Basic Elements of Charting By Apurva Sheth, Editor, Profit Hunter  ·   06 Dec 2014   ·   ARCHIVES

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I am sure that by now you are comfortable with the basic philosophy behind technical analysis.

One of my readers Mr. Raviraj very aptly summed up this philosophy by commenting on my last article that 'TA is more of reading human psychology on charts'.

Yes! That is exactly what it is - studying crowd behavior in a visual form. And when I write to you about price patterns you will know how patterns that were discovered hundreds of years back are still valid. But you will have to wait a bit for that.

After reading your comments on the last article I am sure all of you are excited to learn more about charts and start trading with the new found knowledge that you have gained. But, let me tell you that I have made far more mistakes than anyone else out of excitement and burnt my fingers. And I don't want you to go through the same pain that I have been through.

So, instead of jumping straight to techniques of trading I will first speak to you about chart construction. To those who are new to this field a basic understanding of chart construction will give you a solid foundation before moving on to higher concepts. For those who are familiar with charting, spending a few minutes to brush up your basics is not a bad deal, huh? Also, don't be disheartened as I will spill out one of my secrets of charting in as soon as the following article. So just hang around.

As I promised in my first article, we start right from the basics. The 2 basic elements that you will find on a technical analyst's chart are: price and volume.

Layout of a Basic Chart

Apurva Sheth

Source: Spider Software India

This is what a basic technical chart looks like. It is ideally divided in two parts.

The upper part is where (1) price data is plotted while the lower half is where (2) indicator is plotted.

In most cases you will find volume plotted below the price.

On the top left corner of the chart you will find the (3) name of the ticker alongside other details like open, high, low, close and % change compared to the previous period.

The (4) price and (5) indicator values are plotted on the Y axis placed on the right hand side.

The (6) Indicator name is visible on the left hand side below the ticker in a new panel.

The (7) date or time are plotted on the X axis.

Also note that the (8) time frame that is chosen for charting price is mentioned at the bottom of the chart alongside X axis in the rightmost corner.

Dly for daily, Wkl for weekly, Mon for monthly.

I hope that was clear. I know it seems like a lot of variables, but once you get a hang of these indicators they will seem as familiar as an old friend.

Now, let me walk you through the various types of charts that are commonly available, and tell you which one is my favourite.

1. Line Chart These are the first charts that we come across in our geometry class at school. They are created by plotting the closing prices of the period selected. For example, on a daily time frame a line will be plotted between the daily closing prices to create a line chart. On a weekly time frame weekly closing prices will be used, on monthly time frame monthly closing prices will be used and so on.

Nifty line chart since March 2014

Source: Spider Software India

2. Bar Chart They are also known as OHLC charts. OHLC stands for Open High Low Closerespectively. Bar charts show the range of the timeframe selected. For example, on a daily chart every single bar will show that day's range right from high to low.

Bar charts are normally plotted in black & white but some people, like me, prefer red and green. However, I have rarely used bar charts in my career and prefer candlestick charts over them as these are visually appealing and easier to read.

Nifty bar chart since March 2014

Source: Spider Software India

3. Candlestick Chart Japanese rice traders have been using this technique for ages and the western world discovered this technique later in the eighties. Candlesticks are easier to

interpret. It gives the same open high low close data that bar charts give but in a much more appealing format.

Let's look at how a candle is formed.

4. The adjoining figure shows a green bullish candle. It means the closing price is above the opening price on the time

Source: wikipedia

frame selected. Mind you, a bullish candle can form even on a day when prices have fallen compared to previous day. The nature of the candle (bullish or bearish) is decided based on today's close with respect to today's open and not today's close with respect to yesterday's close.

5. The adjoining figure shows a red bearish candle. It means the closing price is below the opening price on the time frame selected. A bearish candle can form even on a day when prices have risen compared to previous day. For example: - A bearish candle would form even when the stock may have opened gap up today and closed below today's open but above the previous day's close. In this case the stock has registered gains on a day-on-day basis but the nature of the candle will be considered bearish as it closed below its open.

6. Nifty candlestick chart since March 2014

7. Source: Spider Software India

Source: wikipedia

8.This is a candlestick chart of Nifty since March 2014. You can see that it looks nicer than the other two I have shown above.

It is also easier to read. Notice the election results day gap up in Nifty when the index opened at 7,270, moved up to the high of 7,563, but ended the day at 7,203. This was a gain of 80 points compared to the previous day's close of 7,123. But, the daily candle was still marked as red in color because the close is below the open.

Apart from this the candle chart also give details about the day's range which a line chart cannot as it considers only closing prices for plotting. The bar chart adds more depth and value compared to a line chart but the focus is only on the day's range rather than the open and close.

Thus, for me candlestick charts are clear-cut winners when compared to the other two.

Now, when you see stock charts you will know exactly what to look for. Try reading a few charts to see how it feels, and let me know if you have any questions.

Interpreting a Candle By Apurva Sheth, Editor, Profit Hunter  ·   08 Jul 2015   ·   ARCHIVES

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I spoke about basic elements of charting a couple of months back when I started writing to you. There I showed you layout of a basic chart. Along with that I also showed you the three basic type of charts commonly used by technical analysts. These are:-

1. Line Chart2. Bar ChartApurva Sheth

3. Candlestick ChartAmongst all of them candlestick charts are my favourite charts. Candlestick charts add much more depth and value compared to the other two. They focus not only on the day's range but also on the opening and closing prices.

Today I want to delve into greater detail about candlesticks and ways to interpret them. But before that let's refresh our memories and see a candlestick and its components.

Anatomy of a Candle

Source: Profit Hunter

There are three things that one should focus on while studying the anatomy of a candle.

1. Nature

The nature of the candle is determined by its opening and closing levels. If the closing price is above the opening price then it is a bullish candle. If the closing price is below the opening price then it is a bearish candle.

2. Body

The hollow or filled portion from opening level to closing level is the real body. In case the candle is bullish the body is generally coloured with green or white. In case the candle is bearish the body is generally coloured with red or black.

3. Shadows

The long thin lines above and below the body represent the high and low points respectively. They are generally referred as shadows, wicks or tails. The high is marked by the top of the upper shadow and the low by the bottom of the lower shadow.

The basic purpose of interpreting a candle is to find out who is in control.

The Bulls? Or The Bears?

The nature of the candle gives a preliminary indication of who dominated the session. But that isn't enough. There are other things like size and colour of real body and size of the tails that matter as well.

The best way to understand candlesticks is to draw an analogy of two football teams playing against each other. On one side we have the bulls and on the other side we have the bears. The colour of the candle indicates which team dominated. But to find out the extent of which one dominated the other you have to look for the closing with respect to day's range. For example if the close is nearer to the day's high means that bulls are in a dominating position and closer to making a goal. Similarly, if the close is nearer to the day's low then the bears are in a comfortable position and are closer to striking a goal.

There are many variations of candlesticks. Each one of them is given a different name. Today I will show you some of the most basic and frequently seen candles on the charts. Most of the other patterns are nothing but a combination of these basic candles in one way or the other.

Interpreting a Candle

Source: Profit Hunter

A long day represents a large price move from open to close. There isn't a hard and fast rule that clearly defines a long candle but it is always considered with respect to the most recent price action. So if the candle that you are referring to is larger than most of the recent candles then it qualifies as a long day. A long green candle indicates that the stock opened near the lows and ended near the highs. It suggests that bulls dominated the game. A long red candle indicates that the stock opened near the highs and ended near the lows. It suggests that bears dominated the game.

Exactly opposite to a long day candle is the short day where the day's trading range is very

limited compared to the most recent candles. A short green candle indicates that bulls and bears evenly matched but the bulls win as the candle is green. A short red candle indicates that bulls and bears evenly matched but the bears win as the candle is red.

When the shadows are longer than the body itself the candle is referred as a Spinning top. The colour of the body isn't very important here. The formation of this candle indicates indecision amongst bulls and bears.

Spinning tops are indecisive candles but still you can make out who won by simply observing the colour of the candle. This isn't possible in a Doji Candle formation. Here the open and close are so close to each other that the colour of the candle is hardly visible. This is a case of perfect indecision.

So those were the basic candlesticks that you will normally come across on a chart. In my next article we will go one level deeper and see the inner workings of a candle. This will help you interpret candles in an even better way.

Candlestick Development & Addition- By Apurva Sheth

Last time I discussed the basics of Interpreting a Candle. As promised today I will delve one level deeper and show you a better way to interpret candles. 

The first thing that I want to talk about today is Candle Development. It is nothing but breaking a single candle into its component parts. A larger time frame candle is broken down in to smaller time frames for greater insights. Candle development allows us to see the

inner working of a candle. It gives us the best picture of the battle between bulls and bears right from the front seat. 

In the chart below you can notice two examples. In both of them the long green candle to the left is a weekly candle and the ones to the right is the breakup of this weekly candle into 5 trading days. 

The weekly candle in both these examples is exactly the same. The open, high, low and close values are exactly same. But when you break

Apurva Sheth

this weekly candle down into daily candle you get a completely different picture. 

In the chart displayed on the top you can see that the stock ended on Monday with a long green candle. It remained subdued for the following three days. This is quite evident from the formation of short range candles. The final closing on Friday was pretty strong as bulls were able to push the prices back up again. 

In the second chart displayed at the bottom you can see that the stock ended on Monday on a very strong note. Tide turned on Tuesday as the stock opened way lower and gave up all its previous day’s gains. It opened on a positive note on Wednesday but had fair share of intraday volatility which is visible with the long shadow at the bottom. Thursday’s opening was pretty strong but it failed to register any significant gains. The stock opened gap up on Friday and ended the session pretty strong at the highs. 

Candle Development

Source: Profit Hunter

The weekly candles in both the examples are same but when you break them down you can see a completely different picture. The upmove in the first example is very stable and gradual. The stock has moved equal distance in the second example as well. But here the

upmove is much more volatile and turbulent. 

In the first example bulls hold a strong grip in the stock. One would prefer trading such stocks. In the second example the bulls emerge victorious at the end of the week. But they had to face lot of resistance from the bears. One would prefer to avoid trading such stocks. Thus, candle development allows you to see the constant change of sentiment back and forth within a candle. 

Candle Addition is the exact opposite of candle development. Candle Addition is nothing but adding a group of candles into one single candle. It helps to more easily determine bullish or bearish sentiment. Here’s an example for better understanding. 

Candle Addition

Source: Profit Hunter

In the above example I have reversed the process and added 5 days trading data to form one week's candle. Once you have understood candle development process then candle addition becomes quite simple and easy to understand. 

Last time I showed you how to interpret single candlestick which are regularly formed on charts. Candle Addition helps us to interpret a sequence of candles grouped together. This becomes very helpful when one goes deeper in to candlestick analysis. You will find that there are hundreds of bullish and bearish candlestick patterns. It will be difficult for anyone to remember names of each and every candlestick pattern. But with the power of candlestick addition you will realize that remembering pattern names are not that important when you can simply add the candles to get a deeper insight of them. 

You can go and play around with intraday candles and see how they add up to become a daily candle. You can also go ahead and check a weekly candle and see how they break down to become daily candles. 

MACD, short for moving average convergence/divergence, is a trading indicator used in technical analysis ofstock prices, created by Gerald Appel in the late 1970s.[1] It is supposed to reveal changes in the strength, direction,momentum, and duration of a trend in a stock's price.

The MACD indicator (or "oscillator") is a collection of three time series calculated from historical price data, most often the closing price. These three series are: the MACD series proper, the "signal" or "average" series, and the "divergence" series which is the difference between the two. The MACD series is the difference between a "fast" (short period) exponential moving average (EMA), and a "slow" (longer period) EMA of the price series. The average series is an EMA of the MACD series itself.

The MACD indicator thus depends on three time parameters, namely the time constants of the three EMAs. The notation "MACD(a,b,c)" usually denotes the indicator where the MACD series is the difference of EMAs with characteristic times a and b, and the average series is an EMA of the MACD series with characteristic time c. These parameters are usually measured in days. The most commonly used values are 12, 26, and 9 days, that is, MACD(12,26,9). As true with most of the technical indicators, MACD also finds its period settings from the old days when technical analysis used to be mainly based on the daily charts. The reason was the lack of the modern trading platforms which show the changing prices every moment. As the working week used to be 6-days, the period settings of (12, 26, 9) represent 2 weeks, 1 month and one and a half week. [2] Now when the trading weeks have only 5 days, possibilities of changing the period settings cannot be overruled. However, it is always better to stick to the period settings which are used by the majority of traders as the buying and selling decisions based on the standard settings further push the prices in that direction.

The MACD and average series are customarily displayed as continuous lines in a plot whose horizontal axis is time, whereas the divergence is shown as a bar graph (often called a histogram).

A fast EMA responds more quickly than a slow EMA to recent changes in a stock's price. By comparing EMAs of different periods, the MACD series can indicate changes in the trend of a stock. It is claimed that the divergence series can reveal subtle shifts in the stock's trend.

Since the MACD is based on moving averages, it is inherently a lagging indicator. As a metric of price trends, the MACD is less useful for stocks that are not trending (trading in a range) or are trading with erratic price action.

History[edit]

The MACD series proper was invented by Gerald Appel[3] in the 1970s. Thomas Aspray added the divergence bar graph to the MACD in 1986, as a means to anticipate MACD crossovers, an indicator of important moves in the underlying security.

Variations of the MACD include the zero lag MACD [4]

Terminology[edit]

Over the years, elements of the MACD have become known by multiple and often over-loaded terms. The common definitions of particularly overloaded terms are:

Divergence: 1. As the D in MACD, "divergence" refers to the two underlying moving averages drifting apart, while "convergence" refers to the two underlying moving averages coming towards each other. 2. Gerald Appel referred to a "divergence" as the situation where the MACD line does not conform to the price movement, e.g. a price low is not accompanied by a low of the MACD.[5] and 3. Thomas Asprey dubbed the difference between the MACD and its signal line the "divergence" series. In practice, definition number 2 above is often preferred.

Histogram:[6] 1. Gerald Appel referred to bar graph plots of the basic MACD time series as "histogram". In Appel's Histogram the height of the bar corresponds to the MACD value for a particular point in time. 2. The difference between the MACD and its Signal line is often plotted as a bar chart and called a "histogram". In practice, definition number 2 above is often preferred.

Mathematical interpretation[edit]

In signal processing terms, the MACD series is a filtered measure of the derivative of the input (price) series with respect to time. (The derivative is called "velocity" in technical stock analysis). MACD estimates the derivative as if it were calculated and then filtered by the two low-pass filters in tandem, multiplied by a "gain"

equal to the difference in their time constants. It also can be seen to approximate the derivative as if it were calculated and then filtered by a single low pass exponential filter (EMA) with time constant equal to the sum of time constants of the two filters, multiplied by the same gain.[7] So, for the standard MACD filter time constants of 12 and 26 days, the MACD derivative estimate is filtered approximately by the equivalent of a low-pass EMA filter of 38 days. The time derivative estimate (per day) is the MACD value divided by 14.

The average series is also a derivative estimate, with an additional low-pass filter in tandem for further smoothing (and additional lag). The difference between the MACD series and the average series (the divergence series) represents a measure of the second derivative of price with respect to time ("acceleration" in technical stock analysis). This estimate has the additional lag of the signal filter and an additional gain factor equal to the signal filter constant.

Classification[edit]The MACD can be classified as an absolute price oscillator (APO), because it deals with the actual prices of moving averages rather than percentage changes. A percentage price oscillator (PPO), on the other hand, computes the difference between two moving averages of price divided by the longer moving average value.

While an APO will show greater levels for higher priced securities and smaller levels for lower priced securities, a PPO calculates changes relative to price. Subsequently, a PPO is preferred when: comparing oscillator values between different securities, especially those with substantially different prices; or comparing oscillator values for the same security at significantly different times, especially a security whose value has changed greatly.

Another member of the price oscillator family is the detrended price oscillator (DPO) , which ignores long term trends while emphasizing short term patterns.

Trading interpretation[edit]

Exponential moving averages highlight recent changes in a stock's price. By comparing EMAs of different lengths, the MACD series gauges changes in the trend of a stock. The difference between the MACD series and its average is claimed to reveal subtle shifts in the strength and direction of a stock's trend. It may be necessary to correlate the signals with the MACD to indicators like RSI power.

Some traders attribute special significance to the MACD line crossing the signal line, or the MACD line crossing the zero axis. Significance is also attributed to disagreements between the MACD line or the difference line and the stock price (specifically, higher highs or lower lows on the price series that are not matched in the indicator series).

Signal-line crossover[edit]A "signal-line crossover" occurs when the MACD and average lines cross; that is, when the divergence (the bar graph) changes sign. The standard interpretation of such an event is a recommendation to buy if the MACD line crosses up through the average line (a "bullish" crossover), or to sell if it crosses down through the average line (a "bearish" crossover). These events are taken as indications that the trend in the stock is about to accelerate in the direction of the crossover.

Zero crossover[edit]A "zero crossover" event occurs when the MACD series changes sign, that is, the MACD line crosses the horizontal zero axis. This happens when there is no difference between the fast and slow EMAs of the price series. A change from positive to negative MACD is interpreted as "bearish", and from negative to positive as "bullish". Zero crossovers provide evidence of a change in the direction of a trend but less confirmation of its momentum than a signal line crossover.

Divergence[edit]A "positive divergence" or "bullish divergence" occurs when the price makes a new low but the MACD does not confirm with a new low of its own. A "negative divergence" or "bearish divergence" occurs when the price makes a new high but the MACD does not confirm with a new high of its own. A divergence with respect to price may occur on the MACD line and/or the MACD Histogram.[8]

Timing[edit]The MACD is only as useful as the context in which it is applied. An analyst might apply the MACD to a weekly scale before looking at a daily scale, in order to avoid making short term trades against the direction of the intermediate trend.[9] Analysts will also vary the parameters of the MACD to track trends of varying duration. One popular short-term set-up, for example, is the (5,35,5).

False signals[edit]Like any forecasting algorithm, the MACD can generate false signals. A false positive, for example, would be a bullish crossover followed by a sudden decline in a stock. A false negative would be a situation where there was no bullish crossover, yet the stock accelerated suddenly upwards.

A prudent strategy may be to apply a filter to signal line crossovers to ensure that they have held up. An example of a price filter would be to buy if the MACD line breaks above the signal line and then remains above it for three days. As with any filtering strategy, this reduces the probability of false signals but increases the frequency of missed profit.

Analysts use a variety of approaches to filter out false signals and confirm true ones.

A MACD crossover of the signal line indicates that the direction of the acceleration is changing. The MACD line crossing zero suggests that the average velocity is changing direction.

http://www.investopedia.com/university/technical/techanalysis10.asp

Technical Analysis: Indicators And Oscillators

By Investopedia Staff

By Cory Janssen, Chad Langager and Casey Murphy

Indicators are calculations based on the price and the volume of a security that measure such things as money flow, trends, volatility and momentum. Indicators are used as a secondary measure to the actual price movements and add additional information to the analysis of securities. Indicators are used in two main ways: to confirm price movement and the quality of chart patterns, and to form buy and sell signals. 

There are two main types of indicators: leading and lagging. A leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price movement. A leading indicator is thought to be the strongest during periods of sideways or non-trending trading ranges, while the lagging indicators are still useful during trending periods. 

There are also two types of indicator constructions: those that fall in a boundedrange and those that do not. The ones that are bound within a range are calledoscillators - these are the most common type of indicators. Oscillator indicators have a range, for example between zero and 100, and signal periods where the security is overbought (near 100) or oversold (near zero). Non-bounded indicators still form buy and sell signals along with displaying strength or weakness, but they vary in the way they do this. 

The two main ways that indicators are used to form buy and sell signals in technical analysis is through crossovers and divergence. Crossovers are the most popular and are reflected when either the price moves through the moving average, or when two different moving averages cross over each other.The second way indicators are used is through divergence, which happens when the direction of the price trend and the direction of the indicator trend are moving in the opposite direction. This signals to indicator users that the direction of the price trend is weakening. 

Indicators that are used in technical analysis provide an extremely useful source of additional information. These indicators help identify momentum, trends, volatility and various other aspects in a security to aid in the technical analysis of trends. It is important to note that while some traders use a single indicator solely for buy and sell signals, they are best used in conjunction with price movement, chart patterns and other indicators. 

Accumulation/Distribution Line The accumulation/distribution line is one of the more popular volume indicators that measures money flows in a security. This indicator attempts to measure the ratio of buying to selling by comparing the price movement of a period to the volume of that period. 

Calculated: 

Acc/Dist = ((Close - Low) - (High - Close)) / (High - Low) * Period\'s Volume 

This is a non-bounded indicator that simply keeps a running sum over the period of the security. Traders look for trends in this indicator to gain insight on the amount of purchasing compared to selling of a security. If a security has an accumulation/distribution line that is trending upward, it is a sign that there is more buying than selling. 

Average Directional Index The average directional index (ADX) is a trend indicator that is used to measure the strength of a current trend. The indicator is seldom used to identify the direction of the current trend, but can identify the momentum behind trends. 

The ADX is a combination of two price movement measures: the positive directional indicator (+DI) and the negative directional indicator (-DI). The ADX measures the strength of a trend but not the direction. The +DI measures the strength of the upward trend while the -DI measures the strength of the downward trend. These two measures are also plotted along with the ADX line. Measured on a scale between zero and 100, readings below 20 signal a weak trend while readings above 40 signal a strong trend. 

Aroon The Aroon indicator is a relatively new technical indicator that was created in 1995. The Aroon is a trending indicator used to measure whether a security is in an uptrend or downtrend and the magnitude of that trend. The indicator is also used to predict when a new trend is beginning. The indicator is comprised of two lines, an "Aroon up" line (blue line) and an "Aroon down" line (red dotted line). The Aroon up line measures the amount of time it has been since the highest price during the time period. The Aroon down line, on the other hand, measures the amount of time since the lowest price during the time period. The number of periods that are used in the calculation is dependent on the time frame that the user wants to analyze. 

Figure 1Aroon Oscillator An expansion of the Aroon is the Aroon oscillator, which simply plots the difference between the Aroon up and down lines by subtracting the two lines. This line is then plotted between a range of -100 and 100. The centerline at zero in the oscillator is considered to be a major signal line determining the trend. The higher the value of the oscillator from the centerline point, the more upward strength there is in the security; the lower the oscillator's value is from the centerline, the more downward pressure. A trend reversal is signaled when the oscillator crosses through the centerline. For example, when the oscillator goes from positive to negative, a downward trend is confirmed. Divergence is also used in the oscillator to predict trend reversals. A reversal warning is formed when the oscillator and the price trend are moving in an opposite direction. 

The Aroon lines and Aroon oscillators are fairly simple concepts to understand but yield powerful information about trends. This is another great indicator to add to any technical trader's arsenal. 

Moving Average Convergence The moving average convergence divergence (MACD) is one of the most well known and used indicators in technical analysis. This indicator is comprised of two exponential moving averages, which help to measure momentum in the security. The MACD is simply the difference between these two moving averages plotted against a centerline. The centerline is the point at which the two moving averages are equal. Along with the MACD and the centerline, an exponential moving average of the MACD itself is plotted on the chart. The idea behind this momentum indicator is to measure short-term momentum compared to longer term momentum to help signal the current direction of momentum. 

MACD= shorter term moving average - longer term moving average 

When the MACD is positive, it signals that the shorter term moving average is above the longer term moving average and suggests upward momentum. The opposite holds true when the MACD is negative - this signals that the shorter term is below the longer and suggest downward momentum. When the MACD line crosses over the centerline, it signals a crossing in the moving averages. The

most common moving average values used in the calculation are the 26-day and 12-day exponential moving averages. The signal line is commonly created by using a nine-day exponential moving average of the MACD values. These values can be adjusted to meet the needs of the technician and the security. For more volatile securities, shorter term averages are used while less volatile securities should have longer averages. 

Another aspect to the MACD indicator that is often found on charts is the MACD histogram. The histogram is plotted on the centerline and represented by bars. Each bar is the difference between the MACD and the signal line or, in most cases, the nine-day exponential moving average. The higher the bars are in either direction, the more momentum behind the direction in which the bars point. (For more on this, see Moving Average Convergence Divergence - Part 1and Part 2, and Trading The MACD Divergence.) 

As you can see in Figure 2, one of the most common buy signals is generated when the MACD crosses above the signal line (blue dotted line), while sell signals often occur when the MACD crosses below the signal. 

Figure 2

Relative Strength Index The relative strength index (RSI) is another one of the most used and well-known momentum indicators in technical analysis. RSI helps to signal overbought and oversold conditions in a security. The indicator is plotted in a range between zero and 100. A reading above 70 is used to suggest that a security is overbought, while a reading below 30 is used to suggest that it is oversold. This indicator helps traders to identify whether a security's price has been unreasonably pushed to current levels and whether a reversal may be on the way. 

Figure 3

The standard calculation for RSI uses 14 trading days as the basis, which can be adjusted to meet the needs of the user. If the trading period is adjusted to use fewer days, the RSI will be more volatile and will be used for shorter term trades. (To read more, see Momentum And The Relative Strength Index,Relative Strength Index And Its Failure-Swing Points and Getting To Know Oscillators - Part 1 and Part 2.) 

On-Balance Volume The on-balance volume (OBV) indicator is a well-known technical indicator that reflect movements in volume. It is also one of the simplest volume indicators to compute and understand. 

The OBV is calculated by taking the total volume for the trading period and assigning it a positive or negative value depending on whether the price is up or down during the trading period. When price is up during the trading period, the volume is assigned a positive value, while a negative value is assigned when the price is down for the period. The positive or negative volume total for the period is then added to a total that is accumulated from the start of the measure.

It is important to focus on the trend in the OBV - this is more important than the actual value of the OBV measure. This measure expands on the basic volume measure by combining volume and price movement. (For more insight, see Introduction To On-Balance Volume.) 

Stochastic Oscillator The stochastic oscillator is one of the most recognized momentum indicators used in technical analysis. The idea behind this indicator is that in an uptrend, the price should be closing near the highs of the trading range, signaling upward momentum in the security. In downtrends, the price should be closing near the lows of the trading range, signaling downward momentum. 

The stochastic oscillator is plotted within a range of zero and 100 and signals overbought conditions above 80 and oversold conditions below 20. The stochastic oscillator contains two lines. The first line is the %K, which is essentially the raw measure used to formulate the idea of momentum behind the oscillator. The second line is the %D, which is simply a moving average of the %K. The %D line is considered to be the more important of the two lines as it is seen to produce better signals. The stochastic oscillator generally uses the past 14 trading periods in its calculation but can be adjusted to meet the needs of the user. (To read more, check out Getting To Know Oscillators - Part 3.) 

Figure 4

Technical Analysis: ConclusionBy Investopedia Staff

By Cory Janssen, Chad Langager and Casey Murphy

This introductory section of the technical analysis tutorial has provided a broad overview of technical analysis. 

Here's a brief summary of what we've covered: 

Technical analysis  is a method of evaluating securities by analyzing the statistics generated by market activity. It is based on three assumptions: 1) the market discounts everything, 2) price moves in trends and 3) history tends to repeat itself.

Technicians believe that all the information they need about a stock can be found in its charts. Technical traders take a short-term approach to analyzing the market. Criticism of technical analysis stems from the efficient market hypothesis, which states that the market price is always the

correct one, making any historical analysis useless. One of the most important concepts in technical analysis is that of a trend, which is the general direction that a security is

headed. There are three types of trends: uptrends, downtrends and sideways/horizontal trends. A trendline is a simple charting technique that adds a line to a chart to represent the trend in the market or a stock. A channel, or channel lines, is the addition of two parallel trendlines that act as strong areas of support and resistance. Support  is the price level through which a stock or market seldom falls.Resistance is the price level that a stock or market

seldom surpasses. Volume  is the number of shares or contracts that trade over a given period of time, usually a day. The higher the volume,

the more active the security. A chart is a graphical representation of a series of prices over a set time frame. The time scale refers to the range of dates at the bottom of the chart, which can vary from decades to seconds. The most

frequently used time scales are intraday, daily, weekly, monthly, quarterly and annually. The price scale is on the right-hand side of the chart. It shows a stock's current price and compares it to past data points.

It can be either linear orlogarithmic. There are four main types of charts used by investors and traders: line charts, bar charts, candlestick charts and point and

figure charts. A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future price movements.

There are two types:reversal and continuation. A head and shoulders pattern is reversal pattern that signals a security is likely to move against its previous trend. A cup and handle pattern is a bullish continuation pattern in which the upward trend has paused but will continue in an

upward direction once the pattern is confirmed. Double tops  and double bottoms are formed after a sustained trend and signal to chartists that the trend is about to

reverse. The pattern is created when a price movement tests support or resistance levels twice and is unable to break through.

A triangle is a technical analysis pattern created by drawing trendlines along a price range that gets narrower over time because of lower tops and higher bottoms. Variations of a triangle include ascending and descendingtriangles.

Flags  and pennants are short-term continuation patterns that are formed when there is a sharp price movement followed by a sideways price movement.

The wedge chart pattern can be either a continuation or reversal pattern. It is similar to a symmetrical triangle except that the wedge pattern slants in an upward or downward direction.

A gap in a chart is an empty space between a trading period and the following trading period. This occurs when there is a large difference in prices between two sequential trading periods.

Triple tops  and triple bottoms are reversal patterns that are formed when the price movement tests a level of support or resistance three times and is unable to break through, signaling a trend reversal. 

A rounding bottom (or saucer bottom) is a long-term reversal pattern that signals a shift from a downward trend to an upward trend.

A moving average is the average price of a security over a set amount of time. There are three types: simple, linear and exponential.

Moving averages help technical traders smooth out some of the noise that is found in day-to-day price movements, giving traders a clearer view of the price trend.

Indicators  are calculations based on the price and the volume of a security that measure such things as money flow, trends, volatility and momentum. There are two types: leading and lagging.

The accumulation/distribution line is a volume indicator that attempts to measure the ratio of buying to selling of a security. The average directional index (ADX) is a trend indicator that is used to measure the strength of a current trend. The Aroon indicator is a trending indicator used to measure whether a security is in an uptrend or downtrend and the

magnitude of that trend. The Aroon oscillator plots the difference between the Aroon up and down lines by subtracting the two lines. The moving average convergence divergence (MACD) is comprised of two exponential moving averages, which help to

measure a security'smomentum. The relative strength index (RSI) helps to signal overbought and oversold conditions in a security. The on-balance volume (OBV) indicator is one of the most well-known technical indicators that reflects movements in

volume. The stochastic oscillator compares a security's closing price to its price range over a given time period.

Technical Analysis: Moving AveragesBy Investopedia Staff

By Cory Janssen, Chad Langager and Casey Murphy

Most chart patterns show a lot of variation in price movement. This can make it difficult for traders to get an idea of a security's overall trend. One simple method traders use to combat this is to apply moving averages. A moving average is the average price of a security over a set amount of time. By plotting a security's average price, the price movement is smoothed out. Once the day-to-day fluctuations are removed, traders are better able to identify the true trend and increase the probability that it will work in their favor. (To learn more, read the Moving Averages tutorial.) 

Types of Moving Averages There are a number of different types of moving averages that vary in the way they are calculated, but how each average is interpreted remains the same. The calculations only differ in regards to the weighting that they place on the price data, shifting from equal weighting of each price point to more weight being placed on recent data. The three most common types of moving averages are simple, linear and exponential. 

Simple Moving Average (SMA) This is the most common method used to calculate the moving average of prices. It simply takes the sum of all of the past closing prices over the time period and divides the result by the number of prices used in the calculation. For example, in a 10-day moving average, the last 10 closing prices are added together and then divided by 10. As you can see in Figure 1, a trader is able to make the average less responsive to changing prices by increasing the number of periods used in the calculation. Increasing the number of time periods in the calculation is one of the best ways to gauge the strength of the long-term trend and the likelihood that it will reverse. 

Figure 1

Many individuals argue that the usefulness of this type of average is limited because each point in the data series has the same impact on the result regardless of where it occurs in the sequence. The critics argue that the most recent data is more important and, therefore, it should also have a higher

weighting. This type of criticism has been one of the main factors leading to the invention of other forms of moving averages. 

Linear Weighted Average This moving average indicator is the least common out of the three and is used to address the problem of the equal weighting. The linear weighted moving average is calculated by taking the sum of all the closing prices over a certain time period and multiplying them by the position of the data point and then dividing by the sum of the number of periods. For example, in a five-day linear weighted average, today's closing price is multiplied by five, yesterday's by four and so on until the first day in the period range is reached. These numbers are then added together and divided by the sum of the multipliers. 

Exponential Moving Average (EMA) This moving average calculation uses a smoothing factor to place a higher weight on recent data points and is regarded as much more efficient than the linear weighted average. Having an understanding of the calculation is not generally required for most traders because most charting packages do the calculation for you. The most important thing to remember about the exponential moving average is that it is more responsive to new information relative to the simple moving average. This responsiveness is one of the key factors of why this is the moving average of choice among many technical traders. As you can see in Figure 2, a 15-period EMA rises and falls faster than a 15-period SMA. This slight difference doesn't seem like much, but it is an important factor to be aware of since it can affect returns. 

Figure 2

Major Uses of Moving Averages Moving averages are used to identify current trends and trend reversals as well as to set up support and resistance levels. 

Moving averages can be used to quickly identify whether a security is moving in an uptrend or a downtrend depending on the direction of the moving average. As you can see in Figure 3, when a moving average is heading upward and the price is above it, the security is in an uptrend. Conversely, a downward sloping moving average with the price below can be used to signal a downtrend. 

Figure 3

Another method of determining momentum is to look at the order of a pair of moving averages. When a short-term average is above a longer-term average, the trend is up. On the other hand, a long-term average above a shorter-term average signals a downward movement in the trend. 

Moving average trend reversals are formed in two main ways: when the price moves through a moving average and when it moves through moving average crossovers. The first common signal is when the price moves through an important moving average. For example, when the price of a security that was in an uptrend falls below a 50-period moving average, like in Figure 4, it is a sign that the uptrend may be reversing. 

Figure 4

The other signal of a trend reversal is when one moving average crosses through another. For example, as you can see in Figure 5, if the 15-day moving average crosses above the 50-day moving average, it is a positive sign that the price will start to increase. 

Figure 5

If the periods used in the calculation are relatively short, for example 15 and 35, this could signal a short-term trend reversal. On the other hand, when two averages with relatively long time frames cross over (50 and 200, for example), this is used to suggest a long-term shift in trend. 

Another major way moving averages are used is to identify support and resistance levels. It is not uncommon to see a stock that has been falling stop its decline and reverse direction once it hits the support of a major moving average. A move through a major moving average is often used as a signal by technical traders that the trend is reversing. For example, if the price breaks through the 200-day moving average in a downward direction, it is a signal that the uptrend is reversing. 

Figure 6

Moving averages are a powerful tool for analyzing the trend in a security. They provide useful support and resistance points and are very easy to use. The most common time frames that are used when creating moving averages are the 200-day, 100-day, 50-day, 20-day and 10-day. The 200-day average is thought to be a good measure of a trading year, a 100-day average of a half a year, a 50-day average of a quarter of a year, a 20-day average of a month and 10-day average of two weeks. 

Moving averages help technical traders smooth out some of the noise that is found in day-to-day price movements, giving traders a clearer view of the price trend. So far we have been focused on price movement, through charts and averages. In the next section, we'll look at some other techniques used to confirm price movement and patterns. 

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