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Technical Analysis
-Information is money, but rumors
will make your life miserable-Learn and Earn is the best Policy
-You are your own boss
-Trend is your friend
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Basics of Technical Analysis
Technical approach is based on:
Market action discounts everything
Prices move in trends
History repeats itself The purpose of charting the price action is to identify
trends in early stages of their development for thepurpose of trading in the direction of those trends.
A trend in motion is more likely to continue than to
reverse. Chart patterns are based on the study of Human
psychology which tends not to change universally.
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Stock Market
A stock market or equity market is apublic market (a loose network of
economic transactions, not a physicalfacility or discrete entity) for the trading ofcompany stock and derivatives at anagreed price; these are securities listed on
a stock exchange as well as those onlytraded privately.
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Rank Exchange Name Country Domestic Market Cap (in $ billion)
1 New York Stock Exchange United States 11,837
2 Tokyo Stock Exchange Japan 3,306
3 NASD AQ UnitedStates 3,239
4 Euro next Belgium, France, Holland, Portugal 2,869
5 London Stock Exchange United Kingdom 2,796
6 Shanghai Stock Exchange China 2,704
7 Hong Kong Stock Exchange Hong Kong 2,345
8 Toronto Stock Exchange Canada 1,608
9 BM&FBovespa Brazil 1,337
10 Bombay Stock Exchange India 1,306
11 BME Spanish Exchange Spain 1,297
12 Frankfurt Stock Exchange Germany 1,292
13 Australian Securities Exchange Australia 1,260
14National Stock Exchange of
IndiaIndia 1,224
15 SIX Swiss Exchange Switzerland 1,064
The World's Top 15 Stock Exchanges by Domestic Market Capitalization in 2009
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About Stocks
The following are the different ways oftrading in stocks
1.S
hare2. Derivatives
1. Future
2. Option
Derivatives are explained in the last
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Nifty & Sensex
Nifty consists of 50 stocks out of which 16stocks accounts for 69% of weightage asshown in the table below
Sensex consists of 30 stocks out of which15 stocks accounts for 79% of weightageas shown in the table below
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Weightage ofStocks
S. No Company Name NiftyWt % SensexWt %
1 Reliance 10.56 12.53
2 Infosys Tech. 8.84 10.49
3 Larsen & Toubro 6.90 8.19
4 ICICI Bank 6.40 7.59
5 ITC 4.99 5.92
6 HDFC Bank 4.91 5.82
7 HDFC 4.87 5.78
8 State Bank of Ind 4.06 4.81
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Weightage ofStocks - 2
S. No Company Name NiftyWt % SensexWt %
9 ONGC 2.71 3.21
10 BHEL 2.53 3.00
11 TCS 2.44 2.89
12 Bharti Airtel 2.25 2.68
13 Axis Bank 2.19 Below 2%
14 Tata Steel 1.91 2.26
15 Hindustan Lever 1.82 2.15
16 M&M 1.69 2.00
Total 69.06 79.32
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Share
Equity also known as shares, is the capital amountwhich is raised or contributed by the members of thecompany. The net worth of a company represents theownership interest of the shareholders (common and
preferred). In the past, shareholders received a physicalpaper stock certificate that indicated that they owned "x"shares in a company. Today, brokerages have electronicrecords that show ownership details.
The stock or capital stock of a business entity
represents the original capital paid into or invested in thebusiness by its founders. The same can be decreasedor increased later on through resolution.
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Technical Analysis
Technical Analysis is the study of prices withcharts being the primary tool
If we could separate our emotions from our
investment decisions and be totally logical, thenfundamental analysis, the determination of pricebased on future earnings would workmagnificently
Technical Analysis is the process of analyzing a
securitys historical prices in an effort to determineprobable future prices
The foundation of Technical Analysis is the chart
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Resistance & Support
RESISTANCE the price at which the buyers felt that theinvesting is not worthwhile and were not willing to buy formore than that price.
SUPPOR
T the price at which the sellers felt that selling isnot worthwhile and was not willing to sell for less that thatprice
The penetration of Support and Resistance level can betriggered by Fundamental changes that are above or below
investor expectations
Support and Resistance is a classic example of supply anddemand
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Stock Market Cycle in Phases
1st phase aggressive buying by informed investors.
2nd Phase increased corporate earnings & improvedeconomic conditions followed by buying from Technical
Analysts. 3rd Phase general public entry, fully convinced that the
stock market is heading for moon.
The significance of data Price 50%Volume 30%
Open interest 20%
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Indicators
Leading Indicator
1. Helps predicting whatprices do next.
2. Perform best in tradingmarkets.
3. Measures howoverbought/oversoldsecurity is
Lagging Indicator
1. Dont warn of upcoming changes in
prices. 2. Have u buy and sell
late.
3. Greatly reduces risk bykeeping on right side.
4. Work well in trendingmarket
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Tips on Trading
How to trade - Determine the overall market condition, interest rates, trend of NSE,
trend of investor sentiment. Pick the securities Industry you are familiar with. Determine the overall trend of the share (200 days M.A or 39 Weeks
M.A) Pick your entry points based on several indicators.
Much of your success will come from experience - Dont compound your losses by averaging down
Any time you own a security ask yourself if you would buy it today,if you wouldnt buy, you should consider selling it. Dont get disturbed by others investment process. Wise investments are made using logical approaches. Master the basics Dont look for easy money.
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Introduction Candlesticks
The Japanese began using technical analysis to trade rice in the17th century.
Candlestick charting first appeared sometime after 1850. Much ofthe credit for development and charting goes to a legendary ricetrader named Homma
A candlestick chart is a style of bar-chart used primarily to describeprice movements of a security, derivative, or currency over time.
It is a combination of a line-chart and a bar-chart, in that each barrepresents the range of price movement over a given time interval.
Candlesticks provide unique visual cues that make reading priceaction easier.
Candlestick Charts allow Investor/Trader to better comprehendmarket sentiment.
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Types of Candlestick
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Major Candlestick Patterns
1. Doji Star The first day is long redday
Second day is a doji that
opens at the previous dayclose
The doji wicks should notbe long
Star indicates a reversaland Doji indicatesindecision
Bullish
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2. Dragonfly Doji A) Bearish
A very small body with along lower wick The lower wick is at least
twice as long as theprevious candlestick body
No upper wick
Here open, high and closeare almost the same, thereis not much difference
After a market in an overalluptrend the sharp sell-off
reflected by the Dragonflysuggests the bulls mayhave lost sway over themarket trend.
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Dragonfly Doji
B) Bullish Pattern is strongest after anestablished bearish trend
A candle forms with a very smallto almost nonexistent body with along lower wick
The lower wick is at least twice as
long as the previous candlestickbody
Little or no upper wick
Price drives up to new lows, butbuyers take control of the trend bymarket close.
Although this formation is amoderate to weak signal, it is awarning for longs that thedowntrend is losing momentumand bull may retake the marketsoon.
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4. Inverted Hammer Day-one is a red day, continuing
an established trend and closingat the lower trading range near thedays low
The second day is red or blue daythat also trades at a lower rangewith the opening and closing near
each other. The upper wick of the second dayshould be at least twice as long asthe body
The lower wick of the second dayshould be non-existent or verylittle.
The strong bullish Gravestone Dojipattern is similar to the InvertedHammer pattern, exceptGravestone Doji second day ischaracterized by a clear dojiwhere open and close pricesequal each other, rather than asmall body.
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5. Bearish Engulfing In an established uptrend, an average
to small sized blue candle occurs onday-one.
on the second day a longer red candleforms
Ideally with a red candles high isabove the previous days high.
The strength of the signal isadditionally increased by the furtherthe red candle closes below the low ofthe previous day
The second day bear move acts to
confirm the death to the bull trend. Thebigger the red candle reflects thedeeper the bear move and the betterthe reversal signal.
Bearish Engulfing patterns alsoprovide resistance levels for where thehighest level of price action reached.
In the future this level may be difficultto break.
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6. Bullish Harami First day is a long redcandle continuing anestablished trend Day-two is a small
candle whose range iswithin the first days body.
A day of uncertainty aftera large bearish movesuggests sellers may havelost control of the market.Candlestick analysts willwatch for bullish moves inthe following days.
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BollingerBands
Bollinger Bands is a technical analysis tool invented by JohnBollinger in the 1980s. Having evolved from the concept of tradingbands, BollingerBands can be used to measure the highness orlowness of the price relative to previous trades.
BollingerBands is a versatile tool combining moving averages and
standard deviations and is one of the most popular technicalanalysis tools available for traders. There are three components tothe BollingerBand indicator:
Moving Average: By default, a 20 day - period simple moving averageis used.
Upper Band: The upper band is usually 2 standard deviations
(calculated from 20 day - periods of closing data) above the movingaverage.
Lower Band: The lower band is usually 2 standard deviations below themoving average.
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There are three main methodologies forusing BollingerBands, discussed in thefollowing sections:
Playing the Bands
BollingerBand Breakouts
Option Volatility Strategies
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Playing with the Band
Buy Signal
In the example shown in thechart below of the E-mini S&P500 Future, a trader buys orbuys to cover when the pricehas fallen below the lowerBollingerBand.
Sell Signal
The sell or buy to cover exit isinitiated when the stock, future,or currency price piercesoutside the upper BollingerBand.
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BollingerBand Breakouts
Breakouts occur after a period of consolidation, when price closes outsideof the BollingerBands. Other indicators such as support and resistancelines (see: Support & Resistance) can prove beneficial when decidingwhether or not to buy or sell in the direction of the breakout.
Oversold Position when Security touches or goes below the lower band
Overbought Position when Security touches or goes above the upperband
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Buy Signal
Price breaks above the upperBollingerBand after a period of priceconsolidation. Other confirmingindicators are suggested, such asresistance being broken in the chartabove ofWal-Mart stock.
Sell Signal
Price breaks below the lowerBollingerBand. It is suggested that otherconfirming indicators be used, such asa support line being broken, such as inthe example above ofWal-Mart stockbreaking below support.
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Option Volatility Strategies
Since Bollinger Bands adapt to volatility, Bollinger Bands giveoptions traders a good idea of when options are relativelyexpensive (high volatility) or when options are relatively cheap(low volatility).
When options are relatively cheap, such as in the center of the chartabove ofWal-Mart stock when the Bollinger Bands significantlycontracted, buying options, such as a straddle or strangles, might bea good options strategy.
At times when options are relatively expensive, such as in the farright and far left of the chart above ofWal-Mart stock when theBollingerBands were significantly expanded, selling options in theform of a straddle, strangle, or iron condor, might be a good optionsstrategy to use.
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Buy options with low volatilityin hopes that volatility willincrease and then sell backthose options at a higher price.
Sell options with high volatilityin hopes that volatility willdecrease and then buy backthose same options at acheaper price.
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Moving Average Convergence Divergence
(MACD)
Developed by Gerald Appel in the late seventies, Moving AverageConvergence Divergence (MACD) is one of the simplest and most effectivemomentum indicators available.
MACD turns two trend-following indicators, moving averages, into amomentum oscillator by subtracting the longer moving average from the
shorter moving average.
MACD offers the best of both worlds: trend following andmomentum. MACD fluctuates above and below the zero line as the movingaverages converge, cross and diverge.
MACD is a computation of the difference between two exponential movingaverages (EMAs) of closing prices. This difference is charted over time,alongside a moving average of the difference. The divergence between thetwo is shown as a histogram or bar graph.
Standard MACD is the 12-day Exponential Moving Average (EMA) less the26-day EMA. Closing prices are used to form the moving averagesso MACD is based on closing prices
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MACDGraph
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MACD Explanation
The graph above shows a stock with an MACD indicator underneathit. The indicator shows a blue line, a red line, and a histogram or barchart which calculates the difference between the two lines. Valuesare calculated from the price of the stock in the main part of the
graph. For the example above this means:
MACD line (blue line): difference between the 12 and 26 days EMAs
signal (red line): 9 day EMA of the blue line
histogram (bar graph): difference between the blue and red lines
Mathematically:
MACD = EMA[fast,12] EMA[slow,26]
signal= EMA[period,9] of MACD
histogram= MACD signal
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SLOW STOCHASTIC
The slow stochastic indicator is a price oscillator thatcompares a security's closing price over "n" range. Themost commonly used range for the slow stochasticindicator is 14. The slow stochastic formula is calculatedas follows :
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Graph ofStochastic
Stochastic is a leading indicator.
Stochastic shows overbought and oversold positions
Helps to pick entry and exit points ahead of the market
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Stochastic Buy & Sell signals
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Gann Angles
Gann Angles are Geometric angles in conjunctionwith time and price.
Interpretation ideal balance between time and price
exists when prices rise or fall at a 45 degree anglerelative to the time axis.
Gann Angles are drawn between a significant bottomand top.
Gann Angles exactly (to the nearest price) shows theResistance and Support Levels, when drawn fromsignificant tops and bottoms. Several lines need to bedrawn to predict different supports and resistance.
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Percent Retracement the amount that prices retractfollowing a higher high can be measured.
Price retracement
Vigorous bull market up to 33%
Normal market up to 50%
End of move more than 66%
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How to draw Gann angles
Gann was fascinated by the relation of time (T) and price (P). Gann drew his anglesfrom all significant price pivot point highs and lows. He used just one pivot point todraw an angle that rose (or fell) at predetermined and fixed rates of speed, as follows:
T x P =n degrees1 x 8 = 82.5 degrees1 x 4 = 75 degrees
1 x 3 = 71.25 degrees1 x 2 = 63.75 degrees1 x 1 = 45 degrees2 x 1 = 26.25 degrees3 x 1 = 18.75 degrees4 x 1 = 15 degrees8 x 1 = 7.5 degrees
where
T is the number of units of time, graphically plotted on the horizontal x-axis.P is the number of units of price, graphically plotted on the vertical y-axis.
x is read as "by".n degrees specifies the slope of the Gann angle, measured in degrees.
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For practical purposes, weekly Gann angles, drawn on a weekly barchart, appear to offer the most useful perspective. Gann often saidthat the weekly chart was more important than the daily chart.Nevertheless, Gann angles are flexible and can be used on anytime-scale, so long as the time by price proportions are correctly
calculated. For example, during an up-trend, the 1 x 1 angle tends to provide
major support. A major reversal is signaled when prices fall belowthe 1 x 1 angle. According to Gann, prices should then be expectedto fall to the next angle below, the 2 x 1 angle. In other words, asone angle is penetrated, expect prices to move to and consolidate at
the next angle, which is less steep.
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Fundamental Analysis
Fundamental Analysis is the study ofeconomic, industry and company conditions inan effort to determine the value of a companys
stock. It is most popular to use Fundamental Analysis
to select securities and then use technicalanalysis to time individual trades.
A weak stock in a strong industry is preferableto a strong stock in weak industry.
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Types of Ratios
Ratios fall under 5 categories:
1. ProfitabilityR
atio2. Price Earning Ratio
3. Liquidity Ratio
4. Leverage Ratio
5. Efficiency Ratio
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Explanation of Ratios
1. Profitability Ratio = Net profit * 100 / Total salesShows how much profit is squeeze out of sales.
2. P/E Ratio = Current share price / Earning pershareShows how much an investor should pay to buy 1Re. of earning Company with lower P/E Ratio is
better, all else being equal.B
ook value / share=
Assets Liabilities / Total shares Shows securityis overpriced or under priced.
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Explanation of Ratios
3. Liquidity Ratio or Current Ratio =Current Asset Stock / Current Liabilities
Shows company ability to meet short termLiabilities.
4. Leverage Ratio =Borrowed funds / Total AssetsReflect how much of companys assets have been financedwith borrowed funds.
5. Efficiency Ratio Inventory turnover=Cost of goods sold / Closing stock
Shows no. of times per year the inventories are turned over
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Technical Vs Fundamental Analysis
Technical Analysis concentrates on the study of market action. Fundamental Analysis focuses on the economic forces of market
action. Share is Overpriced when Intrinsic Value < Market Price Share is Undervalued when Intrinsic Value > Market Price
Fundamentals studies the cause of market movement, technicalsstudies the effect. At the beginning of important market moves, theCharts and Fundamentals are often in conflict with each other.
Market price tends to lead the known Fundamentals. Technician begins to like being in the minority. He knows that
eventually the reasons for market action will become commonknowledge. Technicians believe their approach is superior to that of
Fundamentals because by definition the Technical approachincludes the Fundamentals
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Futures
A futures contract is a standardized contract between two partiesto buy or sell a specified asset of standardized quantity and qualityat a specified future date at a price agreed today (the futures price).
A futures exchange orderivatives exchange is a central financial
exchange where people can trade standardized futures contracts;that is, a contract to buy specific quantities of a commodity or financial instrument at a specified pricewith delivery set at a specified time in the future.
For the buyer, the contract of futures means the obligation of havingto buy the underlying asset at a future price at the date of expire and
for the salesman, it supposes the obligation to sell such underlyingasset at the future price at the same date of expire.
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Long position (buying): If the future price is < than the liquidation
price, the buyer obtains a profit.
If the futures price is > than the liquidationprice, the buyer has a loss.
Short position (selling): If the futures price is > than the liquidation
price, the seller has a loss. If the futures price is < than the liquidation
price, the seller obtains a profit.
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Option
Option gives its holder the right, but not the obligation, tobuy (call option) or to sell (put option) some underlyingasset on or before the option's expiration date at anagreed on price (the strike price).
In return for granting the option, the originator of theoption collects a payment (thepremium) from the buyer.
A call option gives the buyer of the option the right butnot the obligation to buy the underlying asset at thestrike price.
A put option gives the owner of the option the right butnot the obligation to sell the underlying asset at the strikeprice.
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Example of Put option
PUT - You have the right to sell 100 shares of Relianceat $10 until July 2010 (usually the last Friday of themonth). If shares of Reliance fall to $5 and you exercise
the option, you can purchase 100 shares of Reliance for$5 in the market and sell the shares to theoption's owner for $10 each, which means you make$500 (100 x ($10-$5)) on the put option. Note that themaximum amount of potential profit in this
example ignores the premium paid to obtain the putoption.