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Technical Analysis – Stock Market Trading – The Ultimate Beginners Guide

This in depth blog will give you EVERYTHING you need to be able to use financial charts as a crystal ball to predict when to buy quality stocks at the lowest possible prices and sell them at the highest prices for a large profit.

TECHNICAL ANALYSIS – ‘Charting’

Technical analysis in its simplest form attempts to reflect patterns or trends in share price movement over specified time frames. These patterns tend to repeat themselves and hence we can use this information to improve our buy and sell decision timing.

It is important to remember when we make investment decisions to first study the fundamentals and then perform the technical analysis. Some investors only rely on fundamental analysis, while other investors rely only on technical analysis.

I use both.

I find technical analysis helps us to better time our entry and exit points for investments in companies which we have already pre-screened through our fundamental analytical tool, the Model which I talk about in another blog.

In this section we are going to look at technical analysis which is primarily interested in the share price movement patterns during the market opening hours.

Please see the later blogs which illustrate exactly how to set up your charts for use on your own computer.

Technical Analysis - Stock Market Trading - The Ultimate Beginners Guide
Technical Analysis – Stock Market Trading – The Ultimate Beginners Guide

This section is going to explain the theory of technical analysis or ‘charting’.

There is a large amount of detail contained in this blog. Do not be alarmed. As you become more experienced you will be able to ‘read’ charts very quickly. As with all skills, practice makes perfect.

What is Technical Analysis (TA)?

In simple terms it is a graphical illustration of stock price movements over time, i.e. charts or charting the changes in the share price. Charts are used for technical analysis because they are the easiest way to visualise all of the historical price data. Technical analysis is the study of share price movement on a chart.

Technical analysis studies supply and demand on the charts in an attempt to determine where the markets are likely to go in the future. It is based on trying to forecast the future movement of price based on past price movements, various ‘signals’ from indicators and volume. It does not give any absolute forecasts or predictions but can help in identifying what is “likely” to happen to the share price over a given time frame. This time frame can be a one minute, five minute, hourly, daily, or weekly chart.

 

Why use technical analysis for Investing?

We have all heard the famous quote originally by Edmund Burke the British statesman and philosopher, “Those who don’t know history are destined to repeat it”. This not-so common sense can be applied to stock market investing.

Technical analysts believe that investors collectively repeat the behaviour of the investors that preceded them. To a technician, the emotions in the market may be irrational, but they exist. Because investor behaviour repeats itself so often, technicians believe that recognizable (and predictable) price patterns will develop on a chart.

Technical analysts look for patterns that have formed in the past. They believe that if a price level held as a key ‘support’ or ‘resistance’ level in the past, then they will keep an eye on that level for the future and base their trades around that, believing that price will act the same way that it did before. You might think it likely that patterns will work in the markets more often as more and more traders look at the same patterns, but not everyone comes up with the same visual picture of where the price is heading on the charts so this is not necessarily the case.

Technical Analysis - Stock Market Trading - The Ultimate Beginners Guide
Technical Analysis – Stock Market Trading – The Ultimate Beginners Guide

It is important to acknowledge from the outset that charts and indicators are precisely that – indicators of where the share price may go. They represent a form of investment ‘crystal ball’!

Major news events can alter patterns instantly. For example, a company’s earnings report can immediately change the short term trend of a share price. Hence, it is critical you include fundamental analysis in your investment routine. This must include monitoring of key news releases on your company. We call this the ‘heartbeat’ of the company. You must be aware of key dates such as earnings date and ex-dividend dates for each of your investments. We cover all this on our very popular Mac & Dec weekly online live ‘Traders Lounge’ and ‘Traders Floor’ investor support session.

Where do I find Charting Software so I can setup my own charts for Technical Analysis?

  1. Free Software Service

There are many free charting services one of which is Freestockcharts that can be found at www.freestockcharts.com

This service is more than adequate for beginners. I discuss this later in the manual and show you how to set up your charts on your own computer.

  1. Subscription Charting Service

There are many charting systems out there at the moment. I use Worden charting software called TC2000 (or Telecharts) which is a subscription service. I discuss this in more depth later in this blog showing you how to set up your charts.

There is a full library of videos and tutorials and webinars from Worden available at the link below, with a fantastic back up service. You can even get a free 14 day trial of TC2000.

Worden also has an online discussion forum with multiple tutorial videos for TC2000 Version 7. To access these online tutorials simply click the link below.

CANDLESTICK CHARTS GUIDE

There are two main types of charts.

  1. Bar Chart (OHLC) – these show the open price, high price, low price and close price.
  2. Candlestick Chart – these show all the above but also show a body which indicates whether the share closed lower or higher than the open price

We focus on Candlestick charts as they are more informative in our opinion.

Candlesticks can be used in any time frame whether it is one minute, one day, one hour, one month or one year. Candlesticks are formed using the open, high, low and closing share price. They illustrate what happened to the share price in the time frame you have selected to view.

Candlesticks give us a visual indication of who won the battle between the ‘bulls’ and the ‘bears’ in whichever time frame you choose. Candlestick charts are much more visual than bar charts.

Technical Analysis - Stock Market Trading - The Ultimate Beginners Guide - Candlesticks
Technical Analysis – Stock Market Trading – The Ultimate Beginners Guide – Candlesticks

If the price closes higher than it opened the candle will be coloured green. Conversely, if the share price closes lower than it opened the candle will be red. Candlesticks are easy to interpret, and are very helpful for identifying turning points in the market or share price.

In the following section you will see how using the green and red candles will allow you to visually see things on the charts much quicker, especially trend reversals.

Later in the module you will learn about major and minor one and two candle formation patterns. Some candlestick pattern names that you will learn about are those called a Doji, Bullish Engulfing or Bearish Engulfing candles and lots more as your trading experience grows.

3. CANDLESTICK FORMATIONS – Technical Analysis

Compared to line charts and bar charts many traders consider candlestick charts more appealing visually and much easier to interpret. Each candle provides an easy to read picture of price action for any time frame and patterns can be spotted quicker.

Bar Chart Versus Candlestick Chart - Technical Analysis
Bar Chart Versus Candlestick Chart – Technical Analysis

OHLC (Bar Chart) v Candle Chart

Candlesticks are formed using the open, high, low, and closing share prices. Without opening prices you cannot draw a candle. The box portion of the candle is called the body or the ‘real body’. The long lines above or below the body, which represent the high or low range of the candles, are called either shadows, wicks, hairs or tails. These can be upper shadows or hairs (found above the body of the candle), or lower shadows or tails (found below the body of the candle).

If the close of the candle is above the open then you have a clear bodied candle, as in the figure on the right above. If the close of the candle is below the open then you have a filled bodied candle, as in the figure on the left above. The body colour only indicates where the close was compared to the open.

A clear green candle shows us a gain for the share price from the previous day’s close, where the closing price is greater than the opening price, indicating positive days and buying pressure. Only the outline of the candle is coloured green.

A ‘filled’ green candle tells us that the share price has finished higher than the previous day’s closing price. However it indicates to us that the share price gapped up at open and then closed lower than the opening price by the end of the trading session. So even though it is a filled candle, it was still a positive day in the market as the share price closed above the previous day’s closing price. The entire body of the candle is shaded green (‘filled’).

A filled red candle shows us a drop in the share price, where the closing share price is lower than the opening price, indicating a negative day and selling pressure.

A clear red candle shows us that the share price closed below the previous day’s closing price. However it indicates to us that the share price had gapped down at open and then closed higher than the opening price by the end of the trading session. So even though it is a red candle it was a still a positive day in the market as the share price closed above the opening price.

Generally speaking the longer the body the more intense the buying or selling pressure the candle will indicate.

The Japanese candlestick trading patterns are easily visible. The signals and patterns become easily identified (See ‘Candlestick Chart Patterns – An Introduction’ in a later section in this blog).

4. THE BASICS OF TECHNICAL ANALYSIS

The foundations of technical analysis are trend lines, support and resistance levels, trading ranges, trends, moving averages, momentum, buying pressure, money flow and candlestick patterns. These can be applied to all charts and to all time frames.

4.1. Trends – Technical Analysis

Studying different time frames of charts, it can become possible to spot both short term and long term trends – that is uptrend’s, downtrends and sideways trends. Technical analysis is built on the assumption that prices trend either upwards, downwards or sideways.

You will hear technical analysts say “Let the Trend be your Friend”. An interesting twist of this is “the trend is your friend, until it ends”. It is not advisable to trade against the trend, although occasionally we will do this when we observe reversal indicators.

A trend line is usually a straight line that can be drawn diagonally or horizontally to connect two or more price points, and then extends on into the future to act as a line of support or resistance that the price ‘bounces’ off.  The more times a share bounces off a trend line the more solid that level can become.

A ‘channel’ consists of two parallel trend lines. Figure 1 depicts an upward sloping channel. This is a bullish trend or an upward trend.

visible upward trend - technical analysis
visible upward trend – technical analysis

Figure 1.  A visible upward trending channel or a ‘Bullish’ upward trend channel from 2009 up to 2012.

  • Channel Up: means that both support and resistance trend lines are sloping upwards.
  • Channel Down: means that both support and resistance trend lines are sloping downwards.
  • Upwards trends: are when you have higher highs and higher lows in the stock price.
  • Downwards trends: are when you have lower highs and lower lows in the stock price.

Trend lines are a very important tool in technical analysis for both identifying uptrends and more importantly identifying a reversal downtrend.

We always say that you need confirmation that a trend has changed direction before you can make decisions based on the assertion that the prior trend has ended.

4.2. What is Support and Resistance in Technical Analysis?

Support and Resistance is the basis of most technical analysts charting systems. The more often price ‘tests’ or reaches a level of support or resistance without breaking it the stronger  that level of support or resistance becomes.

Support levels are price levels where a share price tends to stop moving down and then turns around and starts climbing higher or ‘bounces’. The “bulls” or buyers take control over the price of the share and try to prevent the price from falling any lower. Hence, support levels are levels where investors believe the share price will move higher from or bounce. As such they can become self manifesting to some extent as many investors set orders to buy at support or to sell at resistance.

Support levels are sometimes called the ‘floor’ because that support level often ‘prevents’ the share from going further downwards. When the stock price hits this value it tends to bounce off it and trend back up towards its resistance level.

Resistance levels on the other hand are where the “bears” or sellers take control of the share price and try to prevent the share from climbing any higher. Resistance levels are levels from where investors believe the share price will move lower.

Technical Analysis - Stock Market Trading - The Ultimate Beginners Guide - Support and Resistance
Technical Analysis – Stock Market Trading – The Ultimate Beginners Guide – Support and Resistance

Resistance levels are sometimes called ‘ceilings’ because they tend to prevent the market from moving prices higher. When the stock price hits this level it tends to bounce off it and trend down towards its support point. Again this is based on historical price action at these price points.

Support and resistance levels are based on supply and demand for the share. When a resistance level is successfully broken through to the upside the prior level then becomes a support level.

Conversely, when a support level is successfully broken down through, that level then becomes a resistance level.

The chart below (Fig. 2) shows a support level for HUM from December 2011 until end of April 2012 of $84 and after the breakdown through that prior support level then $84 became a future resistance level for the share.

Technical Analysis - Support and Resistance Lines
Technical Analysis – Support and Resistance Lines

Figure 2.  Prior Support of $84 on chart above (Dec 2011, Jan 2012, Feb 2012 and March 2012) then after the breakdown in May the $84 level becomes the future Resistance of the share as can be seen above.

The more times a share price bounces off a certain point the stronger the support or resistance level becomes. You can think of support being the ‘floor’ and the resistance being a ‘ceiling’ but yet we can also have a ‘basement room’ below our floor support and we can have further floors above giving other various support and resistance levels.

The more times a share hits off a previous resistance area the stronger that resistance is. If a share breaks up through a resistance line and holds that area we have what is known as ‘a breakout’. A break above resistance levels would be considered bullish. The prior resistance level would then become our new support level.

If a share price breaks down through a support line we have a ‘breakdown’ as seen above in Figure 2 chart on HUM and we then look for the next lower support level that can be found. A break below a support level would be considered bearish. Defensive strategies should be considered at this stage (the break of $84 as in above figure 2 chart).

In technical analysis it is important to understand that as we said earlier history tends to repeat itself in terms of price movement. One of the most important points of technical analysis is to identify how the share is ‘trending’, i.e. how it is moving – up, down, or sideways.

Many of the principles applicable to support and resistance levels can be applied to trend lines as well.

4.3. Know your Charts! – Technical AnalySis

Resistance  Support    Trend

Before you initiate any position in the market, and after doing your fundamental analysis, you should always check the charts. Use charts and various time frames to improve your entry and exit timing on shares and options.

I trade short term, intermediate and long term.

We look at the daily, two day and weekly charts to give us information as to what is happening at various time frames and to know what the sentiment of the stock market is over a longer period. We are always trying to find the support and resistance lines of any chart we look at.

When we are about to invest in a trade we look at the four hourly, hourly and five minute chart to give us an indication of what is going on over a shorter period of time. We need to know what’s going on now. This would give us an indication of what the sentiment of the market is today and in the shorter time frames. This can give us an indication whether the market is giving a positive or negative bias during that time frame.

This can fine tune our entry and exits points.

 

4.4. Trends and Patterns – Technical Analysis

When checking charts for trends and patterns it is important to also check over a longer period on the charts. This will give you an in depth idea of the chart over a longer period. You can identify the overall trend this way. There are three types of trends.

  1. Up trends
  2. Down trends
  3. Sideways trend
technical analysis - up and down trends
technical analysis – up and down trends

Figure 3. The CSCO chart above shows a visible uptrend from August 2011 until April 2012 and then into a downtrend from April 2012 until May 2012.CSCO share started to trade sideways from May 2012 through June into July of 2012.

A trend is identified when a line can be drawn between two points or more. The trend is not totally confirmed until the stock tests this initial line again and holds either support or resistance therefore creating a third point. Once the third point is created, this then informs us of the trend. Any of these three trend types can be broken down into a long term trend, intermediate trend or a short term trend.

A major long term trend can last longer than a year. An intermediate trend is considered as one that lasts between one and three months and a short term trend is one that only last anything less than a month. You will observe we can also have a trend within longer term trends.

Technical Analysis - Upward Support Line
Technical Analysis – Upward Support Line

Figure 4. Visible up trending support Line on INTU .We can see in this chart that INTU is in an uptrend and each time it comes down to that up-trending line it bounces and heads further up. If we owned this share having bought it in August 2011 as our Plan A then our Plan B might be to sell if the share breaks down below our up-trending line thus holding on to our profits after the fantastic drive upwards since august 2011.

You are always looking to see if the chart is trending up, down or sideways. If the share is still above its uptrend line the trend will still be considered bullish. You can find support levels where the share bounced, you will also find resistance levels where the share hit tops in the past and retraced from those levels when sellers took control.

These levels will be pivotal to your chart and the cornerstone of your technical analysis. You can then zoom in to find other support and resistance levels and finally bring the chart further up to date and fine tune those levels.

Support and Resistance lines on an upward trend - Technical Analysis
Support and Resistance lines on an upward trend – Technical Analysis

Figure 5. Long term uptrend chart from 2009 to 2012 showing support levels (lower line) & resistance levels (upper line) along the way.

As you can see from the longer term chart above (Fig 5), the trend was up since 2009 but the share had many rolls (rolling from the bottom trendline to the top trendline and back again) within that uptrend.The share price hit its resistance (upper trend line) and support (lower trend line) levels many times on its journey upwards.

In the chart below (Fig 6) we see a downtrend from 2010 in CSCO. We can also see the way the share moved in this downtrend. It hit the support levels of the chart at B,D,F,H (on the lower trend line) and the resistance levels of C,E,G,I (on the upper trendline) before it changed from a downtrend into an uptrend again.

Support and Resistance lines on an downward trend - Technical Analysis
Support and Resistance lines on an downward trend – Technical Analysis

Figure 6. Down-trending chart bouncing from support at ,B,D,F,H, up to resistance at C,E,G,I.

A share can be in a uptrend ,downtrend or sideways trend. Being able to identify these trends gives you a great opportunity to collect rent or option premium from your shares as they trend either up or down or even sideways. You can see from the CSCO chart above (Fig 6) knowing the support and resistance levels meant that one could have traded that share for profit by buying at support and selling at resistance, even though the share was in an overall downtrend.

Looking at the TSM chart below (Fig 7) you can immediately identify the support Level around $9.50 and resistance levels around $11 that the share was trading within the period April 2009 to November 2010.

Technical Analysis - Support and Resistance Lines
Technical Analysis – Support and Resistance Lines

Figure 7. TSM chart visibly showing great support at $9.50 and resistance levels $11.00 over a 19 month period. A perfect example of a share trading within a boxed zone.

We can visibly see that the share went from $9.50 up to $11 and back to $9.50 five times from April of 2009 up to November 2010. If one had bought that share in April of 2009 at support of $9.50 and sold it at $11 and locked in a profit of $1.50 and then bought it again at $9.50 and resold it at $11 one would have locked in another $1.50. As it rolled five times between support and resistance that would have been $1.50 x 5 = $7.50 profit in 19 months. Now let us not forget that the share price originally cost $9.50 so we would have earned $7.50 or 79% (being $7.50 divided by $9.50 x100 = 79%) Return on Investment in the 19 months from a rolling stock strategy.

Finding the support and resistance levels on a longer term chart will give you a road map of what the share has done over that longer period of time. You will be amazed to see how the share found some levels and then immediately changed trend. Stocks seem to be attracted to prior levels of support and resistance. Try and think about all the traders who are looking at these charts, looking to find a share that is at a support or resistance level, as well as yourself.

When we look at charts we also have to keep an eye on what we call DOUBLE TOPS, DOUBLE BOTTOMS, TRIPLE TOPS, and TRIPLE BOTTOMS. Now this is where support and resistance really come into play.  Market makers, fund managers, institutional investors and day traders are always looking out for areas where a share can bounce off being support levels or areas where a share is hitting resistance levels to take profits.

We will spot many DOUBLE TOPS, and TRIPLE TOPS, on charts when we look at them in hindsight. The same thing when we look at them in relation to DOUBLE BOTTOMS and TRIPLE BOTTOMS.

4.4.1. Double Top (Resistance)

Technical Analysis - Double Tops
Technical Analysis – Double Tops

Figure 8. Visible double top – as we can see above the share reached a high in Oct 2011 (see arrow) then when it reached that high again in April of 2012 (see arrow). It retraces from the April high of 2012 because sellers came in at that level. This was the second time it had hit that same area on the chart and retraced. So that is why it was called a ‘double top’.

 

4.4.2. Double Bottom Pattern (Support)

Technical Analysis - Double Bottom
Technical Analysis – Double Bottom

Figure 9. Visible double bottom – on the XLNX chart above chart in December 2010 we were at $27 and we rallied up to $37 before retracing back to the $27 again in October 2011. Buyers ‘stepped in’ at the October $27 level as they were confident the share would find support at that level having bounced from there in December 2010.

Technical Analysis - Double Bottom
Technical Analysis – Double Bottom

Figure 10. Double bottom and Double top above shown with arrows.

After the double bottom in Oct 2011 the share starts an uptrend to reach a new high on December the 5th which was retested as a double top on the 26th December 2011 shown with arrows at around $90. The double bottom is seen in the above chart when we look at the low that the share came down to in Aug 2011 at around $65 (see arrows) and bounced from. It then returned to that area in October 2011 where buyers came into the market and bought the share back up again. This gave us a double bottom on this share (Aug 2011 and Oct 2011).

Investors were looking to see if the share would bounce off this previous low and when it did the buyers stepped in and the share gained momentum to the upside.

Technical Analysis - Double Bottom
Technical Analysis – Double Bottom

Figure 11. Double bottom on TOT chart seen above in early June and then that low was retested and successfully held in late June  and then a gap up on buyers stepping in or on possible good news from the company.

The most important point to remember is when the markets come down to these support levels we have to be ready to step out and make those trades. However, what tends to happen is that fear comes into the market and yourself as a market participant. So when the share does actually come down from let’s say twenty dollars down to fifteen dollars and it’s at a good support level, instead of making the trade when they should, most investors feel afraid to act in case the share falls further.

That is because some investors panic or let fear take over their thinking. They get paranoid because the share went from twenty dollars down to fifteen that it might go down to ten dollars and that the market could totally collapse, they sell out of their positions or do not buy when the share price is low at a support level (it is important to control your emotions and be prepared to take action when the opportunity arises). In the traders Lounge we always discuss dipping your toes into the market or averaging into positions.

What often happens next is that buyers step in at that support level and then the share proceeds to bounce from a double bottom or a triple bottom and then heads back up again. It is advisable to wait for the confirmation that support will hold before going long (i.e. buy the share).

Investing in the Stock Market Ultimate Beginners Guide - Psychology of Trading
Investing in the Stock Market Ultimate Beginners Guide – Psychology of Trading

The fear and emotion at this time can also take control of a buyer who has waited on this opportunity in the market. This fear and panic and what’s on the news (CNCB, Bloomberg, etc )can cloud the judgement of even the best traders and the investment can be missed even though all the work had been done and they patiently waited on the share to come down but fear and panic took over and they did not execute the trade even though they had a Plan B in mind if it went down further.

We have to conquer our fear and emotion when trading the stock market. But how?

Plan the Trade and Trade the Plan. Plan B should be part of ‘The Plan’.

Plan A is our initial plan or logic for making the trade. However, before we open the trade we know what our backup plan is, i.e. our Plan B. Our backup plan may be to exit the trade if it goes against us. Knowing when to exit a trade is sometimes overlooked, ignored and even neglected by traders.

Another Plan B may be to collect premium or ‘rent’ from the shares. This is discussed in the later module on Generating Income from Shares using Covered Calls.

Another Plan B may involve dollar cost averaging whereby we decide we wish to buy for example 1,000 shares of a particular stock. We would normally begin by purchasing say 300. If the share falls to certain points on a chart we have been watching then we would buy the next 300. The final 400 may be bought at another support point.

Plan B is just as important as Plan A. Why? If your initial plan does not work out as you expected in the short term, inexperienced investors tend to panic and make decisions which are based on emotions and the fear of losing money takes over which can cause financial underperformance in your investments. If the underlying rationale or fundamentals for making the investment in the share still holds then we should not be too concerned about which way the share price moves short term. Most people have heard Warren Buffett’s comment to buy when others are fearful and sell when others are greedy. Control your emotions and you will have a major advantage over the majority of market participants. A Plan B approach will help you to achieve control of your emotions.

A familiar saying in the market is the share price in the short term is driven 80% by investor sentiment and 20% by fundamentals but over the long term it is driven 80% by fundamentals and only 20% by sentiment. We use short term price movements driven by sentiment to buy on price drops and sell on price rallies.

4.4.3. V shaped Bottom Formation

We can see in the HUN chart (fig 12) a nice V bottom in October of 2011.This is where the market came down sharply and reversed sharply back up just like a V sign.

Technical Analysis - V Shaped Bottom Pattern
Technical Analysis – V Shaped Bottom Pattern

Figure 12. Example of a V shaped bottom visible in the above HUN chart in October of 2011.The share came down sharply from August to October 2011 and then went back up in the space of a couple of weeks.

The BAC chart (Fig 13) below clearly indicates some nice support and resistance levels.You can see the way the share bounced off a prior support level creating a very strong support area in February and March that was retested again in May.

Technical Analysis - Support and Resistance Lines
Technical Analysis – Support and Resistance Lines

Figure 13. BAC chart showing how prior lows are important as support levels for the future. Remember also that if these support levels are broken to the downside they then become resistance levels on the way back up.

In the chart below of MSFT (Fig 14) we can see a double top in March $33 and April $33. Where the share in April went to a prior high of $33 and sellers came in at that level. We can also see the start of the uptrend from the bottom of the large green candle in February was retested in May and that level held as a support level and this was the springboard for the share to start another uptrend to a prior high where it found resistance again.

We can see in April that once the share came down to the support level of the bottom of the large green candle from February,the $30.25 area that was enough for the bulls to step in and buy the share to bring it back up again.The bulls (those that are bullish on the market) had found a prior level of support $30.25 to start entering the market again.I hope at this stage you are already seeing that the bulls exited the market in April at the ‘double top’ area around $33 where the share had found a prior level of resistance in March. The bears (those that are bearish on the market or a specific share, pessimistic) had found a level of resistance,the $33 area that they stepped out and started selling to bring the share down again.

A true visible battle between the ‘Bulls and the Bears’.

Technical Analysis - Double Top Resistance Candlestick Pattern
Technical Analysis – Double Top Resistance Candlestick Pattern

Figure 14. Double top resistance level on MSFT chart at around $33 and nice support at around $30.25 area.

4.4.4. Triple Top Pattern (Resistance)

A nice visible triple top on the chart (Fig 15) where the share PCP went up to $179 in October of 2011 and then reversed back down when the bears took control of the share.

When it retested the $179 area again in January of 2012 as a double top the sellers came in at that level again and sent the share down for the second time.

Then in May of 2012 the share again went back up to the $179 area again for the third time and failed to break through that level of resistance. It shows us how strong that resistance level was but it also shows us what happens to a share when it hits a resistance level. History repeating itself!

It had now created a triple top at this area but most of all it showed us the sentiment of the traders in the market in relation to this share that each time the share went up to that $179 level, suddenly sellers sent the share back down again. We can take it that $179 is the strong resistance level for PCP until it has a breakout above that level to the upside and then and only then when confirmed with the $179 level become a support level for the share going forward. So we can watch that $179 resistance level for the future and see what happens when we retest it again.

Technical Analysis - Triple Top Resistance Candlestick Pattern
Technical Analysis – Triple Top Resistance Candlestick Pattern

Figure 15. Triple top resistance level on PCP chart at around $179.  Share price had failure at this level each time. This showed us that the sellers were waiting on the share to go to this level and then they were happy to sell each time it hit that $179 area. The Bears took control again.

4.4.5. Triple Bottom (Support)

Technical Analysis - Triple Bottom Resistance Candlestick Pattern
Technical Analysis – Triple Bottom Resistance Candlestick Pattern

Figure 16. Triple bottom visible on TSO at around $18 in January 2011, August of 2011 and then again in October of 2011. Each time the share came down and visited that $18 area buyers came into the market for that share and it shows the strong support there was at that $18 level.  It also shows us the power of patience and discipline to wait on those good support levels before investing.

Technical Analysis - Support and Resistance Candlestick Pattern
Technical Analysis – Support and Resistance Candlestick Pattern

Figure 17. Chart of ACOR. Visualise the sentiment of the traders each time the stock hits a support or resistance level on this chart.  Where would you buy? Where would you sell?

As you can see the support is around $21. Why do we say the support is at $21? Because of the triple bottom support visible on the chart. Each time the share hit $21 buyers entered the market and purchased the share. The chart shows us that each time the share came down to $21 in November, and December of 2012 and May of 2013 it bounced. Buyers were aware of this good support level.

This support level triggered buyers to step out and invest in the share at that price. This was showing us a triple bottom on the share.  If you were a longer term holder you could buy at $21 and Sell at $27 for a $6 profit that would be 6/21 x100 = 28.6% on that trade if it went up to $27.

Technical Analysis - Support and Resistance Candlestick Pattern
Technical Analysis – Support and Resistance Candlestick Pattern

Figure 18. MSFT chart showing support at $30.25 and resistance levels at $31.70 in February and also a breakout to new highs of $33 in March that was retested as a double top in mid April. During that time the share trades within a known ZONE of between $30 and $33.

Remember after checking your charts for your Support and Resistance levels you are always looking for confirmation that the trend has changed.

5. SUMMARY CHART INDICATORS

Now lets take a look at some useful indicators we can add to financial charts to help us ‘see’ when the good times to buy and sell are

  1. Moving Averages – price
  2. Stochastics
  3. MACD – Moving average convergence divergence
  4. Wilders Relative Strength Index.
  5. Money stream
  6. Balance of Power
  7. Bollinger Bands

On our quick view charts we use Moving Averages, along with three ‘key’ indicators:

  • Stochastics:  give us an indication of whether the share is overbought or oversold
  • MACD:  positive or negative bias showing us hidden strength or weakness in the share
  • Relative Strength Index – indicating a change of trend when above 70% in an overbought area or below 30% in an oversold area

When we are studying the charts in more detail we use the remaining indicators described above. We use all of our indicators as ‘tools’ to assist our trading.

It is wise to back test the effectiveness of the various chart indicators we discuss below on the specific share you are considering for investment. Take a look at your charts following the module which shows you how to setup your own charts on your computer and go back over time to see what the indicators were ‘telling you’ at the time when price trends changed. This will help you gain confidence in the indicators you use for specific shares.

Do not lose sight of the fact that indicators are simply that…. indicators. Specific news releases can cause share prices to move suddenly in an unexpected direction despite what the indicators may have been suggesting.

 

5.1. Moving Averages – Price – Technical Analysis Guide

Moving averages of the share price are sometimes called ‘trigger points’. The reason I call moving averages trigger points is that Fund Managers, Market Makers, Day traders and Institutions are all looking at the same chart settings, and in time you will see how important the moving averages are for trading.

Shares have a habit of bouncing from different moving averages. Professional traders use moving averages as trigger points (i.e. a price point at which they are likely to either trigger a buy or sell). Traders are always looking for areas that shares are either going to bounce from (support areas) or that shares are going to retreat from (resistance areas).

Moving averages are also used extensively and should be well understood. Moving averages are trigger points that traders use to find some support for a share on the way down or a resistance level for that share on the way up. You will notice from looking at charts that shares do have a habit of bouncing off various moving averages. Some traders will put more emphasis on a 50 DMA (50 Daily Moving Average) than they do on a 20 DMA (20 Daily Moving Average) while others will use a combination of various Moving averages on their charts like the 20 DMA, 50 DMA, 100 DMA, 200 DMA and 500 DMA.

As your knowledge grows in Technical analysis and studying charts you will get to know the moving averages and how important they are to the traders of those shares.

Price Simple Moving Averages – Calculation

Don’t worry, your charting software calculates this figure for you, but this section gives you some background knowledge on how the figure is determined.

The simple moving average uses the closing price for all price time points (for example daily) for a chosen time frame (for example 10 days). Each day has an equal weighting. We tend to use simple moving averages rather than exponential which give more weight to the more recent days action. Some people prefer exponential moving averages. The choice is yours.

Taking the 10 day simple moving average we could calculate it manually by taking the closing prices for the past 10 days:

10 DMA= (P1+ P2+ P3+ P4+ P5+ P6+ P7+ P8+ P9+ P10) ÷ 10

Where P1 = the most recent day and so on then we add on the newest day each time and lose the further average. The oldest data day is dropped for each new data day added.

Therefore the average is always moving as the new day’s data is added.

Moving Average as Support or Resistance –
Technical Analysis Guide

Moving averages can be used as support or resistance levels as well as trigger points.

Stocks sometimes tend to rebound off moving averages lines as support and resistance levels. Technical analysts keep a close eye on moving averages and they can use them as trigger points for entry and exists into and out of positions.

Moving averages can be plotted onto a chart using any period. Moving averages are visible on any time frame. Some of the most important ones of note are the 10 day moving average  (10 DMA),the 20 day moving average (20 DMA),the 50 day moving average (50 DMA),the 100 day moving average (100 DMA),the 200 day moving average (200 DMA) and the 500 day moving average (500 DMA). All Moving averages be they the 20DMA, 50 DMA, 100 DMA etc. can be viewed on any time frame (hourly, daily, weekly, monthly etc).

Moving averages can also be trigger points for trend reversals .Buyers or sellers can step in when a share hits an important moving average and this can be the trigger for a trend reversal.(see charts below)

They are widely used by market makers, institutional fund managers and technical analysts. When you look at charts you will be very surprised to see how many times a share has bounced or retraced from a moving average. Buyers and sellers use them as trigger points for trading.

Moving Averages – on charts –
Technical Analysis Guide

If you have subscribed to TC2000 or you are using the free stock charts you can set up your charts like ours. See the videos on the Worden links below or my blog about fundamental analysis.

http://www.worden.com/Video/TC2000v7/Tutorial  … where you can dig deeper by selecting Version 7 videos where you can find numerous videos by Worden trainer.

http://forums.worden.com/default.aspx?g=topics&f=2

I use these colours for my own settings – (See module on setting up your charts or Worden videos as above)

  • 20 Daily Simple Moving Average – Yellow
  • 50 Daily Simple Moving Average – Cyan Blue
  • 100 Daily Simple Moving Average – Dark Blue (dashed)
  • 200 Daily Simple Moving Average – Grey (dashed)
  • 500 Daily Simple Moving Average  – Brown (dashed)
Technical Analysis - Moving Averages Indicator
Technical Analysis – Moving Averages Indicator

Figure 19. Above you can see my own chart settings showing Simple Moving Average settings of the 20 DMA (yellow line), 50 DMA (cyan blue), 100 DMA (blue dashed), 200 DMA (grey dashed) and 500 DMA (brown dashed). You can see how the share reacted when it hit various moving averages. Traders were also viewing these same setting and using these moving averages to determine what trade to make.

Have a look at the Google chart below (Fig 20) where you can see what happens to price movement when it hits some relevant moving average. Have a close look at the 200 DMA in January, April and early May. That 200 DMA was a trigger point for buyers to step in the share at those times. Moving Averages can be a trigger point to step in and buy or a break of a certain moving average can be a signal to step out and sell.

Notice from the chart when the share broke the 200 DMA downwards in May it found its support level at the next moving average the 500 DMA in June.

You can see from the chart the way the moving averages kind of ‘cradle’ the share and are there as comfort just in case it falls further. Moving averages can tend to act as support for a stock. They seem to be there to catch the share or so it seems. I tend to think they are there ‘just in case’ the share falls further.

You will always find some indication of what the share is going to do at various trigger points. You can see the support level the 200 DMA at $595 gave to the share in January, April and May and then when it broke that support it found the next support level exactly on the 500 DMA in June at $570.

Technical Analysis - Moving Averages Indicator
Technical Analysis – Moving Averages Indicator

Figure 20. Share movement using the 200 Daily Moving Average(grey dashed line) as a trigger point in January, April and early May and then when that support level was broken to the downside in late May we can see the share found the next support at the 500 DMA (brown dashed) on 1st June.

We can see from the next chart of AEO apparel stores (Fig 21), that each time the share came down to a moving average buyers stepped in. The 50 Daily Moving Average (Cyan line) was a very good back up support level going back to March 2012, and then in June 2012 when it came back to that 50 DMA, the price bounced off that support level. If AEO broke the 50 DMA (cyan Line), the next support level would be the 100 DMA (blue dashed line) and then if it broke that the next support level would be the 200 DMA (grey dashed line) and then the 500 DMA (brown dashed line).

Knowing this the important question now is whether you have the discipline and patience to wait until a share comes down to a key support level?

Technical Analysis - Moving Averages Indicator
Technical Analysis – Moving Averages Indicator

Figure 21. Moving Averages lining up below the share ‘just in case’ the market breaks downwards. This gives us visible support levels below the share so we can prepare for our trade when the share comes down.

5.2. Stochastics – Technical Analysis Guide

Stochastics is a momentum indicator which was developed by George C. Lane in the late 1950’s.  It measures the relative position of the closing price compared to the daily trading range, being 14 days of data or 14 bars of data which is the period you put into your settings. We use 14 days (14:3:3). The stochastics indicator or oscillator has a range from 0-100.

The stochastics indicator is most relevant when the lines are above the 80% line which represents an overbought condition and below a 20% line which represents an oversold condition. The stochastics settings we use are 14:3:3, although various other settings can be used. That is a period of 14 and a SK period of 3 and a SD period of 3. We set the stochastics indicators up in a window on our charts (see charts below and also tutorial section on setting up your TC2000 version 7 charts at the link below for more information about setting up your charts).

http://www.worden.com/Video/TC2000v7/Tutorial

As you get comfortable with your charts you will set up different settings on your own charting platform in different windows (see charts below). Do not be afraid to alter the various settings until you find one which best suits your trading style. See section on how to set up chart settings or parameters in the manual.

For more on Stochastics, select the link below and scroll down to see the various short videos from Worden’s website

http://forums.worden.com/default.aspx?g=topics&f=2

A quick shortcut for you to add Stochastics on your TC2000 or Telecharts programme chart is to click on your charts and press the Hot Key ‘S’. Then you can add Stochastics to any of your top, middle or bottom windows of your chart. Once you click OK this brings up a second dialogue box where you can set the parameters you wish to use.

There is a later section which details how to setup your charts on either Worden TC2000 (Telecharts) or Freestockcharts.

 

Stochastics (Scale 0 – 100%) – ‘rules of thumb’

  • When Stochastic lines are less than 20% = Oversold. The 20% line is the lower horizontal Red line on the stochastics window on the chart. You will see the number 20 in the right hand side scale.
  • When Stochastic lines are greater than 80% = Overbought. Again this line is reflected in the stochastics window by the upper horizontal Green line with the number 80 on the right hand side. A buy signal is given when stochastic lines are below the 20% line and moving up through to cross above this line from an oversold area.
  • A sell signal is given when stochastic lines are above the 80% line and moving down through to cross below this line from an overbought area.

Our rules are we take heed of a share in an overbought area to collect some premium and we take heed of a share in an oversold area to collect some premium (see Module 5 on Income Generation – Covered Calls).

The following charts show some example charts with stochastics.

Stochastics - Technical Analysis Guide
Stochastics – Technical Analysis Guide

Figure 22. Chart above shows share price movement (circled) in the upper window and when stochastics are in overbought or oversold areas (circled) in the bottom window.

On the chart below of GE (Fig 23) we can see each time the stochastics go down into oversold  at the red line at 20 and each time they go into overbought up at the green line at 80. We get buy signals when the stochastics are coming out of oversold (red line) and we get sell signals when the shares are coming out of overbought (green line). Notice what happens the share in the top window when we get buy or sell signals in the bottom window from stochastics.

Remember this is only one of many indicators we look at to get our information and trend reversal signals.

Stochastics - Technical Analysis Guide
Stochastics – Technical Analysis Guide

Figure 23. Chart showing the reaction of the share GE in the top window to Stochastics in the bottom window going into overbought (at 80) or oversold areas (at 20 – boxed). We can visually compare the stochastics in the bottom window with the share price in the upper window.

The chart above (Fig 23) shows the share above the 80 stochastics line (green horizontal) in an overbought area and when it is below the 20 stochastics line (red horizontal) in an oversold area.

Stochastics - Technical Analysis Guide
Stochastics – Technical Analysis Guide

Figure 24. INTC chart. After bouncing from the 200 DMA (grey dashed) on the 26th May and the 4th of June the share could not stay above the resistance level of the 50 DMA(cyan) and 20 DMA (yellow) in July.  Now the stochastics are also pointing downward again and pressure may come on the 200 DMA (grey dashed).

If INTC breaks the 200 DMA (grey dashed) we will be looking for support levels further down. If we were holding the share we would be looking to take defensive action or sell the share if it broke the 200 DMA and wait for a future support level lower to re invest in the share.

As you can see the share was running out of steam to the upside because it could not break above the 50 DMA or the 20 DMA in July (a case of moving averages acting as resistance levels) so we would be watching very closely to see what happens at the crucial 200 DMA.

 

Stochastics - Technical Analysis Guide
Stochastics – Technical Analysis Guide

Figure 25. In the chart above, we can see when PFE share hit $22.80 in March (top window) the stochastics (in the bottom window) were above 80 in an overbought area. The share then retraced down to around $21 in mid April and the stochastics also were now in an oversold area (under 20).

The buy signal if you were looking for it came as the stochastics crossed back up above 20 line heading upwards and also a green candle (positive day) on our share. The share rallies up to $23.20 where again the stochastics were now back up in an overbought area. Once we get the sell signal of the stochastics crossing down through the 80 line on the lower window we can see the sellers coming into the share and it starting to fall. We can also see by looking at the candle that when the share hit $23.20 we had sellers coming in at that level.

 

Stochastics - Technical Analysis Guide
Stochastics – Technical Analysis Guide

Figure 26. Visible double top on GLW chart above, in March the share hit $14.50 (see top window). Stochastics (bottom window) were in an overbought area i.e. above 80. The share retraced to the $13 to $13.40 area (top window) where the stochastics were in an oversold area i.e. below 20 (bottom window).

At the end of April the share rallied back up to create a double top by retesting the $14.50 (top window) area from the prior high of March. We can also see that at the end of April that as the share was retesting the $14.50 area the stochastics (bottom window) were also back in an overbought area. Both times the share was in the overbought area on stochastics.

5.3. Moving Average Convergence Divergence (MACD) – Technical Analysis Guide

MACD is an acronym for Moving Average Convergence Divergence. This trading tool is used to identify a change in trend in the share.

MACD is an indicator best viewed as a histogram and gives us an indication of hidden strength and weakness in the stock. It can be viewed with candlestick patterns (see later in manual) to give a clearer picture of what is happening within the chart.

  • Look for positive bias when the bars are below the zero line and decreasing in length.
  • Look for negative bias when the bars are above the zero line and decreasing in length.
  • When the Bars are below the Zero Line and decreasing we are getting positive bias.
  • When the Bars are above the Zero Line and decreasing we are getting negative bias.

Chart Settings Tip MACD

A quick shortcut for you to add MACD on your Telecharts programme chart is to click on your charts and press the Hot Key M. Then you can add MACD to any of your top, middle or bottom windows of your chart. Once you click OK this brings up a second dialogue box where you can set the parameters you wish to use.

You can find out more about MACD by clicking the link below:

http://www.worden.com/Video/TC2000v7/Tutorial  where you can dig deeper by selecting Version 7 videos where you can find numerous videos by Worden’s trainer on everything to do with TC2000 charts. Also check out the link below:

http://forums.worden.com/default.aspx?g=topics&f=2

The settings we use for MACD are three numbers 12/26/9. That is 12 short term, 26 long term and a 9 period (see TC2000 (Telecharts) and Freestockcharts set up appendix for further details).

  • The 12 represents the previous 12 bars of the faster moving average.
  • The 26 represents the previous 26 bars of the slower moving average.
  • The 9 represents the previous 9 bars of the difference between the two moving averages.

Remember price moves the MACD.

You can see from the GE chart below (Fig 27) how we get negative bias in the MACD (see histogram  in the lower window in a cyan blue colour) the pipes of the histogram are above the zero line and start decreasing when the share hits a resistance level in mid March. You can visually see the hidden weakness as the histogram starts decreasing.

MACD - Technical Analysis Guide
MACD – Technical Analysis Guide

Figure 27. Chart above showing stochastics in the middle window & MACD in the bottom window as potential entry points (green arrow).

Positive bias is visible in the chart above marked with a green arrow when the MACD (see bottom window above) is below the zero line and has reached a bottom and turned upwards. Negative bias is visible on MACD chart above when the MACD pipes are above the zero line and they are decreasing. You can also see stochastics in oversold and or overbought areas at the same time as the MACD is about to give either positive or negative bias. You can see that the stochastics and MACD are both in oversold areas and are just turning upwards again as seen above marked with green arrows. This happen as the share was finding a bottom and getting ready to go upwards again.  It’s all about lining up the indicators to give you that ‘edge’ against the market in finding better entry and exit levels.

 

MACD - Technical Analysis Guide
MACD – Technical Analysis Guide

Figure 28. In this GE chart above you can see from the green arrows how the MACD gives us positive bias when the pipes are getting shorter. This coinsides with our Stochastic indicator giving us a nice buy signal coming up through the 20 area which is coming up from the oversold area.

Once you get your charts set up study the movement of shares in relation to the movement of the MACD.  Remember one of the most important things about trading is your understanding of the charts and having the patience and discipline to wait until the share comes to you. Of course that is taking it for granted that you have already completed your research of the company and are happy to own it and that once you invest in the company that you have a plan B.

Even though moving averages lag behind price, MACD is still one of the most favoured tools of many traders. I know it will be a favourite tool in your trading too

5.4. Wilder’s Relative Strength Index (RSI) – Technical Analysis Guide

The RSI index was developed by J. Welles Wilder, and was first introduced in June 1978.

It is a Momentum Oscillator that measures the speed and change of price movement over time for a stock, and is similar to Stochastics in that it identifies when a share is overbought or oversold relative to a scale.

The index oscillates between 0 and 100, with the RSI considered overbought when above 70%, indicating that price may be nearing the top or nearing a trend reversal.  The RSI is considered oversold when below 30%, indicating that the price is closer to the bottom, or a bullish reversal.

  • Overbought when the value reads above 70.
  • Oversold when the value reads below 30.

A quick shortcut for you to add Wilders RSI to your TC2000 or Telecharts programme chart is to click on your charts and press the Hot Key R. Then you can add Wilders RSI to any of the top, middle or bottom windows of your chart. Once you click OK this brings up a second dialogue box where you can set the parameters you wish to use.

I use a 14 – day RSI period with a 1 day Simple Moving Average period.

We can find tops and bottoms in shares using this indicator indicating if we are overbought or oversold. We can find our entry levels in conjunction with other indicators when we see the Wilders RSI line heading back up through the 30 line or our exit level when in conjunction with other indicators the Wilders RSI line is crossing down through the 70 line.

Stocks with high RSI values can be interpreted as being in overbought positions and stocks with low RSI values can be interpreted as being in oversold positions. The best bullish signals occur when the RSI line moves above the 30% line from the oversold area. The best bearish signal for RSI is when the RSI line moves below the 70% line from an overbought area.

Always remember Indicators are just that, Indicators.

Relative Strength index – Illustration

I have added Wilders RSI onto the chart in fig. 29, as well as stochastics, and highlighted what happens when the indicator hits the oversold area of 30% and the overbought area of 70%.

Wilder’s Relative Strength Index (RSI) - Technical Analysis Guide
Wilder’s Relative Strength Index (RSI) – Technical Analysis Guide

Figure 29. Share price movement of GE with share price in the top window, Stochastics in the middle window and Wilders RSI in the bottom window.

We can see the reaction of the share price in the top window when we examine and see the green arrows showing stochastics in an oversold area in the middle window and the bottom window showing Wilders RSI (green arrows) down at the 30% oversold area.

Wilder’s Relative Strength Index (RSI) - Technical Analysis Guide
Wilder’s Relative Strength Index (RSI) – Technical Analysis Guide

Figure 30. GLW chart showing RSI (bottom window) in an overbought area as GLW share (top window) has hit the resistance levels in March of $14.50 and RSI again in an overbought area at the end of April at $14.50 again (double top).

Wilder’s Relative Strength Index (RSI) - Technical Analysis Guide
Wilder’s Relative Strength Index (RSI) – Technical Analysis Guide

Figure 31. INTC chart showing RSI in the middle window & MACD histogram in the bottom window were both indicating that the share was in an overbought area, as the share was testing a double top at $27.50 in June as the RSI was up at 80 and the MACD was giving negative bias as the cyan blue bars were decreasing.

5.5. Money stream – Technical Analysis Guide

Cumulative Money Stream Indicates the Money stream flow into or out of the Stock.

  • It is usually shown as a yellow line.
  • The line moving up indicates inflow.
  • The line moving down indicates outflow.

I use a 20 Daily Moving average of Money stream on my charts and I set this as a red line (see chart Fig 32 below).

Chart Setting Tip

A quick shortcut for you to add Money stream on your TC2000 or Telecharts programme chart is to click on your charts and press the Hot Key Y. Then you can add Money stream to any of the top, middle or bottom windows of your chart.

A quick shortcut to get the moving average of Money stream on to your chart is once you have Money stream on your chart and saved then hit the Hot Key A and from that box select Money stream and this brings up a further dialogue box from where you can set the parameters of the period you require. I use the 20 Daily Moving Average of Money stream on my charts (see charts below).

Fig 32 shows a steady inflow of money stream flow into PFE from February until end of April and then we see the outflow and the dip in the share price.  Another tool for the traders toolbox.

Money stream - Technical Analysis Guide
Money stream – Technical Analysis Guide

Figure 32. Price chart of PFE ( top window) showing price movement and the reaction of Money stream flow (MS – yellow line) with a 20 Daily moving average (the red line) in the middle window and Stochastics in the bottom window.

The SBUX chart below (Fig.33) shows us the money flow going into the share from February 2012 until April 2012 and then after that fantastic drive the share took a breather and the money flow started to dip in the share for the months of April and May. Then for June and into July we can see that as the share trades sideways so also does the money stream.

Money stream - Technical Analysis Guide
Money stream – Technical Analysis Guide

Figure 33. A very positive money stream flow into SBUX from March up to April. Then the money stream dipped in the end of May and we can see the reaction of the share price is visible. It came down from a high of $62 in April to $52 in July.

5.6. Balance of Power – Technical Analysis Guide

Balance of power is shown on my charts in Green, Yellow and Red.

Green:  Systematic Accumulation or Buying Pressure

Red:  Systematic Distribution or Selling Pressure

Yellow:  In-conclusive.

Chart Setting Tip

A quick shortcut for you to add Balance of Power to you TC2000 or Telecharts programme chart is to click on your charts and press the Hot Key B. Then you can add Balance of Power to any of the top, middle or bottom windows of your chart. You can have the colours as I do or you can alter to your selected preference (see appendix on setting up TC2000, Telecharts and Freestock charts, or use the link to Worden Tutorials).

What is Balance of Power – Technical Analysis Guide

It is defined as ‘the Systematic Accumulation and or Distribution of a share’ and is better known as its acronym BOP (Balance of Power).

Look at Fig 34. Notice the reaction to price when we have systematic accumulation or buying pressure (Green Bars) which can be considered positive. You have to think of this as shares going from weaker hands into strong hands. Taking into consideration that institutions and fund managers are often long term holders of stocks that’s why I say shares are going from weak hands into strong hands.

Balance of Power - Technical Analysis Guide
Balance of Power – Technical Analysis Guide

Figure 34. In the Bottom window we see Green bars of systematic accumulation in Mid March up to early May and the rise in the share price.  Shares are going from ‘weaker’ hands into ‘stronger’ hands.

Systematic Distribution

Notice in fig 35 below what happened to the share price when there is Systematic distribution or selling pressure on the share price of Nokia (NOK). In April we can see the Red bars of the BOP or Balance of Power showing us the beginning of systematic distribution or selling pressure that the share was under during that time. This systematic distribution or selling that happened in the share could have been because of bad earnings at that time or an announcement of bad news that was harmful to the company’s prospects.

The share price dropped 25% from $4.25 in early April down to $3.15 in May as a result of the systematic distribution of the shares as visible on the Balance of Power in the bottom window.

Balance of Power - Technical Analysis Guide
Balance of Power – Technical Analysis Guide

Figure 35. In the bottom window  we see the Red bars of Systematic distribution or selling pressure on  Nokia in early April visible and the share price gapping down from $5.00 down to $4.25 after  news was released that was harmful to the company’s prospects.

Balance of Power - Technical Analysis Guide
Balance of Power – Technical Analysis Guide

Figure 36. Systematic Accumulation or Buying Pressure of SONC visible on the above chart with the Green bars on the Balance of Power or BOP in February some in April and then again in May, June and July. Shares going from weak hands to strong hands and we can see the rise in the share price from $7 on the 1st of February up to $10.50 in July.

Balance of Power - Technical Analysis Guide
Balance of Power – Technical Analysis Guide

Figure 37. Once all the selling and Systematic distribution or selling pressure (Red Bars on the Balance of Power) visible in the bottom window that was negative for the share and took it down from a high in February of $47.50 down to a low of $25 in early May was finished we can see a gap up in the share price in June on some good news and then the Systematic accumulation or buying pressure (Green Bars on the Balance of Power) starts and this was positive for the share.

5.7. Bollinger Bands – Technical Analysis Guide

Bollinger Bands are a technical analysis tool developed by John Bollinger in the 1980’s.

John Bollinger settings are constructed by placing two bands around a moving average in the centre (see fig 38).

Some traders buy when the price touches the lower Bollinger Band and exit when the price touches the moving average in the centre of the bands or the upper Bollinger band. If a stock rallies that the price is outside the upper Bollinger band it is considered to be in an overbought condition and is likely due for a pullback. Similarly if the stock price falls below the bottom Bollinger band it is considered to be oversold.

Remember this is only an indicator and stop loss orders (exit strategy) should be used to mitigate losses from market pressures if using this system.

  • Consist of a centre line and two price channels (bands) above and below it.
  • A 20 Day moving average (Exponential) with two trading Bands (20/20/20)
  • Bollinger Bands add and subtract a standard deviation calculation. They expand and contract with price volatility.
  • The bands work using a mathematical formula that measures volatility.
  • Bollinger bands adjust themselves to market conditions.
Bollinger Bands - Technical Analysis Guide
Bollinger Bands – Technical Analysis Guide

Figure 38. John Bollinger’s 20/20/20 Band settings on the IBM chart.

As the market as we have already discussed trades sideways for up to 80% of the time Bollinger Bands help me to find and hone in to the charts to find the breakout levels.

I have played about with the Bollinger bands over my trading years and in that time I have developed a set that are different from the original ones that are described above.

My settings are 10 /8 (Period 10 and width or standard Deviation of 8) (see Appendix on setting up TC2000 Telecharts and Freestockcharts). I encourage you to also play about with the Bollinger Band settings until you find ones that you are happy with and that you can get the feel for the market over time.

What happens when a share goes above the Bollinger Bands or below the Bollinger Bands settings that I use?

  • When the share is above the Bollinger Bands it is momentum up which is bullish ( I call this MOBO up)
  • When a share is below the Bollinger bands it is momentum down which is bearish (I call this MOBO down)
Bollinger Bands - Technical Analysis Guide
Bollinger Bands – Technical Analysis Guide

Figure 39. The Bollinger Band settings I use on the IBM chart.

So you can see that the chart above (fig 39) is the same IBM chart that we had with the John Bollinger 20/20/20 Bollinger Band settings (fig 38), but this time with my settings.

I use Bollinger Bands to see when a share is momentum up or down (MOBO up or MOBO down). You can see that using both charts in my technical analysis I gain a lot of knowledge in relation to the possible share movement. When the share goes momentum UP (MOBO UP) I get the opportunity of riding that wave to the upside.

When the share goes momentum DOWN (MOBO DOWN) I get the opportunity to ride the wave to the downside.

Remember indicators are just that, indicators, and should be checked with other indicators for the proper entry and exit points.

Bollinger Bands - Technical Analysis Guide
Bollinger Bands – Technical Analysis Guide

Figure 40. Momentum up in May once we broke the Bollinger bands to the upside at $7.50 in mid May and riding the wave i.e. price holding on or above the Bollinger bands  all the way to $10.68 in July.

Bollinger Bands - Technical Analysis Guide
Bollinger Bands – Technical Analysis Guide

Figure 41. Notice how the share price always comes back to the bands from both above the bands and below the bands. The Bollinger bands act like elastic bands pulling the share back in again.

Bollinger Bands - Technical Analysis Guide
Bollinger Bands – Technical Analysis Guide

Figure 42. We can see the momentum down in the Bollinger bands in early May when the share broke the bottom Bollinger band at around $26 and we can see that the top Bollinger band was resistance at the end of May and early June before the share went momentum down again ending up at $18 at the end of June. This share never went momentum up from early May.

Remember the share only goes momentum up when it is above the top Bollinger band. A share may just pop up above the Bollinger bands for a day, so give that as a day of forgiveness. You need to see that the trend has changed.

 

Technical Analysis Guide
Technical Analysis Guide

Figure 43.One of my trading charts showing the Moving averages 20 DMA, 50 DMA, 100 DMA, 200 DMA and 500 DMA in the top window. I also have the Bollinger bands in the top window. In the middle window we can see the MACD and Wilders RSI and in the bottom window we have the Stochastics settings.

The Bollinger bands act kind of like elastic bands. If the share goes a bit too far up they tend to pull it back down again and if the share goes too far down then they tend to pull it back up again.

One other ‘minor’ indicator to consider.

5.8. Volume (i.e. how many shares traded) – technical Analysis Guide

Fig 44 below shows the GE (General Electric) chart with Volume. You can see the volume spike on the chart for the 16th May and the 7th and 8th of June and you can see how that affected the price movement of the share (see top window). Good solid buying volume (green bars showing positive up days) from early June sent the price higher until the end of June and into July where some selling volume (red bars showing down days) came in and started to bring the share down again.

We like to see high volume days coincide with bounces off support or resistance to give us confirmation or higher confidence in a follow through.

Volume can spike on important news releases. This can lend weight to the new direction.

Volume on a financial Chart - Technical Analysis Guide
Volume on a financial Chart – Technical Analysis Guide

Figure 44. Volume settings in the bottom window on the GE chart. Notice the change of the share price after the volume spike of the 7th and 8th of June.

Looking at the Disney chart below (fig 45) we can see the strong green volume bars and the share price movement. We can see that volume was very steady over that period of the chart but the most noticeable thing is the way the share has been holding onto and using as a support the 20 Daily Moving Average.

If it breaks the 20 DMA (we can see the red volume bars 2nd.3rd and 5th of July) we can see that the 50-DMA is there as back up just in case to give some level of support underneath the 20 DMA.

Volume on a financial Chart - Technical Analysis Guide
Volume on a financial Chart – Technical Analysis Guide

Figure 45. This chart of Disney shares shows the large volume spike days and the reflection that has on price movement on the 7th, 8th and 9th of May and the 22nd of June. Prices traded higher. Also notice on this Disney chart how the 20 DMA (20 daily moving average in yellow) is cradling the share as a support level. We can also see that the 50 DMA (cyan blue) is backing up the 20 DMA ‘just in case’ of some bad news that makes the share fall. We also have the 100 DMA (blue line) and the 200 DMA (grey line) visible as back up support levels as well.

Charting Checklist before buying or selling a stock      

  1. Are we at a Support or Resistance Level?
  2. Where are Stochastics? Overbought or Oversold? i.e. are we above 80% or below 20%?
  3. Are the MACD bars giving us Positive or Negative Bias?
  4. Where is the Relative Strength Index? i.e. are we in an oversold area turning up through the 30% or in an overbought area turning down through the 70% Level?

6. CANDLESTICK CHART PATTERNS – Technical Analysis Guide

– An Introduction

Earlier in this module I outlined some basic features of candlestick charting. There are many books written on the subject for those who wish to delve deeper into the subject matter. We aim to introduce the key concepts in a brief outline.

Let’s look at a couple of Major Candle Signals using one candle and two candle patterns.

6.1. The Doji Candle – Technical Analysis Guide

The Doji Candle - Technical Analysis Guide
The Doji Candle – Technical Analysis Guide

The Doji is one of the major candle signals, and is comprised of one single candle.

It is formed when the opening price and the closing price are the same. The true Doji opens and close at the exact same level, although this doesn’t always necessarily hold.

A Doji candle shows a day of indecision in the market. The Doji shows a tug of war between the Bulls and the Bears with no-one gaining control of the day, which forms a horizontal line. The Japanese say that whenever a Doji appears, you should always take notice.

It is equally important to take notice of a Doji at the top of a trend or the bottom of a trend.

The Doji Candle - Technical Analysis Guide
The Doji Candle – Technical Analysis Guide

Figure 1. In the above Dell chart several Doji candlesticks are identified by the arrows informing us of days of indecision in the market.

A rule of thumb upon witnessing a Doji is that the direction will be dictated by the open the next day.

 

6.2. Bullish & Bearish Engulfing Candlesticks Patterns – Technical Analysis Guide

6.2.1. Bullish Engulfing Candlestick Pattern

Candlestick patterns are even more powerful when two candles or more are used to form the pattern. One such pattern using two candlesticks is a Bullish Engulfing pattern (see picture below). This is a major reversal pattern which you will find after a downtrend. The market falls and a red candle has formed. Next the market opens lower than the previous day’s close and closes higher than the previous days open.

Bullish & Bearish Engulfing Candlesticks Patterns - Technical Analysis Guide
Bullish & Bearish Engulfing Candlesticks Patterns – Technical Analysis Guide

The share has been in a downtrend.  The real body of the second day candle (which is green) wraps around the prior session’s red candle, completely engulfing it.  Shadows or tails are not a consideration. The buyers (or Bulls) have taken charge by moving the price above where it opened the previous day. This shows a definite change of investor sentiment. The low of the Bullish Engulfing candle now becomes your support level.

In the following figures you can see some charts showing Bullish Engulfing Candlestick patterns for specific shares.

Bullish & Bearish Engulfing Candlesticks Patterns - Technical Analysis Guide
Bullish & Bearish Engulfing Candlesticks Patterns – Technical Analysis Guide

Figure 2.  In this NATI stock price chart the bullish engulfing pattern formed in October (see arrow) when the share was around $22.  After the downtrend, buyers stepped in and the bulls took control of the share and bought it all the way back up to $28.

Bullish & Bearish Engulfing Candlesticks Patterns - Technical Analysis Guide
Bullish & Bearish Engulfing Candlesticks Patterns – Technical Analysis Guide

Hence the visible ‘Bullish Engulfing’ candlestick pattern.

Figure 3. In the case of ORCL chart above we can visibly see the Bullish Engulfing candle (see arrow) that formed in October when the share was at a price of $28 when the buyers (Bulls) came in and took control of the share and the rally continued until the share hit $33.50 at the end of October and beginning of November

6.2.2. Bearish Engulfing Candlestick Pattern – Technical Analysis Guide

Bearish engulfing patterns appear at the top of a trend after an uptrend. The Bearish engulfing pattern is a major reversal pattern. The candle opens higher than the previous day’s close and closes lower than the previous day’s open. The real body (which is red) wraps around the prior sessions green candle, completely engulfing the body of the first day. The sellers (or Bears) have taken control, moving the price below where it opened the day before. The high of the bearish engulfing candle pattern now becomes a level of resistance.  With confirmation this shows a definite change of investor sentiment.

Bearish Engulfing Candlestick Pattern - Technical Analysis Guide
Bearish Engulfing Candlestick Pattern – Technical Analysis Guide

 

In the ORCL chart shown in Figure 4 below we can see the Bearish Engulfing candlestick pattern (see arrow) that started the down trend in March. We can see a second Bearish Engulfing pattern in May that continued the downtrend until late May and early June.

Bearish Engulfing Candlestick Pattern - Technical Analysis Guide
Bearish Engulfing Candlestick Pattern – Technical Analysis Guide

Figure 4. ORCL chart showing two Bearish Engulfing patterns (see arrows) where the sellers (Bears) came in at those levels.

Remember it is not essential for an engulfing pattern either bullish or bearish that the body wraps around the prior session’s upper or lower wicks or shadows. Rather it must engulf the body of the prior session’s candle.

This is just an introduction to a couple of Candlestick patterns and I will introduce more to you at various levels of your trading education.

This blog should have now given you all the resources you need to be able to ‘read’ a financial chart and now predict with great accuracy when to buy a stock at a low price and sell for a high price.

Get to know your share properly and identify your trading and investment opportunities. Technical analysis is a powerful tool to assist you. Use it!

So lets Summarise Technical Analysis

Technical analysis is the study of past market action to try to gauge what the market might do in the future. At its most basic, it is the study of price. Fundamental analysis involves analyzing the characteristics of a company in order to estimate its value. Technical analysis takes an entirely different approach; it doesn’t care about the “value” of a company. Technical analysis is only interested in the price movements in the market.

Market action discounts everything

  • All known information related to the security is reflected in the price of the stock; this includes fundamental factors
  • As soon as new information comes to light it’s immediately reflected in the stock’s price

Prices move in trends

  • In technical analysis, prices of securities tend to move in observable trends with a tendency to stay in the trend
  • The trend is considered to be intact until the trend line is broken
  • After a trend has been established, the future price movement is more likely to go in the same direction as the trend rather than against it
  • The old adage “the trend is your friend” means you should trade in the same direction as the trend

History repeats itself

  • Technical analysis is the study of what has happened to the price of a security in the past with the expectation that history tends to repeat itself
  • Many of the chart patterns in technical analysis have been used for more than 100 years, and they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves
  • The repetitive nature of price movements is attributed to market psychology

What Are charts in Technical Analysis – Summary

Image: Candlestick chart.

Summary of Trends in Technical Analysis

Image: Downtrend line drawn on chart.

7. MULTIPLE CHOICE TEST QUESTIONS ON TECHNICAL ANALYSIS

This section consists of a series of multiple choice questions designed to confirm you understand the key points of Module 3.

Only one answer is correct. Choose which one you believe is correct. The correct answers are identified at the end.

Don’t cheat yourself. If you get some wrong then reread the material to improve your understanding or ask for clarification

1. How many companies are in the Standard and Poor’s 500 Index?

(a) 50

(b) 100

(c) 500

2. How would you define an Uptrend on a Stock Price Chart?

(a) A series of Lower Lows and Lower Highs on a chart.

(b) A series of Higher Highs and Higher lows on a chart.

3. How would you define a Downtrend on a Stock Price chart?

(a) A series of Lower Lows and Lower Highs on a chart.

(b) A series of Higher Highs and Higher lows on a chart

4. Which of the following is a Support level sometimes called?

(a) A Crutch.

(b) A Ceiling.

(c) A Floor.

5. Which of the following is a Resistance Level sometimes called?

(a) A Floor.

(b) A Ceiling.