Technical Analysis : The First Step.

Show me a trader with good records, and I will show you a good trader — Dr. Alexander Elder

When was the last time you found yourself hearingrd that trading in the stock market is like gambling? Or some lucky chum made a killing in the stocks? Well, let’s say for a moment that it is gambling. And there are a few lucky people. What about those who have come on top of the Poker industry using their wits and mathematics? The true similarity between both fields is that both of them are a probability game, but with securities market, it’s more about the knowledge and there is no Casino that always wins. This is the reason why technical analysis has come in so far in the industry not to mention the increase in winning probablity.

OUTLINE-

1. What is Technical Analysis?
2. Indicators and Averages.
3. The Simple but Powerful Strategy.
4. Insight for the Week.

What is Technical Analysis?

Technical analysis is a fascinating field of study. It is as much science as it is an art.

Its major strength is that a lot of it is visual, giving practitioners a better understanding of the underlying dynamics of the market.

But one step into this field and we encounter — Candlesticks, Indicators, Patterns, Trendlines, etc. which are like a buffet of a thousand dishes to choose from. Millions of combinations to approach the market using these tools has made charting an indispensable tool for the budding trader.

Although many experts have claimed that it doesn’t work, the fact that this tool has lasted for over 100 years makes it significant. There have been traders like Robert Rhea who have amassed great fortunes just by technical analysis and Gann who predicted the 2008 crash with an error of 1 year, over 50 years ago!

Indicators and Averages-

If you wanted some specific information form a 150- page contract without any knowledge of it beforehand what would you do? Well that’s what indicators are for, they extract exactly what you want to know from a huge dataset and present it in an easy to understand format.

One such popular indicator is RSI (Relative Strength Index) with its value fluctuating between 0 & 100. The default value for period is set to 14. It indicates the strength of a trend. The security is called oversold if the value is below 30, and overbought if above 70.

Interpretation –

RSI acts as a support for bullish trends in the range of 35–45, any breakout below this gives an early warning of exit. Similarly, for a downtrend, the resistance is in the range of 55–65.

Moving Averages-

As suggested by the name, they are the average of closing prices of a security over the selected period. They help in filtering out the noise in the charts, providing a clear view of the price movement.

Interpretation-

M.A of different periods can be used as signals to enter and exit. They follow the price and unlike RSI, give delayed signals. For instance, using 9-period EMA and 50- period EMA. When 9-EMA crosses 50-EMA it produces a bullish signal and vice-versa.

The Simple but Powerful Strategy-

Created using Trading View

RSI and M.A strategy parameters-

1. 9- EMA should be above 50 EMA
2. RSI should be rising and maintaining itself above it’s support of 46.78.
3. The two Averages must be diverging with time.
4. Exit can be at Averages crossover, or when RSI breaks from its support.

Signals in the chart-

1. Crossover with RSI well above support.
2. After channel establishment, position can be taken every time price touches the lower trend line, with confirmation from RSI.
3. Exit when RSI penetrates the support and is unable to bounce back.

The beauty in looking at charts is the fine print. Some people may be to find additional signals (Give it a try!), some may find fewer. The interpretation varies from person to person.

This is the outline of a strategy so it requires refining according to the user’s needs.

Other Factors that play a role-

1. Time Frame- If this chart is viewed at a weekly period or and hourly period, the signals, support lines and interpretation will change.
2. RSI period- Here the default 14-day period is used but it should be changed for different securities or for the number of signals required.
3. Scale of the chart — Here, a log-scaled chart has been used to fit the trendlines better. Again, scaling varies according to the security selected.

Spotting signals and adjusting parameters is an ongoing process. Even a strategy, starting out with just RSI and Moving Average may take weeks to suit to a trading style. It’s all about training your eye and that happens with practice.

It’s not about finding the ‘Holy Grail’, rather making one on your own.

Insight for the Week-

Here’s a little push towards application of these concepts. Recently the results of TATA Motors were out. The stock has been taking a beating since a full year, but don’t be tempted by the low price just yet.

Created using Trading view

Try to spot the RSI peak range which is completely bearish. The trend is also not showing any sign of weakening (no rounding bottom in sight).

It would be wise to wait for a proper reversal signal or take a short position when price touches 50 — EMA.

Again, it’s just a game of probability, technical analysis will increase your chances of winning but there is no guarantee with it. There is no magic indicator or moving average value on a certain time frame that will generate the perfect signal every time. False positives are common, especially in ranging markets. The challenge is to tune a basic strategy on various factors suiting your style, and increase your win to loss ratio.

This is just a scratch on the surface of this area. But I am sure that after reading this, you have gained insights on this field and its purpose.

Thanks for Reading!