when the bottoms are rounding up. Though this is quite difficult but Bollinger Bands can assist you in getting those signals. What are Bollinger bands? Bollinger Bands are a technical analysis tool invented by John Bollinger in the 1980s. Having evolved from the concept of trading bands, Bollinger Bands can be used to measure the highness or lowness of the price relative to previous trades. Bollinger Bands consist of: A middle band being an N-period simple moving average(MA)(Moving average means a simple average of the closing prices of N-period) An upper band at K times an N-period standard deviation above the middle band (MA+K*sigma) A lower band at K times an N-period standard deviation below the middle band (MA-K*sigma) (Sigma stands for standard deviation which shows the deviation from the average and is a measure of risk measuring volatility) Typical values for N and K are 20 and 2, respectively. The default choice for the average is a simple moving average, but other types of averages can be employed. Usually the same period is used for both the middle band and the calculation of standard deviation.

Pic Reference: Bollingerbands.com

Purpose of Bollinger bands The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition, prices are high at the

upper band and low at the lower band. This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators to arrive at systematic trading decisions. How to read signals? The use of Bollinger Bands varies widely among traders. Some traders buy when price touches the lower Bollinger Band and exit when price touches the moving average in the center of the bands. Other traders buy when price breaks above the upper Bollinger Band or sell when price falls below the lower Bollinger Band. When the bands lie close together a period of low volatility in stock price is indicated. When they are far apart a period of high volatility in price is indicated. When the bands have only a slight slope and lie approximately parallel for an extended time the price of a stock will be found to oscillate up and down between the bands as though in a channel. Traders are often inclined to use Bollinger Bands with other indicators to see if there is confirmation. In particular, Bollinger Bands are often coupled with a indicators like chart patterns or trend lines; if these indicators confirm the recommendation of the Bollinger Bands, the trader will have greater evidence that what the Bands forecast is correct.

Statistical significanceSecurity prices do not follow normal distribution in statistics, thus we cannot find 95% of the data within the band (a characteristic of normal distribution where 95% of data is within 2 standard deviation or within the band) and how data is within the band is the function of assets volatility (standard deviation).

13 Rules to remember with Bollinger bands

1.

Bollinger Bands provide a relative definition of high and low.

2.

That relative definition can be used to compare price action and indicator to arrive at rigorous buy and sell decisions.

3.

Appropriate indicators can be derived from momentum, volume, sentiment, open interest, inter-market data, etc.

4.

Volatility and trend have already been deployed in the construction of Bollinger Bands, so their use for confirmation of price action is not recommended.

5.

The indicators used for confirmation should not be directly related to one another. Two indicators from the same category do not increase confirmation.

6.

Bollinger Bands can also be used to clarify pure price patterns such as M-type; tops and W-type bottoms, momentum shifts, etc.

7.

Price can, and does, walk up the upper Bollinger Band and down the lower Bollinger Band.

8.

Close outside the Bollinger Bands can be a continuation signal, not reversal signal, as is demonstrated by the use of Bollinger Bands in some very successful volatility-breakout system

9.

The default parameters of 20 periods for the moving average and standard deviation calculations, and two standard deviations for the bandwidth are just that, defaults. The actual parameters needed for any given market/task may be different.

10. The average deployed should not be the best one for crossovers. Rather, it should be descriptive of the intermediate-term trend.

11. If the average is lengthened the number of standard deviations needs to be increased simultaneously; from 2 at 20 periods, to 2.1 at 50 periods. Likewise, if the average is shortened the number of standard deviations should be reduced; from 2 at 20 periods, to 1.9 at 10 periods.

12. Bollinger Bands are based upon a simple moving average. This is because a simple moving average is used in the standard deviation calculation and we wish to be logically consistent.

13. Be careful about making statistical assumptions based on the use of the standard deviation calculation in the construction of the bands. The sample size in most deployments of Bollinger Bands is too small for statistical significance and the distributions involved are rarely normal.

References: 1.) Achelis, Steve. Technical Analysis from A to Z (pp. 71 73). Irwin, 1995. 2.) Murphy, John J. Technical Analysis of the Financial Markets (pp. 209 211). New York Institute of Finance, 1999 3.) Bollingerband.com

Coppock Indicator Coppock Indicator is a technical analysis indicator named after Edwin Coppock, an economist who was asked by the American Episcopalian Church to identify cheap buying opportunities for long-term investors. It is meant to identify the start of a bull market. Coppock thought setbacks in the stock market were like bereavements and required a period of mourning before normal spirits revived. So he asked the bishops how long it took people to get over the death of a loved one. The answer was between 11 and 14 months. From this Coppock developed a series of calculations - based on 11 and 14 month rates of price change - designed to signal when stock market mourning could be said to be over. The indicator's signal does not emerge at the bottom, but comes as a rally is established. Supporters of the indicator claim that it has signalled rallies to the benefit of investors. The indicator is designed for use on a monthly time scale. It's the sum of a 14-month rate of change and 11-month rate of change, smoothed by a 10-period weighted moving average. Coppock= WMA[10] of (ROC[14] + ROC[11]) A buy signal is generated when the indicator is below zero and turns upwards from a trough. The indicator is trendfollowing, and based on averages, so by its nature it doesn't pick a market bottom, but rather shows when a rally has become established. Coppock designed the indicator (originally called the "Trendex Model") for the S&P 500 index, and it's been applied to similar stock indexes like the Dow Jones Industrial Average. It's not regarded as well-suited to commodity markets, since bottoms there are more rounded than the spike lows found in stocks.

Coppock Curve Interpretation


Buy and Sell Signals There are two commonly accepted ways of determining buy and sell signals from a Coppock Curve. The first is to trade on reversals from extremes. When the indicator was published in Barron's (1962), it was intended to generate buy signals in the S&P 500 only, and the suggested signal was an upturn in the Coppock Curve from an extreme low. The second interpretation involves divergence analysis. The initial thrust off of a low in the stock market is often accompanied by the highest Coppock Curve reading (peak momentum). Subsequent advances tend to be accompanied by diminishing momentum (lower peaks on the Coppock Curve). That combination of a higher peak in price accompanied by a lower peak in the Coppock Curve creates a bearish divergence. Those signals warn of a weakening, aging advance, but often precede the ultimate top.

Coppock Curves and Sentiment in Different Markets


Stock markets E.S. Coppock designed the indicator to identify significant lows in the stock market. The Coppock Curve is very good at discriminating between bear market rallies and true bottoms in the stock market. Stock markets tend to make spike bottoms and rounding tops. That is a result of the fact that fear is a stronger emotion than greed. At the end of a bear market in stocks, investors fear losing their money. As prices fall, they fear further losses, and sell stocks, accelerating the decline, and creating the spike bottom. Stock market tops tend to be much more gradual affairs. As

stocks get more overvalued, companies are only too happy to satisfy demand by issuing more paper. The supply of stocks gradually overwhelms demand. Commodity markets Commodity markets tend to have the opposite behavior, with spike tops and rounding bottoms. Consequently, the Coppock Curve is better at identifying tops in commodities than bottoms. In commodity markets, the fear is that of commodity buyers (who typically produce added-value products from the commodity). Those buyers fear that they won't be able to obtain sufficient supplies - a shortage. A cereal manufacturer would much rather pay more for corn than not have enough corn to make corn flakes. An oil refiner marks up the cost of crude when selling gasoline. The refiner would rather pay more for crude and charges more for gasoline than shut down the refinery.

References: (1) Coppock indicator- By E.S.C. Coppock in the 15 October 1962 issue of Barron's. (2) Wikipedia on coppock indicator

Williams %R Introduction Developed by Larry Williams, Williams %R is a momentum indicator that works much like the Stochastic Oscillator. It is especially popular for measuring overbought and oversold levels. The scale ranges from 0 to -100 with readings from 0 to -20 considered overbought, and readings from -80 to -100 considered oversold. William %R, sometimes referred to as %R, shows the relationship of the close relative to the high-low range over a set period of time. The nearer the close is to the top of the range, the nearer to zero (higher) the indicator will be. The nearer the close is to the bottom of the range, the nearer to -100 (lower) the indicator will be. If the close equals the high of the high-low range, then the indicator will show 0 (the highest reading). If the close equals the low of the highlow range, then the result will be -100 (the lowest reading). Calculation %R = [(highest high over n periods - close)/ (highest high over n periods - lowest low over n periods)] * -100 Typically, Williams %R is calculated using 14 periods and can be used on intraday, daily, weekly or monthly data. The time frame and number of periods will likely vary according to desired sensitivity and the characteristics of the individual security. Use It is important to remember that overbought does not necessarily imply time to sell and oversold does not necessarily imply time to buy. A security can be in a downtrend, become oversold and remain oversold as the price continues to trend lower. Once a security becomes overbought or oversold, traders should wait for a signal that a price reversal has occurred. One method might be to wait for Williams %R to cross above or below -50 for confirmation. Price reversal confirmation can also be accomplished by using other indicators or aspects of technical analysis in conjunction with Williams %R. One method of using Williams %R might be to identify the underlying trend and then look for trading opportunities in the direction of the trend. In an uptrend, traders may look to oversold readings to establish long positions. In a downtrend, traders may look to overbought readings to establish short positions. Example

The chart of Weyerhaeuser with a 14-day and 28-day Williams %R illustrates some key points:

14-day %R appears quite choppy and prone to false signals. 28-day %R smoothed the data series and the signals became less frequent and more reliable. When the 28-day %R moved to overbought or oversold levels, it typically remained there for an extended period and the stock continued its trend. Some good entry signals were given with the 28-day %R by waiting for a move above or below -50 for confirmation. References: (1) Winner take all-William Gallacher, Page 29- McGraw-Hill Companies (May 1, 1997) (2) Stockcharts.com

Average Directional Moving index Directional movement is one of the most fascinating concepts in technical analysis. Defining it is like chasing the end of rainbow, you can see it, you know it's there but the closer you get to it the more elusive it becomes. The Father of new technical trading systems, Mr. J.WELLES WILDER, Jr in his book "NEW CONCEPTS IN TECHNICAL TRADING SYSTEMS" once said that he had spent more time studying directional movement than any other concept in his life and it was his most satisfying work. Average directional movement index is a part of study of direction and was developed by J. Welles Wilder to evaluate the strength of a current trend, be it up or down. It is important to determine whether the market is trending or trading (moving sideways) because certain other indicators provide useful results depending only on what is the trend. ADX In a gist- The Average directional moving index is an oscillator that fluctuates between 0 and 100. Even though the scale is from 0 to 100, readings above 60 are relatively rare. Low readings, below 20, indicate a weak trend and high readings, above 40, indicate a strong trend. The indicator does not grade the trend as bullish or bearish, but merely assesses the strength of the current trend. As shown in the diagram below a reading above 40 can indicate a strong downtrend as well as a strong uptrend. It can also be used to identify potential changes in a market from trending to non-trending. When ADX begins to strengthen from below 20 and moves above 20, it is a sign that the trading range is ending and a trend is developing.

Source: stockcharts. Structure of ADX: The ADX is derived from two other indicators, also developed by Wilder, called the Positive Directional Indicator (sometimes written +DI) and the Negative Directional Indicator (-DI). The ADX combines them and smoothens the result with an exponential moving average. To calculate +DI and -DI, one needs price data consisting of highs, lows, and closing prices of each period (typically each day). One has to first calculate the Directional Movement (+DM and -DM) which is as follows:

Up Move = Today's High ? Yesterday's High Down Move = Yesterday's Low ? Today's Low If Up Move > Down Move and Up Move > 0, then +DM = Up Move, else +DM = 0 If Down Move > Up Move and Down Move > 0, then -DM = Down Move, else -DM = 0 After selecting the number of periods (Wilder used 14 days originally), +DI and -DI are: +DI = exponential moving average of +DM divided by Average True Range -DI = exponential moving average of -DM divided by Average True Range Here Average true range is:True range = max (high, closeprev) - min (low, closeprev) Or, in simpler terms, true range is the largest of themost recent period's high less the most recent period's low absolute value of (the most recent period's high less the previous close) or Absolute value of (the most recent period's low less the previous close). The exponential moving average is calculated over the number of periods selected, and the average true range is an exponential average of the true ranges. ADX = 100 times the exponential moving average of the Absolute value of (+DI ? -DI) divided by (+DI + -DI) In simple words it compares two direction indicators: the 14-period +DI one and the 14-period -DI. To do this, one either puts the charts of indicators one on top of the other, or +DI is subtracted from -DI. W. Wilder recommends buying when +DI is higher than -DI, and selling when +DI sinks lower than -DI. How to use ADX: The best application of DMI is done when it is used with other indicators. DMI should either confirm or contradict the indicator being used. It is also best to use DMI in long-term trade situations. Because the study is not as sensitive as other indicators it is appropriate to use it as a confirmation tool. When the DMI is advancing, the average is higher on the 0 to 100 scale, trend following systems are best employed. Likewise with a decreasing DMI average, the line is lower on the scale closer to 0, a counter trend system might be best. These traits represent the fact that as the average line goes higher in the scale the strength of the trend is gaining, and as the ADX goes lower when the trend is losing strength. It is also important to look at the individual lines for changes in price movement. The other application for DMI is to look at the D+ and D- lines themselves. When the D+ line crosses above the D- line a buy signal is initiated. This indicates that the positive price direction is greater than the negative. Conversely, once the D+ line crosses below the D- line, a sell trigger is present. The negative price movement is overtaking the positive. When looking at reversals the ADX should be above both lines and once it turns lower we should see a change in market direction. One should also look to ADX for confirmation. For a good sell signal, the D+ should be greater than D- and both should be greater than ADX ( D+ > D- > ADX ). For a good buy signal, D+ should be lower than D- and both should be lower than ADX ( D+ < D- < ADX ) When using the D+ and D- crossover method, Wilder stresses the use of an extreme point. On the day the crossover occurs, the extreme point is the high or low of the day, (high for a buy, and low for a sell). The market should be able to take out that price and stay beyond it for several days before the trade is initiated or exited. This use of extreme points should keep the trader from getting into whipsaws or false breakouts.

ADX's Weaknesses: Each indicator has its weaknesses and the ADX is no exception. Imagine that you have a nice long base, and jump aboard when ADX starts rising from a low level. If you successfully carry this trade all the way up to a high ADX level - somewhere above 30 - and then the market turns down, the ADX will start to decline. This decline suggests an absence of trending direction, but the price does not have an absence of direction: it is moving down. In other words, with all the smoothing and other data that is used to determine the plotting of the ADX, we are actually looking at 30 days of data versus the 14 that we use as a default in our software models.

The Bottom Line The average directional index (ADX) measures the strength of a prevailing trend and whether movement exists in the market. However, this indicator does not work well as a trigger, because prices always move faster than the ADX. ADX is best used as an indicator of trend strength. References: (1) Investopedia (2) http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:average_directional_index_adx

Spikes and Saucers There are two types of patterns in technical analysis continuation patterns and reversal patterns. Continuation patterns indicate that the trend will continue whereas reversal patterns indicate the trend will be broken. There are many reversal patterns like head and shoulders, triple bottoms, double bottoms etc but sometimes reversal patterns take the shapes of saucers or rounding bottoms. The saucer bottom shows a very slow and gradual turn from down to sideways to up. It is difficult to tell exactly when the saucer has been completed or to measure how far prices will travel in the opposite direction. Saucer bottoms are usually spotted on weekly or monthly charts that span several years. The longer they last the more significant they become.

In the above example you can see how the rounding bottom or the saucer pattern marked the formation of a bottoming pattern. The pattern took five years to complete. Spikes are the hardest market turns to deal with because the spike or V pattern happens very quickly with very little or no transition period. They usually take place in the market that has gone overextended in one direction and that a sudden piece of adverse news causes the market to reverse direction very abruptly. A daily or weekly reversal on heavy volume is sometimes the only warning signal they give us.

As shown in the above example there is a sudden spike with heavy volumes which marks the beginning of the downturn. Though this pattern is very difficult to identify but it happens very rarely and various other technical indicators can be used in conjunction to mark the change in trend. The patterns discussed above the rounding saucer and the spike formation though happen very rarely and are difficult to identify but at times when used in conjunction with other tools can prove to be quite useful tools. References: (1) Charting and Technical Analysis -By Fred McAllen, Page 150. (2) Technical analysis- Murphy, Pub:12, Page 166.

Hammer and Hanging Man-Reversal patterns Compare an uptrend to a car travelling forward at 30 kmph, when the traffic signal turns red the car stops, this is a reversal signal because the car is not going forward which was the prior trend and the trend has now changed to stationary (sideways). Reversal patterns in technical analysis signify that the prior trend is likely to change but not necessarily reverse. There are several reversal patterns but two of the most important reversal patterns in candlesticks technical analysis are hammer and the hanging man.

The figure above shows candlesticks with long lower bodies and short real bodies. The real bodies are near the top of the daily range, if either of the above lines appear or emerges during a downtrend it is a signal that the downtrend should end. In such a scenario, this line is labeled as a Hammer, as in "the market is hammering out" a base. Interestingly the actual Japanese word for this is Takuri, this word means something to the affect of "trying to gauge the depth of the water by feeling for its bottom." If these lines appear after an uptrend or emerge after a rally it tells us that the prior move may be ending. Such a line is ominously called a hanging man. The name "hanging man" is derived from the fact that it looks like a hanging man with dangling legs. The hammer and hanging man can be recognized by three characteristics :

1. 2. 3.

The real body is at the upper end of the trading range. The color of the real body is not important. A long lower shadow should be twice the height of the real body It should have no, or a very short, upper shadow.

The longer the lower shadow, the shorter the upper shadow and the smaller the real body the more meaningful the bullish hammer or bearish hanging man. Although the real body of the hammer or hanging man can be white or black, it is slightly more bullish if the real body of the hammer is white, and slightly more bearish if the real body of the hanging man is black. If a hammer has a white real body it means the market sold off sharply during the session and then bounced back to close at, or near, the session's high. This could have bullish ramifications. If a hanging man has a black real body, it shows that the close could not get back to the opening price level. This could have potentially bearish implications.

There are certain aspects that increase the importance of hanging-man & hammer lines because in the hanging man and hammer a long lower shadow may not have to be twice the height of the real body in order to give a reversal signal though the longer the lower shadow, the more perfect the pattern.

Hammer

Hanging Man

The Hammer is a bullish reversal pattern that forms after a The Hanging Man is a bearish reversal pattern that can decline. In addition to a potential trend reversal, hammers also mark a top or resistance level. Forming after an can mark bottoms or support levels. After a decline, advance, a Hanging Man signals that selling pressure is hammers signal a bullish revival. The low of the long lower starting to increase. The low of the long lower shadow shadow implies that sellers drove prices lower during the confirms that sellers pushed prices lower during the session. However, the strong finish indicates that buyers session. Even though the bulls regained their footing and regained their footing to end the session on a strong note. drove prices higher by the finish, the appearance of While this may seem enough to act on, hammers require further bullish confirmation. Further buying pressure, and selling pressure raises the yellow flag. As with the Hammer, a Hanging Man requires bearish confirmation

preferably on expanding volume, is needed before acting. before action. Such confirmation can come as a gap Such confirmation could come from a gap up or long white down or long black candlestick on heavy volume. candlestick. References: (1) Japanese Candlestick Charting Techniques by Steve Nison, Page 99. (2) Timeless techniques for trading stocks and futures: Candlestick charting explained by Gregory L. Morris, Page 122. (3) Stock Charts.com

Continuation patterns: Pennant and Wedges Road trips are some of our favorite vacations. You jump in the car, head out on the open highway and soak in all of the scenery that you miss when you fly somewhere. Of course, every once in a while you have to interrupt your cruising to take a pit stop---to put some gas in your car and buy some snacks for you. Pit stops are part of the adventure. And let's face it, driving would get pretty old after a while if you didn't stop and take a break every now and then. At the same time, nobody wants to spend their entire vacation at the rest stop. So once you've had a chance to stretch your legs and fill up the gas tank, you jump back into the car and head back out on the open road. Stocks take exciting road trips all of the time. They cruise along for a while passing support and resistance levels and other significant price points along the way but every once in a while, they need to take a pit stop. After big price moves, the traders who are pushing these stocks higher and lower have to stop to catch their breath. Don't get too comfortable though. The pit stop isn't going to last forever. If a stock really is in the middle of a road trip, a continuation pattern will form while the stock price consolidates in its pit stop. Continuation patterns tell you that the stock is going to resume its previous trend after it breaks out of the continuation pattern. Continuation patterns, like all price patterns, are made of the following four pieces: - Old trend: the trend that the stock price is in as it starts to form the price pattern - Consolidation zone: a constrained area defined by set support and resistance levels - Breakout point: the point at which the stock price breaks out of the consolidation zone - New trend: a resumption of the old trend that the stock price enters as it comes out of the consolidation zone .

The following are the most common continuation patterns you will see during an uptrend: Pennants - A pennant is a small symmetrical triangle that begins wide and converges as the pattern matures (like a cone). The slope is usually neutral. Sometimes there will not be specific reaction highs and lows from which to draw the trend lines and the price action should just be contained within the converging trend lines.

Continuation Wedges -bullish wedges form during an uptrend as the down trending support level and the down trending resistance level that encompass the consolidation zone converge. A Continuation Wedge (Bullish) is considered a bullish signal. It indicates a possible continuation of the current uptrend. A Continuation Wedge (Bullish) consists of two converging trend lines. The trend lines are slanted downward. Unlike the Triangles where the apex is pointed to the right, the apex of this pattern is slanted downwards at an angle. This is because prices edge steadily lower in a converging pattern i.e. there are lower highs and lower lows. A bullish signal occurs when prices break above the upper trend line.

Though both the patterns shown above are continuation patterns but slight variations in the patterns can also indicate reversal so one should be very careful while using these patterns. References: (1) Master Forex V, Chapter 5, Page 199. (2) Stockcharts.com

Moving Averages Moving Averages Moving average is the most basic technical indicator. According to its simplicity and usefulness, it is the most popular indicator for analyzing all financial markets. Almost all traders effectively use it, even those who are focused on fundamental analysis rather than technical analysis. Mathematics of Moving Average Moving Average is just based on a simple averaging formula, as calculates the average value of price in a given period of time. What Is It Good For? All financial markets including forex and stock have severe price fluctuations, and sometimes it leads to sharp peaks, i.e. temporarily price movements. These sharp peaks are not a part of the overall market trend, but just temporary shocks to the market. Moving average just normalizes the price chart by ignoring such temporary movements. On the other hand, moving average is the basis of several leading trading systems. Considering moving averages with different periods can show the difference in the market trends in various time scales. One of the most famous trading systems is 'moving average crossing', which provides useful information about the turning points. Moving Average Parameters Period -The main parameter of moving average is the period of time, in which the moving average is calculated and drawn. Depending on the period in study different moving averages can be used. Types of Moving Averages -There are many different types of moving averages that vary in the way they are calculated, but how each average is interpreted remains the same. The calculations only differ in regards to the weighting that they place on the price data, shifting from equal weighting of each price point to more weight being placed on recent data. The three most common types of moving averages are simple, linear and exponential. Simple Moving Average (SMA) -This is the most common method used to calculate the moving average of prices. It simply takes the sum of all of the past closing prices over the time period and divides the result by the number of prices used in the calculation. For example, in a 10-day moving average, the last 10 closing prices are added together and then divided by 10. As you can see in Figure 1, a trader is able to make the average less responsive to changing prices by increasing the number of periods used in the calculation.

Many individuals argue that the usefulness of this type of average is limited because each point in the data series has the same impact on the result regardless of where it occurs in the sequence. The critics argue that the most recent data is more important and, therefore, it should also have a higher weighting. This type of criticism has been one of the main factors leading to the invention of other forms of moving averages. Linear Weighted Average - This moving average indicator is the least common out of the three and is used to address the problem of the equal weighting. The linear weighted moving average is calculated by taking the sum of all the closing prices over a certain time period and multiplying them by the position of the data point and then dividing by the sum of the number of periods. For example, in a five-day linear weighted average, today's closing price is multiplied by five; yesterday's by four and so on until the first day in the period range is reached. These

numbers are then added together and divided by the sum of the multipliers. Exponential Moving Average (EMA) - This moving average calculation uses a smoothing factor to place a higher weight on recent data points and is regarded as much more efficient than the linear weighted average. The most important thing to remember about the exponential moving average is that it is more responsive to new information relative to the simple moving average. This responsiveness is one of the key factors of why this is the moving average of choice among many technical traders. As you can see in Figure below, a 15-period EMA rises and falls faster than a 15-period SMA. This slight difference doesn't seem like much, but it is an important factor to be aware of since it can affect returns.

Major Uses of Moving Averages -Moving averages are used to identify current trends and trend reversals as well as to set up support and resistance levels. Moving averages can be used to quickly identify whether a security is moving in an uptrend or a downtrend depending on the direction of the moving average. As you can see in Figure below, when a moving average is heading upward and the price is above it, the security is in an uptrend. Conversely, a downward sloping moving average with the price below can be used to signal a downtrend.

Another method of determining momentum is to look at the order of a pair of moving averages. When a short-term average is above a longer-term average, the trend is up. On the other hand, a long-term average above a shorter-term average signals a downward movement in the trend. Moving average trend reversals are formed in two main ways: when the price moves through a moving average and when it moves through moving average crossovers. The first common signal is when the price moves through an important moving average. For example, when the price of a security that was in an uptrend falls below a 50-period moving average, like in Figure below, it is a sign that the uptrend may be reversing.

The other signal of a trend reversal is when one moving average crosses through another. For example, as you can see in Figure below, if the 15-day moving average crosses above the 50-day moving average, it is a positive sign that the price will start to increase.

If the periods used in the calculation are relatively short, for example 15 and 35, this could signal a short-term trend reversal. On the other hand, when two averages with relatively long time frames cross over (50 and 200, for example), this is used to suggest a long-term shift in trend. Moving averages are a powerful tool for analyzing the trend in a security. They provide useful support and resistance points and are very easy to use. 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 be a good measure of a trading year, a 100-day average of a half a year, a 50-day average of a quarter of a year, a 20-day average of a month and 10-day average of two weeks. Moving averages help technical traders smooth out some of the noise that is found in day-to-day price movements, giving traders a clearer view of the price trend.

References: (1) Spencer's 15-Point Moving Average - from Wolfram MathWorld, Page- 39 (2) G.R. Arce, "Nonlinear Signal Processing: A Statistical Approach", Wiley:New Jersey, USA, 2005.

Moving Average Convergence-Divergence (MACD) Introduction Developed by Gerald Appel in the late seventies, Moving Average Convergence-Divergence (MACD) is one of the simplest and most effective momentum indicators available. MACD turns two trend-following indicators (two moving averages), into a momentum oscillator by subtracting the longer moving average from the shorter moving average. As a result, MACD offers the best of both worlds: trend following and momentum. MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, centerline crossovers and divergences to generate signals. Because MACD is unbounded, it is not particular useful for identifying overbought and oversold levels. Calculation MACD: (12-day EMA - 26-day EMA) Signal Line: 9-day EMA of MACD MACD Histogram: MACD - Signal Line Standard MACD is the 12-day Exponential Moving Average (EMA) less the 26-day EMA. Closing prices are used to form the moving averages so MACD is based on closing prices. A 9-day EMA of MACD is plotted alongside to act as a signal line to identify turns in the indicator. The MACD-Histogram represents the difference between MACD and its 9-day EMA, the signal line. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA. Interpretation MACD is all about the convergence and divergence of the two moving averages. Convergence occurs when the moving averages move towards each other. Divergence occurs when the moving averages move away from each other. The shorter moving average (12-day) is faster and responsible for most of the MACD movement. The longer moving average (26-day) is slower and less reactive to price changes in the underlying security. Positive MACD indicates that the 12-day EMA is above the 26-day EMA. Positive values increase as the shorter EMA trades further above the longer EMA. This means upside momentum is increasing. Negative MACD indicates that the 12-day EMA is below the 26-day EMA. Negative values increase as the shorter EMA trades further below the longer EMA. This means downside momentum is increasing. There are times when MACD crosses the zero line, which is also known as the centerline. This signals that the 12-day EMA has crossed the 26-day EMA. The direction of the centerline cross, of course, depends on direction of the moving average cross. In the example below, the yellow area shows MACD in negative territory as the 12-day EMA trades below the 26-day EMA. The initial cross occurred at the end of September (black arrow) and MACD moved further into negative territory as the 12-day EMA diverged further from the 26-day EMA. The orange area highlights a period of positive MACD, which is when the 12-day EMA was above the 26-day EMA. Notice that the 12-day EMA remained below 1 during this period (red dotted line). This means the distance between the 12-day EMA and 26-day EMA was less than 1 point, which is not a big difference

Signal Line Crossovers Signal line crossovers are the most common MACD signals. The signal line is a 9-day EMA of MACD. As a moving average of the indicator, it trails MACD and makes it easier to spot turns in MACD. A bullish crossover occurs when MACD turns up and crosses above the signal line. A bearish crossover occurs when MACD turns down and crosses below the signal line. Crossovers can last a few days or a few weeks, it all depends on the strength of the move that causes the crossover. Signal crossovers are quite common. As such, due diligence is required before relying on these signals. Signal line crossovers at positive or negative extremes should be viewed with caution. Even though MACD is an unbounded oscillator, chartists can estimate historical extremes with a simple visual assessment of the indicator. It takes a strong move in the underlying security to push momentum to an extreme. Even though the move may continue, momentum is likely to slow and this will usually produce a signal line crossover at the extremities. Volatility in the underlying security can also increase the number of crossovers. Centerline Crossovers Centerline crossovers are the next most common MACD signals. A bullish centerline crossover occurs when MACD moves above the zero line to turn positive. This happens when the 12-day EMA of the underlying security moves above the 26-day EMA. A bearish centerline crossover occurs when MACD moves below the zero line to turn negative. This happens when the 12-day EMA moves below the 26-day EMA. Centerline crossovers can last a few days or a few months. It all depends on the strength of the trend. MACD will remain positive as long as there is a sustained uptrend. MACD will remain negative when there is a sustained downtrend. Divergences Divergences form when MACD diverges from the price action of the underlying security. A bullish divergence forms when a security records a lower low and MACD forms a higher low. The low lower in the security affirms the current downtrend, but the higher low in MACD shows less downside momentum. The slowing of the downtrend sometimes foreshadows a trend reversal or a sizable rally. A bearish divergence occurs when a security records a higher high and MACD forms a lower high. The higher high in the security is normal for an uptrend, but the lower high in MACD shows less upside momentum. Waning upward momentum can sometimes foreshadow a trend reversal or sizable decline. Divergences should be taken with caution. Bearish divergences are commonplace in a strong uptrend, while bullish divergences occur often in a strong downtrend. Yes, you read right. Uptrend's often start with a strong

advance that produces a surge in upside momentum (MACD). Even though the uptrend continues, it continues at a slower pace and this causes MACD to decline from its highs. The opposite occurs at the beginning of a strong downtrend. Conclusions MACD is special because it brings together momentum and trend in one indicator. This means MACD will never be far removed from price action. MACD's unique blend of trend and momentum can be applied to daily, weekly or monthly charts. The standard setting for MACD is the difference between the 12 and 26-period EMAs. Chartists looking for more sensitivity may try (5, 35, 5). Chartists looking for less sensitivity may consider (20, 50, 10). A less sensitive MACD will still oscillate above/below zero, but the centerline crossovers and signal line crossovers will be less frequent. MACD is not particularly good for identifying overbought and oversold levels. Even though it is possible to identify levels that historically represent overbought and oversold, MACD does not have any upper or lower limits to bind its movement. MACD can continue to overextend beyond historical extremes. MACD calculates the absolute difference between two moving averages and not the percentage difference. A Rs.20 stock may have a MACD range of -1.5 to 1.5, while a Rs.100 stock may have a MACD range from -10 to +10. It is not possible to compare MACD for securities that vary in price. An alternative is to use the Percentage Price Oscillator (PPO), which shows the percentage difference between two moving averages References: (1) http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:moving_average_conve (2) http://www.incrediblecharts.com/indicators/macd.php (3) Appel, Gerald (1999). Technical Analysis Power Tools for Active Investors. Financial Times Prentice Hall. pp. 166 (4) Murphy, John (1999). Technical Analysis of the Financial Markets. Prentice Hall Press. pp. 252-255

Oscillators and Contrary opinion Oscillators are alternative to trend following approaches. The oscillator is extremely useful in non trending market where prices fluctuate in a horizontal price band, or trading range creating a market situation where most trend following systems simply don't work that well. The oscillator provides the technical trader with a tool that can enable him to profit from these periodic sideways and trendless markets. The value of the oscillator is not limited to horizontal trading ranges. Used in conjunction with price charts during trending phases the oscillator becomes an extremely valuable ally by alerting the trader to short term market extremes, commonly referred to as overbought or oversold conditions. The oscillators can also warn that a trend is losing momentum before that situation becomes evident in the price action itself. The oscillator is only a secondary indicator in the sense that it must be subordinated to basic trend analysis. The RSI method is classified as a momentum oscillator measuring the velocity and magnitude of directional price movements (momentum is the rate of the rise or fall in price).

Interpretation of oscillators While there are many different ways to construct momentum oscillators the actual interpretation differs very little from one another. Most oscillators look very much alike. They are plotted along the bottom of the price chart and resemble a flat horizontal band. The oscillator band is basically flat while prices may be trading up down or sideways. However the peaks and troughs in the oscillator coincide with the peaks and troughs on the price chart. Some oscillators have a midpoint value that divides the horizontal range into two halves an upper end and lower. Depending on the formula used the midpoint is usually a zero line. Some oscillators also have upper and lower boundaries ranging from 0 to 100.

General rules for interpretation As a general rule when the oscillator reaches an extreme value in either the upper or lower end of the band, this suggests that the current price move may have gone too far too fast and is due for a correction or consolidation of some type. As another general rule, the trader should be buying when the oscillator line is in the lower end of the band and selling in the upper end of the band. The crossing of the midpoint line is often used to generate buy signals and sell signals.

The three most important uses of the oscillators are:The oscillator is most useful when its value reaches an extreme reading near the upper or lower end of its boundaries. The market is said to be overbought when it is near the upper extreme and oversold when it is near the lower extreme. This warns that the price is overextended and vulnerable. A divergence between the oscillator and the price action when the oscillator is in an extreme position is usually an important warning. The crossing of the zero line can give important trading signals in the direction of the price trend.

Various oscillators which are used as momentum indicators are relative strength index(RSI), Stochastics (K%D), MACD etc.

The principle of contrary opinion Oscillator analysis is the study of market extremes. One of the most widely followed theories in measuring those market extremes is the principle of contrary opinion. Contrary opinion though listed in technical analysis, is a part of psychological analysis. Contrary opinion adds a third important dimension to market analysis, the psychological analysis by determining the degree of bullishness or bearishness among participants in various financial markets. The principle of contrary opinion holds that when the vast majority of people agree on anything, they are generally wrong. A true contrarian, therefore, will first try to determine what the majority are doing and then will act in the opposite direction.

Interpreting bullish consensus Most traders seem to analyze market sentiments, if bullishness is above 75% the market is considered to be overbought and a top may be near. A reading of 25% is interpreted as oversold and an indication of market bottom.

Contrary opinion measuring buying or selling power If 80-90% of market participants are bullish on a market it is assumed that they have already taken their market positions then there are very less people left to buy and push the market higher. This is one of the keys to understanding Contrary opinion.

Contrary opinion measuring strong versus weak hands A second feature of this philosophy is its ability to compare strong versus weak hands. Future trading is a zero sum game. For every long there is also short. If 80% of the traders are on the long side of a market, then the 20% ( who are holding short positions) must be well financed enough to absorb the longs held by other 80%. The shorts, therefore, must be holding much larger positions than the longs. This means further that the shorts must be well capitalized and are considered to be strong hands.

Combine Contrarian opinion with other technical tools

It goes without saying that standard technical analysis tools can and should be used to help identify market turns at critical times. The breaking of support or resistance levels, trend lines or moving averages can be utilized to help confirm that the trend is in fact turning.

References: (1) Technical Analysis of the Futures Markets- John Murphy, Page 191 (2) Technical Analysis Explained : The Successful Investor's Guide to Spotting Investment Trends and Turning PointMartin J. Pring, Page-329.

Relative Strength Index (RSI) The Relative Strength Index (RSI) was developed by J. Welles Wilder and published in 1978 in a book called New Concepts in Technical Trading Systems. The Relative Strength Index is a trading indicator which is intended to indicate the current and historical strength or weakness of a market based on the closing prices of completed trading periods. It assumes that prices close higher in strong market periods, and lower in weaker periods and computes this as a ratio of the number of incrementally higher closes to the incrementally lower closes. The RSI method is classified as a momentum oscillator measuring the velocity and magnitude of directional price movements (momentum is the rate of the rise or fall in price).

Calculation For each trading period an upward change (U) or downward change (D) is calculated. Up periods are characterized by the close being higher than the previous close U = closenow - closeprevious D=0 Conversely, a down period is characterized by the close being lower than the previous period's U=0 D = close
previous - closenow

This is converted to a Relative Strength Index between 0 and 100,

Triangles Triangles are continuation patterns which are commonly found in the price charts of financially traded assets (stocks, bonds, futures, etc). The pattern derives its name from the fact that it is characterized by a contraction in price range and converging trend lines, thus giving it a triangular shape. Though triangles are continuation patterns but they can also act as reversal patterns and mostly they are seen as intermediate patterns but they can also occur on long term charts. ^ (1) Triangle Patterns can be broken down into three categories: The ascending triangle, the descending triangle, and the symmetrical triangle. While the shape of the triangle is significant, of more importance is the direction that the market moves when it breaks out of the triangle. The Ascending Triangle ^ (2) The ascending triangle is formed when the market makes higher lows and the same level highs. These patterns are normally seen in an uptrend and viewed as a continuation pattern as buying demand gain more and more control, running up to the top resistance line of the pattern. While you normally will see this pattern form in an uptrend, if you do see it in a downtrend it should be paid attention to as it can act as a powerful reversal signal.

The Descending Triangle^ (2) The descending triangle is formed when the market makes lower highs and the same level lows. These patterns are normally seen in a downtrend and viewed as a continuation pattern as the bears gain more and more control running down to the bottom support line of the pattern. While you normally will see this pattern form in a downtrend, if you do see it in an uptrend it should be paid attention to as it can act as a powerful reversal signal.

The Symmetrical Triangle ^ (2)

The symmetrical triangle is formed when the market makes lower highs and higher lows and is commonly associated with directionless markets as the contraction of the market range indicates that neither the bulls nor the bears are in control. If this pattern forms in an uptrend then it is considered a continuation pattern if the market breaks out to the upside and a reversal pattern if the market breaks to the downside. Similarly if the pattern forms in a downtrend it is considered a continuation pattern if the market breaks out to the downside and a reversal pattern if the market breaks to the upside.

Volume pattern in triangles The volume pattern in both ascending and descending triangles is very similar in that the volume diminishes as the pattern works itself out and then increases on the breakout. In ascending triangles the volume tends to be slightly heavier on bounces and lighter on dips. In the descending triangle volume should be heavier on the downside and lighter during the bounces. References: (1)Technical Analysis by Murphy. Published by New York Institute of Finance, 2003 Edition. (2)Informed Trades: informedtrades.com

WAVE THEORY Historical background- In 1938, a monograph entitled The Wave Principle was the first published reference to what has come to be known as the Elliot Wave Principle, it was based on the original work of R.N ELLIOT. ^ (1) Basic tenets of wave principle- There are three important aspects of wave theory- pattern, ratio and time- in that order of importance. Pattern refers to the wave patterns or formations that comprise the most important element of the theory. Ratio analysis is useful in determining retracement points and prices objectives by measuring the relationships between the different waves. Finally, time relationships can be used to confirm the wave patterns and ratios but they are considered less reliable. ^ (2) Introduction- In its most basic form, the theory says that the stock market follows a repetitive rhythm of a five wave advance followed by a three wave decline. If you count the waves in the diagram below you will find that one complete cycle has eight waves five up and three down. In

the advancing portion of the cycle waves 1,3,5 are rising waves and are called impulse waves while waves 2 and 4 move against the uptrend and are called corrective waves because they correct waves 1 and 3. After the five wave numbered advance has been completed, a three wave correction begins and the three corrective waves are identified by the letters a, b, c. There are many different categories of trend; Elliot in his work categorized nine different degrees of trend from grand super cycle spanning 200 years to subminuette degree covering only a few hours. The basic point to remember is that the basic eight wave cycle remains constant no matter what degree of trend is studied. Each wave subdivides into waves of one lesser degree that in turn, can also be subdivided into waves of even lesser degree. It also follows that each wave is itself part of the wave of the next higher degree. This relationship is demonstrated in the figure below. The largest two waves 1 and 2 can be subdivided into eight lesser waves that in turn can be subdivided into 34 even lesser waves and these 34 waves will divide them into 144 waves and so on. The thing to note here is that these numbers 1,2,3,5,8,13,21,34,55,89,144 are not just random numbers but Fibonacci number sequence. Whether a given wave subdivides into five waves or three waves is determined by the direction of the next larger wave, notice that waves 1, 3, 5 subdivides into 5 waves because the next larger wave of which they are part of is wave 1 which is an advancing wave.

As wave 2 and 4 are moving against the trend, they subdivide into only three waves. One of the most important rules to remember is that a correction can never take place in five waves. In a bull market if a five way decline is seen, this means that it is probably only the first wave of the three wave (a-b-c) decline and there is more to come on the downside. In a bear market, a three wave advance should be followed by resumption of the downtrend. A five wave rally would warn of a more substantial move to the upside and might possibly even be the first wave of a new bull trend. Points to remember with wave theory

A complete bull market cycle is made up of eight waves, five up and three down. Correction always takes place in three waves either in (5-3-5) or (3-3-5) format. Waves can be expanded into longer waves and subdivided into shorter waves. Sometimes one of the impulse waves extends. The other two should then be equal in magnitude. The Fibonacci sequence is the mathematical basis of the Elliot Wave Theory. Bear markets should not fall below the bottom of the previous fourth wave which acts as a support. Wave four should not overlap wave one. Fibonacci ratios and retracements are used to determine price objectives. The most common retracements are 62%, 58% and 38%.

The theory was originally applied to stock market averages and does not work as well on individual stocks. The theory works best in those commodity markets with the largest public following, such as gold. References: (1) Wikipedia (2) Elliott, Ralph Nelson (1994). Prechter, Robert R., Jr. ed. R.N. Elliott's Masterworks. Gainesville, GA: New Classics Library. pp. 70, 217, 194, 196. ISBN 978-0932750761.

Three Black crows candlestick formation The Ominous Call Of Three Black Crows The three black crow patterns consist of three consecutive black declining candlesticks. This candle formation does not happen very frequently in stock trading, but when it occur swing traders should be very alert to the crow's caw. These crows are also sometimes called three-winged crows. The Japanese have an expression that bad news has wings. This is an appropriate saying for three winged crow pattern. The candlestick pattern's metaphor is three crows sitting in a tall three. Essentially, it is a reversal formation that occurs following a strong advance. On the day the first black crow makes its appearance, the formation is most predictive if the first "crow" or dark candlestick closes below the white candle's real body. That is the first step in setting up a Minor trend reversal where today's high is lower than yesterday's high and today's low is below yesterday's low. Two more long-bodied consecutive down days then ensue. On each of these days, it appears as if the stock wants to regain its former strength, as the stock opens higher than on the previous day close. By the end of each session, however, the sellers regain control and the stock drops to a new closing low. Here are what three black crows candlestick pattern looks like:

Three Black crow patterns

Note that the lower shadows on three black crows are small, or in some cases even nonexistent. Although three black crows is a complete pattern in, swing traders should always be alert to what happens on the fourth day after the pattern is formed. Since there has been intense selling throughout the pattern, the stock may then be overextended

to the downside. However, if the stock continues its negative pattern on the fourth day, then it is likely that the issue is going much lower. The chart below provides a good example of three crows pattern. In mid June three crows appear but the market recovered after that. Another three crows appear later in mid July which marked the beginning of the downtrend.

THE HARAMI PATTERN A reversal pattern implies that the prior trend is likely to change but not necessarily reverse. There are many reversal indicators in candlestick technical analysis, one of them is the Harami pattern. The Harami pattern is a reversal indicator but it is not the most effective one and requires confirmation from other indicators as well. What it is? The Harami pattern is a small real body which is contained within a prior relatively long real body as shown in the figure below. The term "Harami", means "pregnant" in old Japanese & the long candlestick is "the mother" and the small candlestick is the "baby" or "fetus".

The Harami pattern is the reverse of the engulfing pattern. In the engulfing pattern, a long real body engulfs or covers the preceding small real body whereas for the Harami pattern, a small real body follows an unusually long real body. For the engulfing pattern the colour of the two bodies should be opposite but that is not necessary for the Harami pattern. The Harami cross - A Harami cross has a doji for the second day of the Harami pattern instead of a small real body as shown in the figure below. The Harami cross, because it contains a potent doji pattern, is viewed more powerful reversal signal than the Harami pattern. The Harami cross is sometimes referred to as the petrifying pattern.

What does it signify - A Harami pattern signifies or displays disparity about the market's health. After a bull move, the long white real body's vitality is followed by the small real body's uncertainty. This shows the bull's upward drive has weakened. Thus a trend reversal is possible. During a bear move, the heavy selling pressure reflected by a long, black real body is followed by the second day's vacillation. This could portend a trend reversal since the second day's

small real body is an alert that the bears powers has diminished.

As shown in the figure above a small rally started on April 18 and Harami 1 called its end and the selloff that started with it stopped with Harami 2. Harami 3 reflects how a Harami pattern might be useful even if there is no evident trend during the first few days of May. Then Harami 3 arose with its long, white real body followed by a small, black real body (the colour of second real body is not important). A trader could use this pattern as a signal that the rally started on the strong white day has failed. The market is now at a point of indecision. A buy would not be recommended until the indecision has been resolved (a close above the highs of Harami 3). Harami 4 is a classic example; an uptrend was evident prior to the tall white candlestick. The next day's small real body completed the harami pattern and marked the beginning of a bearish trend. A regular Harami Pattern has a tall real body followed by a smaller real body. Yet, there are no rules as to what is considered a "small" candlestick. This like many other charting techniques is subjective. As a general rule, the smaller the second real body the more potent the pattern. This is usually true because the smaller the real body, the greater the ambivalence the more likely a trend reversal. Thus in the end we can say that the Harami pattern is a good reversal indicator but it should be used in confirmation with other indicators as its strength lies in giving early signals but those signals can be misleading as well so they must be confirmed with other indicators. References: (1) Candlestick Charting by Gregory Morris: Edition 3rd, Pg-233.

Fibonacci retracements Fibonacci numbers: For all those who are not familiar with the name Fibonacci you may remember hearing something about it in the year 2006, when the movie DA VINCI CODE appeared in theatres. When Jacques Sauniere was found murdered at the Louvre museum in Paris, the strange position that this deceased was placed in mimicked the famous painting of the Vitruvian man by Leonardo da Vinci. This painting has been known to illustrate how Fibonacci ratios appear in the human form. The film also piqued the curiosity of some people when the characters in the film started talking about Fibonacci numbers as a part of a clue or code of some sort. The Fibonacci number series and the properties of this series were made famous by Italian mathematician Leonardo de Pisa. The Fibonacci number series starts with 0 and 1 and goes out to infinity, with the next number in the series being derived by adding the prior two. For example, 55+89=144, 89+144=233, 144+233=377, and so on (see the following number series): 0,1,1,2,3,5,8,13,21,34,55,89,144,233,377,610,987 out to infinity. What is the most fascinating about this number series is that there is a constant found within the series as it progresses towards infinity. In the relationship between the numbers in the series, you will find that the ratio between consecutive numbers after 13 is 1.618, which is called the golden ratio, golden mean, or the Divine Proportion. Fibonacci price retracements: Fibonacci price retracements are run from prior low to high swing using the ratios .382 (1-.618), .5 (1/2), .618 (the golden ratio), .786 (square root of .618 the golden ratio).236 is also used in some cases to identify possible support levels as the market pull backs from a high. Retracements are also run from prior high to low swings using these ratios, looking for possible resistance as the market bounces from the low. Though most basic technical analysis packages will run the ratios for you but to understand the math behind it, multiply the length of the swing (from low to high or high to low) by the retracement ratios and then subtract the results from high if you are running low to high swings and add to low if you are running high to low swings (1) ^. Now let's go through certain examples using the Fibonacci retracements, in the diagram below we ran the Fibonacci retracement from 04/10/06 low to 1/12/06 high, which was an 86.9 point swing looking for potential support. Note that this contract found support only around the .618 retracement of this prior swing. None of the other ratios provide meaningful support.

The next retracement is daily chart of Microsoft. Here we retraced from 15/11/04 highs to 29/03/05 lows. Notice that resistance was mostly around .618 retracement levels.

Correct retracements: One of the ways to create Fibonacci price cluster is by running retracements on multiple swings on the chart, the important point is to select the right swings which can be demonstrated with the help of figures belowIncorrect Way:

Correct Way:

Thus we can see that Fibonacci retracements can provide important resistance and support levels but one very important thing to consider over here is unlike other studies in technical analysis support does not become resistance or vise a versa. The more accurate way is to find new support and resistance levels. References: (1) John Murphy- Technical Analysis, Chapter: Fibonacci Series, Page-177

Volume and Open Interest Most technicians in the financial markets use a multidimensional approach to market analysis by tracking the movement of three sets of figures- price, volume and open interest. Apart from price volume and open interest, there are also other important indicators. Open interest is used in derivative markets while volume is used in all markets as an indicator. Volume : Volume is the number of entities traded during the time period under study. Open interest : The total number of outstanding or unliquidated contracts at the end of the day is known as open interest. It represents the total number of outstanding longs or shorts in the market not the sum of both. (1) ^ Every time a trade is completed on the floor the open interest is affected in any of the following three ways Sr.No. 1 2 3 4 Buyer Buys new long Buys new long Buys old short Buys old short Seller Sells new short Sells old long Sells new short Sells old long Change in open interest Increases No change No change No change

So to sum it up, if both participants in a trade are initiating a new position the open interest will increase. If both liquidating an old position, the open interest will decrease otherwise no change. (2) ^ General rules for interpreting Volume and Open interest : The rules for the interpretation of volume and open interest are generally combined because they are very similar. The table below will help in the interpretation Price Rising Rising Declining Declining Volume Up Down Up Down Open Interest Up Down Up Down Market Strong Weak Weak Strong

If both volume and open interest are increasing, then the current price will probably continue in the present direction, and if volume and open interest are declining the action can be viewed as a warning that the current price trend may be nearing its end. The figure below will demonstrate the above fact that as the volume and open interest increases the price will continue its trend. (3) ^

Interpretation of volume for all markets

The level of volume measures the intensity or urgency behind the price move. Heavier volume reflects a higher degree of intensity or pressure. By measuring the level of volume the technician is better able to gauge the buying or selling pressure. Volume should increase in the direction of price trend to make it a continuous pattern. If there is a divergence between price and volume, then the intensity is getting reduced and this can be a sign of reversal. This is the reason why volume is used as a confirmation indicator to price patterns. By the mere fact that prices are trending higher, it means buying is more than selling, and it stands to reason that greater volume should take place in the same direction as a prevailing trend. Thus volume precedes price.

Interpretation of open interest There are four important points to remember while analyzing open interest :- Rising open interest in an uptrend is bullish Declining open interest in an uptrend is bearish Rising open interest in a down trend is bearish Declining open interest in a downtrend is bullish This can be seen in the chart below. The price rise is accompanied by falling open interest, while the price decline shows rising open interest. A strong trend would see open interest trending with price, not against it.

Conclusion : Volume and open interest are important indicators for the markets, volume in all markets and open interest in the

futures and options market. They can be used in conjunction with other price patterns to confirm the trend. Volume especially is an important indicator that helps to identify the intensity and strength in the market. References: (1) Wikipedia : http://en.wikipedia.org/wiki/Open_interest (2)Open Interest&lsquo ; Financial Dictionary. Retrieved 2010 -09-01. (3) Donna Kline (2001): Fundamentals of the futures market. McGraw-Hill Professional. p. 142,143 of 256. Retrieved 2010-09-01.

Windows Candlesticks Most candlesticks signals are trend reversals. There is however a group of candlestick patterns which are continuation indicators. As the Japanese say there are times to buy, times to sell, and times to rest. Many of these continuation patterns imply a time of rest a breather before market presumes it prior trend. One of the most important continuation patterns is windows. Windows Japanese commonly refer to gap as window. A window is a gap between a prior and the current session s price extremes. The diagram below shows open window in an uptrend and a window in a downtrend showing no activity between the previous day lower shadow and current day upper shadow.

It is said by Japanese technicians to go in the direction of the window. Windows also become support and resistance areas. Thus a window in a rally implies a further price rise. Windows also acts as a floor in a pull back. If the pull back closes the window and selling pressure continues after the closing of the window then it means that the prior uptrend is broken or violated. Likewise in a downtrend any up price movement will be given resistance by the window and if the resistance is broken or the window is closed it means that the downtrend is broken.^(1) Traditional technical analysis asserts that corrections go back to the window. In other words the test of an open window is likely. Thus in an uptrend one can use pullbacks up to windows as buying zone but longs should be vacated and even shorts should be considered if selling pressure continues after closing the window. In the diagram below we can see window 1 and 2 amid a rally which started with bullish engulfing pattern. A bearish shooting star arose after window 2, a day after this shooting star market opened lower and closed this window but the pull back was up to that point of window 2 only and there was no selling pressure after that so the market bounced back. Window 3 was also formed acting as a support to the uptrend.^(1)

The Japanese believe that a window from a congestion zone or a new high deserve special attention. So far the focus has been on the use of windows as support or resistance zones but there is a third use also. A window especially if it made with small black candlestick from a low price congestion area can mean a meaningful upside

breakout. The figure below demonstrates this fact, there was large congestion area but after the window was formed it gave a breakout and acted as support on many occasions.

Thus in the end we can say that window is an effective continuation pattern and can become important resistance or support zone. If windows are used with other indicators like volumes they can provide important insights and room to earn huge returns. References (1)Chapter 6, Pg.70-83, Japanese candlestick charting techniques By Steve Nison, Published by New York Institute of Finance.

What are Candlestick Stars? Stars have small real bodies which gap away from a large real body that precedes it. The key rule to a star is that its' real body does not overlap the previous candles real body. There are several variations of the star pattern like the morning star, evening star, doji star, and shooting star. These basic patterns are the beginning of candlestick technical analysis education.

Psychology of the Candlestick Star Pattern As a star has a small real body, it represents indecision by both the bulls and the bears. While the larger trend may be strongly up or strongly down, the presence of the star indicates that the prevailing direction may have come under profit taking or that the other side has actually taken control. Remember, the previous bar should be a strong bar in the direction of the trend which indicates that the bulls (in an up trending market) or the bears (in a down trending market) are in control. This strength in direction is what makes the appearance of the star much more important as the conviction has dissipated. Candlestick Star Variations Morning Star

The morning star candle is a bottom reversal signal that comes after an extended downtrend. This pattern is a three

candle reversal setup. The first two bars are the typical star setup discussed above. The major difference with this pattern is the third candle in the formation. It is a very strong green candle, which does not have to be a gap, which closes at least half way into the first candle. The further it eats in the first bar, the more bullish the formation. Outside of morning star showing itself, look for other indications that this pattern is for real. For example, you want to see high volume in the third candle, indicating strength. It is noticed that the morning star works very well when it occurs at previous support levels. This adds that extra layer of confidence to the analysis.

Morning star chart example This is a beautiful morning star setup. Let's consider why. First of all, the morning star came at previous support near the 60.37 level. The star candle came in the form of a hammer. There was high volume that came along with the hammer and this was an even bigger sign that this level would hold as support. The following day, the stock accelerated with a gap higher and closed well into the top half of the first bar. As I said earlier, the presence of this pattern does not indicate an immediate rally. As you can see, the gap created from the second to third bar was back filled. Smaller gaps, such as this one, tend to get filled in the short term more times than not. Even if one would have waited for the high of the third candle in morning star to be broken above, five points could have been made in a short amount of time. Evening Star The evening star candlestick is the bearish version of the morning star. It is a top reversal pattern that occurs after a sustained up trend. The evening star also a three candle pattern with the first candle being a strongly bullish candle with good price spread. The second candle is the star while the third is red real body that closes well into the first candle. Again, as with the bullish morning star, the third candle in the evening star does not have to be in the form of a gap. Here are a couple of factors that increase the chances of this pattern succeeding : 1. The real bodies of all 3 candles do not overlap on each other 2. The third candle closes well into the first one; preferably regaining 75% of the candle 3. Volume should lighten up on the first candle and increase on the third. Doji Stars When a doji represents the star within the morning star and evening star, the formations are known as the morning doji star and evening doji star. A doji is a candle that lacks a real body, meaning the open and close of the bar are the same or have a very small difference. It has a strong significance after substantial advances or declines. The lack of direction that the doji illustrates can offer a potent reversal signal, especially if it is followed by a candle in the anticipated direction. Therefore, when a doji represents the star of the morning and evening star pattern, you need to take notice.

Morning doji star and Evening doji star If you think about the psychology of this setup, the first gap came in an almost exhaustive fashion. The stock was already in a strong uptrend or downtrend and then it made a gap which closed right near its open. This was the first sign that the directional pressure was fading. Now, with the third candle gapping in the opposite direction of the trend, we now have confirmation that a more significant trend reversal has taken place. Shooting Star

Shooting star and gravestone doji The final star variation is the shooting star which occurs after a strong uptrend (or the inverted hammer that occurs after a strong move down). The shooting star has a long upper shadow with a small real body at the lower end of the candle. This pattern usually presents itself as a sign of a short term correction rather than a more potent reversal signal. The shooting star is basically tells that the market rally could not be sustained. The market opened at or near its lows, shot up much higher and then reversed to close near the open. Ideally, the real body of the shooting star should gap away from the previous candles' real body. While it is not necessary, it adds confirmation to the validity of the impending reversal. When a shooting star forms near a resistance level, which also was created with a shooting star, a very powerful resistance level is created. As mentioned before, the shooting star is a short term topping formation and any break above the high of this candle negates the ramifications of the formation. There is one variation to the shooting star, it is known as the gravestone doji. The gravestone doji is a shooting star with virtually no real body, the open and close are exactly the same. This formation is more powerful than the typical shooting star as portends a more serious reversal.

References Chapter 5, Pg.55-70, Japanese candlestick charting techniques By Steve Nison, Published by New York Institute of Finance.

The Magic Doji Introduction - Doji is considered a very significant reversal indicator in candlesticks technical analysis. A Doji occurs when the open and close for that session are the same or very close to being same. The length of shadows can vary. The perfect doji has the same opening and closing price, yet there is flexibility to this rule. If the opening and closing price are within a few ticks of each other, the line could still be considered a doji. But how to decide whether its a near doji day or not is very subjective and there are no rigid rules for it. One technique to identify it is based on recent market activity. If the market is at an important market junction or it is mature part of bull or bear move or there are other technical indicators sending out an alert the appearance of near doji should be treated as a doji.

The doji is a distinctive trend signal. However, the likelihood of reversal increases if subsequent candlesticks confirm the dojis reversal potential. Doji sessions are important only in market where there are not many doji. If there are many doji on a particular chart, one should not view the emergence of a new doji in that particular market as a meaningful development . Doji at Tops - Doji are valued for their ability to call market tops. This is especially true after a long white candlestick in an uptrend. The reason for the dojis negative implications in uptrends is because a doji represents indecision. Yet, as good doji are at calling tops, they tend to lose reversal potential in downtrends. The reason may be that a doji reflects a balance between buying and selling forces. With ambivalent market participants, the market could fall due to its own weight. Because of this doji requires more confirmation to signal bottom than they do a top.

Types of dojis - Mostly three kinds of dojis appear : 1) Long legged doji or the rickshaw man This kind of doji has very long upper and lower shadows or very long legs. This is very important doji at tops. If the opening and closing price or the real body is near the center the line is referred to as rickshaw man. To the Japanese, a very long upper body or lower shadows represent a candlestick that has lost its sense of direction.

2) Gravestone doji This is yet another distinctive doji. It develops when the opening and the closing prices are at the low of the day. While it can sometimes be found at market bottoms, its forte is in calling tops. As shown in the figure below the shape of the gravestone doji makes its name appropriate. The gravestone doji represents the graves of those bulls and bears who have died defending their territory

3) Simple doji or near day doji It is the most simplest of doji which has very close opening and closing prices or very near opening or closing prices. Doji as support and resistance Doji is very significant in calling tops and bottoms it can also sometimes turn into support or resistance zones. As shown in the figure 1 below the lower shadow of the doji became a resistance level. The rickshaw man on March 21 in figure 2 gave a clue that the previous uptrend could be reversing. A doji occurring a few hours later give more proof for this outlook. These two doji became a significant resistance area as shown in the figure.

Conclusion Doji is of utmost importance in candlestricks studies and are significant in reversal patterns. They are very useful in calling market tops thus they should be treated with utmost care in identifying trend reversal.