Technical Analysis – Chapter 2

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Before we actually learn about technical analysis or pattern recognition to pick a stock either for investment purpose or making profit in short term; it is important that we learn a bit about the tools used for technical analysis.

Tools used in Technical Analysis: There are several tools available for technical analysis; few are very easy to understand and others might overwhelm you with sheer complexity. Let us look into the most common tools available, try to understand the basics and eventually over the period we will try to improve on our pattern recognition capability.

With advancement in technology nowadays most of the technical analyst use sophisticated software to analyze the trend but more or less every technical analyst study charts. There are several types of charts available which we will study in this course. Below is the list of few commonly used charts.

  1. Line Charts
  2. Bar Charts
  3. Candlestick charts

Key points to study in Charts:

  1. Stock Price Trend: As a common saying goes “Trends are Friends”. One of the common use of charts is to study trends and recognize the hidden trends.
  2. Support and Resistance: In stock market technical analysis, support and resistance are certain predetermined levels of the price of a security at which it is thought that the price will tend to stop and reverse. These levels are denoted by multiple touches of price without a breakthrough of the level.
  3. Breakout: Stocks when breaks out from support or resistance, they tend to make huge movement and in that direction.

Along with charts there are few technical indicators which are used to make better judgement while picking stocks. We will study each one of the indicators in detail along with few very important definitions.

Commonly used Technical Indicators:

On balance volume: On balance volume is a momentum indicator that measures the positive or negative flow of funds in a security over a period. Basically, On balance volume gives sum total of inflow or outflow of funds, in other words this tool is running total of up volume and down volume of funds. Up volume is how much volume there is on a day when the price rallied. Down volume is the volume on day when the price falls.
When OBV is rising, it shows that buyers are willing to step in and push the price higher. When OBV is falling, the selling volume is outpacing buying volume, which indicates lower prices.

Accumulation and Distribution: Accumulation and Distribution is again a momentum indicator which attempts to measure the supply and demand of security by determining whether there is in general buying trend or selling trend for a given stock.

Average directional index: The average directional index (ADX) is a trend indicator used to measure the strength and momentum of a trend. When the ADX is above 40, the trend is considered to have a lot of directional strength, either up or down, depending on the direction the price is moving.

Aroon Indicator: Aroon is a technical indicator used to measure whether a security is in a trend, and more specifically if the price is hitting new highs or lows over the calculation period (typically 25).

Moving Average Convergence/Divergence: The moving average convergence divergence (MACD) indicator helps traders see the trend direction, as well as the momentum of that trend. It also provides a number of trade signals. When the MACD is above zero, the price is in an upward phase. If the MACD is below zero, it has entered a bearish period.

Relative Strength Index: The Relative Strength Index (RSI), developed by J. Welles Wilder, is a momentum oscillator that measures the speed and change of price movements. The RSI oscillates between zero and 100. Traditionally the RSI is considered overbought when above 70 and oversold when below 30.

Stochastic Oscillator: Stochastic Oscillator is one of the important tools used for technical analysis in securities trading. The indicator picks one observation point in current base and refers to all points in the defined range from where the highest and lowest point are considered for comparison. It helps to decide the current momentum when compared to high & low of historic set in form of support and resistance levels.

Technical Analysis Chapter -1

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