Technical Analysis

Technical Analysis
• Technical analysis is the study of market timing or
market action. By reviewing past price movement,
technical analysis uses charting systems and
mathematically-drawn trend indicators to forecast
future price reactions. Thus by evaluating price
swings and patterns, one can make an educated
assumption as to whether the share price of a stock
was headed for a profitable gain or loss within a
short term perspective. The foundation of technical
analysis lies in its use of charted trends, the general
direction of either the overall market or the price of
an asset.
J.G. Barredo
Technical Analysis vs Fundamental Analysis

• Technical analysis involves the

development of trading rules based on
past price and volume data for individual
stocks and the overall stock market.
• Fundamental analysis involves economic,
industry, and company analysis that lead
to valuation estimates for companies,
which can then be compared to market
prices to aid in investment decisions.
 Underlying Assumptions
• Trading via technical analysis involve a
number of assumptions about markets
– The market value of any good or service is
determined solely by the interaction of supply
and demand
– Supply and demand are governed by numerous
factors, both rational and irrational
 Underlying Assumptions
• Disregarding minor fluctuations, the prices
for individual securities and the overall value
of the market tend to move in trends, which
persist for appreciable lengths of time
• Prevailing trends change in reaction to shifts
in supply and demand relationships and
these shifts can be detected in the action of
the market.
 3 Key Principles
1. Price discounts everything else.
The market price tells you everything you
need to know about a stock’s expectations
regardless of company performance, book value,
product development and so forth. There are
various geopolitical factors that can affect the
market price such as a change in government and
natural disasters thus whatever the reason
whether stemmed from logic or pure emotion,
they will all factor in to the resulting share price of
a company.
 3 Key Principles
2. Prices move in trends. According to
Newton’s Law of Motion
“An object in motion tends to stay in motion
while an object at rest tends to stay at rest unless
acted upon by an unbalanced force.” By
recognizing familiar patterns in the daily or
intraday price swings within the early stages of
development, one can try to forecast the possible
direction the share price will take simply by
following that trend
 3 Key Principles
3. History repeats itself.
People will tend to react in similar fashion
to certain kinds of stimuli, thus encouraging a
repetitive response to price activity. The
market has a sharp and sensitive memory
and traders will often recall what happened in
the past in order to associate it with the
future.
Advantages of Technical Analysis
• Unlike fundamental analysis, technical
analysis is not heavily dependent on financial
accounting statements.
– Problems with financial statements:
• Lack of information needed by security analysts
• GAAP allows firms to select reporting procedures,
resulting in difficulty comparing statements between
firms
• Many psychological and other non-quantifiable factors
do not show up in financial statements
Advantages of Technical Analysis
• Fundamental analyst must process new
information and quickly determine a new
intrinsic value, but technical analyst merely
has to recognize a movement to a new
equilibrium.
• Technicians trade when a move to a new
equilibrium is underway but a fundamental
analyst finds undervalued securities that may
not adjust to “correct” prices as quickly.
• There is a great advantage when understanding
technical analysis for active investors especially when
supported by fundamentally strong research. Seeing
prices through the illustrated form of charts and area
patterns can quicken one’s trading as market timing
does require faster decision-making. Ultimately,
technical analysis also provides price ranges and
boundaries for traders to work with so they can
measure their potential risk-reward ratios. This allows
them to make the most of their profit while managing
their risk and guarding themselves against heavy
drawdowns.
• In short, technical analysis prepares an active
investor with a trading plan when choosing a
potential stock candidate by executing the
following rules:
– Looking for a justified entry. By estimating price
targets, an active investor will have a better sense
of when to enter into a trade at bargain valuations
and not highly expensive prices when the upside for
profit is less.
– Establishing an exit. Likewise, it is just as
important to know when to exit from a trade whether
to lock in profit or limit one’s loss.

– Assessing risk-reward. One must always evaluate

one’s prospects. A key component to a successful
trader is to determine one’s risk versus reward
level, using that ratio to guide their investment
decisions. It answers the question of whether the
potential profit will be worth entering into a trade as
compared to the potential losses.
Technical Analysis: Introduction to Stock Charts

CHART BASICS
 Basic Terms
• Volatility
• Fluctuations
• 52-week high / low
• Price / trading range
• Open / closing price
Charts
• Maps price performance

• Sheds light on supply

and demand

• “investment roadmap”

• Price / volume
relationship important
 Chart Types - Line Charts
• Most basic of all charts

• Just a line that connects

the closing prices over a
time frame

• No trading range
 Chart Types – Bar Chart
• Vertical line represents highs/lows of the day
• Horizontal line represents closing price
• Red = down
• Blue/Black = up

Daily High
Closing Price
Daily Low Price Gap
Chart Types – Candlestick Charts
• Vertical line represents the
trading range
• Wide bar represents open
and close
• White bar – Up and closes
above opening price
• Red Bar – down
• Black bar – up, but closes
below the opening price
 Chart Basics – Time Scale
• Time Scale
– Dates along bottom of chart (varies from
seconds to decades)

– Common Types: intraday, daily, weekly, monthly

– Subtle differences between different time scales

Chart Basics – Time Scale

Daily Chart Weekly Chart

Volume
• Amount of shares that
trade hands between
seller and buyers

• Price movements
more significant when
volume is above
average
 Price and Volume

Average
Volume
 Trends are your Friends
• Trend: general direction of stock
• Uptrend: higher highs, higher lows
Sometimes, trends difficult to see
 Trendlines

• Simply put, a line

drawn on a chart to
represent the overall
trend

• Upward trendline,
connecting the lows,
represents support
 Channels
• Two parallel trend lines that act as areas of
support and resistance
• Any break through the channel is a break of the
trend, otherwise the price should stay in range
Technical Analysis: Introduction to Stock Charts

BASIC CONCEPTS
 Support and Resistance

• Support is the price that, historically, a

stock has had difficulty falling below. This is
the point where the market considers the
price to be “cheap”. Demand becomes so
strong that it stops the price from going any
lower.
 Support and Resistance

• Resistance is simply the opposite of

support. This is the point where the stock
price usually starts going down because
there is too much supply and not enough
demand.
• Support and resistance levels are not
always precise and they can be broken,
but it’s a simple and proven concept that
many find useful. The basic rule when
trading using support and resistance is
to buy on support and sell on
resistance.
 Trend Analysis

• There are always going to be ups and

downs in the stock market and in every
stock, but these ups and downs will
eventually form a trend that moves in
some general direction—this is actually
one of the key assumptions of TA.
 Uptrend
• Identified by a series of higher highs and higher
lows. The general movement over time is going
upward.
 Downtrend
• Identified by a series of lower highs and lower
lows. The general movement over time is going
downward.
 Sideways
• There is no clear pattern going upward or
downward. The general movement over time is
horizontal or flat.
• Similar to support and resistance, trends are
not guaranteed to continue to hold. That’s
why they can be further classified into short-,
medium-, and long-term trends. Trends can
and do change. But unless something
happens to change the market behavior,
then the trend is likely to continue.
• The general rule of thumb? Buy stocks on
an uptrend. Avoid stocks on a downtrend.
 Volume

• A lot of technical analysis involves looking

at the stock price, but that’s not the only
important statistic in TA. Another equally
important, if not more important, number
to look at is the trading volume.
• The trading volume tells you the number
of shares that were bought and sold in a
particular time frame (usually a day).
• Volume is important because it gives context
to price movements. It tells you how strong
or weak a trend or chart pattern is.
• For example: If the price of a downtrending
stock starts going up, does it mean the trend
changed to an uptrend? Take a look at the
volume and you’ll find out. If the volume is
low, then the trend will probably continue
going down. If the trading volume is high,
it means that there is a strong demand for
the stock and the trend will likely change
to an uptrend.
CHART PATTERNS
 CANDLESTICK CHART
• There are many kinds of charts that traders
can use to monitor the stock market, but the
most popular is probably the candlestick
chart.
• A candlestick chart shows four key prices for
the day—the opening price, closing price,
highest price, and lowest price. These are
based on that day’s completed transactions.
• If the candle is green, it means that the
closing price was higher than the opening
price. If it is red, it means the opening price
was higher than the closing price.
• The colors might change depending on the
chart you’re using, but one color will always
show an increase in price over the day and
another color will show a decrease in price.
 HEAD AND SHOULDERS
• On the technical analysis chart, the Head and
shoulders formation occurs when a market trend
is in the process of reversal either from a bullish
or bearish trend; a characteristic pattern takes
shape and is recognized as reversal formation.
• A chart formation that resembles a baseline with
three peaks, the outside two are close in height
and the middle is highest. In technical analysis,
a head and shoulders pattern describes a
specific chart formation that predicts a bullish-
to-bearish trend reversal.
 CUP AND HANDLE
• A cup and handle is considered a bullish
continuation pattern and is used to identify
buying opportunities.
• This pattern signals that the stock is bullish.
If the pattern is completed, the price will likely
resume its previous upward trend. If the right
side of the handle breaks above the peak
formed between the cup and the handle, it
confirms that the pattern is complete and that
the uptrend will resume.