Technical Analysis Chart Patterns and Moving Averages - Chapter 5 pt 3

Candlestick Charts

  • A candlestick chart displays four key prices for a specific day based on completed transactions:

    • Opening price

    • Closing price

    • Highest price

    • Lowest price

  • Candle color indicates price movement:

    • Green candle: Closing price is higher than the opening price (price increase).

    • Red candle: Opening price is higher than the closing price (price decrease).

    • Colors may vary depending on the chart being used, but one color signifies an increase, and another signifies a decrease.

  • Technical Analysis (TA) assumes history repeats itself, enabling the use of past patterns to predict future market movements.

Basic Chart Patterns

  • Examples of chart patterns:

    • FNI

    • S&R

    • Fib

    • Multiple

Head and Shoulders

  • Characterized by three peaks:

    • The middle peak (head) is the highest.

    • Two lower peaks of roughly equal height flank the head (shoulders).

  • Indicates a potential trend reversal.

  • The line connecting the two shoulders represents a key support level.

  • If the price drops below this support level, a trend reversal or breakdown is anticipated.

  • An inverse head and shoulders pattern may indicate an upcoming shift from a downtrend to an uptrend.

Cup and Handle

  • Formation:

    • Begins with an uptrend.

    • Chart forms a large, U-shaped curve (the cup).

    • Followed by a smaller dip (the handle) before resuming upward.

  • Signals a bullish stock.

  • Completion:

    • The price is expected to resume the previous upward trend.

    • Confirmation occurs when the right side of the handle breaks above the peak between the cup and handle, indicating the uptrend will continue.

Double Top or Double Bottom

  • Occurs when a stock repeatedly reaches the same support or resistance level without breaking through.

  • After the second peak or valley, monitor whether the chart breaks the key support or resistance level.

  • A breakthrough suggests the price is likely to continue moving in that direction, signaling a trend reversal.

Moving Averages

  • Purpose: To smooth out day-to-day price fluctuations and simplify chart analysis by plotting smoother lines that reveal clearer trends and patterns.

  • Simple Moving Average (SMA): A popular type of moving average.

  • Calculation: Sum of prices over a specific period divided by the number of prices:

    • SMA=∑<em>i=1nPrice</em>inSMA = \frac{\sum<em>{i=1}^{n} Price</em>i}{n}

    • Where:

      • PriceiPrice_i is the price for day i

      • nn is the number of periods

  • Common periods: 20, 50, 100, or 200 trading days, but any period can be used.

  • Usage: Determine support and resistance levels and identify trend reversals.

  • Long-term Moving Average:

    • Example: 200-day moving average.

    • Often used as a baseline for stock support or resistance.

    • Reflects the stock's general trend.

  • Short-term Moving Average:

    • Example: 20-day moving average.

    • Indicates current stock performance.

    • Compared to the long-term moving average, it shows current performance relative to past performance.