Chart Patterns

Chart patterns are attached in my summer internship project as below. Kindly read it.

https://docs.google.com/file/d/1krhAWM_NziAHhAmkS6N_bM2Bi3IrauQuZYxnFt8oVxrsitD01KVQ0JkJyUwR/edit?pli=1

Oscillators, Importance and RSI

Introduction to Oscillators-

1) An oscillator is a technical analysis indicator that varies over time within a band (above and below a center line, or between set levels).

2) Oscillators are used to discover short-term overbought or oversold conditions.

3) The Oscillators are very useful in non trending markets, i.e when markets are in a range or in a consolidation phase. 

4) However, Oscillators can also be used in trending markets to determine short term market extremes called as overbought and oversold conditions.

5) The Oscillator can also warn that the trend is losing momentum before that situation becomes evident in the price action itself.

6) Hence, Oscillators can give important signals in range bound as well as trending markets, and Oscillators when combined with other analysis like trend lines breakout, chart pattern breakout, candlestick patterns, etc, it would give you a very good probability of success. 

For example, a stock is trading in oversold zone, that means now any time the stock can move up, but not sure when exactly can we expect an up move, and suddenly you see a particular candlestick pattern which is Bullish. So, that gives you an extra edge that OK now is the time to go long. So, Oscillators alone as a tool may not help you sometime, you have to use it in conjunction with various other tools to benefit out of it.

P.S - {Oversold means bahut jyada selling aah chuki hai, which means now buying can start, and Overbought means bahut jyada buying aah chuki hai, which means now selling will start, So whenever an indicator reaches its highest levels, it is said indicator is overbought and selling can come, and whenever an indicator reaches its lowest levels, it is said indicator is oversold and now buying can start soon}

THREE most Important uses of the Oscillators:

There are three situations when the oscillator is most useful. You will see that these three situations are common to most types of oscillators that are used:

1) The Oscillator is most useful when its value reaches an extreme reading near the upper or lower end of its boundaries. The market is said to be Overbought when its near the upper extreme, and oversold when its near the lower extreme. 

2) A Divergence between the oscillator and the price action when the oscillator is in an extreme position is usually an important warning.

3) The crossing of a zero (or midpoint ) line can give important trading signals in the direction of the price trend.

Different Types of Oscillators -- (Write only the one's asked in exam, if nothing is mentioned then you can write about oscillators in brief and explain 3 or 4 oscillators which you feel its easy):

1) Relative Strength Index-

• Relative strength index (RSI) was introduced in 1978 by J. Welles Wilder.
• It ranges between 0 and 100 and compares the magnitude of a stock's recent gains/losses with the stock's pricing action over a given time period (14-day RSI is most popular).
• RSI= 100 - 100/1+RS
• As with any other oscillator, buying and selling signals are generated when value of relative strength index crosses defined boundaries. If RSI closes above 70, value of security is overbought and selling signal is generated. If value crosses below 30, security is oversold and buying signal is generated.
• When stock is in up trend, then the overbought levels are 80 and oversold are around 40.
• When stock is in down trend, then the overbought levels are 60, and oversold are around 20.
• Divergence in RSI is very important to see :

1) CLASS 1 DIVERGENCE---YOU MAKE MORE MONEY

Here is the most basic example of how the price is increasing, and RSI is also increasing, but at the top when price is still moving higher, you see RSI losing strength and showing downside. Here is the time traders have to be cautious and sell all their long positions, as this can be end of an uptrend, and now the stock may come down soon. 

2) CLASS 2 DIVERGENCE--- YOU MAKE MEDIUM MONEY

Here is the second type of divergence, where the price is increasing, and the RSI is making double top pattern, as we can see in right hand side, when double top pattern on RSI breaks down, we can be sure that the stock is going to follow suit and fall in coming sessions. Sanjay sir refers this pattern as Class 2 divergence where you can make medium amount of money.

3) CLASS 3 DIVERGENCE--- YOU MAKE LESS MONEY AS COMPARED TO ABOVE 2

Hence this the last example of divergence shown, where Price remains flat and lose momentum, and RSI has already shown weakness, and we can expect prices to come down soon.

ALL THE 3 TYPES OF DIVERGENCE SHOWN ABOVE ARE TAKEN FOR OVERSOLD POSITIONS, AND ARE CALLED NEGATIVE DIVERGENCE, AS AFTER THIS, PRICES WOULD COME DOWN.

SIMILARLY ONE CAN SEE POSITIVE DIVERGENCE, AT OVERBOUGHT POSITIONS, WHICH MEANS WHERE PRICES WOULD FALL, AND YOU WILL SEE RSI STARTING TO RISE, WHICH WILL LEAD THE PRICES TO RISE SOON.

SO, CLEARLY RSI IS ONE OF THE BEST TOOLS TO ANALYSE THE STOCKS.

Short note on SUPPORT AND RESISTANCE

Support and Resistance Introduction:

Support and resistance represent key junctures where the forces of supply and demand meet. In the financial markets, prices are driven by excessive supply (down) and demand (up). Supply is synonymous with bearish, bears and selling. Demand is synonymous with bullish, bulls and buying. As demand increases, prices advance and as supply increases, prices decline. When supply and demand are equal, prices move sideways as bulls and bears slug it out for control.

What is Support?

Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.

In the above chart, we can see the chart of Apollo Hospitals which have taken support atleast 3 times, from where bounce back was seen. So, normally people tend to buy when the stock moves up from its support levels, but in case if the stock goes below the support levels, people should not buy, as the stock will fall more, may be up to the next support level if any.

What is Resistance?

Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. The logic dictates that as the price advances towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.

In the above chart, we can see the Max India Ltd have taken resistance three times at the peak levels (see resistance line), and then corrected back downwards. So, normally people tend to sell whenever the stock touches the resistance point and reverses back, and one should only sell if it comes down after testing the points, otherwise sometimes the resistance may be breached and stocks may move up. So always wait for the confirmation.

It is very important to note that once the support is broken, it becomes resistance, and it acts as resistance next time the stock moves up, and once the resistance is broken, it acts as a support next time, when stock comes down after moving up from that earlier resistance.

Bollinger Bands and Its Importance

Introduction to Bollinger Bands:

1) Bollinger Bands were developed by John Bollinger. They are a set of bands that are plotted at 2 standard deviations above and below an exponential moving average (20-day is widely used) and are displayed over a stock's price chart. 

2) Using 2 standard deviations guarantees 95% of the price data will lay between the bands.

3) Because of the tendency for a stock to stay within the bands, prices are considered overbought when they reach the upper band and oversold when they reach the lower band.

Seven Rules for Bollinger Bands given by Sanjay Ved sir himself:

1) The bands tend to converge towards the mean when prices are confined to a very narrow range.

2) When volatility increases, the band tend to expand in opposite direction (one can initiate position in the direction of the breakout).

3) The first move outside the band is a sign of the beginning of a new trend (generally).

4) The move outside the band, followed by the move within the band is a sign of a breather and not an end of the trend.

5) The median line may act as a support in downtrend, and resistance in an uptrend.

6) Tops/Bottoms made outside the band, followed by Tops/Bottoms made within the band will signal a change in trend.

7) Move starting from one end of the band will usually touch the other side of the band (in consolidation).

So, Bollinger offers the following characteristics:

• Expect sharp prices changes after volatility lessens and the bands narrow. 

• When a stock moves outside the bands, expect the trend to continue.

• A reversal usually occurs after a bottom or top is made outside the bands and then the underlying issue moves back inside the bands.

• Prices tend to move from one band to the other, so this can aid in projecting price targets

Graphical representation can be made in paper---looks good :

Exampe 1: To show buy at bottom- sell at top of the band. Just draw a dummy figure.

Here is a typical set of Bollinger Bands with VECO. You can see how the stock spends most of its time within the bands and the general tendency to move back and forth between the bands. Used in conjuction with other indicators for confirmation, buying at the bottom band and selling at the top would provide consistent profits. 

Example 2: To show what happens when bands narrow ?

This XICO chart demonstrates two Bolliger Band principals. First is the tendency for a stock to experience a big move after the bands have narrowed. You can see this in late June. Second, when the stock moved outside the top band, although the stock did pull back, and took support at median line, the uptrend continued.

Candlesticks Simplified

INTRODUCTION TO CANDLE STICKS:

Candle stick charting is one of the most preffered technical analysis tool , as candle sticks helps you analyse the emotions of the traders graphically by just looking at candles. Though these techniques have come from Japan, it was given popularity by Steve Nison, who hails from America. Let us look at the basics of how candle stick is formed through this image:

There are 2 types of Candlestick patterns - Reversal Patterns and Continuation patters, but we will concentrate only on Reversal patterns, as these are the prominent one's used in markets, and also comprise of the majority of the patters.

Note - (Reversal patterns means those patterns which shows you reversal, i.e after stock has increased from 100 Rs to 120 Rs, and now you see a bearish pattern, so stock will reverse now, that is fall or correct and same vice versa).

Candles which are Green and White signifies Bullish or Positive closing of stock, Candles which are Red and Black signifies Bearish or Negative closing normally, though the colour can be changed as per your wish. Here, while explaining I will use Black for bearish candle, and White for bullish candle.

CANDLE STICK PATTERNS:

1) Bullish Hammer Pattern:

Bullish hammer pattern is formed when the stock is coming down and suddenly you see a Hammer like formation at the bottom of the bear run. It typically looks like a hammer as shown in the image. The hammer should be white, but it can also be black. Once the hammer is formed, one should wait for confirmation of the next day's candle, if it is white, then we can be confident that the trend has changed and now we can go bullish.

2) Bearish Hanging man Pattern:

It looks same like Hammer but the only difference is it is formed after stock has moved up. The hanging man should be black in colour, but if its white its fine. Once the hanging man is formed, one should wait for the confirmation of the next day's candle, if it is in black, and the stock corrects, then we can be confident that the trend has changed and now we can be bearish on the same.

3) Bullish Engulfing Pattern:

In Bullish Engulfing pattern, after a down trend, you see a  white candle stick real body, totally engulfing the earlier preceding black candle real body. The shadows are not important here, just you have to see that the white body of the candle engulfs last preceding black candles real body in it. (In simple terms, white body-black body ko kha jata hai). Here also after bullish engulfing pattern, you can take confirmation only if the next day candle is white and the stock starts moving up.

4) Bearish Engulfing Pattern:

In Bearish Engulfing pattern, after an uptrend, you see a black candle stick real body, totally engulfing the earlier preceding white candle real body. The shadows are not important here as well, the only thing important is that black body of the candle engulfs the last preceding white candle real body in to it. (In simple terms, black body-white body ko kha jata hai). Here also after bearish engulfing pattern, you can take confirmation only if the next day candle is black and the stock starts moving down.

5) Bullish Harami Pattern:

In Bullish Harami pattern, after a down trend, you see a small white real body contained within a prior relatively large black real body. This is sort of inverse of Bullish Engulfing as in Bullish engulfing, white body contains the black body, but here black body contains the white body. Confirmation can be taken next day in form of white candle stick.

6) Bearish Harami Pattern:

In Bearish Harami pattern, after an uptrend, you see a small black real body contained within a prior relatively large white real body. This is sort of inverse of Bearish Engulfing , as in Bearish engulfing, black body contains the white body, but here white body contains the black body. Confirmation can be taken next day in form of black candle stick.

7) Bullish Piercing Line:

In Bullish Piercing Line, you see a stock in a downtrend, and after a long black candlestick, next day we see a gap down (candle opening lower than yest's close), but the stock closes in white covering more than 50% of previous days black candle body. This is a very strong pattern, and confirmation is not required, but if taken, its an added advantage.

8) Bearish Dark Cloud Cover:

In Bearish Dark Cloud cover, you see a stock in an uptrend, and after a long white candlestick, next day we see a gap up (candle opening higher that yest's close), but the stock closes in black covering more than 50% of previous days white candle body. This also is very strong pattern, and confirmation is not required, but if taken, its an added advantage.

9) Bullish Morning Doji Star:

This is a three-candlestick formation signalling a major bottom reversal. In a down trend, it is composed of a long black candlestick followed by a doji, which characteristically gaps down to form a doji star. Then we have a third white candlestick whose closing is well in to the first sessions black real body. This is a meaningful bottom pattern.

10) Bearish Evening Doji Star:

This is a major top reversal pattern formed by three candlesticks. In an uptrend, you see the first candlestick is a long white body, the second is a Doji, characterized by a higher gap thus forming a Doji star. The third one is a black candlestick with a closing price, which is within the first day's white real body. It is a meaningful top pattern.

This are important candlestick patterns, which can be really helpful to find out reversals. Some more good candlestick patterns are there, but would update after exams. Diagrams are easy, do draw it.

Image Source- @candlesticker.com

Dow Theory Principles and Criticism

Introduction:

Charles Dow, who is referred to as "Father of Technical Analysis" has made immense contributions to the field of Technical Analysis. One of the important contributions include the DOW THEORY. The Dow Theory evolved from the work of Charles Dow, who published a series of The Wall Street Journal editorials between 1900 and 1902.

Principles of Dow Theory:

1) Averages Discount Everything-

Market averages discount everything means all the news and factors which affects the stocks are already priced in the index. This shows that just like stocks, the averages of these stocks, which we call INDEX also discounts everything in the market and everything is already priced in.

2) The Market has Three Trends-

A) Primary Trend:

Primary trend also called as major trend lasts from more than one year to up to may be around 3 to 5 years duration. The primary trend can be Bull run (bullish) or Bear run (bearish). However, the Bullish run may be interrupted by small corrections in between and so is Bearish run may also see some small up moves in the formation of Primary trend.

B) Intermediate Trend:

The intermediate trend lasts from around three weeks to months but normally less than a year. The intermediate trend may be bullish, but not necessarily the primary trend is. The primary trend may be bearish but the intermediate trend is bullish, that means overall long term trend is bearish, but now for some time the trend has changed and it is bullish and vice-versa. It may be 33, 50 or 66 % retracement of the prior trend.

C) Short Term Trend:

The short term trend may last from a week up to as long as 6 weeks. It is a minor trend and may be bullish or bearish or consolidation. As it is very short term, it is a bit difficult to analyse short term trends, and major focus remains on Primary and Intermediate trend.

3) The Market has Three Phases- Accumulation, Participation and Distribution-

A) Accumulation:

Accumulation phase is the first phase of a primary bull market where informed investors make buying decisions and there is no much noise in the market. People accumulate stocks on declines and hold it for gaining in coming times. The market may be down, but smart people think this is it and no more decline in markets -lets accumulate.

B) Participation:

Participation is the phase when market starts showing signs of reversal, and people join in and starts confidently buying stocks, taking the market to rise at higher levels, as most of the macro data like GDP, Inflation, IIP, etc works in the favour of the markets. In short, buying interests is at its peak.

C) Distribution: 

Once the markets are heated up with excess buying, we see smart investors booking profits followed by other people who accumulated in the second stage of participation. Suddenly, lot of profit booking happens, and the markets are back in the selling spree. And hence the market falls like pack of cards, which is nothing but the distribution stage.

4) Averages must confirm each other:

Dow was of the view that two averages must confirm each other, which means the two average suggested by him - Rail averages and Dow Industrial, must go hand in hand. So, if the Dow Industrial is moving higher, and the Rail average is not performing, this means there is something fishy in markets, and the bullish run cannot be confirmed yet, and vice versa. So, averages must confirm each other. If the Dow Industrial is going up, even the Rail average must follow suit and vice versa.

5) Volumes must support the trend:

Dow was of the view that any run whether bullish or bearish must be confirmed with High volumes. If the volumes are small, it means that market trend is still not confirm. So, when markets rise, it must be accompanied with High volumes, and even when market falls, it should also comprise higher volumes for the trend to be confirmed.

6) It is considered that the trend remains in force until it gives definite signals that it has reversed:

This principle is basic principle of Technical Analysis. Practically, if it is not true, the entire technical analysis would not make sense. The principle is linked to the law of motion in general: anything that moves is likely to continue to move until an external force does not prevent it. So, don't take hasty decisions, wait for the confirmation that the trend has reversed its direction.

Criticisms to Dow Theory: (Taken from Kilpatrick book):

Although Dow Theory forms the building blocks for modem-day technical analysis, this theory is not without criticisms. One of the criticisms is that following the theory will result in an investors acting after rather than before or at market tops and bottoms. With Dow Theory, there is an inevitable lag between the actual turn in the primary trend and the recognition of the change in trend. The theory does not recognize a turn until long after it has occurred and has been confirmed. On the other hand, the theory, if properly interpreted, will recognize that primary trend change and will thus never allow a large loss. Dow's contention was that concentrating on any direction change of shorter duration than the primary trend increased the chances of having one's portfolio whittled away by high turnover, many errors in judgment, and increased transaction

costs. Therefore, Dow Theory is biased toward late recognition of a change in trend to minimize the costs of wrongly identifying a change in trend.

A second criticism of Dow Theory is that the different trends are not strictly defined. Often the interpretation of price swings is difficult to assign to a specific trend type. Secondary trend beginnings often appear like primary trend beginnings, for example. This makes the determination of the primary trend unclear at times and can incite investment in the wrong direction. Others, however, criticize Dow Theory for being too specific about the requirements needed to identify a change in trend. Requiring that only closing prices be used or that any break to a new level no matter how small is significant often places too much emphasis on a small change in price.

What is Technical Analysis ?

Introduction to Technical Analysis:

Technical Analysis is the past study of market action, primarily through the use of charts, for the purpose of anticipating future price trends. It is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. In short, Technical Analysis studies the supply and demand in a market, in an attempt to determine what direction or trend will continue in the future. It tries to gauge the emotions of the people trading in market, and tries to find out the possible course of movement going ahead. There are lots of things which can be studied under technical analysis and people use it in different ways depending on their needs and understanding. Some use chart patterns, some use candlestick patterns, some use only indicators, and some use the combination of these.

Assumptions:

There are 3 main assumptions on which Technical Analysis is based:

1) The Market Discounts Everything

2) Prices Move in Trends

3) History tends to repeat itself

The Market Discounts Everything:

A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of the company. However, technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company -including fundamental factors. Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market, and rest all is already discounted in the market already.

Prices Move in Trends:

In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption. The whole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. There is a corollary to the premise that prices move in trends-a trend in motion is more likely to continue than to reverse.

History Tends to Repeat Itself:

One of the most important assumptions which Technical Analysis follows is that history keeps repeating itself and things which happened in the past would probably happen again in coming times. Most of the part of technical analysis is related to study of human psychology. Chart patterns, for example, which have been identified and categorized over the past one hundred years, reflect certain pictures that appear on price charts. These pictures reveal the bearish or bullish psychology of the market. Since these patterns have worked well in the past, it is assumed that they will continue to work well in the future. They are based on the study of human psychology, which tends not to change. Another way of saying this last premise: that “History repeats itself”, is that the key to understanding the future lies in a study of the past, or that the future is just a repetition of the past.

Why Technical Over Fundamentals ?

Fundamentals have some flaws such as :

1) It is for long term, and it does not define what long term is.

2) It does not quantify risk, i.e stop loss, which technical analysis does.

3) Lets take this example, A company which is listed may come out with its quarterly numbers every quarter, but of course the price of the stock would change every day the stock is traded, and hence it is necessary to gauge people's sentiments on a stock, which Technicals will help you.

4) In short, just see this following flow -

If you see, once the fundamentals are found out, valuations are done, there is perception about the company, which leads to volumes, and which finally lead to PRICE . So, clearly Price and Volumes are at the top of the pyramid, and this is what Technical Analysis is all about, directly focussing on the top of the pyramid, which is of utmost importance.

Advantage of Technical Analysis:

1) In fundamentals, you are only focussed on a particular sector, or few sectors, but Technicals once learnt can be applied to any sector, any asset class (commodities, equities, currencies, etc).

2) You can short in the market on negative view.

3) Technicals can give you 360 degree view of all markets which are traded.

4) There are lot of stocks which can be viewed and analysed and opportunities can be found out, unlike fundamentals.