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In February 2004, Capital Dynamics Sdn Bhd launched icapital education.

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Home > Brief Guides > Technical Analysis & Trading

Guide to Technical Analysis & Trading (Part 1)

 

Introduction

This is a brief introduction to a vast subject. Technical analysis, as opposed to fundamental analysis, includes analyzing charts and technical indicators like RSI, MACD, moving averages, etc. It has its uses if the trader or investor is aware of its good and bad points.

Subscribers are encouraged to do more research into this technique before using it with your capital. Just like any other methods, it is useful to deeply understand its strength and weakness.

One weakness is that its interpretations can be affected if you draw the same charts on a different scale, i.e. arithmetic or semi-log scale. Another potential weakness is that the price and volume of a stock can be manipulated so as to give certain patterns or readings for the other traders.

A. Relative Strength Index (RSI)
RSI Chart (Click to open in New Window)
This indicator is also very popular with traders in the future markets. Its formula is:

RSI = 100 - ( 100/1+ rs )

Where rs = average of X day's up closes / average of X day's down closes.

The number of days can be varied. In our case we choose 9 days instead of the usual 14 days. The RSI can also be calculated on a weekly or monthly basis. The shorter the time, the more sensitive RSI becomes.

The maximum and minimum levels that the RSI indicator can theoretically go to are 100 and 0. Usually if the RSI is above 70, it is overbought and if it is below 30, it is oversold. These are useful for short-term traders.

An important use of RSI is when there is a divergence between the company's price or a market index and its RSI. A "bullish divergence" signals a short-term bottom while a 'bearish divergence" signals a short-term peak.

B. Moving Average Convergence/Divergence
MACD Chart (Click to open in New Window)
The MACD trading method is actually based on 2 exponentially smoothed moving average and buy / sell signals are given when the 2 lines cross.

The MACD just like the RSI can also be calculated on a weekly or monthly basis. In addition, a divergence between the share price or a market index and its MACD is a powerful indicator of a reversal. It is also useful for short - term traders and should be used in conjunction with other indicators.

C. Directional Movement Index (DMI)
DMI Chart (Click to open in New Window)
Under this index, two lines are generated. Buy / Sell signals are again given when the 2 lines cross.

The signals given are, from our experience, longer term than the MACD or RSI.

D. Other Indicators
Demand Index Chart (Click to open in New Window)
Demand Index.

Besides the above 3 technical indicators, there is a whole list of other technical indicators that a brief guide like this cannot cover. Stochastics, Demand Index, On - Balance Volume, Momentum, William's R, Advance Decline Line, etc are just examples of the many more that the ingenious human mind can think of. The bookshops have a wide range of books on such topics and subscribers are encouraged to buy some and work through them.

Tech Analysis & Trading (Pt2)>>