TECHNICAL ANALYSIS

Hriday Rajendra Kothari,

TYBFM,

A-127
1. What are technical analyst charts? What do Technical Charts Plot? How do
Technical Charts Work? What are advantages of Using Charts? What are the
main chart types used for technical analysis?

Technical analysis charts are graphical representations of price and volume data for a security
over a period of time, used to analyze trends and patterns to predict future price action.

Technical analysis charts can be used to:

Identify trends

Technical analysis charts can help identify patterns, formations, and trends in price data.

Make trading decisions

Investors and traders use technical analysis to help determine entry and exit points for trades.

Analyze economic indicators

Line charts can be used to analyze economic indicators like housing starts, employment trends,
and consumer prices.

There are several types of technical analysis charts, including:

Line charts: Good for identifying overall trends, comparing investments, and analyzing economic
indicators

Bar charts: Good for analyzing longer-term price movements and spotting trends and areas of
buying or selling

Candlestick charts: A type of technical analysis chart

Open & high-low-close charts: A type of technical analysis chart

Point & figure charts: A type of technical analysis chart

Technical analysis charts are plotted with prices on the Y-axis and time scales on the X-axis.
Intervals can be based on logarithmic or linear scales.

Technical charts are graphical representations of price and volume data that plot price over time
to help identify patterns and trends. They are used in technical analysis, which is a type of
security analysis that uses price and volume data to make investment recommendations.

Technical charts can be created using any security that has price data over time. There are
several types of technical charts, including:

Bar charts

These charts plot the open, high, low, and close (OHLC) prices for each time period. They are
useful for longer-term price movements.

Candlestick charts

These charts also plot the OHLC prices, and can be useful for shorter-term price action. The size
of the body and wick can indicate the intensity of buying or selling.

Line charts

These charts connect data points over a specific time period and provide a high-level overview of
price action.

Professional analysts often use technical analysis in conjunction with other forms of research.
Retail traders may make decisions based solely on the price charts of a security and similar
statistics. But practicing equity analysts rarely limit their research to fundamental or technical
analysis alone.

Technical analysis can be applied to any security with historical trading data. This includes
stocks, futures, commodities, fixed-income securities, currencies, and more. In fact, technical
analysis is prevalent in commodities and forex markets where traders focus on short-term price
movements.

Technical analysis attempts to forecast the price movement of virtually any tradable instrument
that is generally subject to forces of supply and demand. Some view technical analysis as simply
the supply and demand forces reflected by the market price movements of a security.
Technical analysis most commonly applies to price changes, but some analysts track numbers
other than just price, such as trading volume or open interest figures.

Charts have several advantages, including:

Easy to understand: Charts are visual representations of data that can be used to make information
easier to understand and remember.

Compare data: Charts can be used to compare multiple sets of data in a way that’s easy to see.

Highlight patterns: Charts can help you highlight trends, patterns, relationships, comparisons, or
contrasts that might be difficult to see or explain in text.

Concise: Charts can present information in a concise, consistent, and compact style.

Engaging: Charts are visually more engaging than plain textual content.

Draw conclusions: Charts can help audiences draw conclusions from slides by allowing them to
compare different data and numbers.

Summarize large data: Charts can help summarize large data in a crisp and easy manner.

Technical analysts use a variety of charts to identify trade signals, including:

Line charts

A simple chart that shows the closing price of an asset over time. Line charts provide a high-level
overview of price action.

Bar charts

Also known as HLOC charts, these charts show the open, high, low, and close (OHLC) prices for
each period. Bar charts are more dynamic than line charts and can be helpful for longer-term
price movements.

Candlestick charts

These charts show the same data as bar charts, but represent the information differently.
Candlestick charts are popular with traders and can be helpful for shorter-term price action.
Point and figure charts

Another type of chart used in technical analysis.

Renko charts

These charts ignore smaller prices that move below a set value. For example, if a value is set at 10
points, a new brick is only made if there is a movement of 10 points or more.
2. Explain the technical indicator Stochastic Oscillator and trading strategies
based on it.

A stochastic oscillator is a momentum indicator comparing a particular closing price of a security

to a range of its prices over a certain period of time. The sensitivity of the oscillator to market
movements is reducible by adjusting that time period or by taking a moving average of the result.
It is used to generate overbought and oversold trading signals, utilizing a 0–100 bounded range
of values.

A stochastic oscillator is a popular technical indicator for generating overbought and oversold
signals.

It is a popular momentum indicator, first developed in the 1950s.

Stochastic oscillators tend to vary around some mean price level since they rely on an asset’s
price history.

Stochastic oscillators measure the momentum of an asset’s price to determine trends and predict
reversals.

Stochastic oscillators measure recent prices on a scale of 0 to 100, with measurements above 80
indicating that an asset is overbought and measurements below 20 indicating that it is oversold.

The stochastic oscillator is range-bound, meaning it is always between 0 and 100.

This makes it a useful indicator of overbought and oversold conditions.

Traditionally, readings over 80 are considered in the overbought range, and readings under 20
are considered oversold. However, these are not always indicative of impending reversal; very
strong trends can maintain overbought or oversold conditions for an extended period. Instead,
traders should look to changes in the stochastic oscillator for clues about future trend shifts.

Stochastic oscillator charting generally consists of two lines: one reflecting the actual value of
the oscillator for each session and one reflecting its three-day simple moving average. Because
price
is thought to follow momentum, the intersection of these two lines is considered to be a signal
that a reversal may be in the works, as it indicates a large shift in momentum from day to day.

Divergence between the stochastic oscillator and trending price action is also seen as an
important reversal signal. For example, when a bearish trend reaches a new lower low, but the
oscillator prints a higher low, it may be an indicator that bears are exhausting their momentum,
and a bullish reversal is brewing.

The stochastic oscillator is only one of several technical indicators used by option traders to time
entry and exit points.

FORMULA FOR THE STOCHASTIC OSCILLATOR

%K=( H14−L14/C−L14 )×100

Where:

C = The most recent closing price

L14 = The lowest price traded of the 14 previous

Trading sessions

H14 = The highest price traded during the

same 14-day period

%K = The current value of the stochastic indicator

Notably, %K is referred to sometimes as the fast stochastic indicator. The “slow” stochastic
indicator is taken as %D = 3-period moving average of %K.

The general theory serving as the foundation for this indicator is that in a market trending
upward, prices will close near the high, and in a market trending downward, prices close near the
low. Transaction signals are created when the %K crosses through a three-period moving
average, which is called the %D.
The difference between the slow and fast Stochastic Oscillator is the Slow %K incorporates a
%K slowing period of 3 that controls the internal smoothing of %K. Setting the smoothing
period to 1 is equivalent to plotting the Fast Stochastic Oscillator.

History of the Stochastic Oscillator

The stochastic oscillator was developed in the late 1950s by George Lane. As designed by Lane,
the stochastic oscillator presents the location of the closing price of a stock in relation to the high
and low prices of the stock over a period of time, typically a 14-day period.

Lane, over the course of numerous interviews, has said that the stochastic oscillator does not
follow price, volume, or anything similar. He indicates that the oscillator follows the speed or
momentum of price.

Lane also reveals that, as a rule, the momentum or speed of a stock’s price movements changes
before the price changes direction.

In this way, the stochastic oscillator can foreshadow reversals when the indicator reveals bullish
or bearish divergences. This signal is the first, and arguably the most important, trading signal
Lane identified.

Relative Strength Index (RSI) vs. Stochastic Oscillator

The relative strength index (RSI) and stochastic oscillator are both price momentum oscillators
that are widely used in technical analysis. While often used in tandem, they each have different
underlying theories and methods. The stochastic oscillator is predicated on the assumption that
closing prices should move in the same direction as the current trend.

Meanwhile, the RSI tracks overbought and oversold levels by measuring the velocity of price
movements. In other words, the RSI was designed to measure the speed of price movements,
while the stochastic oscillator formula works best in consistent trading ranges.

In general, the RSI is more useful during trending markets, and stochastics more so in sideways
or range-bound markets.

Limitations of the Stochastic Oscillator

The primary limitation of the stochastic oscillator is that it has been known to produce false
signals. This is when a trading signal is generated by the indicator, yet the price does not actually
follow through, which can end up as a losing trade. During volatile market conditions, this can
happen quite regularly. One way to help with this is to take the price trend as a filter, where
signals are only taken if they are in the same direction as the trend.
3. What are Qualities of a successful trader?

The success of any business hinges on the ability and skills of its entrepreneur. Identifying
opportunities, building strategies and executing require skill, patience and perseverance. While
many are lured by dreams of making quick bucks from the stock market, one must know this
profession isn’t child’s play.

Unlike other businesses, the trading environment can change rapidly, giving little or no time for
corrective action. A trader’s knowledge, beliefs and patience are constantly tested. Apart from
this, you will have to develop some unique personality traits if you want to be a successful
trader.

We will help you along the way to develop the skills of a trader.

The American Psychological Association (APA) Dictionary of Psychology defines ‘personality

trait’ as “a relatively stable, consistent, and enduring internal characteristic that is inferred from a
pattern of behaviours, attitudes, feelings, and habits in the individual”.

1. Stick to the plan

In the previous chapter, we learned the importance of having a proper trading plan. A good trader
always sticks to that plan which helps him save time on thinking and executing trades quickly as
planned. However, the market sometimes will not move as per expectations. Hence, you may
need to modify strategies while keeping in mind the broader plan and goal.

2. Consistency & Discipline

Other qualities of an effective trader are consistency and discipline. You will need to create a
trading philosophy and train your mind to work towards your goals. You need to be consistent
with your plan and strategies. Trading in a disciplined manner is also necessary. To be a
successful trader, you must remember to avoid taking on unnecessary large risks unless you are
completely
confident about the trade. You must control your emotions and not let them drive your trades in
the market.

3. Have realistic expectations

Being optimistic in the market is important, but so is being a realist. Every trade is executed with
the motive of generating profit. However, the expectations of the returns in the market should be
realistic. Efficient traders have reasonable expectations. Every trade or strategy you make may
not be successful. But remember, effective traders make more money on their winning bets than
they lose on their unsuccessful bets.

4. Diversification

We have learned the importance of diversification. Both long-term investors and short-term
traders have a diversified portfolio which minimises their risks and increases the chances of
making money. Diversification ensures one bad trade does not impact the overall returns.

5. Exit strategy

Professional traders know the importance of exiting the trades. You must chart out exit plans
even before entering a position. An exit plan helps in handling losing trades. Therefore, it is
important to know when to exit a trade. The timing of the exit is crucial to cap losses.

6. Research

Knowledge is power. Proper fundamental and technical research about the stocks before
investing in them is most necessary. Do your homework. Blindly choosing stocks without any
prior knowledge about it could be a bad strategy. An efficient trader also keeps track of all the
latest developments and events that impact the stock market. You must prepare a wish list of
companies you want to track and remain informed about all the happenings related to those
companies which may impact the stock prices.

7. Managing risk

Trading involves managing risks efficiently. This is an important quality of a successful trader to
manage his risk in every trade he executes. Everyone trades with finite capital. A proper risk
management habit ensures the capital to be employed in a particular trade and limits the losses in
case of a wrong trade. Apart from these seven habits, an effective trader always learns from his
trades, whether successful or unsuccessful and focuses on executing trades in the best cost-
effective way. Being successful in the stock market requires discipline, persistence and hard
work like any other profession.