Technical Analysis - Notes

While I learn TA, will be posting notes here from various resources as a refresher.

Source: TECHNICAL ANALYSIS OF FINANCIAL MARKETS by John Murphy

Main belief of TA
• Market action discounts everything
• Prices move in trends
• History repeats itself

Timing becomes very important in TA – especially futures market.

Leverage is very risky!

TA can be applied to different markets, different TFs,

Dow Theory
• Averages discount everything
• Market has 3 trends – primary, secondary & minor (tide, waves & ripples allegory)
• Major trends have 3 phases – accumulation, public participation and distribution
• Averages must confirm each other (eg. Sectoral indices)
• Volume must confirm trend – increase/diminish in the direction of the major trend
• Trend assumed to be in effect until it gives definite signals that it has reversed (use TA to establish this)

Closing prices relied on to a great extent

Basic concepts of Trend
• Markets don’t move in a straight line but in zigzags;
• Uptrend = Series of successively higher peaks & troughs;
• Downtrend = Series of declining peaks & troughs;
• Sideways = Horizontal peaks & troughs;
• Most TA tools and systems are trend following - so, better to stand aside when trendless
• Trend has 3 classifications – major, intermediate and near-term

Support & Resistance
• Support = Troughs / reaction lows. Area on the chart where buying interest > selling pressure. Decline halted, prices turn back up again.
• Resistance = Peaks / highs. Area on the chart where selling pressure > buying interest. Price advance turned back.
• Uptrend = Each successive “Low & High” higher than previous. If support violated, trend reversal likely. Likewise, failure to exceed previous peak implies trend might change.
• Downtrend = Each successive “High & Low” lower than previous. If resistance violated, trend reversal likely. Likewise, failure to exceed previous low implies trend might change.
• Support & Resistance reverse their roles. Recollect psychology behind this – “buy @ next dip” and “sell @ next rise”. Also concept of margin contributes to “square-offs”
• Level of significance of S&R determined by: Period of time that prices trade in and around the area / Volume / How recent?
• Penetration of S/R puts trend in question. Level of subjectivity involved. ‘Close’ is important. S/R role reversal takes place when markets move far enough to convince participants that they made a mistake. Place SL keeping this in mind. (Round nos. are important!). Also refer TL breach section.

Trendlines
• Uptrend lines drawn upward, connecting successive reaction lows
• Downtrend lines drawn downward, connecting successive reaction highs
• Experimenting may be required in drawing TLs, redrawing may become necessary. Small penetrations may occur (use judgment in such cases!)
• Third touch point makes it a valid TL. Longer it has been intact & more it has been tested ---> significance improves ---> more important is its penetration
• Ascertaining validity of breaking TL: Close more important than intraday penetration; Extent of penetration (eg. 1-3% depending on TF); 2 day rule (Again, idea is to convince participants that they made a mistake)
• TLs also reverse roles (Support vs. Resistance)
• Steepness of TL: Too steep? – might require redrawing after correction; too flat means too weak and must not be trusted. ~45 degrees best!
• Other concepts: Channels, Speed lines, Gann lines, Fibonacci retracements

Gaps
• Areas where no trading had taken place
• Breakaway gaps – occurs at end of an important price pattern. Breaking of S/R. Significant move likely. Usually involves heavy volume.
• Runaway or measuring gap – Trend acceleration. Sign of strength/weakness (in up/down trend). Moderate volumes.
• Exhaustion gap – ‘Last gasp’.
• Prices closing below/above the gap (in up/down trend), has bearish / bullish implications respectively.
• Look out for Island reversals & Reversal days

Source: TECHNICAL ANALYSIS OF FINANCIAL MARKETS by John Murphy

Price patterns
• Important changes in trend are not abrupt but require a period of transition - where there might be sideways movement
• 2 types of patters – Continuation and Reversal
• Volume plays an important confirming role – in times of doubt, helps decide whether or not to trust the pattern

Reversal patterns
• Head & shoulder / Inverse head & shoulder
• Triple tops & bottoms
• Double tops & bottoms
• Spike (or V) tops & bottoms
• Rounding / saucer pattern

Continuation patterns
• Triangles – symmetrical, ascending, descending & broadening formation
• Flags & Pennants
• Wedges
• Rectangles
• Continuation head & shoulders pattern

Source: TECHNICAL ANALYSIS OF FINANCIAL MARKETS by John Murphy

Pages 135 to 165

Reversal patterns – important considerations
• There must be a prior trend – if no trend, pattern is suspect. Important to know where pattern would occur in the trend structure
• First signal of impending trend reversal is break of important TL – can be trend reversal or just result in sideways movement
• Larger patter = greater subsequent moves. Height measures volatility; width measures time taken.
• Topping patterns: shorter in duration + more volatile than bottom patterns
• Bottom patterns: take longer to build + smaller price changes
• Volume: Completion of pattern should be accompanied by noticeable increase in volume. Very important on the upside. For downsides, not that necessary as markets can fall off their own weight.

Pattern I - Head & Shoulders
• There should be a prior uptrend
• LEFT SHOULDER ('A') formed on heavy volume, then a correction (to 'B')
• HEAD: Rally beyond 'A' up to 'C', but this is on lighter volume
• A decline that instead of finding support at 'A' (remember breached resistance becomes a support in uptrend), breaches it approx. until previous reaction low at 'D'
• RIGHT SHOULDER: Another rally, but this doesn't go higher than 'C' - again on lighter volume
• Decisive closing violation of neckline - determined by level of penetration (1%-3% based on TF) or say, 2 successive closes below neckline. Only now should one think of entering.
• Rebound: Possibility of a rebound up to bottom of neckline (which is now a resistance) - look out for volumes on breach of neckline (if high, rebound may not happen. If low, bounce must be on light volume and subsequent decline must be on higher volumes)

Inverse Head & & Shoulders
• Greater tendency for price to rebound
• Also, Volumes play a much more important role @ bottoms than tops - prices can fall due to inertia, but for rising - volume is important.
• Dip to head and right shoulder must be on light volumes. Breach of neckline should be at heavy volume. Again rebound should be on lower volume and the rise thereafter should be on high volumes.

Additional points
• Slope of neckline can be upward, horizontal or downward
• While price target is said to be at least the distance b'ween the head and neck, keep in mind any support/resistance areas and adjust targets accordingly.
• Variations: There could be 2 left/right shoulders, 2 heads - look for symmetry in such cases
• Use of tactics - Aggressive traders may take a position before breach, Adding of positions on rebound etc.
• On rebound, if prices recross and close decisively above the neckline - pattern is likely to fail.
• H&S / Inverse H&S can sometimes be a consolidation pattern.

Pattern II - Triple tops & bottoms
• Pretty much same rules apply as H&S / Inverse H&S.
• Here, all 3 peaks are at pretty much same level instead of a prominent head sticking out in the middle -
• Remember volume conditions when peaks & troughs are formed
• Pattern is complete only when both troughs are decisively penetrated
• Pattern may not always be 'picture perfect'

Pattern III - Double tops & bottoms
• Again, same rules - differing factor being 2 peaks/troughs instead of 3
• Pattern is complete only when trough is decisively penetrated
• Pattern may not always be 'picture perfect'
• Time b'ween peaks & troughs is important - usually difference b'ween the peaks is at least a month

Patterns IV & V - Saucers & Spikes
• Not very frequent
• Saucers - Rounded bottoms. Difficult to measure when the pattern is completed. Price targets are difficult to establish
• Spikes - Very difficult to spot in advance. Sudden change in direction. Daily / weekly reversals on heavy volume may be the only warnings.

FINAL NOTE: PRICE PATTERNS ARE NOT INFALLIBLE. FALSE BREAKOUTS AND TRAPS DO OCCUR. RISK & MONEY MANAGEMENT IS VERY IMPORTANT.

Source: TECHNICAL ANALYSIS OF FINANCIAL MARKETS by John Murphy

Pages 165 to 193

These patterns indicate that sideways trend is just a pause in the prevailing trend and the next move will be in same direction as preceding trend.

The patterns are usually of shorter duration than reversal patterns.

Pattern I - Triangles
• 4 types: Symmetrical, ascending, descending & broadening
• Symmetrical: 2 converging TLs (upper descending & lower ascending). Neutral formation - Bullish or bearish implication depending on prior trend and direction of breakout.
• Ascending: Rising lower TL; flat/horizontal upper TL. Generally bullish implication - resolved by upside breakout. (May occur during uptrend as a continuing pattern or during downtrend as a reversal pattern)
• Descending: Declining upper TL; flat/horizontal lower TL. Generally bearish implication - resolved by downside breakout. (May occur during downtrend as a continuing pattern or during uptrend as a reversal pattern)
• Minimum of 4 reversal points must exist within the TLs (Many formations have 6 points)
• Decisive breakout should take place b'ween 2/3 to 3/4 of horizontal width of the triangle. If beyond 3/4, formation not very potent.
• Volumes: Usual rules w.r.t rising/declining prices. Must pick-up noticeably at penetration.
• Rebound may occur - same rules as reversal pattern
• Target: determined by length of triangle's base from breakout - consider S&R as well. Another alternative - use of channels.
• Broadening formation: Left nosed triangle. Usually occurs at the top after a bull run. Generally bearish implication.

Pattern II - Flags & Pennants
• Represent brief pauses in a dynamic market move. Usually treated together as similar in appearance, have same volume and measuring criteria.
• Preceded by a sharp and almost straight line move (the 'pole'). Very reliable continuation pattern - in rare cases act as a reversal pattern
• Flag is a parallelogram while pennant is a triangle. Slant is opposite to prevailing trend
• Volume: Heavy when the pole is formed; dries up during consolidation; again heavy on penetration.
• Relatively short term in nature and pattern should be completed in 1 or 2 weeks.
• Target: Length of the pole from breakout point - consider S&R as well.

Pattern III - Wedges
• Similar to symmetrical triangle (so no horizontal TLs) - distinguishable due to its noticeable slant.
• Like flags/pennant - slant is opposite[/B] to prevailing trend. Falling wedge is bullish. Rising wedge is bearish
• Generally occurs within existing trend. Can appear at top or bottom to signal trend reversal. (similar concept as ascending and descending triangles)

Slant holds the key.
• In uptrend, rising wedge is bearish (indicates market top) while falling wedge is bullish (indicates continuation).
• In downtrend, rising wedge is bearish (indicates continuation) while falling wedge is bullish (indicates market bottom).


Pattern IV - Rectangles
• Pause in trend wherein there is sideways movement b'ween 2 horizontal parallel lines.
• Decisive penetration important. Support and resistance reverse roles after penetration.
• May evolve into a reversal pattern!! Eg. triple or double top/bottom. Keep a close eye on volumes for this purpose.
• Swings within the range may be traded. Alternatively, avoid the sideways movement.
• Target: determined based on height of trading range - as usual consider S&R as well.

Pattern V - H&S / Inverse H&S as a continuation pattern
• An inverse H&S during uptrend has bullish implication
• A Normal H&S during downtrend has bearish implication

Thanks this will be useful for learners like me.

Checklist - as of now

1. Trend on monthly and weekly chart
2. Any defined candlestick pattern?
3. Support & Resistance points on daily and weekly charts?
4. Any known chart patterns based on TLs (incl gaps)?

Good Stuff for learning
:clapping::clapping::clapping:

In our minds we think we understand a concept,but when put on the spot we,often over-analyse,over-think,and try to see too much.This is specially true if we have too much of technical analysis in our heads and we don't know how to apply effectively.We think we need to be smart when we just need to be observant.We stray from the rules and start thinking too much.Sometimes the most brilliant thing to do is not act smart but just follow the rules.

Analysing the trends isn't always easy.You will get better with each chart you study.If you get the main direction right everything else will seem a lot easier.If you get the direction wrong you will be left wondering why investing seems so complicated

Charles Schaap-Invest with Success

To add to what you've mentioned - one can have the best strategy but still lose money by simply not being disciplined.

Stay humble, swallow your pride and stomach that loss - 'that' one move can wipe away all your gains if you are arrogant. No strategy is infallible - so often everything on the chart seems perfect and market has this uncanny way of embarrassing you.

A quote you put up some time back sums it up beautifully - the one that goes "Stocks don't know you have a plan for them...."