Momentum Momentum is used to indicate the speed with which prices are changing. When a change in direction occurs in a short-term trend, technicians say that a reversal has occurred. A correction occurs when the reversal involves only a partial retracing of the prior movement. Correction maybe followed by a period of consolidation.

Use of charts in Technical analysis Technical analysis rely primarily on line charts, bar charts, and point and figure charts, and candlestick charts. Bar charts: In bar charts prices are plotted on the vertical axis and time on the horizontal axis. Each day price movement is represented by a vertical bar whose top represents the high and for the day or bottom represent the low price of the day.

Use of charts in Technical analysis The bottom of the bar chart usually shows the trading volume for each day, permitting the simultaneous observation of both price and volume activity. Technicians using bar chart will look for pattern in the chart that can be used to predict future price movements. Usually a sell or buy signal is identified when price movements occur on heavy volume.

Use of charts in Technical analysis Point and Figure Charts: The charts show only significant changes , but the volume is not shown. The chart will show price movements only if the move is considered to be significant for a given stock. An “X” is typically used to show upward whereas an “O” is used for downward movements. If Rs.4 is considered to be significant movement for a stock, each X and O will represent Rs.4. The point and figure chart compresses many price changes into a small space.

Point and Figure Chart Example

Moving Averages Moving averages are used for analyzing the overall market and individual stocks. They are used to detect both the direction and the rate for change. An average of share prices is calculated for a given number of days. New value for the moving average is calculated by dropping the earliest observation and adding the latest one.

Moving Averages This process is repeated daily or weekly. The resulting moving averages line represents the basic trend. A comparison of the current market price to the moving average produces a buy or sell signal. The general buy signal is generated when actual prices rise through the moving average on high volume. Opposite of the above applies to sell signal.

Moving Averages Specific signal of an upper turning point (sell signal) are the following: Actual price is below the moving average, advances toward it, does not penetrate the average, and starts to turn down again. Following a rise, the moving average flattens out or declines, and the price of the stock or index penetrates it from the top. Buy signals would be generated if these situations were turned upside down.

Moving Average Convergence Divergence (MACD) The MACD is calculated by subtracting a 26-day moving average of a security’s price from a 12-day moving average of its price. When MACD is above zero, it means the 12-day moving average is higher than 26-day moving average. This is bullish trend as it shows that current expectations are more bullish than previous expectations. When MACD falls below zero it implies a bearish trend. Buy signal is generated when MACD value has positive value. Whereas a sell signal is generated when MACD has a negative value.

Relative Strength One of the techniques for the analysis of individual stocks is relative strength analysis. The relative strength for a given stock is calculated as the ratio of the stocks prices to a market index, or an industry index, or average price of the stock itself over some period. The graph will show the relative strength of the stock relative to the market or industry.

Relative Strength The ratio of RS can be plotted on a graph across time. A rising ratio (an upward-sloping line of RS) indicates that the stock is outperforming the market and is assumed to continue to do so. One rule of thumb is this that a stock is attractive when the relative strength has improved for at least four months.

Relative Strength Technician use RS first for industries. If an industry is outperforming the market, then RS is calculated for individual stocks in that industry. This way investor narrow down the number of possibilities to be considered. One problem with RS is that a stock or group could show increasing RS because it is declining less quickly than the market, not because it is increasing. So RS is not a technique to be used in isolation.

Relative Strength Index RSI was first introduced by Wells Wilder in 1978. RSI = 100 – [100 / (1+RS)] RS is the average of upward change in the last 14 days / average of downward price change in the last 14 days RSI fluctuates between 0 and 100. It usually tops above 70 and bottoms below 30. RSI peak indicates overbought levels and suggest price tops. RSI trough denotes oversold levels.

Relative Strength Index Example

Stochastic Oscillator Developed by George C. Lane in the late 1950s, the Stochastic Oscillator is a momentum indicator. It shows the location of the current close relative to the high/low range over a set number of periods. The idea behind this indicator is that prices tend to close near their past highs in bull market, and near their lows in bear markets. This is why investor should stop buying when prices reach their previous high or stop selling when prices drop to their previous lows.

Stochastic Oscillator The Stochastic Oscillator is displayed as two lines. The main line is called %K. The second line, called %D, is a Moving Average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line.

Stochastic Oscillator %K tells us that the close (115.38) was in the 57th percentile of the high/low range, or just above the mid-point.  Because %K is a percentage or ratio, it will fluctuate between 0 and 100. Readings below 20 are considered oversold and readings above 80 are considered overbought.