Stock Market Analysis Guru

Monday, 2 July 2018

Started With Candle Sticks - Technical Analysis

We discuss till now what is technical analysis , assumptions in technical analysis , the chart types in technical analysis , candlestick anatomy and time frames in technical analysis . Today we discuss about candlestick patterns and what to expect and certain assumption .

History tends to repeat itself – The big assumption :

As mentioned earlier one of the key assumptions in technical analysis is that, we rely on the fact that the history tends to repeats itself. This probably is one of the most important assumptions in Technical Analysis.

It would make sense to explore this assumption in greater detail at this juncture as candlestick patterns are heavily dependent on it.

According to the assumption – History tends to repeat itself. However we need to make an addendum to this assumption. When a set of factors that has panned out in the past tends to repeat itself in the future, we expect the same outcome to occur, as was observed in the past, provided the factors are the same.

Candlestick patterns and what to expect :

The candlesticks are used to identify trading patterns. Patterns in turn help the technical analyst to set up a trade. The patterns are formed by grouping two or more candles in a certain sequence. However, sometimes powerful trading signals can be identified by just single candlestick pattern.

Hence, candlesticks can be broken down into single candlestick pattern and multiple candlestick patterns.

Under the single candlestick pattern we will be learning the following…

1. Marubozu

(I) Bullish Marubozu

(II) Bearish Marubozu

2. Doji

3. Spinning Tops

4. Paper umbrella

(I) Hammer

(II) Hanging man

5. Shooting star

Started With Candle Sticks - Technical Analysis

Multiple candlestick patterns are a combination of multiple candles. Under the multiple candlestick patterns we will learn the following:

1. Engulfing pattern

(I) Bullish Engulfing

(II) Bearish Engulfing

2. Harami

(I) Bullish Harami

(II) Bearish Harami

3. Piercing Pattern

4. Dark cloud cover

5. Morning Star

6. Evening Star

Of course you must be wondering what these names mean. As I had mentioned in the previous post , some of the patterns retain the original Japanese name.

Candlestick patterns help the trader develop a complete point of view. Each pattern comes with an in built risk mechanism. Candlesticks gives an insight into both entry and stop loss price.

Few assumptions specific to candlesticks - TA :

Before we jump in and start learning about the patterns, there are few more assumptions that we need to keep in mind. These assumptions are specific to candlesticks. Do pay a lot of attention to these assumptions as we will keep referring back to these assumptions quite often later.

At this stage, these assumptions may not be very clear to you. I will explain them in greater detail as and when we proceed. However, do keep these assumptions in the back of your mind:

Buy strength and sell weakness :

Strength is represented by a bullish (blue) candle and weakness by a bearish (red) candle. Hence whenever you are buying ensure it is a blue candle day and whenever you are selling, ensure it’s a red candle day.

Be flexible with patterns (quantify and verify) :

While the text book definition of a pattern could state a certain criteria, there could be minor variations to the pattern owing to market conditions. So one needs to be a bit flexible. However one needs to be flexible within limits, and hence it is required to always quantify the flexibility.

Look for a prior trend :

If you are looking at a bullish pattern, the prior trend should be bearish and likewise if you are looking for a bearish pattern, the prior trend should be bullish.

Conclusion Of Started With Candle Sticks - Technical Analysis :

1. History tends to repeat itself – we modified this assumption by adding the factor angle .

2. Candlestick patterns can be broken down into single and multiple candlestick patterns .

3. There are three important assumptions specific to candlestick patterns

(I) Buy strength and sell weakness

(II) Be flexible – quantify and verify

(III) Look for a prior trend.

In the next post we are going to discuss about Single Candlesticks patterns .

Time Frames - Technical Analysis

We discuss about what is technical analysis , assumptions in technical analysis , the chart types of technical analysis and candle stick anatomy in the last posts . Today we are going to discussion about time frames .

A time frame is defined as the time duration during which one chooses to study a particular chart. Some of the popular time frames that technical analysts use are:

o Monthly Charts

o Weekly charts

o Daily or End of day charts

The closing price as on the 5th minute

No. Of Candles :

75 candles per day

As you can see from the above as and when the time frame reduces, the number of candles (data points) increase. Based on the type of trader you are, you need to take a stand on the time frame you need.

The data can either be information or noise. As a trader, you need to filter information from noise. For instance a long term investor is better off looking at weekly or monthly charts as this would provide information. While on the other hand an intraday trader executing 1 or 2 trades per day is better off looking at end of day (EOD) or at best 15 mins charts. Likewise for a high frequency trader, a 1 minute charts can convey a lot of information.

So based on your stance as a trader you need to choose a time frame. This is extremely crucial for your trading success, because a successful trader looks for information and discards the noise.

Candle Stick Anatomy - Technical Analysis

We discuss about what is technical analysis , assumptions of technical analysis and the chart types of technical analysis in the last posts . Today we discuss about candlestick chart which is very important .

Candlestick Anatomy - Technical Analysis :

While in a bar chart the open and the close prices are shown by a tick on the left

and the right sides of the bar respectively, however in a candlestick the open and close prices are displayed by a rectangular body.

In a candle stick chart, candles can be classified as a bullish or bearish candle usually represented by blue/green/white and red/black candles respectively. Needless to say, the colors can be customized to any color of your choice; the technical analysis software allows you to do this. In this module we have opted for the blue and red combination to represent bullish and bearish candles respectively.

Let us look at the bullish candle. The candlestick, like a bar chart is made of 3 components.

The Central real body :

The real body, rectangular in shape connects the opening and closing price

Upper shadow :

Connects the high point to the close

Lower Shadow :

Connects the low point to the open

Have a look at the image below to understand how a bullish candlestick is formed:

Candle stick Anatomy - Technical Analysis

This is best understood with an example. Let us assume the prices as follows..

Open = 62
High = 70
Low = 58

Close = 67

Likewise, the bearish candle also has 3 components:

The Central real body :

The real body, rectangular in shape which connects the opening and closing price. However the opening is at the top end and the closing is at the bottom end of the rectangle

Upper shadow :

Connects the high point to the open

Lower Shadow :

Connects the Low point to the close

This is how a bearish candle would look like:

This is best understood with an example. Let us assume the prices as follows..

Open = 456
High = 470
Low = 420

Close = 435

Here is a little exercise to help you understand the candlestick pattern better. Try and plot the candlesticks for the given data.

If you find any difficulty in doing this exercise, feel free to ask your query in the

comments box .

Once you internalize the way candlesticks are plotted, reading the candlesticks to identify patterns becomes a lot easier.

This is how the candlestick chart looks like if you were to plot them on a time series. The blue candle indicates bullishness and red indicates bearishness.

Also note, a long bodied candle depicts strong buying or selling activity. A short
bodied candle depicts less trading activity and hence less price movement.

To sum up, candlesticks are easier to interpret in comparison to the bar chart. Candlesticks help you to quickly visualize the relationship between the open and close as well as the high and low price points.

In this post we learn about two types of candlesticks – Bullish candle and Bearish candle. The structure of the candlestick however remains the same .

In the next post we will go to learn about time frames .

The Chart Types In Technical Analysis

As we discuss about what is Technical Analysis and difference between technical analysis and fundamental analysis by example in last post . We also discuss about Assumptions and versatility of Technical Analysis . Today we are going to discuss about The Chart Types In Technical Analysis .

Having recognized that the Open (O), high (H), low (L), and close (C) serves as the best way to summarize the trading action for the given time period, we need a charting technique that displays this information in the most comprehensible way. If not for a good charting technique, charts can get quite complex. Each trading day has four data points’ i.e the OHLC. If we are looking at a 10 day chart, we need to visualize 40 data points (1 day x 4 data points per day). So you can imagine how complex it would be to visualize 6 months or a year’s data.

As you may have guessed, the regular charts that we are generally used to – like the column chart, pie chart, area chart etc does not work for technical analysis. The only exception to this is the line chart.

The regular charts don’t work mainly because they display one data point at a given point in time. However Technical Analysis requires four data points to be displayed at the same time.

Below are some of the chart types of Technical Analysis :

1. Line chart
2. Bar Chart
3. Japanese Candlestick

The focus of this post will be on the Japanese Candlesticks however before we get to candlesticks, we will understand why we don’t use the line and bar chart.

The Line Chart Of Technical Analysis :

The line chart is the most basic chart type and it uses only one data point to form the chart. When it comes to technical analysis, a line chart is formed by plotting the closing prices of a stock or an index. A dot is placed for each closing price and the various dots are then connected by a line.

If we are looking 60 day data then the line chart is formed by connecting the dots of the closing prices for 60 days.

The line charts can be plotted for various time frames namely monthly, weekly, hourly etc. So ,if you wish to draw a weekly line chart, you can use weekly closing prices of securities and likewise for the other time frames as well.

The advantage of the line chart is its simplicity. With one glance, the trader can identify the generic trend of the security. However the disadvantage of the line chart is also its simplicity. Besides giving the analysts a view on the trend, the line chart does not provide any additional detail. Plus the line chart takes into consideration only the closing prices ignoring the open, high and low. For this reason traders prefer not to use the line charts.

I hope you clearly understand why line chart is not important for technical analysis . If you have any query or doubt write down in comment box . Now we discuss about bar chart .

The Bar Chart Of Technical Analysis :

The bar chart on the other hand is a bit more versatile. A bar chart displays all the four price variables namely open, high, low, and close. A bar has three components.

The central line :

The top of the bar indicates the highest price the security has reached. The bottom end of the bar indicates the lowest price for the same period.

The left mark/tick :

indicates the open

The right mark/tick :

indicates the close

For example assume the OHLC data for a stock as follows:

Open – 67
High – 70
Low – 60
Close – 64

For the above data, the bar chart would look like this:

As you can see, in a single bar, we can plot four different price points. If you wish to view 5 days chart, as you would imagine we will have 5 vertical bars. So on and so forth.

Note the position of the left and right mark on the bar chart varies based on how the market has moved for the given day.

If the left mark, which represents the opening price is placed lower than the right mark, it indicates that the close is higher than the open (close > open), hence a positive day for the markets. For example consider this: O = 46, H = 51, L = 45, C = 49. To indicate it is a bullish day, the bar is represented in blue color.

Likewise if the left mark is placed higher than the right mark it indicates that the
close is lower than the open (close <open), hence a negative day for markets. For example consider this: O = 74, H=76, L=70, C=71. To indicate it is a bearish day, the bar is represented in red color.

The length of the central line indicates the range for the day. A range can be defined as the difference between the high and low. Longer the line, bigger the range, shorter the line, smaller is the range.

While the bar chart displays all the four data points it still lacks a visual appeal. This is probably the biggest disadvantage of a bar chart. It becomes really hard to spot potential patterns brewing when one is looking at a bar chart. The complexity increases when a trader has to analyze multiple charts during the day.

Hence for this reason the traders do not use bar charts. However it is worth mentioning that there are traders who prefer to use bar charts. But if you are starting fresh, I would strongly recommend the use of Japanese Candlesticks. Candlesticks are the default option for the majority in the trading community.

History of the Japanese Candlestick :

Before we jump in, it is worth spending time to understand in brief the history of
the Japanese Candlesticks. As the name suggests, the candlesticks originated from Japan. The earliest use of candlesticks dates back to the 18th century by a Japanese rice merchant named Homma Munehisa.

Though the candlesticks have been in existence for a long time in Japan, and are probably the oldest form of price analysis, the western world traders were clueless about it. It is believed that sometime around 1980’s a trader named Steve Nison accidentally discovered candlesticks, and he actually introduced the methodology to the rest of the world. He authored the first ever book on candlesticks titled “Japanese Candlestick Charting Techniques” which is still a favorite amongst many traders.

Most of the pattern in candlesticks still retains the Japanese names; thus giving an oriental feel to technical analysis.

Conclusion Of The Chart Types In Technical Analysis :

1. Conventional chart type cannot be used for technical analysis as we need to plot 4 data points simultaneously

2. Line chart can be used to interpret trends but besides that no other information can be derived

3. Bar charts lacks visual appeal and one cannot identify patterns easily. For this reason bar charts are not very popular

We are going to discuss about Candlestick Anatomy in next post . If you have any query or suggestions write in the comment box .

Technical Analysis - Introduction

Everyone want success in stock market . But very few people achieve it . First of all we have to know that developing a well researched point of view is critical for stock market success . A good point of view should have a directional view and should also include information such as:

1. Price at which one should buy and sell stocks

2. Risk involved

3. Expected reward

4. Expected holding period

Technical Analysis (also abbreviated as TA) is a popular technique that allows you to do just that. It not only helps you develop a point of view on a particular stock or index but also helps you define the trade keeping in mind the entry, exit and risk perspective.

Like all research techniques, Technical Analysis also comes with its own attributes, some of which can be highly complex. However technology makes it easy to understand. We will discuss this attribute latter .

Technical Analysis, what is it?

Consider this analogy.

Imagine you are vacationing in a foreign country where everything including the language, culture, climate, and food is new to you. On day 1, you do the regular touristy activities, and by evening you are very hungry. You want to end your day by having a great dinner. You ask around for a good restaurant and you are told about a nice food street which is close by. You decide to give it a try.

To your surprise, there are many vendors selling different varieties of food. Everything looks different and interesting. You are absolutely clueless as to what to eat for dinner. To add to your dilemma you cannot ask around as you do not know the local language. So given all this, how will you make a decision on what to eat?

Well, you have two options to figure out what to eat.

Option 1:

You visit a vendor, figure out what they are cooking / selling. Check on the ingredients used, cooking style, probably taste a bit and figure out if you actually like the food. You repeat this exercise across a few vendors, after which you would most likely end up eating at a place that satisfies you the most.

The advantage with this technique is that you know exactly what you are eating since you have researched about it on your own. However on the flip side, the methodology you adopted is not really scalable as there could be about 100 odd vendors, and with limited time at your disposal, you can probably cover about 4 or 5 vendors. Hence there is a high probability that you could have missed the best tasting food on the street!

Option 2:

You just stand in a corner and observe all the vendors. You try and find a vendor who is attracting the maximum crowd. Once you find such a vendor you make a simple assumption -‘The vendor is attracting so many customers which means he must be making the best food!’ Based on your assumption and the crowd’s preference you decide to go to that particular vendor for your dinner. Chances are that you could be eating the best tasting food available on the street.

The advantage of this method is the scalability. You just need to spot the vendor

with the maximum number of customers and bet on the fact that the food is good based on the crowd’s preference. However, on the flipside the crowd need not always be right.

If you could recognize, option 1 is very similar to Fundamental Analysis where you research about a few companies thoroughly. We will explore about Fundamental Analysis in greater detail in the other blog .

Option 2 is very similar to Technical Analysis where one scans for opportunities based on the current trend aka the preference of the market.

Technical Analysis is a research technique to identify trading opportunities in market based on the actions of market participants. The actions of markets participants can be visualized by means of a stock chart. Over time, patterns are formed within these charts and each pattern conveys a certain message. The job of a technical analyst is to identify these patterns and develop a point of view.

Like any research technique, technical analysis stands on a bunch of assumptions. As a practitioner of technical analysis, you need to trade the markets keeping these assumptions in perspective. Of course we will understand these assumptions in details as we proceed along.

Also, at this point it makes sense to throw some light on a matter concerning FA and TA. Often people get into the argument contending a particular research technique is a better approach to market. However in reality there is no such thing as the best research approach. Every research method has its own merits and demerits. It would be futile to spend time comparing TA and FA in order to figure out which is a better approach.

Both the techniques are different and not comparable. In fact a prudent trader would spend time educating himself on both the techniques so that he can identify great trading or investing opportunities.

Setting expectations in Technical Analysis :

Often market participants approach technical analysis as a quick and easy way to make a windfall gain in the markets. On the contrary, technical analysis is anything but quick and easy. Yes, if done right, a windfall gain is possible but in order get to that stage one has to put in the required effort to learn the technique.

If you approach TA as a quick and easy way to make money in markets, trading

catastrophe is bound to happen. When a trading debacle happens, more often than not the blame is on technical analysis and not on the trader’s inability to efficiently apply Technical Analysis to markets. Hence before you start delving deeper into technical analysis it is important to set expectations on what can and cannot be achieved with technical analysis.

Trades :

TA is best used to identify short term trades. Do not use TA to identify long term investment opportunities. Long term investment opportunities are best identified using fundamental analysis. Also, If you are a fundamental analyst, use TA to calibrate the entry and exit points

Return per trade :

TA based trades are usually short term in nature. Do not expect huge returns within a short duration of time. The trick with being successful with TA is to identify frequent short term trading opportunities which can give you small but consistent profits.

Holding Period :

Trades based on technical analysis can last anywhere between few minutes and few weeks, and usually not beyond that. We will explore this aspect when we discuss the topic on timeframes.

Risk :

Often traders initiate a trade for a certain reason, however in case of an adverse movement in the stock, the trade starts making a loss. Usually in such situations, traders hold on to their loss making trade with a hope they can recover the loss. Remember, TA based trades are short term, in case the trade goes sour, do remember to cut the losses and move on to identify another opportunity.

We discuss about Technical analysis on asset types , assumptions in technical analysis and the trade summary in the next blog .

Conclusion of Technical Analysis - Introduction :

1.Technical Analysis is a popular method to develop a point of view on markets.
Besides, TA also helps in identifying entry and exit points

2. Technical Analysis visualizes the actions of market participants in the form of stock charts

3. Patterns are formed within the charts and these patterns help a trader identify trading opportunities

4. TA works best when we keep a few core assumptions in perspective

5. TA is used best to identify short terms trades

Monday, 2 July 2018

History tends to repeat itself – The big assumption :

Candlestick patterns and what to expect :

Few assumptions specific to candlesticks - TA :

Buy strength and sell weakness :

Be flexible with patterns (quantify and verify) :

Look for a prior trend :

Conclusion Of Started With Candle Sticks - Technical Analysis :

Sunday, 1 July 2018

Monthly Time Frame :

Open :

High :

Low :