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Tech charts that can help decide when to enter or exit a stock

Technical charts can help investors identify the support and resistance level of a scrip.

Updated: Apr 28, 2018, 01.05 PM IST
ThinkStock Photos
There can be many variations, but the basic idea of using the charts is mainly to identify a trend.
A picture is worth a thousand words.

This famous saying sits so perfectly for chart reading in the financial world. A chart is nothing but graphical representation of data. Financial markets come alive through the eyes of charts, and this is precisely the reason why it keeps the interest factor alive for everyone, whether he is a beginner or an advanced trader or analyst.

These technical charts can help market participants identify the support and resistance level of a particular scrip and take buy-sell decisions. There can be many variations, but the basic idea of using the charts is mainly to identify a trend.

Mustafa Nadeem, CEO, Epic Research, said, “There are several benefits of reading a chart. The most important thing chart reading helps you with is trend identification and second, risk management. Risk management depends on how effective chart reading is. So, when risk management meets the objective, one is able to take a decision.”

The bedrock of the story is chart reading is an art and takes time to master. Below are six basic technical indicators that can help spot a market trend.

Moving averages: It is one of the simplest and most powerful tools, given its wide applicability. This helps in smoothening price data by forming a single flowing line. The line basically represents the average price movement over a period of time.

Moving averages can also provide support or resistance to price levels. These can be a simple moving average (SMA) and exponential moving average (EMA). SMA is calculated by dividing the sum of a set of prices by their total number in the series. For example, a 10-period moving average can be calculated by adding the following 10 prices together and then, dividing the result by 10. SMA assigns equal weights to all values. On the other hand, EMAs place a higher weighting on recent data than older data and these are more reactive to the latest price changes than SMAs.

“The use of moving average is in the identification of a trend and important points of polarity that will guide the price action in terms of support and resistance,” said Nadeem.

MACD: Moving average convergence and divergence (MACD) is a trend following indicator and widely used by traders across the world due to its overall simplification of identifying the overall trend. It is the difference between the 26-day and 12-day exponential moving averages. A nine-day exponential moving average, called the ‘signal’ line, is plotted on top of the MACD to reflect ‘buy’ or ‘sell’ opportunities. When the MACD falls below the signal line, it sends out a bearish signal on the charts, indicating that the price of the security may experience a downturn, and vice versa.

macd chart

Bollinger Bands: Bollinger Bands are based on the study of price variations from an average. The average is plotted and two bands using volatility of a stock is plotted above and below that, which factors in two standard deviation movements of the prices. The period for a moving average used is usually 20 days that can be changed and the calculation is as same as the simple average. Since it's an indicator that works according to volatility, one needs to be careful while using it as it can have various implications on prices in short as well as long term. It is widely used for gauging the trend with support and resistance based on the bands.

Stochastic Oscillator:
The Stochastic indicator denotes momentum and trend strength. Chandan Taparia of Motilal Oswal Financial Services said, “It analyses the price movements and indicates how fast and strong the price moves. It measures the level of the close relative to the high-low range over a given period of time.”

Commodity channel index: The indicator was developed in 1980. Unlike its name which confuses many newbies, it is an oscillator that can be used for not just commodities but indices, ETF or stocks. “The CCI calculation is a bit complex though its understanding and usability are important. It helps in identifying the overbought and oversold conditions and when a trend may begin. It oscillates between 100 to -100 and can go beyond that, but usually these levels beyond the 100 range either side indicates extremely oversold and overbought implications of price and signal a potential reversal,” added Nadeem.

OBV: Many indicators have been developed by technical analysts that deal in volumes -- one of the most important and often overlooked indicators used for confirmation of a trend. On-Balance-Volume (OBV), developed by Joseph Granville, is one of such metrics most widely used. Milan Vaishnav, Technical Analyst, Gemstone Equity Research and Advisory, said, “Analysts can look for divergences between OBV and price to predict price movements or use OBV to confirm the price trend.”

Let's learn how the calculation works. The line is started with an arbitrary number, which rises and falls depending on what the price does. The volume for the day is added when the price goes up and subtracted when it falls. In other words, OBV is simply the running total of positive and negative volume.

Granville noted in his research that OBV would often move before prices. Expect share prices to move higher if OBV is rising and vice versa.

obv graph 1

obv graph 2

(Disclaimer: The graphs used are for the purpose of illustration only. )
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