Lecture 17: Technical Analysis, Candlestick Mechanics, and Moving Average Trading Strategies

Course Administration and Examination Details

• Examination Schedule:

  • The upcoming examination takes place on Monday in the regular classroom.

  • Exam coverage topics are posted directly on Blackboard.

• Study Materials:

  • A $5$ to $6$ page technical analysis PDF is uploaded on Blackboard covering core exam topics.

  • A line-by-line review of all examination topics occurs during Friday's lecture.

• Trading Software Platform:

  • Demonstrations utilize the Thinkorswim trading platform.

  • Charts, indicator builds, and pattern analysis are demonstrated using an active Thinkorswim trading account.

Fundamental Analysis vs. Technical Analysis

• Fundamental Analysis:

  • Core Focus: Evaluates the underlying intrinsic financial value of a company using core financial statements:

    • Income Statement

    • Balance Sheet Statement

    • Statement of Cash Flows

  • Key Metrics Evaluated:

    • Revenue growth (evaluating whether revenue is accelerating or decelerating).

    • Earnings trends (evaluating whether earnings are accelerating or decelerating).

    • Earnings Per Share ($\text{EPS}$).

    • Price-to-Earnings ratio ($\text{P/E}$).

    • Price/Earnings-to-Growth ratio ($\text{PEG}$).

  • Primary Function: Tells an investor what asset to buy or sell based on financial strength.

• Technical Analysis:

  • Core Focus: Evaluates price action, chart patterns, moving averages, and technical indicators.

  • Primary Function: Tells a trader when to buy or sell an asset.

• Synergistic Analysis:

  • Combining fundamental analysis with technical analysis creates a powerful framework that dictates both asset selection (what to buy) and execution timing (when to buy/sell).

• Pure Technical Chart Trading:

  • Certain professional traders purely trade price charts without knowing the underlying company's identity or ticker (e.g., hiding company names like Netflix or Apple).

  • Chart reading is a trainable skill similar to reading a text message, enabling instant visual interpretation when proper technical tools are applied.

Macroeconomic Impact on Software Stocks and Charting Styles

• Macro Trends in Software Sector:

  • Software companies (e.g., Workday) face fundamental margin compression and revenue disruption due to artificial intelligence (AI).

  • AI agents and plug-ins (such as those developed by Anthropic) are actively replacing legacy enterprise software solutions.

• Inadequate Chart Types (To Be Avoided):

  • Mountain Charts & Line Charts:

    • Mountain and line charts represent primitive visual depictions of asset prices.

    • Relying on line or mountain charts signals a complete lack of market sophistication.

    • Operational Limitation: Line/mountain charts require hovering a cursor over individual dates to display the Open, High, Low, Close (OHLC) prices and Volume.

• Superior Chart Types:

  • Candlestick Charts:

    • Provide complete intraday OHLC price action visually without requiring cursor hovers.

  • Hollow Candlestick Charts:

    • The preferred visual charting format (default on Yahoo Finance and Thinkorswim) as it displays maximum intraday and interday directional data.

Anatomy and Mechanics of Hollow Candlesticks

• Candlestick Wicks (Shadows):

  • The thin upper and lower lines extending from the candlestick body.

  • Upper Wick (North): Represents the absolute High price achieved during the trading session.

  • Lower Wick (South): Represents the absolute Low price achieved during the trading session.

• Candlestick Body Colors (Interday Price Change):

  • Color is determined exclusively by comparing today's closing price to the prior trading day's closing price:

    • Green Candle: Today's closing price is strictly higher than the prior day's closing price ($\text{Close}_{\text{today}} > \text{Close}_{\text{yesterday}}$).

    • Red Candle: Today's closing price is strictly lower than the prior day's closing price ($\text{Close}_{\text{today}} < \text{Close}_{\text{yesterday}}$).

• Candlestick Body Fill Status (Intraday Price Direction):

  • Body fill (hollow vs. filled) is determined exclusively by comparing today's closing price to today's opening price:

    • Hollow Body: Today's closing price is higher than today's opening price ($\text{Close}_{\text{today}} > \text{Open}_{\text{today}}$). Intraday movement was upward.

    • Filled (Solid) Body: Today's closing price is lower than today's opening price ($\text{Close}_{\text{today}} < \text{Open}_{\text{today}}$). Intraday movement was downward.

• Four Complete Candlestick Permutations:

  1. Hollow Green: Price closed above yesterday's close ($\text{Green}$) AND price closed above today's open ($\text{Hollow}$).

  2. Filled Green: Price closed above yesterday's close ($\text{Green}$), BUT price closed below today's open ($\text{Filled}$) (stock gap-opened significantly higher, then traded downward during the session while retaining a net gain over yesterday).

  3. Hollow Red: Price closed below yesterday's close ($\text{Red}$), BUT price closed above today's open ($\text{Hollow}$) (stock gap-opened significantly lower, then traded upward during the session while remaining net negative relative to yesterday).

  4. Filled Red: Price closed below yesterday's close ($\text{Red}$) AND price closed below today's open ($\text{Filled}$).

• Visual Pattern Recognition:

  • Mastery requires reviewing approximately $10{,}000$ charts until visual identification becomes an instinctive reaction—analogous to a football running back instinctively recognizing jersey colors through a hole without conscious calculation.

Trade vs. Trend Dynamics and Market Terminology

• Timeframe Classification:

  • The Trade: Refers to short-term price windows spanning $5$ trading days to $2$ weeks ($5\,\text{days} - 2\,\text{weeks}$).

  • The Trend: Refers to long-term macro price direction spanning months to years.

• Market Direction Terminology Etymology:

  • Bullish Market: Represents an upward price trajectory. Term derived from how a bull attacks by thrusting its horns upward.

  • Bearish Market: Represents a downward price trajectory. Term derived from how a bear attacks by swiping its paws downward.

• Optimal High-Probability Trade Setups:

  • The highest probability setups occur when short-term trade signals align perfectly with long-term trend signals:

    • Perfect Bullish Alignment: Short-term trade indicators are bullish AND long-term trend indicators are bullish.

    • Perfect Bearish Alignment: Short-term trade indicators are bearish AND long-term trend indicators are bearish (ideal shorting opportunities).

Moving Average Indicators and Color Standardizations

• Short-Term Trade Moving Averages:

  • $5$\text{-Day Moving Average} ($5$\text{ MA}): Calculates the arithmetic mean of closing prices over the preceding $5$ trading days. Highly sensitive and volatile.

  • $13$\text{-Day Moving Average} ($13$\text{ MA}): Calculates the arithmetic mean of closing prices over the preceding $13$ trading days.

• Long-Term Trend Moving Averages:

  • $50$\text{-Day Moving Average} ($50$\text{ MA}): Calculates the arithmetic mean of closing prices over the preceding $50$ trading days. Reflects medium-to-long-term trend momentum.

  • $200$\text{-Day Moving Average} ($200$\text{ MA}): Calculates the arithmetic mean of closing prices over the preceding $200$ trading days. Reflects macro long-term support and trend structure.

• Mandatory Color Standardization:

  • Traders must assign strict, permanent color schemes to moving averages across all personal devices to train visual processing speed without cognitive lag:

    • $50$\text{-Day MA} Color: Standardized to Purple.

    • $200$\text{-Day MA} Color: Standardized to Blue.

    • $5$\text{-Day} and $13$\text{-Day} MAs: Standardized to high-contrast shades (e.g., Yellow and White on dark backgrounds; Black and Yellow on light backgrounds).

Moving Average Signals, Slopes, and Crossover Rules

• Slope Analysis:

  • Upward Slopes: Both $50$\text{-day} and $200$\text{-day} lines sloping upward confirm strong structural support; buying is safe.

  • Downward Slopes: Both lines sloping downward confirm systemic macro weakness; buying is dangerous and long positions must be avoided.

  • Divergent/Conflicting Slopes: A mixed signal (e.g., $200$\text{-day} sloping up while $50$\text{-day} slopes down). Requires risk-averse avoidance or tight position management.

• Crossover Signals:

  • Bullish Crossover / Golden Cross:

    • Definition: Occurs when a shorter-term moving average crosses from below to above a longer-term moving average (e.g., $50$\text{-day} crossing above $200$\text{-day}$, or$5$\text{-day} crossing above$13$\text{-day}$).

    • Significance: Signals a powerful upward shift in price momentum; acts as an explicit Buy trigger.

  • Bearish Crossover / Death Cross:

    • Definition: Occurs when a shorter-term moving average crosses from above to below a longer-term moving average (e.g., $50$\text{-day} crossing below $200$\text{-day}$, or$5$\text{-day} crossing below$13$\text{-day}$).

    • Significance: Signals a breakdown in price momentum; acts as an explicit Sell or Short-Sale trigger.

• Dynamic Support Mechanics:

  • In a established uptrend, the $50$\text{-day} moving average acts as dynamic technical support. Pullbacks frequently bounce precisely off the $50$\text{-day} line.

• Moving Average Mechanics and Volatility:

  • As time progresses, moving averages dynamically drop the oldest daily data point and add the newest closing price.

  • The $50$\text{-day} line is significantly more volatile than the $200$\text{-day} line due to its smaller sample size.

  • Froth / Overextension Risk: When the visual gap/spread between the $50$\text{-day} and $200$\text{-day} moving averages expands excessively, risk increases as the asset becomes overextended.

• False Signals / Head Fakes:

  • Moving average lines may converge as if to cross, touch ("kiss"), and then sharply diverge without completing a full crossover.

Practical Asset Case Studies

• Workday:

  • Price closed at $\$189.26$ with an intraday High of $\$190.00$ and Low of $\$186.00$.

  • The $50$\text{-day} moving average stood at $\$213.00$.

  • Trading below the $50$\text{-day} MA pulls the average line downward, confirming a bearish trend.

• Pan American Silver:

  • Generated a Golden Cross ($50$\text{-day} crossing above $200$\text{-day}$) in April 2024 at approximately$\$18.00 per share.\n * The long-term bullish thesis remained uninterrupted as the stock trended continuously up to \$65.00 per share.\n * During a severe macro silver crash in late January where silver fell 30\%$in a single day, Pan American Silver dropped but bounced directly off its$50\text{-day} moving average dynamic support.\n * Short-term trade execution: On February 16, a short-term bullish crossover (5$\text{-day} crossing above$13$\text{-day}$) signaled a short-term re-entry trigger.

• NVIDIA (NVDA):

  • Demonstrated clear Golden Cross and Death Cross signals.

  • Triggered a bullish entry in the $\$160.00$ range and surged to $\$185.00$.

  • Caution indicated as the purple $50$\text{-day} moving average flattened out horizontally.

• ExxonMobil (XOM):

  • Transitioned from downward-sloping averages into a Golden Cross at $\$112.00$ per share, trending upward past $\$149.00$ - $\$156.00$.

  • Demonstrated repeated dynamic support bounces off the $50$\text{-day} moving average line.

  • Short-term signal update: The $5$\text{-day} moving average crossed below the $13$\text{-day} moving average at the top right of the chart, triggering a short-term trade exit while long-term trend remained intact.

• GameStop (GME):

  • Characterized by extreme volatility within a broad long-term downward sloping $200$\text{-day} trend.

  • Illustrates that short-term trades ($5$\text{-day} / $13$\text{-day} crossovers) can yield profitable long trades (e.g., entry at $\$20.24$) even inside a macro downward-trending asset.

Advanced Technical Indicators and Execution Strategy

• Advanced Charting Indicators (Preview):

  • Parabolic SAR: Visualized as white dots tracking price stops and reversals.

  • Volume Profile: Visualizes traded volume distribution across price levels.

  • Bollinger Bands: Visualizes volatility channels.

  • Supply and Demand Zones: Highlights institutional buying and selling liquidity blocks.

  • Momentum Indicators: Quantifies velocity of price changes.

  • Relative Strength Index (RSI): Measures speed and change of price movements for overbought/oversold conditions.

• Execution Infrastructure (Desktop vs. Mobile):

  • Mobile phone trading apps severely restrict visible technical data, indicators, and multi-timeframe overlays.

  • Professional trading requires desktop multi-screen setups running platforms like Thinkorswim to view multiple indicators simultaneously across multiple assets.

  • Strict adherence to standard moving average crossover rules ($5$, $13$, $50$, $200$\text{-day}$) eliminates emotional bias, achieving a win/hit rate of$65\%$to$70\%$$ on trades.