SAM GHOSH

Beginner's Guide to
Technical Analysis
UUID: 922c8e3e-fdd2-11e8-8a58-17532927e555

T h i s e b o o k w a s c r e a t e d w i t h S t r e e t L i b Wr i t e
h t t p : // w r i t e . s t r e e t l i b . c o m
Table of contents

WHO AND WHY OF THIS BOOK 1

WHY READ THIS BOOK? 3

TECHNICAL ANALYSIS AND

FUNDAMENTAL ANALYSIS 4

ASSUMPTIONS IN TECHNICAL
ANALYSIS 6

THEORIES GUIDING TECHNICAL

ANALYSIS 8

TOOLS FOR TECHNICAL ANALYSIS 10

CANDLESTICK CHARTS 15

LINKS TO MORE TOPICS 19

 WHO AND WHY OF THIS
BOOK

Au​thor In​for​ma​tion
Sam Ghosh is an Investment Advisor and
Founder of Wisejay Pvt. Limited. He has
an MBA in Finance from University of Cal‐
gary, Canada, completed all three levels of
the CFA pro​gram of​fered by the CFA In​si​ti​‐
tute, USA and holds various NISM certifi‐
cates including Research Analyst Certifi‐
cate.

Why this book?

This book is written to give beginners
some basic idea about stock selection based
on tech​ni​cal analy​sis.

Copy​right
All rights reserved. No part of this publi‐

Beginner's Guide to Technical Analy… 1

cation may be reproduced, distributed, or
transmitted in any form or by any means,
including photocopying, recording, or
other electronic or mechanical methods,
without the prior written permission of
Wisejay Private Limited , except in the case
of brief quotations embodied in critical re‐
views and certain other noncommercial
uses permitted by copyright law. For per‐
mission requests, write to support@
wisejay.com, addressed “Attention: Permis‐
sions Co​or​di​na​tor,” at the ad​dress be​low.

2 Beginner's Guide to Technical Analy…

 WHY READ THIS BOOK?

If you just started thinking about invest‐

ing and trying to learn about the stock
market, technical analysis is all you hear –
support, resistance, trends, etc. For many
people who did not have any formal train‐
ing in investing, technical analysis may feel
syn​ony​mous to stock mar​ket trad​ing which
is a faulty assumption. One of the reasons
for popularity of technical analysis is that it
does not take much time and training to
start trading- but becoming successful is a
dif​fer​ent story. That is why you need to un​‐
derstand the basics of technical analysis,
though the assumptions and theories be‐
hind it.

Re​lated Link:
In​tro​duc​tion to Tech​ni​cal Analy​sis.

Beginner's Guide to Technical Analy… 3

 TECHNICAL ANALYSIS
AND FUNDAMENTAL
ANALYSIS

The basic difference between fundamental and

technical analysis is that the fundamental analysis
is dealing with Value and the technical analysis is
based on Price. Al​low me to elab​o​rate.

Consider you are thinking about buy‐

ing/selling shares of a particular company.
If you are doing fundamental analysis the
question you are dealing with is what is the
intrinsic value of the stock. For that you
can do a top-down or bottom-up analysis.
In a top-down approach you start with the
economic conditions, industry and at last
consider the company specific factors. In a
bottom-up approach you start with the
company specific factors. In both ways, the
goal is to determine the true or intrinsic

4 Beginner's Guide to Technical Analy…

value of the company and the stock. Then
you compare whether the market is under‐
valuing or overvaluing the stock and make
a buy/sell decision. The analysis is mainly
based on value.

The approach in technical analysis is com‐

pletely different. A technical analyst does
not care about the value – the only thing
matters to her is the trends in the price and
volume of the stock. It is the timing that
matters. If she considers that the prices will
go up, she buys and if she considers that
the prices will go down she sells/shorts the
shares.

Re​lated Links:
In​tro​duc​tion to Tech​ni​cal Analy​sis.
Ba​sics of Fun​da​men​tal Analy​sis

Beginner's Guide to Technical Analy… 5

 ASSUMPTIONS IN
TECHNICAL ANALYSIS

1. Ef​fi​cient Mar​ket Hy​poth​e​sis :

This hypothesis postulates that the securities
prices reflect all the publicly available information.
Here information includes the fundamental factors
and mar​ket psy​chol​ogy.

2. Price depends only on demand and

sup​ply :
All other factors are reflected in the de‐
mand for a se​cu​rity.

3. Markets tend to repeat itself and prices

fol​low trends.
These trends are primarily due to cycles of
greed and fear.

6 Beginner's Guide to Technical Analy…

 Re​lated Link:
In​tro​duc​tion to Tech​ni​cal Analy​sis.

Beginner's Guide to Technical Analy… 7

 THEORIES GUIDING
TECHNICAL ANALYSIS

1. Dow The​ory:
This theory was developed by Charles
Dow, who co-founded the Dow Jones and
Company. According to this theory, the
stock price move​ment is gov​erned by three
cycli​cal trends-

a. Primary Trend: Long term trend, ranging

1-3 years.
b. Secondary Trend: Medium term trend
run​ning few weeks to a few months.
c. Minor Trend: Short term ranging to a few
days to weeks.

2. El​liott Wave The​ory:

According to this theory the market moves
in waves that follows a Fibonacci Sequence

8 Beginner's Guide to Technical Analy…

(1, 2, 3, 5, 8, 13, 21, 34, 55 .....). According to
this theory the market moves in five dis‐
tinct waves on the upside and three distinct
waves on the down​side.

3. Kon​dratev Wave The​ory

This is an economic theory which postu‐
lates that growth in economic sectors be‐
have in long-term waves of 40-60 years,
which consists of interval of high and low
growths.

Re​lated Link:
In​tro​duc​tion to Tech​ni​cal Analy​sis.

Beginner's Guide to Technical Analy… 9

 TOOLS FOR TECHNICAL
ANALYSIS

As we have discussed in the previous

chapters, technical analysis assumes that all
publicly available information about a se‐
curity is reflected in the market price and
future movements in the security's price
can be derived from the past trends. In this
article we will introduce some major tools
used in technical analysis to understand
trends and mo​men​tum.

TREND​LINES
A trendline is used to show the overall di‐
rec​tion of the price. It is also called a line of
best fit because of the way it is created. A
trendline is created using a least square fit‐
ting by minimizing the sum of the squares
of the off​sets of the points to the line.

10 Beginner's Guide to Technical Analy…

People often consider trendlines as straight
lines, but they do no have to be. If you are
analyzing medium to long term trend, a
non-linear curve of higher order is often
suit​able as a trend line.

SIM​PLE MOV​ING AV​ER​AGES

In pre​vi​ous chap​ters we have learned that

according to Dow Theory there are Pri‐
mary, Secondary and Minor trends. A sim‐
ple chart of daily prices has been often use‐
less to detect trends – losing the forest in
the trees. This is why moving averages are
used to detect medium to long range
trends. Depending on what kind of trend
you are trying to detect you may need a 15
day, monthly, quarterly or annual moving
averages. A 15 day moving average chart is
created by plotting the average price for
the previous 15 days for each data point
and like​wise monthly chart for 30 days etc.

EXPONENTIAL MOVING AVERAGES

Beginner's Guide to Technical Analy… 11

(EMA)

In case of simple moving averages, the

moving averages are calculated with equal
weightage to each data point. In case of ex‐
ponential moving averages the moving av‐
erage is calculated putting more weight
and significance of the most recent points.
EMA reacts more than simple moving av‐
erage lines to recent changes in price and
use​ful in trend​ing mar​kets.

REL​A​TIVE STRENGTH IN​DEX (RSI)

Till now we discussed the trend indicators.

Now, let us start momentum indicators
with RSI. While trend indicators show
whether the prices are trending up or
down momentum indicators track the
speed of the change. The trend indicators
may show that the price of the security is
picking up, but it cannot capture likelihood
of trend reversal. That is captured by a mo‐
men​tum in​di​ca​tor such as RSI.

RSI is cal​cu​lated as, RSI = 100 - 100 / (1 + RS)

12 Beginner's Guide to Technical Analy…

Where, RS = Average Gain of up periods
during a specified period / Average loss of
the down pe​ri​ods dur​ing the same pe​riod.

RSI ranges from 0-100. A value near 100

(generally over 70) signifies an overbought
mar​ket.

MOVING AVERAGE CONVERGENCE

AND DI​VER​GENCEC (MACD)

Another momentum indicator MACD uses

the difference between a shorter period
moving average and longer period moving
average to capture momentum. The
shorter period moving average will be
faster and more responsive to and longer
period moving average is less responsive.
The MACD line oscillates above and below
the zero line (or cen​ter​line).

As the prices pick up an upward momen‐

tum, the shorter period moving average
moves above the longer period moving av‐

Beginner's Guide to Technical Analy… 13

erage and MACD moves above the zero
line. As the upward momentum increases,
the divergence between the shorter period
moving average and longer period moving
average increases and MACD moves up
further. In case of slowdown in the mo‐
mentum the moving averages tend to con‐
verge and the MACD line moves closer to
the zero line.

A pick-up in downward trend will be re‐

flected downward movement in the MACD
line. The higher downward momentum in
the prices will increase the divergence be‐
tween the shorter period moving average
and longer period moving average in the
opposite direction - the MACD line will
move fur​ther down.

Re​lated Link:
In​tro​duc​tion to Tech​ni​cal Analy​sis: Tools

14 Beginner's Guide to Technical Analy…

 CANDLESTICK CHARTS

One of the most popular charts used in techni‐

cal analysis is the Candlestick Charts. Originally
cre​ated by the Japan​ese, these charts cap​ture the
buying and selling pressure in a period. It gives a
quick idea about the market trend as well as
changes in buying and selling pressures due to its
vi​sual qual​ity.

Beginner's Guide to Technical Analy… 15

P ARTS OF A SIN​GLE CAN​DLE​STICK

There are three parts of a Candlestick –

Upper Shadow, Lower Shadow and the
Real Body. The Upper Shadow shows the
highest prices during the period, the
Lower Shadow the lowest prices and the
real body the movement between the pe‐
riod open and pe​riod close prices.

BEARISH AND BULLISH CANDLE‐

STICKS

16 Beginner's Guide to Technical Analy…

You can notice in the attached image that
there are two distinct kinds of charts –
filled charts (in red) and hollow charts (in
green).

The filled charts are the Bearish Charts and

the hollow charts are the Bullish Charts. In
the Bearish Charts the open price is higher
than the closing price as shown in the at‐
tached image. For the Bullish Charts the
op​po​site is true.

READ​ING A CAN​DLE​STICK

We already learned that we can understand

whether there is a bullish (buying) or a
bearish (selling) pressure during a period
by just the type of the candlestick. The up‐
per and lower shadows show the highest
and the low​est prices dur​ing a pe​riod.

The length of the candlestick signifies the

range of the price movement in that pe‐
riod. A longer candlestick means a higher
in​tra-pe​riod volatil​ity in price.

Beginner's Guide to Technical Analy… 17

A long real body means that the open and
close prices for a period and significantly
different, a shorter real body (or non-exis‐
tent real body) means they are closer to
each other or the same.

No upper shadow means the market

opened at a period high for a bearish can‐
dlestick and closed at a period high for a
bull​ish can​dle​stick.

No lower shadow means the market closed

at a period low for a bearish candlestick
and opened at a period high for a bullish
can​dle​stick.

Traders develop trading patterns which

they watch to detect continuation and re‐
versal in trends. These charts are popular
mainly for their vi​sual na​ture.

Re​lated Link:
Introduction to Technical Analysis: Can‐
dle​stick Charts

18 Beginner's Guide to Technical Analy…

 LINKS TO MORE TOPICS

Basics of Fundamental Analysis for Fi‐

nan​cial Se​cu​ri​ties.
Ba​sics of Fun​da​men​tal Analy​sis: Val​u​a​tion

Basics of Fundamental Analysis: Qualita‐

tive Analy​sis : Com​pany Level Analy​sis

Basics of Fundamental Analysis: Qualita‐

tive Analy​sis : Macro Level Analy​sis

Beginner's Guide to Technical Analy… 19