Technical Analysis

1. Define technical analysis. Distinguish between technical analysis and fundamental analysis.
2. Advantages, challenges and limitations of technical Analysis.
3. Technical Tools:
a. Candlestick Chart
b. RSI
C. MACD
d. MFI
e. Elliott Wave
f. MA cross
g. Candles- Hammer; Bullish Engulfing, Bearish Engulfing, Morning Start, Double Top,
Cup and Handle;
h. Bollinger Bands
i. odd Lot theory
J. Herd behavior

Technical Analysis

Technical analysts, technicians or market analysts develop technical trading rules from
observations of past price movements of the stock market and individual stocks. The philosophy
behind technical analysis is in sharp contrast to the efficient market hypothesis that we studied,
which contends that past performance has no influence on future performance or market values.
It also differs from what we learned about fundamental analysis, which involves making
investment decisions based on the examination of the economy, an industry, and company
variables that lead to an estimate of intrinsic value for an investment, which is then compared to
its prevailing market price.

In contrast to the efficient market hypothesis or fundamental analysis, technical analysis,

according to the Market Technicians Association, is a method of evaluating securities by
analyzing statistics generated by market activity. Whereas fundamental analysts use economic
data that are usually separate from the stock or bond market, technical analysts use data from the
market itself, such as prices and the volume of trading, because they contend that the market is
its own best predictor. Therefore, technical analysis is an alternative method of making the
investment decision and answering the questions What securities should an investor buy or sell?
When should these investments be made?

# Difference between Fundamental and Technical Analysis

 Fundamental Analysis
 o Focuses on the intrinsic value of a security.
o Uses financial statements, economic indicators, and qualitative factors.
o Long-term investment perspective.
 Technical Analysis
o Analyzes price movements and trading volumes using charts and indicators.
o Short-term trading perspective.

Relies on patterns and market sentiment rather than intrinsic value.

RSI:

The relative strength index (RSI) is a momentum indicator used in technical analysis. RSI
measures the speed and magnitude of a security's recent price changes to
evaluate overvalued or undervalued conditions in the price of that security.

The RSI is displayed as an oscillator (a line graph) on a scale of zero to 100. The indicator was
developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, New Concepts in
Technical Trading Systems.1

The RSI can do more than point to overbought and oversold securities. It can also indicate
securities that may be primed for a trend reversal or corrective pullback in price. It can signal
when to buy and sell. Traditionally, an RSI reading of 70 or above indicates an overbought
situation. A reading of 30 or below indicates an oversold condition.

The Money Flow Index (MFI)

MFI is a technical oscillator that uses price and volume data for
identifying overbought or oversold signals in an asset. It can also be used to
spot divergences which warn of a trend change in price. The oscillator moves between 0 and
100.

Unlike conventional oscillators such as the Relative Strength Index (RSI), the Money Flow
Index incorporates both price and volume data, as opposed to just price. For this reason, some
analysts call MFI the volume-weighted RSI.

 An MFI reading above 80 is considered overbought and an MFI reading below

20 is considered oversold,1
Fidelity. "Money Flow Index (MFI)."

although levels of 90 and 10 are also used as thresholds.

  A divergence between the indicator and price is noteworthy. For example, if the
indicator is rising while the price is falling or flat, the price could start rising.

MACD

Moving average convergence/divergence (MACD, or MAC-D) is a trend-

following momentum indicator that shows the relationship between two exponential moving
averages (EMAs) of a security’s price. The MACD line is calculated by subtracting the 26-
period EMA from the 12-period EMA.

 The moving average convergence/divergence (MACD, or MAC-D) line is calculated by

subtracting the 26-period exponential moving average (EMA) from the 12-period EMA.
The signal line is a nine-period EMA of the MACD line.
 MACD is best used with daily periods, where the traditional settings of 26/12/9 days is
the default.
 MACD triggers technical signals when the MACD line crosses above the signal line (to
buy) or falls below it (to sell).
 MACD can help gauge whether a security is overbought or oversold, alerting traders to
the strength of a directional move, and warning of a potential price reversal.
 MACD can also alert investors to bullish/bearish divergences (e.g., when a new high in
price is not confirmed by a new high in MACD, and vice versa), suggesting a potential
failure and reversal.
 After a signal line crossover, it is recommended to wait for three or four days to confirm
that it is not a false move.

MA Cross:

The moving average (MA) is a simple technical analysis tool that smooths out price data by
creating a constantly updated average price. The average is taken over a specific period of time,
like 10 days, 20 minutes, 30 weeks, or any time period the trader chooses. There are advantages
to using a moving average in your trading, as well as options on what type of moving average to
use.

This indicator calculates and plots two moving averages, MA9 and MA21, and highlights the bar
where they cross. It is an indicator that shows when a trend is changing in the short-term and
getting either weaker or stronger.

The Moving Average cross indicator is as simple as it sounds. It measures two moving averages
and detects moments when they cross. The two moving averages being measured are the MA9
and MA21. A cross means that either the MA9 is now higher than the MA21 or vice versa. The
indicator can be used alongside other moving averages or trend following indicators to create a
better picture of momentum.
Ellott Wave:

 The Elliott Wave theory is a technical analysis of price patterns related to changes in
investor sentiment and psychology.
 The theory identifies impulse waves that establish a pattern and corrective waves that
oppose the larger trend.
 Each set of waves is within another set of waves that adhere to the same impulse or
corrective pattern, described as a fractal approach to investing.
Impulse waves consist of five sub-waves that make net movement in the same direction as the
trend of the next-largest degree. This pattern is the most common motive wave and the easiest to
spot in a market. It consists of five sub-waves, three of which are motive waves. Two are
corrective waves.

 Wave 2 can’t retrace more than the beginning of Wave 1

 Wave 3 can not be the shortest wave of the three impulse waves, 1, 3, and 5
 Wave 4 does not overlap with the price territory of Wave 1
 Wave 5 needs to end with momentum divergence2

If one rule is violated, the structure is not an impulse wave. The trader would need to re-label
the suspected impulse wave.

Bollinger Bands

A Bollinger Band® is a technical analysis tool defined by a set of trendlines. They are plotted as
two standard deviations, both positively and negatively, away from a simple moving
average (SMA) of a security's price and can be adjusted to user preferences.

Bollinger Bands® was developed by technical trader John Bollinger and designed to give
investors a higher probability of identifying when an asset is oversold or overbought.

 Bollinger Bands® is a technical analysis tool to generate oversold or overbought signals

and was developed by John Bollinger.
 Three lines compose Bollinger Bands: A simple moving average, or the middle band,
and an upper and lower band.
 The upper and lower bands are typically 2 standard deviations +/- from a 20-day simple
moving average and can be modified.
 When the price continually touches the upper Bollinger Band, it can indicate an
overbought signal.
 If the price continually touches the lower band it can indicate an oversold signal.
Herd Behavior:

Herd behavior occurs when individuals in a group make decisions based on the actions of others,
rather than their own independent judgment. Herd behavior in the stock market refers to
investors collectively following the actions of the majority, often disregarding their own analysis
or fundamental reasoning. This behavior can lead to asset price bubbles or market crashes, as
large groups of investors buy or sell based on sentiment rather than intrinsic value. Some key
drivers of herd behavior include:

1. Fear of Missing Out (FOMO): Investors rush to buy when they see others profiting.
2. Panic Selling: During market downturns, many investors sell in fear of further losses.
3. Social Influence & Media: Market trends, news, and expert opinions can drive
collective decision-making.
4. Overconfidence & Biases: Investors assume that if many others are buying/selling, it
must be the right decision.
Herd behavior can sometimes create self-fulfilling trends, where stocks rise or fall due to
collective action rather than fundamentals.

Odd Lot Theory

Odd Lot Theory is a theory in stock market behavior that suggests small investors (who
typically trade in "odd lots"—quantities of fewer than 100 shares) tend to make decisions based
on emotions or limited information, and their actions often lead to the opposite market
movement. According to the theory, when small investors are buying (in large quantities), it
could be a sign that the market is near a peak, and when they are selling, it could indicate that the
market is close to a bottom.

Key Points of Odd Lot Theory:

1. Small Investors vs. Institutional Investors: Odd lots are typically traded by individual
investors, while institutional investors generally trade in round lots (100 shares or more).
The theory assumes that institutional investors, with more information and expertise, are
more likely to make decisions based on solid analysis.
2. Contrarian Indicator: The theory suggests that the actions of odd lot traders (small
investors) are often wrong and can be used as a contrarian signal. For example, if odd lot
buying activity is high, it could indicate a market top, as the majority is usually late to the
trend. Conversely, high selling activity could signal a market bottom.
3. Emotional Decision-Making: Odd lot traders may be more influenced by fear, greed, or
emotional reactions, causing them to enter or exit the market at inopportune times.