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TECHNICAL ANALYSIS

TECHNICAL ANALYSIS. Finafree Investments. DEFINITION:. Technical Analysis is the study of: PRICE. VOLUME. OPEN INTEREST. It is the study of market action through the help of charts and other technical indicators so as to forecast the trend. ASSUMPTIONS:.

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TECHNICAL ANALYSIS

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  1. TECHNICAL ANALYSIS Finafree Investments FINAFREE INVESTMENTS

  2. DEFINITION: Technical Analysis is the study of: • PRICE. • VOLUME. • OPEN INTEREST. It is the study of market action through the help of charts and other technical indicators so as to forecast the trend. FINAFREE INVESTMENTS

  3. ASSUMPTIONS: • Current Price of an underlying asset discounts all information. • Price always moves in trends. • History repeats often. FINAFREE INVESTMENTS

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  5. DIFFERENCES: FINAFREE INVESTMENTS

  6. ADVANTAGES: • Can be used on any markets and on any underlying asset. • Takes care of fundamental analysis. • Helpful for short term traders and speculators. • Helps in understanding market psychology. • Helps in economic forecasting. FINAFREE INVESTMENTS

  7. LIMITATIONS: • It is a Probabilistic study and not deterministic study. • Chart Patterns are very subjective in nature. • Does not works accurately for illiquid markets and underlying assets with controlled regime. • Past may not be the indicator of future. • Random walk theory. • Contradicting views by different indicators. FINAFREE INVESTMENTS

  8. DIFFERENCES IN APPLICABILITY: Technical analysis as applied to stock Markets is same to even derivative markets. However the following things shall be kept In mind: • Pricing Structure. • Time period. • Margin requirements. • Timing is everything in futures market, where buy and hold strategy does not work. FINAFREE INVESTMENTS

  9. DOW THEORY CHARLES DOW & NELSON FINAFREE INVESTMENTS

  10. DOW THEORY: • Ideas of Charles Dow, propounded by NELSON. • Assumptions of Dow theory: a) The Market indices discounts everything. b) The market has 3 trends, namely: • Primary Trend. (Major trend). • Secondary Trend. (Intermediate trend). • Minor Trend. (Short term trend). FINAFREE INVESTMENTS

  11. STUDY OF VARIOUS TRENDS: • THE PRIMARY OR MAJOR TREND: Dow compares the major trend to a TIDE, where a major uptrend is represented by patterns of rising peaks and troughs and a downtrend is characterized by lower peaks and troughs. A MAJOR TREND LASTS FOR MORE THAN AN YEAR OR SEVERAL YEARS. FINAFREE INVESTMENTS

  12. STUDY OF VARIOUS TRENDS: 2.THE SECONDARY OR INTERMEDIATE TREND: DOW compares the intermediate trend to waves that makeup tides and they represents correction in the Primary trend. AN INTERMEDIATE TREND GENERALLY LASTS FOR THREE WEEKS TO THREE MONTHS. THESE INTERMEDIARY CORRECTIONS GENERALLY RETRACES 1/3 OR 1/2 OR 2/3 OF THE PREVIOUS MOVE. FINAFREE INVESTMENTS

  13. STUDY OF VARIOUS TRENDS: 3.THE MINOR OR SHORT TERM TREND: DOW compares the minor or short term trend to ripples on the waves. Minor trend represents fluctuations in the intermediate trends. A MINOR TREND GENERALLY LASTS FOR LESS THAN THREE WEEKS. FINAFREE INVESTMENTS

  14. FOCUS ON MAJOR TRENDS: Dow suggests to focus on the big picture i.e to focus on the MAJOR TREND. The major trend consists of three phases Namely: • ACCUMULATION PHASE. • PUBLIC PARTICIPATION PHASE. • DISTRIBUTION PHASE. FINAFREE INVESTMENTS

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  16. VOLUME MUST CONFIRM THE TREND!!! According to DOW, Volume must confirm Uptrend by expanding as Price moves Higher and diminishes with decrease in Price. In a Downtrend, Volume should expand as Price drops and diminish as they rally. FINAFREE INVESTMENTS

  17. FAILURE SWING: B C E A D The rally at point B is higher than point A, but the rally at point C fails to exceed the previous rally at point B. This indicates reversal of uptrend and the point below the neck line i.e. D – E indicates a failure swing. FINAFREE INVESTMENTS

  18. FAILURE SWING: C B E G A D H F The rally at point B is higher than point A, and the rally at point C is higher than that of rally at point B; But it falls below D and few theorists sells at a break out Point below E. While others would like to wait to see a lower high at point G to confirm the lower high as well as lower lows and then sell at a Point below H. FINAFREE INVESTMENTS

  19. A trend is said to be at effect until it gives definite signals that it has reversed: • A trend in motion continues to be in motion until any external force causes it to change direction. • Various technical tools help the analyst to identify signals of trend reversals. • A trend before reversing, slows down and then changes direction. • Volume confirmation of a trends direction reversal is to be considered. FINAFREE INVESTMENTS

  20. CRITICISMS OF DOW THEORY: • Dow theory generally misses 20% to 25% of a move before generating a signal. • Use of closing prices (Line charts). • Signals in Dow theory are generally generated during the second phase of the uptrend. • It was primarily used as an indicator of Economy which was substituted to stocks and other underlying assets. • Subjectivity and difficulty in distinguishing the various phases of trends. FINAFREE INVESTMENTS

  21. Dow theory applied to Derivatives instrument: • Dow assumed most of the investors only trade major trend; Whereas in reality traders in futures market generally trend intermediate trend which was unimportant according to Dow’s assumption. • Minor Swings are more important than Major Swings. • Keeping in mind the above differences, Dow theory can be applied even to derivatives market. FINAFREE INVESTMENTS

  22. CHART CONSTRUCTION: • Price and Volume data are generally studied by using graphical representations called charts. • Different types of charts include; a) LINE CHARTS. b) BAR CHARTS. c) CANDLE STICKS. FINAFREE INVESTMENTS

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  26. Based on the investors time period, Daily or Weekly or Monthly charts can be used. • Arithmetic Vs Logarithmic Scale: On an Arithmetic Scale, Price change shows an equal distance for each unit of price change whereas in an Logarithmic Scale, Price change shows an equal distance for equal percentage change. FINAFREE INVESTMENTS

  27. OPEN INTEREST: • Open Interest is the total number of outstanding future contract that are held by the market participants at the end of the day. • Open interest is the number of outstanding contracts held by the longs or the shorts and not the total of the both. • Generally Volume and Open interests will be small at the early stages of futures contract life and expands as it reaches the maturity period and again drop during close to expiration stage. • For trading purpose, avoid stocks with lower volumes and lower open interest. FINAFREE INVESTMENTS

  28. TREND ANALYSIS: “ALWAYS TRADE IN THE DIRECTION OF THE TREND” “TREND IS YOUR FRIEND” “NEVER BUCK THE TREND” It is the direction of the PEAKS and TROUGHS that constitutes market trend. A Trend is simply the indicator of the direction of the market. FINAFREE INVESTMENTS

  29. TYPES OF TREND: • AN UPTREND. Series of successive higher peaks and troughs. • A DOWN TREND. Series of declining peaks and troughs. • SIDEWAYS TREND. • Series of Horizontal peaks and troughs. FINAFREE INVESTMENTS

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  33. TREND STRATEGY: • In an Uptrend, go LONG (BULLISH). • In a Downtrend, go SHORT (BEARISH). • In a Sideways trend, DO NOTHING. • Trend is classified into 3 categories based on their time period: a) Major Trend. b) Intermediate Trend. c) Minor Trend. FINAFREE INVESTMENTS

  34. SUPPORT AND RESISTANCE: SUPPORT: It is an area or level on the chart where buying interest is sufficiently strong to overcome selling pressure i.e. Demand > Supply. In short, the troughs or reaction lows are called as Support. For an Uptrend to continue, each successive lows, (Supports) must be greater than the preceding low. FINAFREE INVESTMENTS

  35. SUPPORT AND RESISTANCE: RESISTANCE: It is an area or level on the chart where Selling pressure is sufficiently strong enough to overcome buying interest i.e. Supply > Demand. In short, the peaks or reaction highs are called as Resistance. For an Uptrend to continue, each successive highs, (Resistances) must be greater than the preceding highs. FINAFREE INVESTMENTS

  36. SUPPORT AND RESISTANCE: CAUTION: If the corrective dip in an uptrend comes all the way to previous low or breaches it, it is an early signal of reversal of a trend (downward move) or beginning of sideway movement. FINAFREE INVESTMENTS

  37. SUPPORT AND RESISTANCE: • BETTER CONFIRMATION: • More the trading that takes place in the Support or Resistance area, more significant it becomes. • Amount of time spent in the support or resistance area is a sign of better confirmation. • Volume also acts as a pivotal point in determination of better future prices and confirms better the support or resistance levels. FINAFREE INVESTMENTS

  38. SUPPORT AND RESISTANCE: • Support becomes resistance and vice versa if a Support level is penetrated (Broken out) with a significant margin and similarly in case of a break out of resistance levels. • In an uptrend, previous resistance levels which have been broken by a significant margin become supports. • In a downtrend, violated support levels becomes resistance levels on subsequent bounces. FINAFREE INVESTMENTS

  39. TREND LINES: • It is a simple but very valuable technical tool. • Uptrend: It is a straight line drawn from left to right along with every successive lows. • Downtrend: It is a straight line drawn from left to right. along with every successive highs. • AN UPTREND OR A DOWNTREND SHALL BE CONFIRMED BY JOINING OF ATLEAST 3POINTS. • Days low or highs shall be considered for drawing a trend line. FINAFREE INVESTMENTS

  40. TREND LINES: • Trendline shall include all price action. • Trendline break on a closing basis is considered more valid than on intraday basis. • Valid trend line break is generally considered with a limit of 3% to 5% from the neckline. • Deciding the levels of tolerance is left to the risk levels of the investor. • A minimum 2day close below or above the trend line break is also generally considered. • Few of them even consider a weekly break of trend line as a valid signal. FINAFREE INVESTMENTS

  41. FAN PRINCIPLE: • Sometimes after the violation of an uptrend line, prices will decline a bit before rallying back to the bottom of the old uptrend line, which is now acting as the resistance. • The breaking of the 3rd trend line in an UPTREND signals the reversal of the trend. Generally the broken trend line 1 and 2 becomes the Resistance levels. • The breaking of the 3rd trend line in a DOWNTREND signals the reversal of the trend. Generally the broken trend line 1 and 2 becomes the Support levels. FINAFREE INVESTMENTS

  42. Steepness of the Trendline: • Generally most important trendlines approximate an average slope of 450. • Generally if trendlines are too steep or flat, it may not be an indication of a sustainable Trendline projections and the same shall not be trusted for. • Multiple trends like major, intermediate and short term are studied in tandem for a better picture. • Thus it is said, “Remember the Rembrandt” i.e. the big picture. FINAFREE INVESTMENTS

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  44. CHANNEL LINES: • Channel line also called as Return line is an area between two parallel lines i.e. the basic trendline and the channel line drawn parallel to the basic trendline. • Generally on an Upward trendline, supports form the basic trendline and the resistance the upper channel. • Confirmation of an existence of channel is proved by the price action within the two parallel lines. • Failure to reach the channel line in an upward trend is an early signal of beginning of weakness. FINAFREE INVESTMENTS

  45. CHANNEL LINES: • Once a breakout occurs from an existing price channel, prices usually travel a distance equal to the width of the channel from the point at which trend line is broken. • Out of the 2 trendlines constituting a channel, the basic trendline is by far the most important and reliable one. • The Channel line is a secondary use of the trendline technique. • The failure to reach the upper end of the channel line is an early warning that the lower line (Basic trend line) may be broken in the near future. FINAFREE INVESTMENTS

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  47. PERCENTAGE RETRACEMENT LINES: • After a particular move, Prices generally retrace a portion of the previous move, before resuming the trend in the original direction. • These counter trend moves are called as retracements and are generally to the extent of 50% of the previous move. • Besides 50% retracements, there are minimum (1/3) and maximum (2/3) retracements too. • Percentage retracements are applicable to all types of trends. FINAFREE INVESTMENTS

  48. PERCENTAGE RETRACEMENT LINES: • If the prior trend is to be maintained, 66.67% or 2/3 retracement is a critical point not to be breached. • 66.67% retracement is low risk area to buy in an uptrend or to sell on a downtrend. • If prices move beyond the 66.67% retracement, then the odds favour a trend reversal rather than just a retracement. The move in such situations usually retrace 100% of the previous trend. FINAFREE INVESTMENTS

  49. SPEED RESISTANCE LINES: • It combines percentage retracements and trendline techniques. • This technique was developed by Edson Gould. • Speed lines measure the rate of ascent or descent of a trendline. • Speed lines are always drawn vertically in the opposite direction from the highest or the lowest point. FINAFREE INVESTMENTS

  50. SPEED RESISTANCE LINES: • If an uptrend is in the process of correcting itself, the downside correction will usually stop at the higher speed line (2/3). If not prices will fall to the lower speed line (1/3). If the lower line is also broken then prices may move down to retrace 100% of the previous trend. Fall in prices below this point is a signal of reversal of the trend. • Incase of a downtrend, breaking of the lower lines is an indication of the prices rallying towards the upper line. If it is broken too then it is a signal of reversal of the trend. FINAFREE INVESTMENTS

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