Technical Analysis of the Stock market- Traders Mantra

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TECHNICAL ANALYSIS
Basic Secondary knowledge
Compiled By Traders Mantra Team
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• Preface
• The stock market is a place where market
  participants can access any publicly listed
  company and trade from their point of view, as
  long as there are other participants who have an
  opposing point of view. After all, different
  opinions are what make a market.
• What moves the stock?
• The price moves because of expectation of news
  and events. The news or events can be directly
  related to the company, industry or the economy
  as a whole. For instance the appointment of
  Narendra Modi as the Indian Prime Minister was
  perceived as positive news and therefore the
  whole stock market moved.
• Where do you fit in?
• Each market participant has his or her own unique
  style to participate in the market. Their style
  evolves as and when they progress and witness
  market cycles. Their style is also defined by
  the kind of risk they are willing to take in the
  market. Irrespective of what they do, they can be
  categorized as either a trader or an investor.
• There are different types of traders
• Day Trader A day trader initiates and closes
  the position during the day. He does not carry
  forward his positions
• Scalper A type of a day trader. He usually
  trades very large quantities of shares and holds
  the stock for very less time with an intention to
  make a small but quick profit.
• Swing Trader A swing trader holds on to his
  trade for slightly longer time duration, the
  duration can run into anywhere between few days
  to weeks.
• Some of the really successful traders the world
  has seen are George Soros, Ed Seykota, Paul
  Tudor, Micheal Steinhardt, Van K Tharp, Stanley
  Druckenmiller ,JIM SIMONS etc
• The Index

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on the stated criteria. If it fails to maintain
the criteria, the stock gets replaced by another
stock that qualifies the prerequisites. Based on
the selection procedure, the list of stocks is
populated. Each stock in the index should be
assigned a certain weightage. Weightage in
simpler terms defines how much importance a
certain stock in the index gets compared to the
others. For example, if ITC Limited has 7.6
weightage on the Nifty 50 index, then it is as
good as saying that the 7.6 of Niftys movement
can be attributed to ITC. The obvious question
is How do we assign weights to the stock that
make up the Index? There are many ways to assign
weights, but the Indian stock exchange follows a
free-float market capitalization method. The
weights are assigned based on the companys
free-float market capitalization, the larger the
market capitalization, the higher is the
weight. Free float market capitalization is the
product of the total number of shares outstanding
in the market and the stock price. For example
company, ABC has 100 shares outstanding in the
market, and the stock price is at 50 then the
free-float market cap of ABC is 10050 Rs.5,000.
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• What is Chart ?
• A chart is a historical representation of data in
  which data is represented in various ways. Data
  representation can vary with different time
  frames. There are many ways of data
  representation, you can represent the same data
  using a line or a chart or pie chart anyone that
  you like and understands better.
• What is Timeframe In trading?
• Data is represented in multiple periods of time.
  The majority of platform give time frame starts
  from 1sec to 1 month for premium members, for a
  free user, its from 1 min to 1 month.
• There are different types of traders in every
  market like short term, midterm, and long term
  traders. The short-term traders mostly use 5 min
  to 1-hour timeframe charts for trading. The
  midterm traders use 4-hour to 1-day timeframe
  charts for trading. The long-term traders use
  mostly weekly and monthly timeframe charts for
  trading.
• Now let us understand some important terms in
  trading
• What did the term define bullish and bearish in
  the market?
• The bullish word itself gives a meaning
  aggressive, and although in the financial market
  this term used refers to market sentiment when a
  security price is in an uptrend (makes higher and
  high).
• Bearish when a security price is in a downtrend
  (makes lower low).
• What is higher high (HH), higher low (HL), lower
  high (LH) and lower low (LL)?
• We all know when the market is trending it
  neither moves straight up or down unless there is
  a piece of fundamental news released. When the
  security is bullish it moves to make Higher High
  (HH) and Higher Low (HL). In a nutshell, when
  prices move upwards and it makes a correction
  slightly lower and makes a new higher high (HH).

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Now lets talk about some popular various types
of charts used in trading.

• Types of charts
• Candlestick Chart
• This chart is the most popular and widely used
  for trading. Each and every platform have this
  candlestick chart. This candlestick was developed
  by a Japanese rice merchant in the late 1700s to
  track the price action of rice futures. Often
  this candlestick is also called Japanese
  Candlestick. This candlestick consists of four
  prices. Prices indicate open, high, low, and
  close (OHLC).

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Heikin Ashi (HA) Heikin Ashi candlesticks if a
side branch of Japanese candlestick. It uses the
data of Japanese candlestick (i.e., OHLC) and
used to plot Heikin Ashi candles. Heikin Ashi
candlestick calculation Open (open of
previous bar close of previous bar)/2. Close
(open high low close)/4. High the maximum
value from the high, open, or close of the
current period. Low the minimum value from the
low, open, or close
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• LINE CHART
• A Line chart is the easiest and the simplest
  trading chart in trading. This chart is plotted
  by the close price of the security under a given
  timeframe. This chart is quite easy to trade, but
  have some limitation because it not provides
  proper data for traders who have a strategy based
  upon price and or something like that.

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• BAR CHART
• A bar chart consists of OHLC price and a stick
  which has a small stick on the left and right on
  that stick which indicates open and close price
  respectively.

There are more different trading charts like
Renko, Kagi, Line Break, Point Figure, etc. but
not used quite often. So, its better to use a
popular and better one available.
History of candlestick In the early around 17th
century, it was first used by rice traders for
understanding the fluctuation of price. A person
from the US named Steve Nison used this technique
to understand Dow Jones and NYSE after 1850 and
published his book Japanese Candlestick Chart
Techniques. Munehisa Homma was the farmer who
developed. What is Candlestick? A candlestick
is a visual representation of price, specifically
to display Open, High, Low, and Close (OHLC). A
candlestick has 4 prices I.e., OHLC prices, which
is used to form bars/body of the candlestick. A
candlestick is also like a bar chart but has a
body between open and close price. A candlestick
can be green or red depending on opening and
closing price or more specifically it can be
bullish or bearish.
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So, what does bullish and bearish candlestick
means? When the closing price is greater than
the opening price then it should be considered as
bullish candlestick and when the open price is
less than the closing price then its a bearish
candlestick. The below Image will make you
clearly understand.
Lets have some basic knowledge of candlestick
patterns
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What is a Doji? A Doji is a price reversal
candlestick that have the same opening and
closing. This candle signifies indecision in the
market between buyers and sellers. This candle
mostly forms at the end of the downtrend or
uptrend and looks like a plus sign. It has small
decent wicks with the same open and closing
price or negligible body. There are different
types of Doji -

• Long Legged Doji
• Its a candle that looks the same as Doji but has
  much longer wicks (shadows) than Doji. Mostly
  appears in a trend indicates strong indecision.
• Gravestone Doji
• This Doji indicates that neither buyers nor
  sellers are active and its a bearish reversal
  candlestick. Between the opening and closing of
  this candle, buyers pushed the market upside but
  afterward seller take over the market and closed
  at the same opening.

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This type of Doji often found at the uptrend,
usually nearby resistance indicating selling
pressure.

• Dragonfly Doji
• This type of Doji is a bullish reversal
  candlestick where sellers push the market
  downside but buyers take over the market and
  closed at the same opening price. This type of
  Doji often found at a downtrend, usually at the
  support level of the market indicating buying
  pressure.

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What is Engulfing Candlestick? Engulfing is a
trend reversal candlestick which consists of two
candles, in which the end candle (2nd candle)
fully engulfs the entire body of the 1st candle.
Engulfing candle can differ in the form whether
its an uptrend or downtrend. This type of
candlestick has 2 types

• Bullish Engulfing
• Bullish Engulfing candlestick found in a
  downtrend indicating the beginning of a bullish
  trend (uptrend). In this candlestick, the 2nd
  candle will engulf the 1st red candle's entire
  body and closed above previous candle highs.
  This indicates a huge surge in buying pressure.
  Bullish Engulfing can appear in between
  continuous uptrend also, it doesnt mean to be
  traded but with some sort of strategy to
  increase the profit factor and winning percentage.

How to trade Bullish Engulfing candlestick Buy
after the candle fully closed and stop loss below
the low of the candle and take profit is up to
next resistance.
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EXAMPLE

• Bearish Engulfing
• Its the just opposite of a bullish engulfing
  candlestick which found in an uptrend indicating
  the beginning of the bearish trend (downtrend).
  Here 1st candle is small and bullish while the
  next candle engulfs the previous candle's body
  and closes below the low. Again, it can form
  anywhere but trade with strategy.

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How to trade Bearish Engulfing candlestick Sell
after the candle fully closed and stop-loss above
the high of the candle and take profit is up to
next support.
What is Hammer Candlestick ? Hammer candlestick
looks like a hammer and its a standalone
candlestick which often found at the bottom of a
downtrend having a long wick below its body
indicating bulls taking control overbears and
the market is most likely to reverse. A hammer
can be bullish or bearish, color doesnt matter
in it and works the same. The hammer candle
itself represents that initially bears pushed
the price down heavily and after that bull has
taken over controls the price closes nearby its
open price
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Hammer and Hanging Man look the same the only
difference is formed in a trend.

• How to Identity Hammer Candlestick ?
• Before considering any candlestick as a hammer
  check few characteristics
• Open and close of the candlestick is not so far.
• The length of the candle should be twice or
  thrice of the body or more.
• The candle should appear after a good downtrend,
  not a short-term downtrend.
• How to trade Hammer candlestick ?
• Buy after the closing of the candle and stop loss
  below the low of the candle and take profits is
  up to you but we consider it till previous
  resistance.
• EXAMPLE

As you can see after Hammer candlestick market
trading higher and higher.
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• What is Hanging Man Candlestick?
• Hanging Man candlestick is the same as hammer
  candlestick the only difference between is it
  often found on the top of the up-trending market,
  having a long wick below its body and the market
  is most likely to reverse. Color doesnt matter
  and works the same.
• How to Identity Hanging Man Candlestick?
• Open and close of the candlestick is not so far.
• The length of the candle should be twice or
  thrice of the body or more.
• The candle should appear after a good downtrend,
  not a short-term Downtrend.
• How to trade Hammer OR HANGING MAN candlestick
• Buy after the closing of the candle and stop-loss
  above the high of the candle and take profits is
  up to you but we consider it till previous
  support.

After Hanging Man appeared, we can sell a heavy
fall giving us a good profit. What is Inverted
Hammer Candlestick? Inverted Hammer is a single
candlestick that looks like a turnabout hammer,
usually found in a downtrend consisting of a
long wick/shadow on its upper body. The colour of
the candle
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doesnt matter, it can be bullish or bearish.
This candle itself represents rejection from the
lower price (or any important key level).
Inverted Hammer and Shooting look the same the
only difference is formed in a trend.

• How to Identity Inverted Hammer Candlestick?
• Open and close of the candlestick is not so far
• The length of the candle should be twice or
  thrice of the body or more.
• The candle should appear after a good downtrend,
  not a short-term downtrend .
• How to trade Inverted Hammer candlestick
• Buy after the candle fully closed and stop loss
  below the low of the candle and take profit is up
  to next resistance.

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• What is Shooting Star Candlestick ?
• Its the same candlestick as Inverted Hammer the
  only difference between these candles is it
  found in an uptrend, having a long wick above its
  body. Again, here color doesnt matter and works
  the same. The candle itself represents that bulls
  pushed the market aggressively and bears have
  taken over the market and closed price near its
  opening price.
• How to Identity Shooting Star Candlestick?
• Open and close of the candlestick is not so far
• The length of the candle should be twice or
  thrice of the body or more
• The candle should appear after a good uptrend,
  not a short-term uptrend
• How to Trade Shooting Star candlestick ?
• Sell after the closing of the candle and
  stop-loss above the high of the candle and take
  profits is up to you but we consider it till
  previous support.

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Here a quick fall and heavy profits after
shooting star appeared.

• What is the Marubozu candlestick?
• Marubozu is a Japanese candlestick pattern,
  consisting of a single candle. Marubozu is a
  Japanese word that holds the meaning Bald.
  Also, Marubozu has no upper and lower wicks
  which indicates that the instrument is traded
  heavily in either direction. There are 2 types of
  Marubozu
• Bullish Marubozu
• Bullish Marubozu indicates that buyers are more
  interested in buying and the price immediately
  spikes. Here Open is equal to Low and close is
  equal to High. Usually, Bullish Marubozu appears
  in an uptrend which indicates that the trend is
  most likely to continue while appearing in a
  downtrend implies a possible trend reversal.

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• Bearish Marubozu
• Bearish Marubozu represents traders are selling
  aggressively which results in a spike down in
  price. The candle has its Open is equal to High
  and Close is equal to Low. It usually appears in
  a downtrend which indicates a continuation of the
  trend, while appearing in an uptrend implies
  possible trend reversal.
• Lets take a Real Example

Always Trade candlesticks patterns wisely with
proper risk management else your trading funds
will always at high risk.
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• Support and Resistance
• In this chapter we shall discuss the following
• What is Support and Resistance
• How to find Support and Resistance
• What to do when a support/resistance break?
• Fakebreakout/breakdown
• Where to put stop loss?
• The concepts of trading level support and
  resistance are undoubtedly two of the most highly
  discussed attributes of technical analysis. Part
  of analysing chart patterns, these terms are used
  by traders to refer to price levels on charts
  that tend to act as barriers, preventing the
  price of an asset from getting pushed in a
  certain direction.
• Support and Resistance is one of the most used
  techniques in technical analysis based on a
  concept that's easy to understand but difficult
  to master. It identifies price levels where
  historically the price reacted either by
  reversing or at least by slowing down and prior
  price behaviour at these levels can leave clues
  for future price behaviour.
• There are many different ways to identify these
  levels and to apply them in trading. Support and
  Resistance levels can be identifiable turning
  points, areas of congestion or psychological
  levels (round numbers that traders attach
  significance to). The higher the timeframe, the
  more relevant the levels become.
• Basics
• Support is a price level where a downtrend can be
  expected to pause due to a concentration of
  demand or buying interest. As the price of assets
  or securities drops, demand for the shares
  increases, thus forming the support line.

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Horizontal Support Line
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How to draw a Support line? The support points
can be easily identified by looking at the chart.
A support is where the price bounce back, look
for that points where the price bounced back many
times and draw a line connecting the support
points. You will get a horizontal support line.
See the chart example below To draw a valid
support line, you need at least two points on the
chart. Horizontal Resistance Line
How to draw a Resistance Line? A resistance is a
point where the price of the asset rejected many
times. The market tests the resistance and
traders start booking profits that results in a
drop in the price. You need at least two points
to draw a valid resistance line.
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Breakout When the price breaks the resistance
line and trade above the line is called a
breakout. Market turns bullish after a valid
breakout and traders start buying/opening long
position in the asset.
The more times a resistance point gets tested,
the weaker it becomes. Majority of traders are
waiting for a breakout of the resistance line to
open long positions. A valid breakout will give
good profits in the coming hour/days/weeks
depends on the timeframe you are using to
trade. Always wait for the confirmation of the
breakout. Dont open a trade instantly because
the breakout maybe a fakeout. We will discuss
fakeout below in this post. Breakdown When a
support line is broken downwards it is called a
breakdown. The market turns bearish after a
breakdown. Its a better idea to close all the
long position when a breakdown confirmed. Many
traders open short position after the breakdown
and make good returns on their trades.
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This is a very good example of breakdown. Always
wait for the confirmation of the breakdown. Dont
open a trade instantly because the breakdown
maybe a fake breakdown. We will discuss fake
breakdown below in this post. Fake
Breakout Fake breakout or fakeout is a condition
when the price breaks the resistance line and
instantly comes below the resistance line in the
next candle. No candle close above the resistance
zone to call it a valid breakout. See the below
example and you understand better.
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In the above chart price breaks the resistance
line and comes back under the resistance line
with a huge red candle. Traders those open a long
just after the resistance line fakeout will be
in huge loss or rekt. Always wait for the
confirmation before opening any trade. Fake
Breakdown Fake breakdown is a condition when the
price breaks the support line and instantly comes
above the support line. No new candle close
below the support line to call it a valid
breakdown. See the chart for better
understanding.
Those traders opened the short trades instantly
after the support is broken are in huge loss
because it is a fake breakdown not a valid
breakdown. Always wait for the next candle for
confirmation of the breakout/breakdown and then
open the trades.
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Where to Put Stop Loss? Stop loss is a must
thing for every trade. The cryptocurrency market
is highly volatile and sometime the market plays
against your analysis or expectations. Stop loss
will help to minimize the loss and open room for
better opportunities. Always open the trades
after trend confirmation. If you are in doubt
than leave it and wait for the next setup. Not
every day is a winning day. The stop loss must be
placed below/above 7- 9 of the trade. This is
for normal trading (spot trading), adjust your
stop loss according to the leverage used (if you
are doing margin/futures trading). Previous
Resistance Become Support The previous
resistance line work as support zone for the
market. Below is a perfect example of this.
Bitcoin is respecting the previous resistance
line as support. The same can be true for a
support line. The previous support line will work
as resistance when the market start moving
upwards. Trading Indicators What is the RSI
(Relative Strength Indicator) indicator? Relative
strength Index or just RSI, is a prevalent
indicator developed by J.Welles Wilder. RSI is a
leading momentum indicator which helps in
identifying a trend reversal. Relative Strength
Indicator (RSI) is a momentum oscillator used by
numerous technical traders to discover the speed
and change in price movements. RSI stands for
Relative Strength Index. RSI is a leading
Indicator, which has a fixed oscillating range of
0 100. RSI below 30 considered to be oversold
and above 70 overbought. Trading with RSI
standalone is not a good strategy. Some traders
use RSI to find divergence to find the best
possible entry. Calculation of RSI But why you
should know the calculation of RSI? As technical
traders whats going on behind it doesnt matter,
but for some people more likely who like to make
bots and auto traders for automatic trading have
to know these things to make something from that
or modify it. Feel free to live the example
section, if youre a technical trader.
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Taking entry-exit using standalone RSI is not a
good strategy while combining with other
strategy and price action techniques will have
better results. Always Trade indicators wisely
with proper risk management else your trading
funds will always at high risk
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What is RSI Divergence RSI (Relative Strength
Index) Divergence is used by price action traders
to enter or exit in any trade. An RSI Divergence
is created when RSI (Relative Strength Index)
line diverges the momentum of the market or we
can say opposes the price with respect to RSI
(Relative Strength Index). When the price is
making Higher High but in RSI (Relative Strength
Index) making lower low or price making Lower
Low or RSI (Relative Strength Index) making
Higher High can be said to be a divergence.
There are 2 types of divergence
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Bearish Divergence Bearish Divergence occurs
when the market making a higher high with respect
to RSI (Relative Strength Index) making a lower
low is said to be Bearish Divergence.
Bullish Divergence occurs when price making
continuous lower low with respect to RSI
(Relative Strength Index) making a higher high,
then its called Bullish Divergence.
What is Moving Average Convergence Divergence
(MACD)? In the late seventies, Gerald Appel
developed the Moving Average Convergence and
Divergence (MACD) indicator. Traders consider
MACD as the grand old daddy of indicators.
Though invented in the seventies, MACD is still
considered one of the most reliable momentum
traders indicators MACD stands for Moving
Average Convergence Divergence is a momentum
indicator used by technical traders that
calculates the interconnection between 2 EMA
(Exponential Moving Averages). In MACD (Moving
Average Convergence Divergence) there is fast EMA
(Exponential Moving Average) of length 12, slow
EMA of length 26, and a single line of length 9
by default in general. There is also a graph
looking thing called histogram which is the
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difference between the MACD (Moving Average
Converging Divergence) line and Single
Line. Calculation MACD Line 12 periods EMA
(Exponential Moving Average) period 26 EMA
(Exponential Moving Average) Single Line 9
period EMA (Exponential Moving Average)
Histogram the difference MACD Line and Single
Line
How to use it? Usually, traders use its
crossovers for buy/sell or entries/ exits, but
standalone using MACD (Moving Average Converging
Divergence) is not a good idea. Use it with some
kind of strategy. When the MACD line (Blue
color) crosses over Signal Line (Red color) below
the histogram then its a buy signal and when
Signal Line (Red color) crosses below the MACD
Line (Blue color) above the Histogram, then its
a sell signal.
Note Crossover may happen anywhere and anytime
which can be a false signal also.
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What is Moving Averages (MA)? Moving Average
(MA) is a very simple and famous indicator used
by the majority of the traders in their
Technical Analysis. MA (Moving Average) uses the
previous price data and average/ smooth out the
price, an average is calculated over a specific
period of time. Some traders use MA (Moving
Average) to find trend direction and some for
entry and exits because it cuts the noise from
the market and smoothest out the price to
understand the trend. There are various types of
Moving Average Simple Moving Average (SMA) SMA
stands for the Simple Moving Average known as
Moving Average in general which just calculates
an average of the price over the given period.
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You can use SMA (Simple Moving Average) to find
trends. Most use any combination of moving
average, which suits you. Most traders use 50 or
100 or 200-period moving average on 4H and 1D TF
(Time Frame) for trend direction. Few traders use
Moving Average crossovers to enter and exit the
trade and price often bounces from MA (Moving
Average) line. As you see its an uptrend and
knowing the bigger TF (Time Frame) trend and
entry/exits in smaller TF will have some good
traders. Also, if you missed any trade then you
can enter while the price is bouncing/ respecting
with an MA (Moving Average).

• Exponential Moving Average (EMA)
• Exponential Moving Average (EMA) is widely used
  by the trader and better than SMA (Simple Moving
  Average) because it gives more weightage to
  recent price by using the most recent data of
  price. The calculation is a little bit different
  in it.

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• Weighted Moving Average

• Golden Crossover
• When a short period MA (Moving Average, can be
  SMA or EMA) breaks above, then a longer period
  Moving Average is known as Golden Crossover.
  Traders usually see it as a long-term uptrend.
  Moving Average can be 50, 100 or 100, 200 or 50,
  200.

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o Death Crossover Its just the opposite of
Golden Crossover, it gives an indication of a
potential long-term downtrend. Values are the
same as Golden crossover has. False crossover may
come because the indicator is lagging.
What is the Bollinger Band? Introduced by John
Bollinger in the 1980s, Bollinger Bands (BB) is
perhaps one of the most useful technical
analysis indicators. BB is used to determine
overbought and oversold levels, where a trader
will try to sell when the price reaches the top
of the band and will execute a buy when the
price reaches the bottom of the band.
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• The BB has 3 components
• The middle line which is The 20 day simple moving
  average of the closing prices
• An upper band this is the 2 standard deviation
  of the middle line
• A lower band this is the -2 standard deviation
  of the middle line
• Bollinger Band is a volatility band that is based
  on the standard deviation. The band expands or
  deflate with the increases and decreases in
  volatility. Price is wrapped with 3 SMA (Simple
  Moving Averages), usually known as Upper Band,
  Lower Band, and Middle Band. Traders use their
  own trade style to trade with this. Default BB
  (Bollinger Band) value of an indicator in 20.

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What is Fibonacci Retracement? The topic of
Fibonacci retracements is quite intriguing. To
fully understand and appreciate the concept of
Fibonacci retracements, one must understand the
Fibonacci series. The origins of the Fibonacci
series can be traced back to the ancient Indian
mathematic scripts, with some claims dating back
to 200 BC. However, in the 12th century, Leonardo
Pisano Bogollo, an Italian mathematician from
Pisa, known to his friends as Fibonacci
discovered Fibonacci numbers. The Fibonacci
series is a sequence of numbers starting from
zero arranged so that the value of any number in
the series is the sum of the previous two
numbers. The Fibonacci sequence is as
follows 0 , 1, 1, 2, 3, 5, 8, 13, 21, 34, 55,
89, 144, 233, 377, 610 Notice the
following 233 144 89 144 89 55 89 55
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infinity. There are few interesting properties of
the Fibonacci series. Divide any number in the
series by the previous number the ratio is
always approximately 1.618. For
example 610/377 1.618 377/233 1.618 233/144
1.618 The ratio of 1.618 is considered as the
Golden Ratio, also referred to as the Phi.
Fibonacci numbers have their connection to
nature. The ratio can be found in the human face,
flower petals, animal bodies, fruits,
vegetables, rock formation, galaxy formations
etc. Of course, let us not get into this
discussion as we would be digressing from the
main topic. For those interested, I would
suggest you search on the internet for golden
ratio examples, and you will be pleasantly
surprised. Further into the ratio properties, one
can find remarkable consistency when a number is
in the Fibonacci series is divided by its
immediate succeeding number. For example 89/144
0.618 144/233 0.618 377/610 0.618 At this
stage, do bear in mind that 0.618, when expressed
in percentage is 61.8.
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Similar consistency can be found when any number
in the Fibonacci series is divided by a number
two places higher. For example 13/34
0.382 21/55 0.382 34/89 0.382 0.382, when
expressed in percentage terms, is 38.2 Also,
consistency is when a number in the Fibonacci
series is divided by a number 3 place
higher. For example 13/55 0.236 21/89
0.236 34/144 0.236 55/233 0.236 0.236, when
expressed in percentage terms, is 23.6.
It is believed that the Fibonacci ratios, i.e.
61.8, 38.2, and 23.6, finds its application in
stock charts. Fibonacci analysis can be applied
when there is a noticeable up-move or down- move
in prices. Whenever the stock moves either
upwards or downwards sharply, it usually tends
to retrace back before its next move. For
example, if the stock has run up from Rs.50 to
Rs.100, it is likely to retrace back to probably
Rs.70 before moving Rs.120. The retracement
level forecast is a technique that can identify
upto which level retracement can happen. These
retracement levels provide a good opportunity for
the traders to enter new positions in the trend
direction. The Fibonacci ratios, i.e. 61.8,
38.2, and 23.6, help the trader identify the
retracements possible extent. The trader can use
these levels to position himself for trade.
39
Have a look at the chart below
VOLUME Volumes indicate how many shares are
bought and sold over a given period of time. The
more active the share, the higher would be its
volume
S.No. Price Volume What is the expectation?
01 Increases Increases Bullish
02
Increases
Decreases
Caution weak hands buying
03
Decreases
Increases
Bearish
40
04
Decreases
Decreases
Caution weak hands selling
High Volume Todays volume gt last 20 days
average volume Low Volume Todays volume lt
last 20 days average volume Average Volume
Todays volume last 20days average volume
DOW THEORY The Dow Theory was introduced to the
world by Charles H. Dow, who also founded the
Dow- Jones financial news service (Wall Street
Journal). During his time, he wrote a series of
articles starting from the 1900s which in the
later years was referred to as The Dow Theory.
Much credit goes to William P Hamilton, who
compiled these articles with relevant examples
over a period of 27 years. Much has changed
since the time of Charles Dow, and hence there
are supporters and critics of the Dow Theory.
Dow theory principle The Dow Theory is built on
a few beliefs. These are called the Dow Theory
tenets. Charles H Dow developed these tenets
over the years of his observation on the markets.
9 tenets are considered as the guiding force
behind the Dow Theory.
41
Sl
Tenet
What does it mean?
No
The stock market indices discount everything
which is known unknown in the public domain.
If a sudden and unexpected event occurs, the
stock market indices quickly recalibrate itself
to reflect the accurate value
discounts
Indice everything
01
Overall there are 3 broad market trends.
02
Primary Trend, Secondary Trend, and Minor Trends
This is the major trend of the market that lasts
from a year to several years. It indicates the
broader multiyear direction of the market. While
the long term investor is interested in the
primary trend, an active trader is interested in
all trends. The primary trend could be a primary
uptrend or a primary downtrend
The Primary Trend
03
These are corrections to the primary trend. Think
of this as a minor counter-reaction to the
larger movement in the market. Example
corrections in the bull market, rallies
recoveries in the bear market. The counter-trend
can last anywhere between a few weeks to several
months
The Secondary Trend
04
Minor
Trends/Daily
These are daily fluctuations in the market some
traders prefer to call them market noise
05
fluctuations
All Indices must confirm with each other.
06
We cannot confirm a trend based on just one
index. For example, the market is bullish only
if CNX Nifty, CNX Nifty Midcap, CNX Nifty
Smallcap etc. all move in the same upward
direction. It
42
would not be possible to classify markets as
bullish, just by the action of CNX Nifty alone
The volumes must confirm along with the price.
The trend should be supported by volume. The
volume must increase as the price rises and
should reduce as the price falls in an uptrend.
In a downtrend, the volume must increase when
the price falls and decrease when the price
rises. You could refer chapter 12 for more
details on volume
Volumes must confirm
07
can Markets may remain sideways (trading between
a range) for an
Sideway markets
secondary extended period. Example- Reliance
Industries between 2010 and
08 substitute markets.
2013 was trading between 860 and 990. The
sideways markets can
be a substitute for a secondary trend
Between the open, high, low and close prices, the
close is the most important price level as it
represents the final evaluation of the stock
during the day.
The closing price is the most sacred.
09
MARKET PHASES Dow Theory suggests the markets are
made up of three distinct phases, which are self-
repeating. These are called the Accumulation
phase, the Markup phase, and the Distribution
phase. The Accumulation phase usually occurs
right after a steep sell-off in the market. The
steep sell- off in the markets would have
frustrated many market participants, losing hope
of any uptrend in prices. The stock prices would
have plummeted to rock bottom valuations, but the
buyers would still be hesitant to buy fearing
another sell-off. Hence the stock price
languishes at low levels. This is when the
Smart Money enters the market.
43
Smart money is usually the institutional
investors who invest in a long term perspective.
They invariably seek value investments which are
available after a steep sell-off. Institutional
investors start to acquire shares regularly, in
large quantities over an extended period of time.
This is what makes up an accumulation phase.
This also means that the sellers trying to sell
during the accumulation phase will easily find
buyers, and therefore the prices do not decline
further. Hence invariably, the accumulation phase
marks the bottom of the markets. More often than
not, this is how the support levels are created.
Accumulation phase can last up to several
months. Once the institutional investors (smart
money) absorb all the available stocks, short
term traders since the support. This usually
coincides with the improved business sentiment.
These factors tend to take the stock price
higher. This is called the markup phase. During
the Markup phase, the stock price rallies
quickly and sharply. The most important feature
of the markup phase is speed. Because the rally
is quick, the public at large is left out of the
rally. New investors are mesmerized by the
return, and everyone from the analysts to the
public sees higher levels ahead. Finally, when
the stock price reaches new highs (52 weeks high,
all-time high), everyone around would be talking
about the stock market. The news reports turn
optimistic, business environment suddenly
appears vibrant, and everyone (public) wants to
invest in the markets. By and large, the public
wants to get involved in the markets as there is
a positive sentiment. This is when the
distribution phase occurs. The judicious
investors (smart investors) who got in early
(during the accumulation phase) will start
offloading their shares slowly. The public will
absorb all the volumes offloaded by the
institutional investors (smart money) there by
giving them the well-needed price support. The
distribution phase has similar price properties
as that of the accumulation phase. Whenever the
prices attempt to go higher in the distribution
phase, the smart money offloads their holdings.
Over a period of time, this action repeats
several times, and thus the resistance level is
created. Finally, when the institutional
investors (smart money) completely sell off their
holdings, there would no further support for
prices. Hence, what follows after the
distribution phase is a complete sell-off in the
markets, also known as the mark down of prices.
The selloff in the market leaves the public in
an utter state of frustration. Completing the
circle, what follows the selloff phase is a fresh
round of accumulation phase, and the whole cycle
repeats. It is believed that that entire cycle
from the accumulation phase to the selloff spans
over a few years. It is important to note that no
two market cycles are the same. For example, in
the Indian context, the bull market of 2006 07
is way different from the bull market of 2013-14.
Sometimes the market moves from the accumulation
to the distribution phase over a prolonged
multi-year period. On the other hand, the same
move from the accumulation to the distribution
can happen over a few months. The market
participant needs to tune himself to evaluating
44

• markets in the context of different phases, as
  this sets a stage for developing a view on the
  market.
• THE DOW PATTERN
• Like in candlesticks, there are few important
  patterns in Dow Theory as well. The trader can
  use these patterns to identify trading
  opportunities. Some of the patterns that we will
  study are
• The Double bottom Double top formation
• The Triple Bottom Triple Top
• Range formation, and
• Flag formation
• The support and resistance is also a core concept
  for the Dow Theory.

THE DOUBLE BOTTOM DOUBLE TOP FORMATION A
double top double bottom is considered a
reversal pattern. A double bottom occurs when a
stocks price hits a shallow price level and
rebounds back with a quick recovery. Following
the price recovery, the stock trades at a higher
level (relative to the low price) for at least 2
weeks (well spaced in time). After which the
stock attempts to hit back to the low price
previously made. If the stock holds up once again
and rebounds, then a double bottom is formed. A
double bottom formation is considered bullish,
and hence one should look at buying
opportunities. Flag formations The flag
formation usually occurs when the stock posts a
sustained rally with almost a vertical or a
steep increase in stock prices. Flag patterns are
marked by a big move which is followed by a
short correction. In the correction phase, the
price would generally move within two parallel
lines. Flag pattern takes the shape of a
parallelogram or a rectangle, and they have the
appearance of a flag on the pole.
45

• The double top
• A double top is a bearish technical reversal
  pattern.
• It is not as easy to spot as one would think
  because there needs to be a confirmation with a
  break below support.

46

• The double bottom
• The double bottom looks like the letter "W". The
  twice-touched low is considered a support level.
• The advance of the first bottom should be a drop
  of 10 to 20, then the second bottom should
  form within 3 to 4 of the previous low, and
  volume on the ensuing advance should increase.
• The double bottom pattern always follows a major
  or minor downtrend in a particular security, and
  signals the reversal and the beginning of a
  potential uptrend.

• Head and shoulder pattern
• A head and shoulders pattern is a technical
  indicator with a chart pattern described by
  three peaks, the outside two are close in height
  and the middle is highest.
• A head and shoulders pattern describes a specific
  chart formation that predicts a bullish-
  to-bearish trend reversal.
• The head and shoulders pattern is believed to be
  one of the most reliable trend reversal patterns.

47
Inverted head and shoulder pattern-

• An inverse head and shoulders is similar to the
  standard head and shoulders pattern, but
  inverted with the head and shoulders top used to
  predict reversals in downtrends
• An inverse head and shoulders pattern, upon
  completion, signals a bull market
• Investors typically enter into a long position
  when the price rises above the resistance of the
  neckline.

48

• Cup with handle-
• A cup and handle is a technical chart pattern
  that resembles a cup and handle where the cup is
  in the shape of a "u" and the handle has a slight
  downward drift.
• A cup and handle is considered a bullish signal
  extending an uptrend, and is used to spot
  opportunities to go long.
• Technical traders using this indicator should
  place a stop buy order slightly above the upper
  trendline of the handle part of the pattern.

Reward to Risk Ratio (RRR) The concept of reward
to risk ratio (RRR) is generic and not really
specific to Dow Theory. It would have been apt
to discuss this under trading systems and Risk
management. However, RRR finds its application
across every trading type, be it trades based on
technical analysis or investments through
fundamentals. For this reason, we will discuss
the concept of RRR here. The calculation of the
reward to risk ratio is straightforward. Look at
the details of this short term long
trade Entry 55.75 Stop loss 53.55 Expected
target 57.20 On the face of it, considering it
is a short term trade, the trade looks alright.
However, let us inspect this further
49
What is the risk the trader is taking? Entry
Stoploss i.e 55.75 53.55 2.2 What is the
reward the trader is expecting? Exit Entry
i.e 57.2 55.75 1.45 This means for a reward
of 1.45 points the trader is risking 2.2 points
or in other words, the Reward to Risk ratio is
1.45/2.2 0.65. Clearly, this is not a great
trade. A good trade should be characterised by a
rich RRR. In other words, for every Rs.1/- you
risk on trade your expected return should be at
least Rs.1.3/- or higher. Otherwise, it is simply
not worth the risk. For example, consider this
long trade Entry 107 Stop loss 102 Expected
target 114 In this trade, the trader is risking
Rs.5/- (107 102) for an expected reward of
Rs.7/- (114 107). RRR, in this case, is 7/5
1.4. This means for every Rs.1/- of risk, the
trader is assuming, he is expecting Rs.1.4 as a
reward. Not a bad deal. The minimum RRR threshold
should be set by each trader based on his/her
risk appetite. For instance, personally, I
wouldnt say I like to take up trades with a RRR
of less than 1.5. Some aggressive traders dont
mind a RRR of 1, meaning for every Rs.1 they risk
they expect a reward of Rs.1. Some would prefer
the RRR to be at least 1.25. Ultra-cautious
traders would prefer their RRR to be upwards of
2, meaning for every Rs.1/- of risk they would
expect at least Rs.2 as a reward. A trade must
qualify the traders RRR requirement. Remember, a
low RRR is just not worth the trade. Ultimately
if RRR is not satisfied, then even a trade that
looks attractive must be dropped as it is just
not worth the risk. To give you a perspective
think about this hypothetical situation A
bearish engulfing pattern has been formed, right
at the top end of a trade. The point at which
the bearish engulfing pattern has formed also
marks a double top formation. The volumes are
beautiful as they are at least 30 more than the
10-day average volumes. Near the bearish
engulfing patterns high, the chart is showing
medium-term support. In the above situation,
everything seems perfectly aligned with a short
trade. Assume the trade details are as
below Entry 765.67 Stop loss 772.85 Target
758.5 Risk 7.18 (772.85 765.67) i.e Stoploss
Entry Reward 7.17 (765.67 758.5) i.e Entry
Exit RRR 7.17/7.18 1.0
50
As I mentioned earlier, I do have a stringent RRR
requirement of at least 1.5. For this reason,
even though the trade above looks great, I would
be happy to drop it and move on to scout the
next opportunity.

• Things to do before entering
• The stock should form a recognisable candlestick
  pattern.
• SR should confirm to the trade. The stoploss
  price should be around SR.
• For a long trade, the low of the pattern should
  be around the support.
• For a short trade, the high of the pattern should
  be around the resistance.
• Volumes should confirm
• Ensure above average volumes on both buy and sell
  day
• Low volumes are not encouraging, and hence do
  feel free to hesitate while taking trade where
  the volumes are low.
• Look at the trade from the Dow Theory
  perspective.
• Primary, secondary trends
• Double, triple, range formations
• Recognisable Dow formation
• Indicators should confirm
• Scale the trade size higher if indicators confirm
  to your plan of action

51
Important Notes/Thoughts