Introduction to Technical Analysis

Contents

1. What’s Technical Analysis?2. Graphs3. Trends4. The Golden Rule5. Trends Lines, Support and Resistance Levels6. Retracements7. Summary

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What’s Technical Analysis?

A method for estimating the future prices of securities based chiefly on two parameters: 1.Price History2.Trade Volumes

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Quarterly Reports, Macro/Micro Indicators, Interest Rates, Stock Market Indices, Predictions, Statements, News, Rumors… Because *:

1. Security prices are ultimately set by market forces – buyers and sellers.

2. History repeats itself, so…3. Historic price and volume data is sufficient to assess

and predict buyer and seller behavior* Per Technical Analysis theory

Technical Analysis Does Not Look At…

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Candlestick Charts

UpDown

Opening Price

Closing price

Low Priceof period

High Priceof periodOpening Price

Closing Price

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Most popular type of graph to use in Tech Analysis

Graph Time Resolutions

• Daily – 1 candle = 1day– Useful for analyzing short-term

trends

• Weekly – 1 candle = 1 week– Useful for analyzing intermediate

trends

• Monthly – 1 candle = 1month– Useful for long-term analysis

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Trend – The Direction of Prices

3 Types of Trends:

Downtrend

Uptrend

Sideways Trend

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Golden Rule of T. Analysis Trading

(The Trend is your Friend)

• In an uptrend – Buy (Long)• In a downtrend – Sell/Don’t Buy/Short• In a sideways-trend – Sell/Don’t Buy So, how do you recognize a trend?

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Trade With The TrendTrade With The Trend

Trend Characteristics - Price

Formal Uptrend1. Every peak is higher than the previous

peak2. Every trough is higher than the

previous trough

Formal Downtrend1. Every peak is lower than the

previous peak2. Every trough is lower than the

previous trough

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Trend Characteristics - Volume• Trade volume = amount of securities traded• In distinct trends volumes typically:

– Are larger than in periods of sideways trends– Grow with the trend

sideways

uptrend

uptrend

growing

sideways

Small volumesMedium volumes growing

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Trend Characteristics – Time Period

Trends are limited to a time period:– Long Term Trend – 1 year or more

• AKA Main Trend• Use monthly chart to detect

– Intermediate Trend – 2-12 months• Most investors use it• Use weekly or daily chart to analyze

– Short term Trend – 1 month or less• Use daily chart

Important: Long-term trends will almost always include intermediate and short term trends in the opposite direction

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Trendline

• Trendline = A line drawn over highs or under lows to show the prevailing direction of price – Needs to touch at

least 3 peaks or troughs– Helps determine future

prices, change rates, buy/sell opportunitiesand more

Intermediate term trendline

Short term

trendline

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Support and Resistance LevelsHorizontal trendlines may indicate Support and Resistance levels

– Support level – The price level which the security has had difficulty falling below. It is thought of as the level at which a lot of buyers tend to enter the stock.

– Resistance level - The price level which the security has had difficulty rising over. It is thought of as the level at which a lot of sellers tend to offload.

Note: Round numbers (100, 800, etc.) tend to create support/resistance levels

Support Level

Resistance Level

Breakout

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Support and Resistance - 2

Trendlines may indicate the change in support and resistance levels during a trend

Resistance line

Support line

Breakout

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Example: an uptrending security with parallel support and resistance lines (price channel)Note: support and resistance trendlines are not always parallel

Support and Resistance Role Reversal

• When a support level is broken it may turn into a resistance level

• And vice-versa Breakout of support level turns it into a

resistance level

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Retracements• Retracement = A temporary reversal in the direction of the

price of a security, countering the prevailing trend. • Retracements usually occur due to profit-taking • Retracements break the distinctiveness of trends

– In uptrends – create a trough that is lower than the previous trough – In downtrends – create a peak that is higher than the previous trough

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The Risk of Retracements

• Retracements may fool us into thinking the trend has stopped or reversed

• Trading based on retracements will cause us to lose or profit less

Example: in this downtrend there are two retracements. Buying the security at these

times will result in loss .

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Retracement Indicators- Price

• In theory the change would often correlate with Fibonacci’s ratios: 23.6%, 38.2%, 50%, 61.8%

• Fibonacci retracements is a popular tool to predict retracement end prices– Draw a line between the high and

low of the last trend and the tool will show relative Fibonacci levels

38.2%

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1. Price should retrace by no more than 66% of the size of the previous move

Movesize 50%

61.8%Retracement

Uptrend

Retracement size

0%

Retracement Indicators - Other

2. Duration - retracements are short-lived– No more than 2-3 weeks in intermediate term

3. Usually arrive after strong price moves– Inducing profit taking

4. Volumes decline as the retracement progresses5. Contradicting/Weak strength indicators

– We’ll discuss those in the next slide deck6. Invariably followed by a higher/lower peak/trough

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Summary - Med-Short Trends Example

*Note how support and resistance level build at round numbers: 700, 800, 900…

Strongdown-trend

Sideway Trend b/w 630-700

Uptrend

SidewaysTrend

RetracementStarts at 700

and stops at 800

Retracement

Uptrend stopped at 900

800 level inducesa retracement

700 level breakout

Small volumesVolume growthHigh

Volumes

900 level broken

Uptrend stopped at 1000

Up

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How Should We Trade?

Hold

Buy long

Sell LongBuy Short

Hold short

Sell Short

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Photo Credits

• Stopwatch / casey.marshall - http://www.flickr.com/photos/rsdio/3642425935/

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