Over the past several sections, we have seen different aspects of
Technical Analysis. We began with what is the subject, defining it, and
then went on to amplify on the role of prices and how they make up the
market. We examined the market structure as a whole and saw the
relative placement of each of the elements, which go into stock
analysis. We then showed how the entire structure –composed of
different elements – is combined through the medium of Price. In the
progress towards Price analysis we paused to look at the Market Cycle
and how prices move or are made to move and how they have a reverse
effect on the people. This took us in to greater details of how prices
can be studied and what the different methods are for studying them. We
have se en a few so far. We thought it would be better to do a mid
session recap of what has been done so far so that going ahead in the
subject become easier
So let us try and summarise what we have understood so far.
The
Market consists of all kinds of players, small to big. It has no
definite form and exists in the minds of the participants and therefore
is an abstract concept even though stocks, companies, prices etc are
all for real. In short there are as many markets as there are players
Everything,
which happens outside the market, falls under the realm of fundamental
analysis. Everything, which happens inside the market, falls within the
realm of technical analysis. Therefore technical analysis deals with
only two variables – price and volumes, as these are the only two elements within the market.
Some
player sponsors every market move or the other (either up or down) and
this is achieved through committing their own funds and then getting
others to commit theirs. This is done through some artful management
and dissemination of the view to the maximum audience. The media is
extensively used in this endeavour to reach the masses.
Every
market cycle has a phase of birth, growth and maturity followed by
decay, degeneration and finally death. The market, being a part of the
crowd phenomenon, is a psychological entity and therefore subject to
manipulations of its moods by the sponsors. This results in the
different stages of the market cycle. At the end of the cycle, the
members of a crowd are released to join new groups.
The study
of the market as a cycle gives rise to the precepts of the Dow Theory
which was the first attempt to structure price study for future
projections. Briefly stated, the Dow Theory stated that the prices
(averages) discount everything, prices move in trends, trends have
phases, trends are confirmed by volumes and movements persist until
reversed. This theory set up the basis for further studies of prices.
The
actual study of prices takes place through plotting of charts. The
Chart is therefore a depiction of the movement of the stock in a time
period. It therefore reflects the play of mass opinion.
There
is any number of methods for drawing charts. The most popular among
these are Line, Bar and Candlestick charts. The charts can be of
different periods ranging from intra day to long term like monthly and
yearly charts. The scaling to be used would depend upon the time frame
of the chart as well as the extent of price moves that the stock shows.
In long-term charts we would use Percentage charts while in short term
we would use arithmetically scaled charts.
Stocks are always
moving from a level of support into a level of resistance and vice
versa. Estimating these would therefore provide us with a valuable idea
of what may be expected.
Tools for trend and trend strength
estimation vary substantially. A few, which we have seen, are Line
studies (both straight and curvilinear) as well as Patterns.
Let us now move on to study a few examples to see how the above knowledge can be applied.
Once
the stock is selected, the first thing to do is to open up different
time frame charts. This will be the daily, weekly and monthly chart.
In
each of these, we eyeball it to see whether the stock is trading in a
trend or is non-trended. We also should note down the trends in each of
these charts. Roughly, they will become the short, medium and long-term
trends.
One should then check each of these charts for the
existence of any pattern. If any pattern is found, its validity to
appear at that portion of the trend should be checked first. Next, we
analyze the pattern for whether it is the reversal type or the
continuation type and whether it is a major or minor pattern. Once the
pattern is identified and classified, we should then fix the resolution
point of the pattern – i.e. the point where the pattern will end and
the next expected move will begin. If possible, then one should also
calculate the target price given by the pattern.
One can then
attempt to overlay the charts with Trendlines. As we have seen we can
have simple trendlines, channels, speed lines , angle lines and
retracement lines. One should try all of them because there is just no
saying which stock will follow which technique at which time. One
should note down the performance of the stock on each time frame chart
vis-à-vis the trendline. Speed lines should be overlaid where some
swings are identified and their values carried into the future to act
as possible support and resistance lines. Retracement levels for
upswings and downswings should be calculated and attempts made at
finding cluster supports or resistance areas.
Moving averages
can then be overlaid on the charts – all three time frames. As
discussed under this topic, a combination of one or more moving average
can be used and the information gleaned from such an overlay should be
noted down. The slope, the direction and distance of the prices from
the averages or one average from another should also be noted.
All
these will give us some common prices around which multiple techniques
are pointing. These price levels would then become the important levels
where one may expect the market to stage a turnaround. The greater the
number of methods pointing to one single set of prices, the more likely
that price level is to work in either arresting or reversing an ongoing
price move. Such points should be carefully noted down as they will
form the backbone of the trading strategy that one will form.
One
must get into the habit of doing this on a regular basis even if one is
not into active analysis or trading. It is said that Luck favours the
prepared man. All these attempts at finding important levels is to
prepare ourselves for identifying market situations which represent low
risk areas for entering or exiting a trade. It would also help us to
check our own analysis and the expectations that we build based on it
against the actual events in the market. If we find we are on the right
track, our own confidence gets a boost and our approach to trading and
analysis will be from a stronger conviction. If we find ourselves on
the wrong side, it will warn us about flaws in our own reading and we
can then go back our drawing boards to check where and how we went
wrong. In other words, the market will prove to be an arbiter of our
state of learning about the subject. |