We have so far looked at a number of techniques to analyse the
charts. While there are still some more commonly followed methods left,
let us pause at the moment in our tutorial serial to check back on what
we have learnt and try to apply it so that we can assimilate the text
matter better. As the saying goes, a picture is worth a thousand words.
So if one sees what has been written in the form of a chart example,
then the impression remains much deeper.
In this attempt to
combine the different techniques, we shall look at trendlines,
channels, retracements, price patterns, moving averages and
candlesticks. There is no necessity to combine everything at every
stage. The idea of combination is not to produce a multiple approach
technique but rather to find areas of confluence that are being
indicated by the different tools within technical analysis.
For
those who may have missed the earlier set of articles or those whose
memories need to be jogged, here is a recap of the main points of the
different techniques that we shall be looking at:
Trendlines
indicate some market symmetry that if broken, suggest that the
supply-demand balance is undergoing some kind of change and this will
therefore lead to some changes in the price structure. If a trend line
has been acting as a support and is broken, one expects the prices to
decline and vice versa.
Channeled moves are variant of trendlines and suggest a stronger symmetry than basic trendlines themselves.
Retracement
is a tool to arrive at some price targets using the normal penchant for
everything in life to pull back by halves and thirds. We also apply the
Fibonacci ratio series and arrive at 38,50 and 62% as the retracement
targets where prices may halt and a trend reversal may appear.
Price
patterns are definite market symmetry that appear from time to time and
are classified as reversal and continuation patterns as well as minor
and major ones. Depending upon when and where they appear, they have
some forecasting qualities and target finding methods.
Japanese
candlesticks are a method of charting which is more visual and gives
more frequent patterns, most of them of a reversal variety.
With
that preamble out of the way, let us now proceed to check out a chart
that we shall analyse using these techniques over a two-year period. We
choose a chart at random – say Infosys.
Note in this chart, we have a rise in the stock and a reaction. We lay our retracement lines and add a trend line.
One
finds that the support trend line has been broken but the stock jumps
back above the trend line soon after reaching the 38% retracement. Such
a quick recovery of the trend line is often a good sign of strength.
The prices seem to be in a good uptrend. One should now buy once the
prices are able to cross the previous swing top, as a rectangle pattern
seems to be developing. The breakout would be giving us a target equal
to the height of the pattern. In this case it is about 20 points and
one can project a target of 165. The trend line would be kept as the
stoploss. The prices then breakout past the high and then proceed to
test this high with a quick decline. It then makes another swing high
past the earlier one and then slips into making another rectangle
pattern. The target of 165 is now comfortably exceeded. The second
rectangle suggests that we are in the midst of a powerful advance.
Prices then proceed to breakout upward from this pattern too. Now our
original trend line is too far away to act as a stop loss. So we now
revise it to a new trend line no.2 drawn to the chart. This will ensure
that some of the substantial profits now on offer are locked in. Note
that all breakouts are occurring with white candles that are long
bodied. This is how breakouts should be.
This moved further
and we could construct a channel by joining the tops with a line
parallel to the trendline no.2. The prices broke upwards from this
channel. Now this many times signals the end of the move. When we found
a modified evening star pattern at the top, one should ideally exit the
long position as substantial profits are in the bag. One now waits for
the prices to break the lower support trend line to confirm the
reversal. But what we find is that the prices halt precisely at the
lower trend line. Overlaying the retracement of the entire upmove so
far, we find that the reaction once again found support on the 38%
retrcement line. We lay a 30 period moving average and find that the
prices had reacted to the average exactly. The jump from the average
levels has been with big white candles showing a resurgence of buying
interest. So one can go long again with the trend line as the stop. One
is rewarded with a big rise in the prices. As the prices reached the
highs, the candle bodies turn into a series of small ones. A long black
then follows this for the first time since the recent buy signal. This
is a warning. The long black is followed by another drive to the top
but this ends with a doji pattern. Another long black now follows this
doji. See the circled part. A good watcher of the market would take
this as a signal of change in market behaviour.
With
some signals of weakening for the first time since the uptrend, we now
need to set up the yardsticks which will warn us of coming declines and
we proceed as follows:
Extend the channel to be present in
current price levels. A break of this line will be a clear warning of
weakness. Aggressive traders can take that as a sell signal also.
We
revise the moving average period such that it catches the first low
from the swing high reached. (see arrow). This comes out to be 24 days.
We add another average that is half this length i.e.12 days. Now we have a two moving average system.
We set up a retracement study from the low from where we started to the current high.
Recall
that both the last dips had met with support at the 38% retracement. A
break of this level would now be yet another signal of a change in
trend. Further, the first dip down to the 24 period average now forms
the first downward swing and a break of this without breaking the top
now would be a signal of the first lower top and lower bottom
formation- something which has not bee seen since a long time.
The
prices rally briefly to make a lower top and then proceed to break
below the first swing low, thereby generating a sell signal for the
first time. We now wait for some confirmation of this. A couple of days
of doji pattern follow. Usually a double doji is a high probability
pattern and a declining candle that also breaks the top boundary of the
channel follows this. The prices are now below both the moving
averages. More confirmation comes in a day later as the short term 12
day moving average cuts the longer term 24 day moving average. Note
that the slope of the averages have also turned down. Usually, this is
a signal of a decline also and a more reliable one at that. Prices then
proceed steadily to break the lower channel boundary, something that
has not occurred since quite some time.
All of the above are sell signals. Let us just collate them for reference
Doji at the top.
Two long black candles preceding and succeeding the doji at the top (almost a modified evening doji star pattern)
First swing down broken after forming a lower top.
Double doji pattern within the minor consolidation followed by a long black candle.
Break of top channel line.
Prices break both averages.
Negative crossover of moving averages.
Trended decline.
Break of lower channel trend line.
Depending on the risk appetite, one would have taken a sell signal at any of them.
We
end this part of the article on the last candle. Note that it is a
white. Plus, it is on the 38% retracement level- our old support
percentage! What to do? We shall find out ahead.
Note that we
are unconcerned about making targets. It is really secondary. If the
focus shifts to money, then one will not follow signals as they come.
Instead, there will always be a tendency to look at the analysis from a
monetary angle only. Better to stick with the signals. If the process
is correct, the money is always a by-product. |