Beginner's Guide to Technical Analysis

SAM GHOSH
Beginner's Guide to
Technical Analysis

UUID: 922c8e3e-fdd2-11e8-8a58-17532927e555
This ebook was created with StreetLib Write
http://write.streetlib.com

Table of contents
WHO AND WHY OF THIS BOOK 1
WHY READ THIS BOOK? 3
TECHNICAL ANALYSIS AND
FUNDAMENTAL ANALYSIS 4
ASSUMPTIONS IN TECHNICAL
ANALYSIS 6
THEORIES GUIDING TECHNICAL
ANALYSIS 8
TOOLS FOR TECHNICAL ANALYSIS 10
CANDLESTICK CHARTS 15
LINKS TO MORE TOPICS 19

WHO AND WHY OF THIS
BOOK
Author Information
Sam Ghosh is an Investment Advisor and
Founder of Wisejay Pvt. Limited. He has
an MBA in Finance from University of Cal‐
gary, Canada, completed all three levels of
the CFA program offered by the CFA Insiti‐
tute, USA and holds various NISM certiﬁ‐
cates including Research Analyst Certiﬁ‐
cate.
Why this book?
This book is written to give beginners
some basic idea about stock selection based
on technical analysis.
Copyright
All rights reserved. No part of this publi‐
1Beginner's Guide to Technical Analy…

cation may be reproduced, distributed, or
transmitted in any form or by any means,
including photocopying, recording, or
other electronic or mechanical methods,
without the prior written permission of
Wisejay Private Limited, except in the case
of brief quotations embodied in critical re‐
views and certain other noncommercial
uses permitted by copyright law. For per‐
mission requests, write to support@
wisejay.com, addressed “Attention: Permis‐
sions Coordinator,” at the address below.
2 Beginner's Guide to Technical Analy…

WHY READ THIS BOOK?
If you just started thinking about invest‐
ing and trying to learn about the stock
market, technical analysis is all you hear –
support, resistance, trends, etc. For many
people who did not have any formal train‐
ing in investing, technical analysis may feel
synonymous to stock market trading which
is a faulty assumption. One of the reasons
for popularity of technical analysis is that it
does not take much time and training to
start trading- but becoming successful is a
different story. That is why you need to un‐
derstand the basics of technical analysis,
though the assumptions and theories be‐
hind it.
Related Link:
Introduction to Technical Analysis.

TECHNICAL ANALYSIS
AND FUNDAMENTAL
ANALYSIS
The basic difference between fundamental and
technical analysis is that the fundamental analysis
is dealing with Value and the technical analysis is
based on Price. Allow me to elaborate.
Consider you are thinking about buy‐
ing/selling shares of a particular company.
If you are doing fundamental analysis the
question you are dealing with is what is the
intrinsic value of the stock. For that you
can do a top-down or bottom-up analysis.
In a top-down approach you start with the
economic conditions, industry and at last
consider the company speciﬁc factors. In a
bottom-up approach you start with the
company speciﬁc factors. In both ways, the
goal is to determine the true or intrinsic

value of the company and the stock. Then
you compare whether the market is under‐
valuing or overvaluing the stock and make
a buy/sell decision. The analysis is mainly
based on value.
The approach in technical analysis is com‐
pletely different. A technical analyst does
not care about the value – the only thing
matters to her is the trends in the price and
volume of the stock. It is the timing that
matters. If she considers that the prices will
go up, she buys and if she considers that
the prices will go down she sells/shorts the
shares.
Related Links:
Basics of Fundamental Analysis

ASSUMPTIONS IN
TECHNICAL ANALYSIS
1. Efficient Market Hypothesis :
This hypothesis postulates that the securities
prices reflect all the publicly available information.
Here information includes the fundamental factors
and market psychology.
2. Price depends only on demand and
supply :
All other factors are reﬂected in the de‐
mand for a security.
3. Markets tend to repeat itself and prices
follow trends.
These trends are primarily due to cycles of
greed and fear.

Related Link:

THEORIES GUIDING
TECHNICAL ANALYSIS
1. Dow Theory:
This theory was developed by Charles
Dow, who co-founded the Dow Jones and
Company. According to this theory, the
stock price movement is governed by three
cyclical trends-
a. Primary Trend: Long term trend, ranging
1-3 years.
b. Secondary Trend: Medium term trend
running few weeks to a few months.
c. Minor Trend: Short term ranging to a few
days to weeks.
2. Elliott Wave Theory:
According to this theory the market moves
in waves that follows a Fibonacci Sequence

(1, 2, 3, 5, 8, 13, 21, 34, 55 .....). According to
this theory the market moves in ﬁve dis‐
tinct waves on the upside and three distinct
waves on the downside.
3. Kondratev Wave Theory
This is an economic theory which postu‐
lates that growth in economic sectors be‐
have in long-term waves of 40-60 years,
which consists of interval of high and low
growths.
Related Link:

TOOLS FOR TECHNICAL
ANALYSIS
As we have discussed in the previous
chapters, technical analysis assumes that all
publicly available information about a se‐
curity is reflected in the market price and
future movements in the security's price
can be derived from the past trends. In this
article we will introduce some major tools
used in technical analysis to understand
trends and momentum.
TRENDLINES
A trendline is used to show the overall di‐
rection of the price. It is also called a line of
best fit because of the way it is created. A
trendline is created using a least square fit‐
ting by minimizing the sum of the squares
of the offsets of the points to the line.

People often consider trendlines as straight
lines, but they do no have to be. If you are
analyzing medium to long term trend, a
non-linear curve of higher order is often
suitable as a trend line.
SIMPLE MOVING AVERAGES
In previous chapters we have learned that
according to Dow Theory there are Pri‐
mary, Secondary and Minor trends. A sim‐
ple chart of daily prices has been often use‐
less to detect trends – losing the forest in
the trees. This is why moving averages are
used to detect medium to long range
trends. Depending on what kind of trend
you are trying to detect you may need a 15
day, monthly, quarterly or annual moving
averages. A 15 day moving average chart is
created by plotting the average price for
the previous 15 days for each data point
and likewise monthly chart for 30 days etc.
EXPONENTIAL MOVING AVERAGES

(EMA)
In case of simple moving averages, the
moving averages are calculated with equal
weightage to each data point. In case of ex‐
ponential moving averages the moving av‐
erage is calculated putting more weight
and significance of the most recent points.
EMA reacts more than simple moving av‐
erage lines to recent changes in price and
useful in trending markets.
RELATIVE STRENGTH INDEX (RSI)
Till now we discussed the trend indicators.
Now, let us start momentum indicators
with RSI. While trend indicators show
whether the prices are trending up or
down momentum indicators track the
speed of the change. The trend indicators
may show that the price of the security is
picking up, but it cannot capture likelihood
of trend reversal. That is captured by a mo‐
mentum indicator such as RSI.
RSI is calculated as, RSI = 100 - 100 / (1 + RS)

Where, RS = Average Gain of up periods
during a speciﬁed period / Average loss of
the down periods during the same period.
RSI ranges from 0-100. A value near 100
(generally over 70) signiﬁes an overbought
market.
MOVING AVERAGE CONVERGENCE
AND DIVERGENCEC (MACD)
Another momentum indicator MACD uses
the difference between a shorter period
moving average and longer period moving
average to capture momentum. The
shorter period moving average will be
faster and more responsive to and longer
period moving average is less responsive.
The MACD line oscillates above and below
the zero line (or centerline).
As the prices pick up an upward momen‐
tum, the shorter period moving average
moves above the longer period moving av‐

erage and MACD moves above the zero
line. As the upward momentum increases,
the divergence between the shorter period
moving average and longer period moving
average increases and MACD moves up
further. In case of slowdown in the mo‐
mentum the moving averages tend to con‐
verge and the MACD line moves closer to
the zero line.
A pick-up in downward trend will be re‐
ﬂected downward movement in the MACD
line. The higher downward momentum in
the prices will increase the divergence be‐
tween the shorter period moving average
and longer period moving average in the
opposite direction - the MACD line will
move further down.
Related Link:
Introduction to Technical Analysis: Tools

CANDLESTICK CHARTS
One of the most popular charts used in techni‐
cal analysis is the Candlestick Charts. Originally
created by the Japanese, these charts capture the
buying and selling pressure in a period. It gives a
quick idea about the market trend as well as
changes in buying and selling pressures due to its
visual quality.

P ARTS OF A SINGLE CANDLESTICK
There are three parts of a Candlestick –
Upper Shadow, Lower Shadow and the
Real Body. The Upper Shadow shows the
highest prices during the period, the
Lower Shadow the lowest prices and the
real body the movement between the pe‐
riod open and period close prices.
BEARISH AND BULLISH CANDLE‐
STICKS

You can notice in the attached image that
there are two distinct kinds of charts –
filled charts (in red) and hollow charts (in
green).
The filled charts are the Bearish Charts and
the hollow charts are the Bullish Charts. In
the Bearish Charts the open price is higher
than the closing price as shown in the at‐
tached image. For the Bullish Charts the
opposite is true.
READING A CANDLESTICK
We already learned that we can understand
whether there is a bullish (buying) or a
bearish (selling) pressure during a period
by just the type of the candlestick. The up‐
per and lower shadows show the highest
and the lowest prices during a period.
The length of the candlestick signifies the
range of the price movement in that pe‐
riod. A longer candlestick means a higher
intra-period volatility in price.

A long real body means that the open and
close prices for a period and significantly
different, a shorter real body (or non-exis‐
tent real body) means they are closer to
each other or the same.
No upper shadow means the market
opened at a period high for a bearish can‐
dlestick and closed at a period high for a
bullish candlestick.
No lower shadow means the market closed
at a period low for a bearish candlestick
and opened at a period high for a bullish
candlestick.
Traders develop trading patterns which
they watch to detect continuation and re‐
versal in trends. These charts are popular
mainly for their visual nature.
Related Link:
Introduction to Technical Analysis: Can‐
dlestick Charts

LINKS TO MORE TOPICS
Basics of Fundamental Analysis for Fi‐
nancial Securities.
Basics of Fundamental Analysis: Valuation
Basics of Fundamental Analysis: Qualita‐
tive Analysis : Company Level Analysis
Basics of Fundamental Analysis: Qualita‐
tive Analysis : Macro Level Analysis

Beginner's Guide to Technical Analysis

More Related Content

Similar to Beginner's Guide to Technical Analysis (20)

More from Sam Ghosh (20)

Recently uploaded (20)

Beginner's Guide to Technical Analysis