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  • Whipsaws


    A condition where a security's price heads in one direction, but then is followed quickly by a movement in the opposite direction. The origins of term are derived from the push and pull action used by lumberjacks to cut wood with a type of saw with the same name. In other words, Whipsaws refer to the rapid moment of stock prices either upwards or downwards according to the market movements.

    There are two types of whipsaw patterns. The first involves an upward movement in the share price, which is then followed by a drastic downward move, which causes the share's price to fall relative to its original position. The second type involves the share price to drop for a little while, and then suddenly, the price abruptly surges towards positive gains relative to the stock's original position.

    Some investors jump on the stock before it has reserved and caused the whipsaw. Investors might lose money from a whipsaw by buying a stock right before the prices fall or by selling a stock just before the prices rise. Whipsaw is there for related to "chasing the market" when an investor seems to lag behind the market. A whipsaw is dangerous to traders because it throws up an initially misleading signal to buy or sell.




  • Bearish Three Line Strike


    This is a bearish candlestick pattern that signals the continuation of the current downtrend. The pattern comprises of 3 long black candlesticks that is placed in the current downtrend with each candlestick closing lower than the previous. The fourth candlestick is a white candlestick that closes near the open of the first candlestick.





    Bearish Three Line Strike found in a stock chart:



    Chart by DirectFN™ TWS


    The first three black candlesticks is essentially the Three Black Crows pattern which is a strong bearish signal. Chartists consider the fourth day's white candlestick not as a bullish signal but more as a signal that the sellers are covering up their positions.

    This chart pattern should not be used in isolation but should be coupled with other confirming evidence to conclude the downtrend is continuing.




  • Book Value per
    Share


    The book value of a company is generally considered its net worth. And the book value per share would be the net worth of a company divided by the number of shares outstanding.

    Net worth of a company is the amount by which assets exceeds the liabilities of a company which is commonly known as Shareholders Equity.





    When calculating the Book value per share the Preferred Equity value is also deducted from the Shareholder's Equity as preferred shareholders are not considered as the owners of a company.

    This is the value that will be available for equity holders after all debts of the company are paid. In other words, it is the amount of safety available for owners of a company.

    Investors can compare the Book Value per Share with the Market Price per Share to determine whether the share is overvalued, undervalued or fairly valued. If the share price is higher than the book value the share can be considered as overvalued and if the share price is lower than the book value the share can be considered as undervalued.




  • Fibonacci Arc


    This is another chart pattern that enables support and resistance levels to be established. As the name suggests this indicator uses Fibonacci number series to draw arcs at significant support and resistance levels



    Chart by DirectFN™ TWS


    The arcs are created by drawing a trend line between the high and low during a given period and then by drawing three curves that intersects this trend line at the Fibonacci levels. The first and the third arcs are drawn at Fibonacci levels of 38.2% and 61.8% and the middle arc is drawn at 50%.

    If the price is in a downtrend the Fibonacci arc will act as a support level and reaching an arc would mean the price would bounce and move up. If the price is in an uptrend, the price reaching an arc would mean the price is finding resistance and would reverse the trend.

    Traders can anticipate the reversal of a trend using the Fibonacci arcs. However, just because prices approach an arc does not mean they will reverse. Prices move right through these arcs in many cases.
    Therefore it is important that this indicator be used with other indicators for confirmation.




  • Profit Margin


    Profit margin which is a key indicator of measuring explains how much profit a company makes for every $1 it generates in sales. Here, the profit is after all costs have been taken into consideration which means profit after interest and tax.

    The formula for the calculation is as follows:-





    Profit Margin is expressed as a percentage. For example a 20% profit margin indicates the company makes $0.20 net income for every $1 of its sales. Profit margin is used to compare the profitability across the industry. Higher profit margin means the company is a more profitable when comparing companies in similar industry and the company control its costs more effectively than their competitors.

    Profit margin provides information on the company's pricing, cost structure and production efficiency. Different pricing strategies and product mix also has the impact on profit margin. For example, retail businesses are willing to have low profit margin in order to increase their volume and sales. In some cases, the cost for product improvements may reduce the profit in the current year though they lead to the increasing profitability in the future. Hence, low profit margin does not always means less efficiency.

    A ratio may vary from year to year due to abnormal conditions and expenses. Therefore, it is always worth analyzing the ratio over several periods to find out the reason for abnormal variations.

    In addition to profit margin, another specific profit margin measure often calculated is gross profit margin. Gross profit margin indicates the profit level after direct costs or cost of sales have been taken into account whereas for the net profit margin the profit is considered after all direct and indirect costs have been taken into account.

    Comparing the gross and net profit margins give a good impression on their non-direct costs such as administration, marketing and finance costs. These comparisons can give better insight into their cost structure. For example, a company with gross profit margin of 80%, but the net profit margin of 20% indicates that their administrative and overheads are high whilst their cost of sales is lower.




  • Bearish Side by Side White Lines


    This is a bearish candlestick pattern found in a downtrend that signals the continuation of the current downtrend. The pattern includes three candlesticks with the first day being a black candlestick placed in the current downtrend. The second candlestick is a white candlestick which opens well below the close of the previous day's candlestick. The third candlestick is again a white candlestick of the same size as the second candlestick and having the same close.





    This pattern in a stock chart:



    Chart by DirectFN™ TWS


    The two white candlesticks in the downtrend shows that the sellers are covering their positions. But these two candlesticks should not be seen as a signal that the downtrend is reversing.

    Since the two white candlesticks cannot break the body of the first candlestick it is considered that bullish investors do not have control over the market yet.

    This candlestick pattern is said to be confirmed if the wicks of the second and third candlesticks do not reach up to the body of the first candlestick.




  • Debt to Equity Ratio


    Debt to equity ratio is the most well-known indicator to measure a company's financial leverage or risk inherent in the shares of the particular company when company employs debt. This ratio explains the proportion of assets of the company that are financed by debt.

    Debt to equity ratio is also known as external to internal equity ratio as it explains how much of capital is contributed by the shareholders or internal equities and creditors or external equities. The ratio is calculated by dividing total debt of the company by shareholder's equity. The formula of the ratio is as follows:-





    The value of the ratio below 1 indicates that the majority of the company's assets are financed by shareholders funds. If the value is more than 1, the assets are primarily financed by the debt rather than by internal funds.

    A higher value for this ratio might not be a good indicator since the company with the more debt may be a more risky investment than a company with the lesser debt. This is because the company must pay their interest and principal amount of debt on time in order to survive. Failing to do so, could lead to liquidation or bankruptcy. On the other hand, companies with very low level of debt are also not preferable as those companies will not have the potential to grow.

    Debt to equity ratio is used not only to select a sound investment but also to decide the interest rate that should be charged when giving out debt to the company. A company with a high ratio will be charged a higher interest rate as creditors are reluctant to give debt to that company because of the default risk inherent in the debt. Therefore, the debt to equity ratio indicates the amount of protection available to creditors.

    Generally, the satisfactory debt equity ratio is 1:1 which means the company can have 1 dollar of debt for every 1 dollar of equity. But in reality, the proper debt to equity ratio depends on the industry in which it operates. For example, manufacturing companies will have a ratio above 2 while the companies in the less capital intensive industry may have a ratio of below 0.5. In order to make a good investment decision, it is important to look at the ratio over several periods and compare with other companies in the same industry.




  • Money Flow


    Money Flow is calculated by multiplying typical price by the volume for that particular day. Typical Price is calculated as follows:








    If the Money Flow for the current day is higher than the Money Flow for the previous day the Money Flow is positive for the current day. Likewise, if the Money Flow for the current day is lower than the Money Flow for the previous day the Money Flow is negative for the current day.

    Money Flow being positive means the investors were willing to pay a premium for the stocks and a negative Money Flow indicates that the selling pressure is high.




  • Bullish Tri Star


    This candlestick pattern is found in a downtrend and signals the reversal of the current downtrend. The chart pattern includes three Dojis ocurring on three consecutive days.



    Chart by DirectFN™ TWS


    A Doji candlestick suggests market indecision as sellers or buyers cannot move the close price away from the open. This kind of price action is quite common during periods with lower market activity but Dojis occurring after an established downtrend suggests a reversal in the trend.




  • Dividend per Share (DPS)


    Dividend per share is the amount of dividend that a shareholder will receive for each share held. This can be calculated as follows:





    For Example If a company pays a total of $ 1million in dividends and has 10 million shares the dividend per shares is 10 cents.

    Dividends are profit-sharing methods allowing the distribution of company profits to the shareholders who actually own the company. Dividends could be paid on a quarterly, half yearly or annually. The dividend per share is important both to shareholders who expect to realize a financial gain from dividends paid and to financial analysts and investment brokers who often use the dividend per share as an indicator of a company's overall financial profitability.

    Dividends are paid to holders of shares on the record date which will be announced before hand by the company. More important form an investor's point of view is the ex-dividend date on, and after, which shares bought or sold on a stock exchange under normal terms will be sold without the dividend so that the seller will get the dividend.




  • Downside Tasuki
    Gap


    The chart pattern is found in a downtrend and would signal the continuation of the current downtrend. This pattern has a moderate reliability and as such should be used in conjunction with other technical indicators when making the trading decision.

    The first two candlesticks are placed in a downtrend with a gap in between the two as shown below. The third candlestick would be a white candlestick which indicates that buyers are taking advantage of the low prices to buy shares. However, when the third candlestick does not fill the gap between the first and the second black candlesticks it is an indication that the downtrend will continue.





    The Downside Tasuki in stock chart:



    Chart by DirectFN™ TWS


    It is considered a black candlestick on the fourth day would act as a confirmation for this candlestick pattern.




  • Envelope


    This is similar to Bollinger Bands but simpler than that. These bands are used by traders to define the upper and lower boundaries of a stock's price. Moving averages, either simple or exponential, are used to draw the two boundaries.

    The Envelopes can be used to identify oversold and overbought conditions of a stock, when they reach the upper and lower boundaries of the Envelope. When the price line touches the upper band the stock is overbought and when the price line touches the lower band the stock is oversold.



    Chart by DirectFN™ TWS


    A BUY signal occurs when the price touches the lower band and a SELL signal is given when the price touches the upper band. The reason this is that stock prices tend to bounce off when they touch the bands.

    However, since only past price data are used to calculate the moving averages which act as the 2 bands of the Envelope the signals given would be lagging behind. Therefore, this indicator is best used for trend identification and not for predictions and should be used along with other indicators.




  • Earnings Yield


    This ratio shows the percentage of the company's earnings for one dollar invested in the company. This ratio is the reciprocal of the well-known PE ratio and is calculated as follows:





    If the company has an earnings per share of $2 and the market price of the share is $20 the PE ratio would be 10 and the Earnings Yield would be 10% (or 1/10). This would mean that the company's earnings are equal to 10% of its market price.

    This ratio is used by investment managers to determine the optimal portfolio of investments. They will often use the earning yield of the overall market to compare it with current interest rates such as the Treasury yield. If the earnings yield less than the Treasury yield, stocks may be considered overvalued and of the earnings yield is more than the Treasury yield, the stocks may be considered undervalued.

    It is generally considered the earnings yield should be higher than the interest rate of bonds to compensate for the additional risk of equity.




  • Falling Three Methods


    This is a bearish candlestick chart pattern which signals the continuation of the current downtrend. The chart pattern includes 5 candlesticks with the first candlestick being a long black candlestick and the second, third and fourth candlesticks are small white candlesticks moving in the opposite direction of the current downtrend. The fifth candlestick is another long black candlestick which resumes the previous downtrend. The chart pattern would look like follows:





    This chart pattern found in a stock chart:



    Chart by DirectFN™ TWS


    When Falling Three chart pattern is found in a downtrend it is an indication that the downtrend will continue and the temporary upward trend is a pause in the downtrend. This is an indication for the investors that the buyers still don't have power to reverse the downtrend.




  • Oversold


    Oversold is the opposite of overbought. This is a condition in which the price of the share has fallen below its true worth. In other words, if the price of a stock has fallen sharply over a short period of time that stock is overbought. This usually happens when as a result of the market overreaction or panic selling. If the price of the stock is too low when compared to the fundamental factors surrounding a stock then the stock is considered to be oversold.

    In technical analysis, oversold stocks can be identified when the values for oscillators, such as Relative Strength Index or the Stochastic Oscillator have reached lower limits. For example, if the RSI for a stock has reached 30 which is considered the lower limit of RSI indicator, such a stock is considered to be oversold.

    If a stock is oversold it is generally considered that the asset is undervalued and as such provides a buying opportunity for investors.




  • Elliott Wave Theory


    Elliott Wave Theory introduced by Ralph Elliott established the fact that although stock markets behave in a chaotic manner, repetitive patterns could be identified in the trading behavior. This theory proves that the upward and downward trends moved in the same repetitive waves.

    Two kinds of waves are identified in this theory, impulsive and corrective. Impulsive waves move in the direction of the main trend and corrective waves move in the opposite direction of the main trend. According to Elliott Wave theory impulsive waves always show five waves in its pattern while corrective waves always have three waves in its pattern.

    In an uptrend the waves that move upward are impulsive waves while the waves that move downward are corrective. On the other hand, in a downtrend the waves that move downward are impulsive waves while the waves that move up are corrective waves.

    A complete wave includes 8 waves out of which 5 are impulsive and 3 are corrective. In the following 8 wave cycle 1,3,5,A and C are impulsive waves while 2,4 and B are corrective waves.





    To identify an Elliott Wave the following rules should be followed:

    • The 2nd wave should not retrace more than 100% of the 1st wave;
    • The 3rd wave should not be the shortest from the three impulsive waves;
    • The 4th wave should not overlap the 1st wave.


    It is also considered that when 3rd wave is the longest wave, the 5th wave will be approximately equal to the length of the 1st wave. If the 2nd wave is a sharp correction (with a high slope) the 4th wave will be flat (flat slope) and if the 2nd wave is a flat correction the 4th wave will be a sharp correction. After a 5 impulsive waves advance, the three ABC waves will end near the low of the 4th wave.


    Chart by DirectFN™ TWS


    When the five wave impulsive cycle is completed there is a fair likelihood that the 3 wave corrective wave cycle will materialize. However, the Elliot Wave Theory is criticized by many as there is not a clear definition of when a wave starts or ends.




  • Bearish Abandoned Baby


    This is a bearish reversal pattern and is found in the top of an uptrend. The first candlestick is a white candlestick, the second candlestick is a Doji or a small candlestick and the third candlestick is a black candlestick as shown below:





    The chart pattern found in a stock chart:


    Chart by DirectFN™ TWS


    The Doji on the second day halts the upward trend and on the third day the downtrend starts. The stronger the move down on day-three, the stronger the reversal signal. If you want additional confirmation signals, look for the following few days for bearish action for the stock.




  • Fixed Assets Turnover Ratio


    This ratio measures the efficiency with which the company's fixed assets are used in generating sales. When calculating the Fixed Assets Turnover Ratio different items would be used for Fixed Assets. While certain people use only Property, Plants and Equipment ratio for the calculation certain others use the Total Non-Current Assets figure for the calculation.

    The ratio is calculated as follows using Total Non-current Assets:






    The higher the value for this ratio better it is as it would mean that the company is generating more sales from the fixed assets available for its use. The higher the ratio, the higher the efficiency of using the fixed assets is.

    This ratio is more appropriate for companies in the manufacturing industry as they purchase high worth fixed assets for manufacturing operations and the efficiency with which revenues are generated from these assets could be measured through this ratio.




  • Overbought


    A share is considered to be overbought when the demand for that share pushes the price up, to a level that is not supported by its fundamentals. What is meant by fundamentals is the factors such as cash flow position of the company, return on assets generated by the company, the quality of debt management of the company and whether profits are retained in the company for future growth.

    If the price of the stock is too high when compared to the fundamental factors surrounding a stock then the stock is considered to be overbought. This definition of overbought is when taking fundamental factors in to consideration.

    In technical analysis, overbought stocks can be identified when the values for oscillators, such as Relative Strength Index or the Stochastic Oscillator have reached upper limits. For example, if the RSI for a stock has reached 70 which is considered the upper limit of RSI indicator, such a stock is considered to be overbought.

    If a stock is overbought it is generally considered as a sign that the price will reduce in the future as the stock is trading above the real worth of that share.




  • Bearish Harami


    This is a candlestick pattern with a long white candlestick followed by a small black candlestick. The small black candlestick will be placed within the body of the large white candlestick.



    Chart by DirectFN™ TWS


    The Bearish Harami is found in an uptrend stock chart and will signal that the uptrend is about to reverse. The smaller the black candlestick stronger the reversal signal is considered to be.


    BUY/SELL Signals

    If you spot a Bearish Harami in an uptrend stock chart a sell signal is given. However, it is important that this technique is accompanied with other techniques when forming the decision as this is considered to be giving a relatively weak signal.




  • Dividend Payout Ratio


    This ratio measures the percentage of earnings of a company paid to shareholders as dividends. The basic formula for this ratio is as follows:





    A high payout ratio would mean the company pays out more money to shareholders than it retains in the company for reinvestment and vice versa.

    The amount of earnings that is retained in the company, without paying out to shareholders as dividends will be reinvested in the company's operations. Investors who prefer current income rather than capital gains in the future would prefer a high payout ratio. On the other hand, shareholders who prefer capital gains in future as opposed to current dividends would prefer a lower dividend payout ratio.

    It is generally considered that relatively mature companies will have a higher dividend payout ratio as the opportunities for new investments are less. Conversely, high growth companies will have a lower level of payout ratio as they tend to reinvest its earnings. But this is not applicable to all companies as investment plans would vary depending on the long term objectives of a company.



  • Chande Momentum Oscillator


    This is a momentum indicator introduced by Tushar Chande. Momentum indicators measure the rate of change in closing prices to identify trend weaknesses and likely reversal points. This is calculated by calculating the difference between the sum of all recent gains and the sum of all recent losses and then dividing the result by the sum of all price movement over the period.



    Chart by DirectFN™ TWS


    The security is considered to be overbought when the value of the oscillator is above 50 and oversold when it is below -50.

    Another variation of this indicator is to add a nine day moving average to use as a signal line. When the oscillator crosses the signal line from below to above a bullish signal is given and when the oscillator crosses the signal line from above to below a bearish signal is given.

    This indicator should be used with other indicators when making the final BUY or SELL decision.




  • Shooting Star


    This is bearish candlestick pattern that is found in an uptrend. The price during day moves well above the opening price but closes below it. The candlestick would look like below:





    The upper should be twice as long as the body of the candlestick and the lower wick should be very small or non-existent. The color of the body could either be black or white.



    Chart by DirectFN™ TWS


    BUY/SELL Signals

    If you spot shooting star in an uptrend it is a reversal of the current uptrend and as such gives a SELL signal. However, other indicators should also be used before making the final decision.




  • Pivot Point


    Pivot point is a predictive indicator and is calculated by averaging a stock's high, low and closing prices. Pivot point acts as support level or resistance level depending on the current price. If the current price is above the pivot point it acts as a support level for the stock and if the current price is below the pivot point it acts as a resistance level for the stock.

    We have explained in a previous article about Support and Resistance and when arriving at these levels one of the most common methods used is Pivot Points. 2 levels of support and resistance are drawn on either side of the Pivot Point as follows:


    SECOND RESISTANCE: R2 = Pivot Point + High - Low
    FIRST RESISISTANCE: R1 = 2(Pivot Point) - Low
    PIVOT POINT = (High + Low + Close) / 3
    FIRST SUPPORT: S1 = 2(Pivot Point) - High
    SECOND SUPPORT: S2 = Pivot Point - High + Low


    As we mentioned earlier, the pivot point itself is the primary support or resistance. This means that the largest price movement is expected to occur at this price level. The other support and resistance levels are less influential, but may still result in significant price movements.

    It is generally considered that if the pivot point is broken in an upward movement then the market is bullish. And if the pivot point is broken in a downward movement, then the market is bearish.

    You should keep in mind that pivot points are short-term trend indicators, useful for only one day until they need to be recalculated.



  • Liquidity Ratios


    Liquidity ratios measure the company's ability to pay off its short term liabilities. Generally it is considered that higher the value of these ratios the better because it signals that the company has enough short term assets to meet its short term liabilities.

    Commonly used liquidity ratios include current ratio, quick ratio, cash ratio and operating cash flow ratio. These ratios differ in the assets they use to calculate the liquidity.

    These ratios are calculated as follows:





    The target value for this is considered to be 2:1 which means the company should have $2 of current assets for every $1 of current liabilities. However, the industry in which the company operates should be taken into account when interpreting this ratio as it would have an effect on the quality of the current assets.





    Quick assets figure arrived at by subtracting inventories or stocks from the current assets. Inventories are considered to be less liquid and the quick ratio measures the company's ability to pay off current liabilities from the most liquid assets available to the company. The generally acceptable value for this ratio is 1:1 although this should not be applied to all companies as the quality of current assets will differ largely based on the industry in which the company operates.





    This ratio is more conservative than the other ratios as it compares the cash available in the company with the current liabilities.





    Operating cash flow ratio measures the cash available from operating activities of the company to pay off its short term debt. Operating activities are the main revenue generating activities of a company.

    Generally trade creditors look at these ratios before selling goods on credit and it is also a good measure for investors to measure the liquidity of a company.




  • PE Ratio


    Price Earnings ratio is one of the ratios frequently used by investors in making investment decisions. This ratio compares the price of the stock with its earnings. The calculation is as follows:





    Interpretation of this ratio is how much investors are paying for a Dollar of its earnings. A PE ratio of 20 suggests that the investors are paying $20 for $1 of its earnings. A higher PE ratio means the stock is more expensive compared to a stock with a lower PE ratio.

    In making investment decisions investors can compare the PE ratio of one company with that of another. But it is important that you compare the PE ratios of companies in the same industry (sector) or the company PE with that of the industry PE ratio to get a meaningful result.

    For example, take three companies of the same sector, ABC, PQR and XYZ. Assume ABC has a PE of 0.5, PQR has a PE of 3.3 and XYZ has a PE of 1.9, when you compare the three ratios ABC company is the best in terms of growth prospects while XYZ comes second and the PQR third. Let's assume the PE ratio for the industry is 2. That would mean both ABC and XYZ are performing in pa with the industry.

    It is generally considered that lower the PE ratio compared to the industry or competitors, the better the growth prospects of the company. However, a lower PE ratio is not in itself considered to be good or a higher PE is not in itself considered to be bad.

    When using PE ratio for stock analysis you should consider the extra amount you are paying for the company's earnings today and determine if it is reasonable for the expected growth in the earnings. PE Growth ratio (which will be explained in a subsequent article) takes the expected earnings growth into account is one step ahead of the PE ratio and is eliminates one shortcoming of PE ratio.




  • Chaikin Oscillator


    This indicator measures the momentum of the Accumulation Distribution line (discussed in an earlier article) which measures the demand and supply of a stock by determining whether there's buying or selling pressure in the market. As such Chaikin Oscillator is an indicator of an indicator.

    This indicator is the difference between the 3-day EMA of the Accumulation Distribution line and the 10-day EMA of the Accumulation Distribution line. Chaikin Oscillator will anticipate the directional changes of the Accumulation Distribution line by studying the momentum of the same. A momentum change in the Accumulation Distribution line will suggest a momentum change in the price of the security under concern. And finally will suggest a change in the trend of the price movement of the security.



    Chart by DirectFN™ TWS


    Interpretation

    The oscillator will fluctuate on either side of zero and a move into positive region indicates that the Accumulation Distribution line is increasing which suggests that buying pressure prevails in the market. On the other hand a move into the negative region suggests that selling pressure is prevailing in the market. When the oscillator moves in to the positive region this indicator gives a BUY signal and when the oscillator moves in to the negative region a SELL signal is given.

    The movements of the oscillator could be identified by divergences between the Chaikin Oscillator and the price line. If the oscillator moves up and the price line moves down it is a bullish divergence and if the oscillator moves down with the price moving up it is a bearish divergence.

    One disadvantage in this indicator is that as it measures the momentum of another indicator it is removed from the actual price and volume data of the security. As with all other indicators, Chaikin Oscillator should not be used as a stand-alone tool in making trading decisions.




  • Fundamental Analysis


    In a previous article we gave you a brief introduction about the difference between fundamental analysis and technical analysis. Today we will explain the importance of fundamental analysis and its role when it comes to analysis of stocks.

    Fundamental analysis is essentially a method of evaluating stocks by attempting to place a value for the stock by examining company specific factors and other external factors affecting a stock.

    Company specific factors include the financial position and performance which is reflected by the profit and loss account, balance sheet and the cash flow statement of a company.

    External factors affecting a stock include the political, social, legal and environmental factors. For example, a favorable change in the taste of the customers for the company's product will affect the company positively whereas introduction of a new tariff will affect the company negatively.

    More commonly valuing a stock involves analyzing the financials of the company. Figures in the financial statements are used to develop ratios that will analyze various aspects of the company, such as, profitability, liquidity, asset quality of a company.

    While Technical Analysis uses past price data to identify trends and predict future price movements, Fundamental Analysis uses internal and external factors surrounding the company that would have an effect on its performance. Investors can compare the values of these ratios of a number of companies and come to a conclusion as to which company is performing well compared to others.

    Ratios most commonly used by investors to evaluate the performance of a company include, Price/ Earnings ratio, Price/ Book Value, Earning per Shares, Profit Margin, Return on Equity, Return on Assets, Assets Turnover, Quick Ratio, Cash Ratio, Equity Ratio, Debt to Equity Ratio, Debtors Days, Creditors Days and Inventory Days.

    The interpretation and the uses of the important ratios will be discussed in later articles.




  • Wedge


    Wedge is a triangular chart pattern with a noticeable slant either upward or downward. Wedge begins wide at the beginning of the pattern and contracts towards the end of the pattern. This charting pattern could either be a continuation pattern or a reversal pattern.



    Chart by DirectFN™ TWS


    If the slant of the Wedge is upward it is a Rising Wedge and is considered to be bearish. If the Rising Wedge is in an uptrend stock chart this is considered to be a reversal signal and the current uptrend will be reversed. And if the Rising Wedge is in a downtrend stock chart this gives a continuation signal and the current downtrend will be continued.

    On the other hand if the slant of the wedge is downward it is a Falling Wedge which is considered to be bullish. When the Falling Wedge is in an uptrend stock chart that is a continuation signal and the current uptrend will be continued. And if the Falling Wedge is positioned in a downtrend stock chart that gives a reversal signal and the current downtrend will be reversed.


    Interpretation

    The fact that wedges can be either reversal or continuation patterns make the identification of the signals a confusing. However, it is considered that if the prices breakout of the upper trend line that gives a signal of the continuation of the current trend. And if the prices breakout below the lower trend line that would signal a reversal of the current trend.

    To make best use of this pattern it is important that you use it with other technical analysis techniques before making the final decision.




  • Negative Volume Index


    This index is the opposite of Positive Volume Index and attempts to determine the trend of trading of the shrewd or experienced investors. As we explained earlier on higher volume trading days inexperienced traders are involved and the experienced investors trade on days when the volume is decreasing.



    Chart by DirectFN™ TWS


    NVI pays attention to the days where the volume decreased from the last day and the index gives signals when it is compared with its one year moving average.


    BUY/SELL Signals

    When the Negative Volume Index crosses above its one year moving average the approach of a bull market is signaled. And when the Positive Volume Index is below its one year moving average a bear market is expected, although with lower probability.




  • Swing Index


    Swing Index is a momentum indicator which indicates the real strength and direction of the market. The Swing Index is calculated using the current day's and previous day's high, low and close in an attempt to isolate the real price of the security. This is primarily used as a component of the Accumulative Swing Index which will be explained at a later date.

    Swing Index gives a value that ranges between +100 and -100 and provides a line which gives definitive short term swing points.



    Chart by DirectFN™ TWS


    You will notice from the above graph that the Swing Index fluctuates often and it is difficult to obtain signals from this index alone. The value of this indicator will improve when it is used in conjunction with Accumulative Swing Index.




  • Chaikin Money Flow


    Money Flow, developed by Marc Chaikin, uses both price and volume to record a more complete picture of the price action of a particular security. It attempts to gauge the market sentiment of a security by identifying buying and selling pressure. This technique is closely linked to Accumulation Distribution Indicator and can be considered an extension of the indicator.

    Chaikin Money Flow (CMF) is an oscillator and fluctuates between -1 and +1. However, this indicator will rarely reach the extreme levels and will typically fluctuate between -.50 and +.50 with zero as the centerline. A positive value for the will signal buying pressure for the security and a negative value will signal selling pressure.



    Chart by DirectFN™ TWS


    BUY/SELL Signals

    A positive value for this indicator signals is considered bullish and a move below zero is considered bearish. However, when zero is taken as the threshold there is a likelihood that false signals will be given with many crossovers of the zero line. You will have to study the indicator and decide whether the threshold should be increased to +.5 or -.5.

    It is important that this indicator is used with other indicators in making the trading decision and it should not be used as a standalone tool.




  • Positive Volume
    Index


    This is an index that attempts to determine the trend of trading of the uninformed crowd. Generally it is believed that on a day with high volume of trading the inexperienced investors are involved. The uninformed crowd tends to trade on days the volumes are rising whereas the informed investors trade on days where there is declining volume.



    Chart by DirectFN™ TWS


    PVI pays attention to the days where the volume increased from the last day and the index gives signals when it is compared with its one year moving average.


    BUY/SELL Signals

    When the Positive Volume Index crosses below its one year moving average the approach of a bear market is signaled. And when the Positive Volume Index is above its one year moving average a bull market is expected.

    Although the Positive Volume Index should demonstrate what the uninformed crowd is doing, it is however moving in the same direction as prices are.




  • Bullish Engulfing


    This is a candlestick pattern which consists of two candlesticks. The first candlestick is a small black candlestick with short tails or shadows. The second is a long white candlestick that completely covers the length of the first black candlestick.



    Chart by DirectFN™ TWS


    This pattern if found in a downward trend stock chart means that the bullish investors have taken control over the bearish investors. This will signal that the stock's downward trend has come to an end and the bottom of the downward trend is marked.

    Generally, the larger the white candlestick and the greater the engulfing, the more bullish the reversal is expected to be.


    BUY/SELL Signals

    A Bullish Engulfing pattern in a downward stock chart gives a BUY signal to the trader. However, as usual in candlestick analysis, the trader must take the preceding and following days' prices into account before making any decisions regarding the security.



  • Bullish Harami


    Bullish Harami is a candlestick pattern with a large black candlestick followed by a smaller white candlestick. The small white candlestick is placed within the body of the preceding black candlestick.



    Chart by DirectFN™ TWS


    The Bullish Harami is found in a downward stock chart and gives the signal that the downward trend is about to reverse. The reversal signal is considered to be stronger when the white candlestick is smaller.

    The long black candlestick is generally on high volume and the next day the volume will be lighter. If the third day closes up it is a signal that the reversal is confirmed.


    BUY/SELL Signals

    If you spot a Bullish Harami in a downtrend stock chart a buy signal is given. However, it is important that this technique is accompanied with other techniques when forming the decision.




  • Accumulation Distribution Indicator


    This is a momentum indicator that measures the supply and demand of a stock by determining whether investors are buying (accumulating) or selling (distributing) the security. This is done by identifying the divergences between stock price and volume movement of the stock, measured through the Accumulation Distribution line.



    Chart by DirectFN™ TWS


    As for an example, in a downtrend if the prices close up a number of days with high volume this is an indication of a reversal in the current downtrend. When the indicator diverges from the price line of the security a reversal of the trend is indicated.


    BUY/SELL Signals

    An uptrend in prices with a downtrend in the Accumulation Distribution Line suggests selling pressure for the stock and would signal a reversal in the current uptrend. A downtrend in prices with an uptrend in the Accumulation Distribution Line indicates buying pressure in the market and would signal a reversal of the current downtrend. Once this divergence of the Accumulation Distribution line and the price line is identified, the trading decision could be arrived at accordingly with the help of other indicators as well.




  • Dark Cloud Cover


    Dark Cloud Cover is a bearish candlestick pattern starting with a long white candlestick followed by a black candlestick. This pattern placed in an uptrend stock chart is an indication that the current uptrend will change. The name of this pattern is derived from the fact that the black candlestick is forming a dark cloud over the preceding uptrend.



    Chart by DirectFN™ TWS


    The closing price of the black candlestick or the dark cloud should be within the body of the preceding long white candlestick and below the mid-point of the same. The black candlestick generally opens above the white candlestick. It is also thought that the signal is stronger and confirmed if the black candlestick on day 2 is followed by another black candlestick with a gap as shown in the above chart.


    BUY/SELL Signals

    Therefore if you spot a Dark Cloud Cover in an uptrend stock chart it is a SELL signal. However, it is important that you should use other techniques when forming the decision.




  • History of Technical Analysis


    For the past few weeks we have been sharing with you various technical analysis techniques that must have undoubtedly helped you in your trading decisions. Today we will share with you the history of this invaluable field of study.

    You will probably be surprised to hear that the history of technical analysis dates back to over hundreds of years and the origin is of technical analysis is considered to be Japan. The candlestick charting patterns which is still used by traders was first designed by a Japanese rice trader named Homma Munehisa in the 18th Century.

    In the United States the modern technical analysis gained popularity with the introduction of Dow Theory by Charles Dow in the late 19th Century. Charles Dow, the owner and editor of The Wall Street Journal wrote a series of articles from 1900 until his death in 1902. Through these articles he developed a series of principles for understanding and analyzing market behavior which later became known as the Dow Theory, the basis for technical analysis. Later S A Nelson and William Hamilton improved the theory to what it is today.

    Today, many more technical tools and theories have been developed and enhanced in recent decades, with an increasing emphasis on computerized trading tools.




  • Dead Cat Bounce


    This phrase has been derived from the fact that even a dead cat will bounce if it is dropped from a great height. So how does it exactly relate to stock markets?

    You must be familiar with the fact that stock markets or at least certain stocks do fall from great heights once in a while. That is to say that stock prices do plummet due to various reasons ranging from economic downturns, adverse earning announcements, etc. In such an instance, if the market or the stock achieves a small and temporary recovery after the large fall, it is considered to be a dead cat bounce. Two points should be noted here. Namely, the recovery is small and it is temporary!

    For example, if a stock has been trading at Rs. 45 and after a poor earnings announcement the price falls to Rs. 34 and few days later it is trading at Rs. 29. The stock has seen a large fall but suddenly the price of the stock rises to Rs. 33 without any positive news. This is known as a Dead Cat Bounce!

    This behavior is considered to be caused basically from the following two reasons:

    • Investors starting to accumulate shares with the perception that the price of the share is lower than the actual worth of the share. These investors buy the share with the idea that the market has undervalued the share and that it will return to its true worth in the long run. The buying pressure resulting from this would push up the prices temporarily;

    • Short sellers covering their positions. (Short sellers borrow a particular stock from the market expecting for the price to drop and then buys it at a cheaper price and replace it, thereby gaining a margin). When short sellers buy the share from the market to replace what they have borrowed the buying pressure would result in an increase in the price in the short run.

    You should remember the fact that this price increase is not as a result of a change in any of the underlying fundamental factors of the company but as a result of the above two factors.

    This is considered to be a continuation pattern which suggests that the initial downward trend will continue after the brief upward movement unless other factors surrounding the stock suggests a long term upward movement of prices.




  • Fibonacci Fan


    Fibonacci Fan consists of three trend lines that act as Support and Resistance levels in the Fibonacci sequence. A trend line is drawn from a trough to a peak and the charting software will draw the three lines of the fan at the Fibonacci levels of 38.2%, 50% and 61.8%. It is assumed that when the price line approaches the Fan lines drawn at Fibonacci levels the trend is likely to reverse. However, if the prices move below or above a Fan's line then the next Fan line will cause the trend to reverse.

    If the Fibonacci Fan is drawn in an uptrend stock chart, if and when a decline starts the fan lines provide key levels at which the prices are likely to reverse. On the other hand, if the Fibonacci Fan is drawn in a downtrend stock chart if the prices start an upward trend the Fibonacci Fan levels will provide levels at which the price is likely to resume the downward trend again.

    As such these Fan lines act as Support and Resistance levels. If price moves down a Fan line that line will act as a Resistance level and the next Fan line will act as a Support level preventing the prices from moving down further. However, if the prices move outside the fan it is expected that the prices will reverse the trend and move back into the fan.


    Chart by DirectFN™ TWS


    BUY/SELL Signals

    If the Fibonacci Fan is drawn in an uptrend stock chart and the prices take a downward move, when the prices reach the lines of the Fan a BUY signal is triggered.

    If the Fibonacci Fan is drawn in a downtrend stock chart and the prices take an uptrend move, when the prices reach the lines of the Fan a SELL signal is triggered.

    However, you should keep in mind that not all the time will the price reverse when in approaches the fan lines and will move right through the fan lines in many cases. As such you should not use this as a standalone tool and other accompanying techniques should be utilized.




  • Piercing Line Pattern


    This is a candlestick pattern that suggests a reversal in the current downtrend. The pattern consists of 2 long bodied candlesticks with the first candlestick being black and the second one being white. The second white candlestick opens below the previous close and closes above the mid-point of the first black candlestick



    Chart by DirectFN™ TWS


    This pattern is found in a downtrend stock chart and the price on the second day, opening below the close of the first day suggests that the sellers or bearish investors are in power. However, the bullish investors step in and push the prices up for the security to close above the mid-point of the first candlestick.


    BUY/SELL Signal

    A BUY signal is given by the Piercing Line pattern and the reversal of the downtrend is suggested. However, other indicators should be used in making the final decision and higher than usual volume on day 2 can be considered a stronger indicator of the reversal.




  • Double Bottom


    This can be seen in a downtrend stock chart and consists of two troughs. Similar to a Double Top the two troughs will be at the same or just about the same levels and a trend line will be placed across the base of the two troughs. When the price moves up cutting through this trend line, that uptrend is considered to continue.



    Chart by DirectFN™ TWS


    The Double Bottom will take the form of letter "W" and the twice touched bottom is considered as a Support Level for the prices of the stock.


    BUY/SELL signal

    Similar to a Double Top when the price line breaks through the trend line drawn across the base of the Double Bottom, the uptrend will continue. At the point the price line cuts the trend line a BUY signal is given. The signal is thought to be stronger if this breakout is on higher volume.

    As a closing comment we would remind you to use this technique with other techniques in forming your trading decision.




  • Aroon


    Aroon is a technical indicator that is used to identify trends in an underlying security and the likelihood of the reversal of the current trends. It could also be used to identify periods of consolidation. This indicator consists of two lines, namely, 'Aroon Up' and 'Aroon Down' which measures the strength of an uptrend and the strength of a downtrend respectively.

    To explain further, Aroon Up line measures the amount of time it has been since the highest price during the time period under concern. For example, a 25-day Aroon Up measures the number of days since a 25-day high. On the other hand, Aroon Down line measures the amount of time elapsed since the lowest price during the time period under concern.

    The value of these two lines vary between 0 to 100 and generally if the Aroon lines are above 70 it is considered to be high and a value of below 30 is considered to be low.



    Chart by DirectFN™ TWS


    It is considered that when Aroon Up moves up crossing Aroon Down it is a bullish signal which means an upward trend is emerging. When Aroon down moves down crossing Aroon Up it is a bearish signal and a downtrend is emerging.

    As can be seen from the above graph when the Aroon Up line is closer to 100 there is a strong uptrend. And when the Aroon Up line fluctuates between 70 and 100 there is a potential for an uptrend. This signal is considered thought to be stronger if the Aroon Down line is fluctuating between 0 and 30.

    On the other hand, when the Aroon Down line is closer to 100 a strong downtrend is prevailing and when the Aroon Down is fluctuating between 70 and 100 a potential downtrend is expected.

    Another important thing to note is that when the two lines are moving parallel to each other (generally below 50 level) it is an indication of a consolidation which means the prices are trading in a channel with no identifiable trend.


    BUY/SELL Signals

    BUY decision could be arrived when the Aroon Up line is between 70 and 100 and the Aroon Down line is between 0 and 30. When the Aroon Down is between 70 and 100 and the Aroon Up line is between 0 and 30 a SELL decision could be entered into.

    However, it is important to note that this should not be used as a standalone tool and is best utilized as a supporting tool.




  • Fibonacci Retracement


    Although you might not have heard of Fibonacci Retracement, you must have come across the Fibonacci number series developed by Leonardo Fibonacci. This is simply a series of numbers arranged in an order so that when you add the previous two numbers it will result in the next number in the number series. This concept is used in Fibonacci Retracement in drawing support and resistance levels in a stock chart.

    The Fibonacci Retracement is the potential retracement of a shares original move in the price. In drawing the retracement lines in a stock chart, you will draw two trend lines through the extreme points in the chart and then the distance between the two lines are divided by the key Fibonacci ratios of 23.6%, 38.2%, 61.8% and 100%. You can also use charting software to draw the Fibonacci Retracement lines. The chart would then look as follows:



    Chart by DirectFN™ TWS


    This technique is best utilized when the market is trending in a particular direction and will help you identify strategic places to place BUY or SELL orders. The above graph depicts a prior uptrend which is then followed by a decline. When the decline starts you should be alert at the Fibonacci levels for a bullish reversal. The bullish reversals are marked in the graph with an 'x'.

    On the other hand after the downtrend of the prices if and when the prices start an upward trend you should again be alert at the Fibonacci levels for bearish reversals.


    BUY/SELL Signals

    When the market is trending upward with a subsequent decline the BUY could be placed at one of the Fibonacci levels in the downtrend since the price is expected to retrace the prior uptrend. With a stock that is trending down once the uptrend starts the SELL could be placed at a Fibonacci level since the prior downtrend will be retraced at one of these levels. Other accompanying techniques would be useful in selecting which level the retracement would occur.

    However, you should keep in mind that Fibonacci levels do not always guarantee a reversal or a retracement of the prior trend. They act as alert points for potential reversal and as such it is important that you use other techniques to confirm the reversal of the trend.




  • Andrew's Pitchfork


    This is a technical indicator that is used to identify possible levels of support and resistance. When drawing the Pitchfork you should first select a major peak or trough on the left side of the chart and a major trough and a peak to the right side of the first point should be selected. Once the three points are selected the draw a trend line from the first point so that it passes through the middle point of the second and third points on to your right which will be the handle of the fork. Two trend lines should be drawn starting from the two points to the right that will go parallel to the middle trend line. The upper line is considered as a Resistance level and the lower line is considered as a Support level.



    Chart by DirectFN™ TWS


    It is considered that the prices will move towards the trend line 80% of the time while the long term trend is in place. However, there could be a situation in which the prices do not return to the median but moves away from it. If the prices fail to reach the median line from above, it is a bullish signal and if the prices fail to reach the median line from below it is a bearish sign.


    BUY/SELL Signals

    This chart pattern can be used to trade when the prices are within the lines and outside the lines. A SELL signal is triggered when the prices pull back from the upper Resistance line and the BUY signal is triggered when the price line reverses from the lower Support level.

    The moves outside the upper and lower lines are considered to be rare and risky to trade. When the prices move outside the pitchfork there are two possibilities. Either the price will move back towards the median line or the share price will continue to move outside the pitchfork and new Support and Resistance levels will be placed. As such it is important that you use other accompanying indicators to form your trading decision when the prices breakout from the pitchfork.

    Please also note that this technique is best utilized as a confirmation tool and not as a basic tool for trading decisions.




  • Head and Shoulders Top


    This is a chart pattern that signals a reversal in the current trend. This is one of the most reliable stock chart patterns but volume must confirm its validity. Just as the name suggests this chart pattern consists of a left shoulder, a head, a right shoulder and a trend line that serves as the neck line.

    Head and Shoulders Top is usually formed at the peak of an uptrend stock chart and once formed will signal the reversal of the current uptrend. The left shoulder is formed with the price reaching a new peak which happens generally on high volume. After the peak of the left shoulder is formed, the prices decline to a certain level generally on low volume. The subsequent rise in prices to form the head is again on normal or heavy volume and the price decline of the head is accompanied with lower volume. The prices rise again to form the right shoulder but remains below the peak of the head. The prices again fall down equal or nearly equal to the trough of the left shoulder. Volume is generally low in the right shoulder than in the left shoulder and the head formation.

    The neckline is drawn across the bottom of the left shoulder, head and the right shoulder. When the prices break through this neckline and continue the downward trend the head and shoulder formation is completed.



    Chart by DirectFN™ TWS


    BUY/SELL Signals

    The neck line is considered as a support line and at the point the price cuts through this and continues the downward trend the SELL signal is triggered. However, it is very important that other techniques are used to confirm this signal rather than acting on this indicator alone.




  • Double Top


    This is another chart formation that signals the reversal of the current trend. A Double Top is simply a chart formation with two peaks. In an uptrend stock chart if the price peaks and then declines to be followed with a second peak at the same or just about the same level of the peak, then a Double Top is said to be formed. This takes the form of the letter "M". A trend line will be drawn across the base of the Double Top and when the price goes down cutting through this trend line, that downward trend is considered to continue. The signal is considered to be stronger if the breakout from the trend line is on higher volume.



    Chart by DirectFN™ TWS


    This pattern illustrates a conflict between buyers and sellers. The bullish investors are attempting to push up the price but are finding resistance from the bearish investors. The stock reaches a double peak, which acts as a Resistance Level and then the bearish investors take precedence over bullish investors reversing the uptrend of the stock price.


    BUY/SELL signal

    When the price line breaks through the trend line drawn across the base of the Double Top, it is an indication that the downtrend will continue. As such if you have a stock in your portfolio which is having a Double Top it is a SELL signal.




  • Cup and Handle


    Cup and Handle is another chart pattern and looks just as it sounds, with the outline of a cup when viewed from the side. This is a bullish continuation pattern with the upward trend pausing and then continuing after the pattern is completed. This pattern is considered to be worthwhile to spot, as many of the greatest stocks broke out of this pattern before making fantastic gains. Basically, the bottom part of the cup will look like a "U" and will be accompanied with a handle. Let's take a look at the graphical interpretation.



    Chart by DirectFN™ TWS


    The Cup and Handle will be found after an upward trend with the prices rising at least 30% and the bottom should be U-shaped not V-shaped. The duration of the cup will range from 7 to 65 weeks and the duration of the handle will usually be 1 or 2 weeks at most. The handle should be formed in the upper half of the cup and the rim of the cup should be in the same level.

    The left side of the Cup includes a downtrend with a series of lower peaks and lower troughs (note that each peak is lower than the previous peak and each trough is lower than the previous trough), rounds up and then takes on a rising trend to form the cup. Then the prices drop to form the handle right after the lip of the cup has been reached. After the handle is formed the expectation is for the prices to rise. It is also important to note that the handle of the cup should not dip beyond the midpoint of the cup.

    The prior upward trend will resume once the security's price moves above the trend line that is drawn to mark the handle of the cup. Generally, it is considered that the volume should be significantly high near the breakout for it to be a successful signal.


    BUY/SELL signals

    The exact point in time for the BUY decision for this chart pattern is right after the high point of the handle. In other words the right rim of the cup. Once the handle is formed the prices are expected to go up significantly.

    You should take caution in identifying the Cup and Handle pattern because small cups with handles tend to form within the actual one. Therefore, it is important that you correctly identify the Cup and the Handle using the characteristics we explained to you before.

    Further, you should also use other accompanying techniques before making a final decision and checking the fundamentals of the company is even more important.




  • Bollinger Bands


    This is one of the most popular technical analysis techniques. The purpose of Bollinger Bands is to provide a relative definition of high and low of prices. Bollinger Bands are curves placed above and below a Simple Moving Average line in relation to the security prices. The two curves are simply the standard deviations of the price movements of a simple moving average over time.

    If you wander what Standard Deviation is, it is a measure of variability that is used to measure the variation from the average or the mean. In this case, the mean or average is the 20 day Simple Moving Average and the gap between the middle line and the two Bollinger Bands are decided by the volatility of the stock prices.



    Chart by DirectFN™ TWS


    The default parameters are as follows:
    Simple Moving Average (SMA)    : 20 day
    Upper Bollinger Band       : SMA + (2 * 20-day standard deviation)
    Lower Bollinger Band       : SMA – (2 * 20-day standard deviation)

    However, you can change these parameters to suit your requirements.

    You will note that the prices largely tend to remain within the Bollinger Bands and as the volatility increases (i.e. when the prices are changing rapidly away from the mean) the band will automatically widen, giving space for prices to move and the band will contract as the volatility decreases (i.e. when the market is moving sideways) containing the prices within it.

    Calculation of the standard deviation and the Bollinger Bands are time consuming and is not the scope of this discussion. Let's move on to the signals given from the Bollinger Bands.


    Buy/Sell Signals

    You can use Bollinger Bands to determine when prices are at extreme and possibly unsustainable levels. Bollinger Bands are generally considered to contain 80% of the price movements and a price move outside these bands is considered to be significant. The closer the prices move to the upper band the more overbought the stock is and closer the prices move to the lower band the more oversold the stock is.

    As a rule, a candle closing outside Bollinger bands followed later by a candle closing inside the Bollinger bands serves as an early signal of a trend reversal. To explain further, if the price line moves out of the Upper Bollinger Band, the SELL signal is triggered when the price line moves into the Bollinger Band. On the other hand, if the price line moves out of the Lower Bollinger Band, the BUY signal is triggered when it moves back in. But this is not 100% correct all the time and you should be mindful of the other factors surrounding the stock.

    It is also thought to be true that if the price is contained within a narrow Bollinger Band for a relatively longer period of time, the more aggressive and extensive the breakout is expected. It is similar to a quiet period before the storm.

    Further, when price is trading near the upper or lower Bollinger Band line, there is a possibility of trend reversal. This is not always the case and other methods of confirming the trend reversal should be used.

    As we always remind you, these indicators are not meant to be used as standalone tools. You should combine this with other basic trend analysis and other indicators for confirmation.




  • Pennant


    This pattern is more or less similar to a Flag, the only difference being the shape of the Flag. While the Flag is rectangular in shape the Pennant is having a triangular shape. The Pennant again is a continuation pattern and would occur after a sharp price movement upwards or downwards which would be followed by resumption of the initial trend.

    The chart pattern would look like follows:



    Chart by DirectFN™ TWS


    After the sharp price movement the prices would take a pause. This breather or pause is the Pennant and the trades would be on lower volumes. However, unlike in a Flag the two trend lines in the Pennant would not be parallel but would converge towards each other forming a triangle. The Pennant should also have a Pole which is the preceding sharp price movement.
    The direction of the Pennant is not important as in the Flag and the Pennant is generally considered to be flat.

    After the resting period the prices will break through the Pennant and again start moving in the initial direction of the sharp price movement. The pattern is complete when the price breaks out through the Pennant in the direction of the initial price movement.


    BUY/SELL signal

    The Pennant could either be in an upward or downward stock chart and the signal would differ accordingly. If the Pennant is in a downward stock chart the point at which the price break through the Support level is a SELL signal and if the Pennant is in an upward stock chart the BUY signal would be triggered when the price breaks through the Resistance level.

    This is considered to be a fairly accurate signal of the trend continuation although you should be careful in identifying the Pennant accurately and as usual we warn you not to use chart patterns in isolation but to use it with other confirming evidence.

    Let's meet with another exiting technique in our next session!




  • Three White Soldiers


    This is a candlestick pattern that is used to signal a reversal in the current downtrend. That is, if the prices have been going down over a considerable period of time and you spot "Three White Soldiers", the gloom is about to break!

    This pattern consists of three long white bodied candlesticks falling one after the other with each candle's open occurring within the body of the previous candle. To simplify further, the second and third candlestick's opening price should be within the body of the previous candlestick.

    Now, let's look at this graphically.



    Chart by DirectFN™ TWS


    The candlesticks are numbered for your ease and as you can see the opening of the 2nd candlestick falling within the body of the 1st candlestick and the opening of the 3rd candlestick falling within the body of the 2nd candlestick.

    You will remember from an earlier discussion of ours that a white bodied candlestick represents that the closing price of the security for that day is higher than the opening and as such the opening will be at the bottom of the candlestick.


    BUY/ SELL Signals

    So if you see the Three White Soldiers in a downtrend stock chart that is a BUY signal. Simple as that! But before you make the final decision make sure you do a quick background search of the company. As we always remind you chart signals should not be used in isolation.




  • Doji


    This is a chart pattern in which the opening and closing prices are virtually the same. A Doji would typically look like a cross, an inverted cross or a plus sign. A Doji indicates a conflict between bullish and bearish sentiment.





    A Doji on its own would be a neutral sign although used in conjunction with adjoining candlesticks would give valuable indications of price movements. Further, Doij has a number of variations and let's look at each in turn.


    Doji Star

    This is a Doij that opens with a gap either above or below the previous candlestick in the direction of the current trend. When a Doji Star appears in an uptrend or a downtrend it is an indication that the current trend is about to break. A Doji Star is twofold depending on the type of trend it appears in.


    Evening Doji Star

    An Evening Doji Star could indicate the top of an uptrend. That is to say, a Doji Star in an uptrend stock chart is to indicate that the trend would break. An Evening Doji Star is a Doji coming after and above a white candlestick with a gap in between the two. However to confirm the break in the trend it is a must for the Doji to be followed by a black candlestick that goes down towards the white candlestick that preceded the Doji. A graphical interpretation would definitely help you to understand the concept better.





    The following graph clearly shows an Evening Doji marking the top of an uptrend.



    Chart by DirectFN™ TWS


    BUY/SELL Signals

    An important point to note here is that the candlestick following the Doji should be a black candlestick for the trend reversal to be confirmed. If this was a white candlestick the signal would be negated.

    So if this pattern is seen in a stock chart it is a SELL signal.


    Morning Doji Star

    Needless to say this is the opposite of an Evening Doji. This Doji would indicate the bottom of a downtrend stock chart. In other words, a Doji in a downtrend stock chart would indicate a potential change in the trend. A Morning Doji Star is a Doji following a black candlestick which will be placed below the black candlestick with a gap in between. Again to confirm the break in the trend it is a must for the Doji to be followed by a white candlestick that moves up towards the black candlestick that preceded the Doji. Let's again look at a graph.






    Chart by DirectFN™ TWS


    The graph shows a Morning Doji placed in a downtrend stock chart which is followed by a trend reversal.


    BUY/SELL Signals

    As noted above for the trend reversal to be confirmed in a Moring Doji the first candlestick after the Doji should be a white candlestick for the trend to reverse. If it was a black candlestick the break in the downtrend would not be confirmed. This pattern in a stock chart is a BUY signal as the downtrend is likely to change.


    Gravestone Doji

    A Gravestone Doji would look like follows:





    This Gravestone Doji is created when the open, close and low occur at the same level or almost the same level. On a Gravestone Doji day the investors are said to be testing where the supply and resistance levels are placed. The price goes up, reaches a resistance level and due to the selling pressure closes at the same level it opened.

    A Gravestone Doji is basically similar to a Doji Star and can be used to signal a trend reversal in the prices depending on the position of the Gravestone. That is to say, if the Gravestone Doji is positioned in an uptrend stock chart it is a bearish Gravestone Doji meaning the uptrend will be reversed. And if it is seen in a downtrend stock chart it is a sign of the reversal of the downtrend.


    Dragonfly Doji


    Yet another form of Doji which looks as follows:





    As opposed to the Gravestone Doji, Dragonfly Doji occurs when the open, close and high occurs at the same or almost the same level. The longer lower wick implies that the investors were testing the demand level. However, the buying pressure pulled up the prices to its opening level at the close of the day.

    This again could be used as a pattern to suggest trend reversals in prices similar to a Doji Star depending on the position of the Doji.

    However, for all the above you should keep in mind not to take action alone on the Doji itself. If you spot a Doji wait for the next market day to confirm the trend reversal before taking action. Furthermore, the uptrend or downtrend in which the Doji occurs should be a fairly longer trend for this signal to be effective.

    Our closing comment as usual is a warning, to remind you that all technical analysis techniques are not guaranteed to be 100% reliable all the time and should be used with other evidence.


    Let's meet with yet another useful technique in our next session!




  • Flag


    This chart pattern as the name suggests resembles a flag on a pole. This pattern is a continuation pattern which suggests the initial price trend will continue.

    This formation occurs after a sharp up or down move in the prices. After such a big price move (up or down) the share price takes a break before continuing the initial trend. This break normally takes the form of a rectangle and as such called the 'Flag' and the sharp price movement (up or down) preceding the Flag is considered to be the 'Pole'. For you to consider a Flag to be present in a stock chart the Pole should definitely be present.

    The Flag or the rectangle is made up of two trend lines that act as support and resistance for the price of the stock until the price breaks through the Flag. Generally, the Flag will not be flat but will be either downward or upward sloping. The slope of the Flag should be the opposite of the previous trend (i.e. the slope of the Pole). If the initial sharp price movement was trending upward, the slope of the Flag will be downward and vice versa.

    Let's see what it looks like graphically:



    Chart by DirectFN™ TWS


    As you can see from the chart above, there are a number of price movements within the flag but these trades are on lower volume. After this quiet period (or after the Flag) the price will break out of the flag and will continue in the direction of the previous sharp price move that occurred before entering the Flag. This breakout will be on higher price and volume. The pattern is complete when the price breaks out in the direction of the initial price movement.


    BUY/SELL signal

    If you are observing a Flag in an upward stock chart (i.e. the price movement prior to the breather was uptrend) the BUY signal is triggered at the point the price breaks out from the Flag.

    On the other hand, if the Flag is in a downward stock chart the SELL signal is triggered when the price breaches the upper level of the Flag.



    Chart by DirectFN™ TWS


    This pattern is considered to be one of the most reliable chart patterns and almost always results in a continuation of the initial trend. However, care must be taken in identifying the Flag correctly as the reliability of the formation depends on correct identification



  • Moving Average Convergence/
    Divergence Indicator


    Commonly known as MACD, is an indicator that signals trend movements. This is a lagging indicator and can be used with other charts and patterns as a conformational tool. The MACD line is arrived at by subtracting a 26 day moving average from a 12 day moving average. A 9 day moving average of the difference between the 26 and 12 day moving averages is drawn as the signal line. This is the most common period used by analysts but other time periods could also be used.


    BUY/SELL signal

    The MACD is supposed to give BUY or SELL signals in three ways. The signals are given with crossovers of MACD and the signal line, divergences of MACD from the security price line and with sharp rises of the MACD line.

    Crossovers of MACD and the signal line are easy to spot and interpret. When the MACD line falls below the signal line, it is considered to be a SELL signal. And if the MACD rises above the signal line it is a BUY signal. Let's look at this graphically.


    Chart by DirectFN™ TWS


    The dotted line is the signal line whereas the solid line is the MACD. You will observe that after the MACD crosses the signal line from above to below it is a SELL signal and the accompanying stock chart confirms the downward trend. However, you will also observe that the signal is given after the stock has started its downward trend. But it can be used as a tool to confirm the stock's downward trend.

    A problem arises when the stock is moving sideways (that is to say the prices are moving up and down without an identifiable trend), there will be many crossovers and you simply cannot buy and sell at all these signal points. In such an instance the signals will have to be used in conjunction with other formations as well.

    Another signal is given when the MACD diverges from the security's prices. That is when the MACD and the security price line moves in opposite directions. When this happens it is signals that the current trend is over and you should structure your BUY or SELL decision accordingly.

    You would remember from our earlier discussions that a downtrend is confirmed with successive lower highs and lower lows. If you see the graph below the price line confirms the downtrend with a lower low. However, the MACD line shows less downside momentum with a higher low. This is considered to be a sign of the reversal in the current downtrend.



    Chart by DirectFN™ TWS


    The above chart depicts a bullish divergence which signals a reversal in the current downtrend.

    The other signal is given when the MACD rises dramatically and is a signal that the security is overbought and will soon return to its normal levels. As the chart below shows the MACD rises significantly which could mean that the security is oversold. This sharp increase is followed by an equally sharp decline which brings the price back to normal levels.



    Chart by DirectFN™ TWS


    As a closing comment we would remind you to use this indicator with other techniques before taking the final BUY or SELL decision.



  • Parabolic SAR


    Parabolic Stop and Reverse is another technical indicator that is used to analyze trending markets. This indicator is similar to a Moving Average but the calculation is different and the SAR line may change its position depending on the movement of the price. The SAR line will move above the prices when the prices are falling and will move below the price when the prices are rising. As such the indicator will pause when the price line crosses the indicator and will move above or below the price line. Let's look at a graphical interpretation to understand this well.



    Chart by DirectFN™ TWS


    If you look at point "1" in the above graph you will note that the SAR is above the price line (which is a down trend) prior to that point and the as the prices starts an uptrend the SAR crosses the price line and moves below it. The opposite happens at point "2" where the price trend moves from upward to downward and the SAR crosses the price line to move above it. This happens each time the price line moves from downward to upward and vice versa.


    BUY/SELL signals

    It is considered that when the indicator or the SAR line is moving below the price line it is a bullish signal indicating that the price will continue its upward momentum. On the other hand, if the SAR is moving above the price line it is a bearish signal and the downward trend will continue.

    Further, when the SAR line crosses the price line form below to above that triggers a SELL signal (as in point "2" of the graph). And as the SAR crosses the price line from above to below, a BUY signal (as in point "1" of the graph) is given as it is a time the SAR is placed at the most recent low price of the stock.


    Caution

    Although this method gives the investor the ability to arrive at buy or sell decisions, during a time period where there are multiple trend reversals Parabolic SAR could give false signals.

    Signals of an indicator could be more useful when it is used in conjunction with other indicators and is more reliable. As such we advise you to use this indicator along with other indicators for it to be more reliable and useful.




  • Importance of Volume in Technical Analysis


    While movements of the price of a security is the main factor taken into consideration when predicting future price movements of the security through technical analysis, volume is also extremely important. The validity of a signal given through price movements is oftentimes confirmed through the behavior of volume.

    Volume is the number of shares transacted during the period under concern and is generally shown below the price chart of the security.

    Volume of the security is considered important because it enables you to measure the strength of the signals given through price movements. A price movement up or down with relatively high volume is considered to be stronger and more relevant than a similar price move with lower volume. Therefore, if you are seeing a large price move in the security, you should look at the volume of trades for confirmation.

    Volume is considered to be moving with the trend. If the prices are moving upward, volume should increase and if the prices are moving downward, the volume should decrease for volume to be giving a confirmation. Furthermore, if the relationship between price and volume starts to deteriorate it is a signal of the weakening of the trend.

    Volume is also used by traders to confirm chart patterns. Chart patterns such as Head and Shoulders and Flag uses volume to confirm the validity of the pattern. These chart patterns will be discussed in future in more detail. If the volume does not confirm the signals given by the price movements those signals are considered to be weaker.

    Another important thing to note is that in technical analysis price is considered to be preceded by volume. For example, if the volume starts to decline in an uptrend this is an early signal of the reversal of the current uptrend.

    Due to the above reasons studying the volume is as equally important as studying the price movements of a security in technical analysis.



  • Three Black Crows


    Today let's learn about another important chart pattern called the Three Black Crows. This is a bearish candlestick pattern that is used to signal a reversal in the current uptrend. The pattern consists of three long black candlesticks falling one after the other with each candle's open occurring within the body of the previous candle.



    Chart by DirectFN™ TWS


    To recap an earlier discussion of ours a black or a colored candlestick would mean that the closing is lower than the opening. Therefore, the opening price of the candlesticks in question is at the top of it and you can see that the opening of the 2nd candlestick is falling within the body of the 1st candlestick and the opening of the 3rd candlestick falling within the body of the 2nd candlestick.


    BUY/SELL Signals

    So if you spot Three Black Crows near the top of an uptrend stock chart the good times are about to change. But forewarned is forearmed! In other words this is a SELL signal. But as we always remind you, chart signals should not be used in isolation.



  • Stochastic Oscillator


    This is yet again another momentum indicator used in technical analysis. The basic idea behind this indicator is that the closing price should close in the same direction as the prevailing trend, if the trend is to be continued. In other words, if the current trend is an uptrend the price should be closing near the highs of the price trend and if the current trend is a downtrend the price should be closing near the lows of the trading range.

    This indicator is plotted within the range of 0 to 100 and if the indicator gives a value of above 80 the stock is considered to be overbought and if the value falls below 20 it is considered to be oversold. The overbought or oversold conditions will not always be followed by a trend reversal. However, it will alert the trader to look for further evidence that a reversal may be near.

    Two lines are drawn for the Stochastic Oscillator and this indicator is generally calculated for a period of 14 days although the period could be adjusted to suit your requirements. The two lines are arrived at using the following formula:





    Caution

    We stated earlier that a value of above 80 for the Stochastic Oscillator is considered overbought and a value of below 20 is considered oversold. However, it is important to note that these signals are not that effective when the market is trending upwards or downwards for a longer period of time.


    Signals

    Stochastic Oscillator gives two kinds of signals. The main signal is given when the %K line crosses the %D line. When the %K line crosses the %D line from below to above it is considered to be a bullish signal and it is a bearish signal if the %K line crosses the %D line from above to below.



    Chart by DirectFN™ TWS


    In the above graph the solid line is the %K line and the smoothed dotted line is the %D line.

    The other signal is arrived at using the %D line (because it is smoothed and as such gives netter signals) and the actual movement of prices. When the %D line and the price line moves away from each other a signal is given that there is a weakening in the current trend.

    More precisely, if the price line is moving upward and the %D line is moving downward this is a bearish signal and if the price of the security is moving downward and the %D line is moving upward that is considered to be a bullish signal. The signal is thought to be stronger if the %D line is situated in the overbought and oversold range of the Oscillator (i.e. above 80 or below 20). The signal is completed when the %K line crosses the %D line in the opposite direction of the price trend.

    Find it a little bit confusing? Let's look at this in a graphical interpretation.



    Chart by DirectFN™ TWS


    If you look at point marked "1" on the above graph, the %D is sloping downwards whereas the price line is sloping upwards and as such gives a bearish signal to the investor.

    On the other hand, if the %D line is upward sloping whereas the price line is sloping downwards and gives a bullish signal.



  • Hammer


    As we told you earlier, this is the opposite of Hanging Man. The formation looks similar to a Hanging Man and the differences are that the Hammer will be positioned in a downtrend stock chart and is considered a bullish chart pattern. In other words it will indicate a reversal in the downtrend of the stock prices.





    Structure Explained

    This pattern is considered to be formed when there is a significant sell off at the market open but buyers are able to push the prices back up at the market close above or near the open price. It is considered an early signal that the bullish trend is about to reverse. Overall, this candlestick placed in a downtrend stock chart serves as an early indication that the bullish traders are gaining momentum.



    Chart by DirectFN™ TWS


    For this signal to be effective the following confirmations are considered to be necessary:

    The lower wick/shadow should be several times as long as the body of the candle because longer the lower wick stronger the sellers have been in pushing down the price and more bearish the signal is;

    Although the color of the candle is not considered when identifying a Hammer, if the candle is white the stronger the bullish signal is to be considered as the bullish traders have succeeded in pushing up the closing price above the opening level. In other words, if the Close is higher than the Open of the Hammer then it is considered a strong bullish signal.


    BUY/SELL signal

    Therefore if you see a Hammer at the bottom of a downtrend stock chart it is a sign of a reversal in the trend and is a BUY signal. However, other considerations should also be taken into account when taking the final decision.

    Join us for our next lesson to learn another important technique!



  • Moving Averages


    Moving Average is a technical indicator and is used to identify the trend in price movements. The prices of a security are averaged over a period of time and the averages keep on moving with the addition of each new day's price. Moving average could be calculated for any period of your choice depending on your requirement and this is depicted by a trend line.

    As for example, if you are looking at a 9 day moving average, you will add the first nine days' closing prices (day 1 - day 9) and divide it by nine (no. of days). That will give you the first point of the Moving Average line. The second point is calculated by adding the closing prices of 2nd to 10th day and dividing it by nine. The process will continue with each new day's price being added to the calculation while the foremost day's price being removed from the calculation. This process will smooth out the day to day price movements of the share and provide the general trend of the price movement.

    Longer the period of the moving average the more smoother the price movement is and each new day's price being added would have a lesser impact on the trend. As such, the extreme ups and downs in the price of a share are smoothed out leaving the general trend. If you are interested in the longer term price trend of a share you can select a longer time period like 100 days. On the other hand if your concern is short term price movement you could look at, say, a 15 day moving average.

    The above explained Moving Average is called an Arithmetic Moving Average. Another form of moving average is Exponential Moving Average and is calculated by adding a certain percentage of yesterday's moving average to a percentage of the today's closing price. This way you can place more value on the current price than the past data.


    Signals from Moving Average

    When you look at this graphically, if the price is below the Moving Average line, it is an indication of bearish behavior for the length of the trend and vice versa. Further, if the price is moving from above the Moving Average to below it then it is a bearish indication of the price trend for the time being considered and vice versa. It is important to note that this is a lagging indicator, meaning it will only signal the trend after it has actually starter and as such is a conformational tool.

    Another way to generate signals from the Moving Average is to draw two moving averages with two time periods: one for a longer period than the other. Then look for crossover points to help identify periods of significant price changes. Let's look at this graphically.



    Chart by DirectFN™ TWS


    BUY/SELL signal

    When a shorter term moving average (18 day Moving Average) crosses from below to above a longer period moving average (50 day Moving Average) it is a bullish signal. That is the trend will be upward and gives a BUY signal. On the other hand, if a shorter term Moving Average crosses down from above a longer term moving average it is a bearish signal and the trend will move downward. This is a SELL signal.

    It is considered that the longer the Moving Average (i.e. longer the period) is the more reliable the signals will be and shorter the Moving Average is there will be more false signals or whipsaws. We will also remind you to consider other factors surrounding the company before taking the final BUY or SELL decision.

    Let's meet with another exciting topic in our next lesson!



  • Principles of Technical Analysis


    We have been sharing with you various technical analysis techniques over the last few days. These techniques are based upon a number of principles which are explained below:


    • The discounting mechanism of the market

    Technical analysis assumes that the all relevant information is already reflected in the stock's prices. In other words, the view of all market participants with regard to profit expectations, economic forecasts, political outlook, news and other factors are assumed to be reflected in the prices of the shares already. If you study the market carefully you will notice that good or bad news does not always affect the prices positively or negatively in the long run. If you buy the shares on the release of good earnings report you might be surprised to find the prices drifting downward. On the other hand if you sell the shares on the release of bad news you will be disappointed to find the price move up after a short dip. This is as a result of the discounting mechanism of the market.


    • Prices move in trends

    Identifying the trend is very important for making profits in the share market and it is also vital in technical analysis. The market is either trending up, trending down or moving sideways. Basically most of the profits could be earned through trading with the trend although there are opportunities to be obtained from sideways moving markets. If you take a look at any chart you could realize that prices move in trends, keeping hold of one long term trend. Obviously even a long term trend could change and does on many occasions but most of the time prices remain in the main trend.


    • History repeats itself

    Technical analysis derives its signals from studying the past price patterns which are largely repetitive. This repetitive nature of the prices derives from market psychology. That is people tend to behave in the same manner in response to similar circumstances. Technical analysis strives to identify these repetitive price movements and this will enable the investors to profit from eacly identification of the price movements.




  • Hanging Man


    This is a bearish candlestick pattern that signals a reversal in the current uptrend. Hanging Man would be positioned in an uptrend stock chart and is characterized with a small real body (either colored or not) at the top, a longer lower wick or shadow with little or no upper wick, which would look like follows:





    This pattern is considered to be formed when there is a significant sell off at the market open but buyers are able to push the prices back up at the market close above or near the open price. It is considered an early signal that the bullish trend is about to reverse. Overall, this candlestick placed in an upward stock chart serves as an early indication that buyers are losing control and bearish traders are gaining strength.



    Chart by DirectFN™ TWS


    However, analysts consider this signal to be fairly weak in predicting trend reversals and would prefer to have the following confirmations:

    The lower wick/shadow should be several times as long as the body of the candle because longer the lower wick stronger the sellers have been in pushing down the price and more bearish the signal is;

    Although the color of the candle is not considered when identifying a Hanging Man, if the candle is colored (black/ blue/ red) the stronger the signal is to be considered as the traders have failed to pull up the price above the opening level. To simplify further if the Close is lower than the Open of the Hanging Man then it is considered a strong bearish signal.


    BUY/SELL Signals

    Therefore if you see a Hanging Man at the top of an uptrend it is a sign of a reversal in the trend and is a SELL signal. However, as we always warn you other considerations should also be taken into account when taking the final decision.




  • Relative Strength Index (RSI)


    Relative Strength Index is a technical indicator that compares the magnitude of recent losses to recent gains in order to identify overbought and oversold conditions of a stock. If you are keen to know the formula of this indicator, it is as follows:





    The value of this indicator could range between 0 and 100 and let's look at this graphically to get a better understanding.



    Chart by DirectFN™ TWS


    BUY/SELL Signals

    If the RSI falls below 30 the stock is oversold and gives a bullish (BUY) signal and if the RSI moves above 70 the share is considered to be overbought and as such gives a bearish (SELL) signal. When you are using the RSI to predict stock price movements you should remember the fact that, large movements up or down in the stock price would result in false buy or sell signals. Therefore, it is very important that you use this tool along with other stock picking tools and not in isolation.

    Further, to interpret buy or sell signals you can also look at the RSI along with the price movement of the stock. In the above graph the upper section depicts the price movements of the share and the lower part depicts the RSI ranging from 0 to 100. When the price of a security deviate from the corresponding Relative Strength Index on that security it gives an advance warning of a possible trend reversal. That is to say the Price and the RSI could move in the same direction or in the opposite direction.

    You will note from the above graph that the price and the RSI both could either move up or down. If both the price and RSI move up it is a BUY signal and it is a SELL signal if the price and RSI are both falling.

    On the other hand, the price and RSI could move in opposite directions. In such an instance, if the price is rising and the RSI is falling it is a SELL signal and when the price is falling and the RSI is rising it is a BUY signal.

    Our next lesson is on "Signals from Hanging Man"



  • Support and Resistance


    Support and Resistance can best be explained as price levels that either support prices from moving below a certain level or resist the price from moving above a certain level. In other words these are price levels that prevent the prices from moving above or below a certain level. Though it sounds simple at first support and resistance can come in various forms and is a little difficult to master than it first appears. So let's get the basics right! Let's look at a simple example to understand Resistance.

    Think you bought a share of a hypothetical company, XYZ PLC at a price of Rs. 25. You have been following the price of this share to note that the price fails to pass the Rs. 29 level although it has come closer to passing it many a time. So, this level of Rs. 29 acts as a resistance level or as a "ceiling" for the XYZ PLC stock price. In other words this price level prevents the price of XYZ share from moving above it.

    The Support level is the opposite of this. If you look at a few stock charts randomly, you will see that prices of certain stocks fail to move below certain levels. Those levels are considered as a support level or a "floor" for that stock. This price level supports the price of that stock from moving below.

    We'll now look at these graphically.



    Chart by DirectFN™ TWS


    As you can see form the above graph, Rs. 38 acts as a ceiling for this stock. This is the Resistance level. Prices have come closer to breaching that level but have failed a couple of times. On the other hand, Rs 30.50 acts as a floor or the Support level for the stock.
    So if you hold a stock which has reached a Resistance level, which has been tested several times but not broken, it is a SELL signal because the price is having a hard time moving above that level. And if you spot a stock which is on the Support level then it is a BUY signal because the price might not fall beyond that level. Makes sense, right? However, it is important that you correctly identify these Support and Resistance levels before making trading decisions.

    Round numbers such as 10, 20, 50, 100 are often cited to be important for Support and Resistance levels because at these levels most traders tend to make buy or sell decisions. The reason behind this is largely psychological.

    Further, it is generally considered that once the price of a share moves above a Resistance level it automatically becomes a Support level for that stock and the price will not move below that level. On the other hand, if the price falls below a Support level that level becomes the Resistance level for that stock. This is called the "Role Reversal" of Support and Resistance. In most cases, a stock will have a Support and Resistance level and will trade within this area until it is breached and new levels are established. The following graph explains the Role Reversal more clearly, where the price level Rs. 30.50 first acts as a Resistance level and once it is breached reverses its role to a Support level.



    Chart by DirectFN™ TWS


    If you identify a Support or a Resistance level and is confident about trading at this level, it is advisable that you do not place the order at that price level itself. This is because the price does not normally reach this level but moves closer to it. So when placing the trade the price should be quoted just a few points above in the case of a Support level or just a few points below in the case of a Resistance level.
    You will hear more about Support and Resistance as we move on as this concept is used in conjunction with other techniques as well.

    The next session is on an important indicator, Relative Strength Index!



  • Leading vs. Lagging Indicators


    Technical indicators as we have already explained are indicators that can be used to predict future trends of price movements. These indicators, depending on the timing of the predictions they give, are categorized into two types. Namely, Leading indicators and Lagging indicators.

    Leading indicators are types of indicators that signal future price movements. These indicators signal reversals or continuations of future price movements before they actually materialize. As such these indicators could be used to form your trading decision. As leading indicators precedes price movements they are stronger during periods of sideways or non-trending periods. Non-trending periods are volatile periods where the price tends to move up and down without an identifiable trend. Leading indicators are thought to give many buy and sell signals which make it better for non-trending markets instead for a trending market where it is better to have lesser entry or exit points.

    On the other hand, Lagging indicators follows price movements confirming the price movement after it has occured. To explain further, a Lagging indicator would confirm a downtrend after the prices have already started its downward movement. Lagging indicators are considered to be useful during trending periods and are not effective during non-trending periods. Trending markets have an identifiable up or down trend and Lagging indicators will not give buy or sell signals until the trend is in place.

    The advantage of Leading indicators are that they give early signals for a buying or selling securities and as such will safeguard investors of potential losses or loss of opportunities.

    The Lagging indicators are more useful during trending periods and will allow the trader to capture more of the trend.

    Two well-known Leading indicators are the Relative Strength Index and the Stochastic Oscillator and most well-known Lagging indicators are Moving Averages and Bollinger Bands. These indicators will be explained to you in detail in subsequent articles.




  • Trend


    You will find this concept easy to understand and is one of the basic concepts in technical analysis. Just like fashions having a trend there is a trend to the way in which share prices move. Trend in relation to share prices is the overall direction of prices for the period being analyzed.

    Any investor's dream would be an upward trend and we will help you identify signals that suggest of an upward trend.

    An uptrend (or a bull trend) is defined as a series of successive higher highs and higher lows. That is where each peak (highest point in a stock chart) is higher than the previous one and each trough (lowest point in a stock chart) is higher than the previous trough. A simple uptrend chart would look like follows:





    Now let's look at this situation in a stock chart.



    Chart by DirectFN™ TWS


    As a general rule, it is considered that an uptrend starts with a higher low and goes above the previous high. And on the other hand an uptrend ends with a lower high and goes below the previous low.

    Hope you got the point clear. However, you must remember that there may be some minor exceptions as the trend continues, but, overall, this is how an uptrend or bullish stock chart would behave.

    A downward trend would be just the opposite, with lower highs and lower lows. And it is considered that a downward or bearish trend is starting with a lower peak and goes below the previous low. That is similar to the end of an upward trend. Similarly the end of a downward trend will be the same as the start of an upward trend.





    Now let's look at this situation in a stock chart.



    Chart by DirectFN™ TWS


    Generally it is considered that the general trend for price movements continue until there is a specific opposing event that changes the trend. You should be able to identify this point in time in advance so that you will be able to gain from the reversal in the trend. For example, if the prices of a particular stock have been rising in general over a period of time and if a trend reversal is to occur you can exit that stock in advance before the prices start coming down.

    Trend comes in handy for you not only to determine how long the existing trend will continue but also to predict possible trend reversals in advance so that you can gain from such knowledge. The trend reversal signals are plenty and we will learn those as we go ahead. However, you should remember that these signals should not be relied upon in isolation as it will only provide you with the possibility of price movements in future. But u can use these signals as a second opinion to confirm a carefully formed buy, sell or hold decision.




  • Stock Charts Explained


    Understanding stock charts should be the first step in understanding the art of technical analysis. Stock charts are the basic tool used in technical analysis to predict likely price movements of stocks based on past price movements. There are a number of different charts you can use to do this and today we will explain the most important charts and how these could be interpreted.

    The charts simply display where the stock has been, in terms of price, over a time frame (which you can change to suit your needs). Each bar on the chart usually represents a day, however you can change the time frame of the bars with charting software. Two most commonly used charts are candlestick charts and OHLC charts.


    Candlestick Charts

    This chart is made up of black and white candlesticks with "wicks" at both ends. A white candlestick would indicate that the opening price is lower than the closing price for that stock and a black candlestick would indicate that the closing price is lower than the opening price. In other words, if the price has dropped during a particular day the candlestick will be black and if the price has risen on a particular day the candlestick will be white. If the candle has wicks on either end of it the lower wick would indicate the lowest price for that day whereas the upper wick would indicate the highest price for the day.


    Chart by DirectFN™ TWS


    OHLC Charts

    OHLC chart also shows the Opening, High, Low and Closing price of a particular stock for a particular day. A typical OHLC chart would look like follows:


    Chart by DirectFN™ TWS


    This chart again shows data in blue and red lines. If the closing price on a particular day is lower than the opening price, the line will be shown in red and if the closing price is higher than the opening price the line will be in black or blue. The short line sticking out to your left from the main line is the opening price and the short line to the right is the closing price. The highest point is the day' highest whereas the lowest point is the day's lowest. The longer the line the higher the price movement is for a particular day and vice versa.

    You will find a lot of these charts as we move on and it is important that you are able to read and interpret the charts if you are to understand the forthcoming techniques!

    Join us for the next session to learn about an important concept, TREND!




  • Technical Analysis
    vs. Fundamental Analysis


    When it comes to stock trading, the intention of any average investor would be to buy a share at a lower price and sell it at a higher price, thereby making a profit on the trade. Although this may sound simple most of you would know that it is not so.

    In forming your trading decision, you should analyze the share you are planning to buy or sell rather than just acting on instinct. Although your instincts may have been proven correct most of the time a little bit of formal analysis would help you further in making a correct decision.

    When it comes to analyzing stocks two methods could be used, namely, fundamental analysis and technical analysis.

    Fundamental analysis mainly focuses on the financials of the share and also the present economic condition affecting the stock. In fundamental analysis you will look at the profits of the company, the cash position and the assets position to obtain the value of the share. This will then be compared with the current market price of the share to decide whether the share is trading at a premium, a discount or at par with the value obtained through analyzing the financial and economic data surrounding the share.

    Technical analysis is analyzing past prices and volumes in order to predict the likely future trend. That's it. Simple as that! In doing this, charts and other similar tools are used to identify patterns that can suggest future price movements.

    As opposed to fundamental analysis where the financial statements are analyzed to obtain the true worth of a share of the company, technical analysis simply studies the past price and volume movements of a share to decide on whether to buy, sell or hold a particular share. So the final outcome of technical analysis would be a BUY, SELL or a HOLD decision.

    To cite a simple example, in a super market a fundamental analyst would study different brands of a product compare the ingredients, price, weight, etc. and decide whether to buy the product or not. On the other hand, the technical analyst would watch the behavior of other buyers or study the statistics for stock movements and come to a conclusion.

    There are many technical analysis techniques that have been developed over the years and we will present you one new technique each day, to help you make better informed trading decisions.

    However, as a closing comment we would also like to let you know, that technical analysis techniques tend to fail at various times. It is generally said that if you are relying only on technical analysis, as a rule of thumb, you should at a minimum look for about 3 technical analysis techniques to see if all 3 are giving the same signal.

    You should keep in mind that technical analysis would not give you absolute predictions about the future but will tell you what is likely to happen to stock prices in future. So a little knowledge about company financials and other factors affecting stock prices wouldn't hurt you at all!