The ABC of Technical Analysis

A Glossary Of Technical Analysis Terms And Its Meanings

Advance/decline line
Each day's declining issues are subtracted from that day's advancing issues. The difference is added to (subtracted from if negative) a running sum.

Failure of this line to confirm a new high is a sign of weakness. Failure of this line to confirm a new low is a sign of strength.

Area pattern

When a stock's or commodity's upward or downward trend has stalled, the sideways movement in price which follows forms a pattern. Some of these patterns may have predictive value.

Examples of these patterns are head and shoulders, triangles, pennants, flags, wedges and broadening formations.

Candlestick charts

A charting method originally developed in Japan. The high and low are described as shadows and plotted as a single line. The price range between the open and close is plotted as a rectangle on the single line.

If the close is above the open, the body of the rectangle is white. If the close of the day is below the open, the body of the rectangle is black.

Congestion area

At a minimum, a series of trading days when there is no or little progress in price.

Correction

A price reaction of generally 1/3 to 2/3 of the previous gain.

Cup and handle

A pattern on bar charts. The pattern can be as short as seven weeks and as long as 65 weeks. The cup is in the shape of a U. And the handle has a slight downward drift. The right hand side of the pattern has low trading volume.

Double bottom/double top

These are reversal patterns. It is a decline or advance twice to the same level (plus or minus 3 per cent). It indicates support or resistance at that level.

Elliott Wave Theory

Originally published by Ralph Nelson Elliott in 1939, it is a pattern recognition theory. It holds that the stock markets follow a pattern of five waves up and three waves down to form a complete cycle.

Many technicians believe that this pattern can hold true for as short a time period as one day. However, it is generally used to measure long periods of time in the markets.

Fibonacci ratio

It's the relationship between two numbers in the fibonacci sequence. In general terms the fibonacci series is 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 - where the previous two numbers are added to derive the next number. 0+1 is 1, so the first number is 1. 1+1 is 2, so the next number is 2, and so on. The sequence for the first three numbers is 0.618, 1.0, and 1.618.

Fibonacci Ratios and Retracements can be applied both to price and time, although it is more common to use them on prices. The most common levels used in retracement analysis are 61.8 per cent, 38 per cent and 50 per cent.

When a move starts to reverse the three price levels are calculated (and drawn using horizontal lines) using movements from low to high. These retracement levels are then interpreted as likely levels where counter moves will stop.

Head and shoulders pattern

This can also be inverted. It is a reversal pattern and is one of the more common and reliable patterns. It is comprised of a rally which ends a fairly extensive advance. It is followed by a reaction on less volume.

This is the left shoulder. The head is comprised of a rally up on high volume exceeding the price of the previous rally. And the head is completed by a reaction down to the previous bottom on light volume.

The right shoulder is comprised of a rally up which fails to exceed the height of the head. It is then followed by a reaction down. The last reaction down should break a horizontal line drawn along the bottoms of the previous lows from the left shoulder and head. This is the point in which the major decline begins.

The major difference between a head and shoulder top and bottom is that the bottom should have a large burst of activity on the breakout.

KST

Short for know sure thing, the KST indicator was developed by Martin Pring. A weighted summed rate of change oscillator. Four different rates of change are calculated, smoothed, multiplied by weights and then summed to form one indicator.

Moving averages convergence/divergence (MACD)

The crossing of two exponentially smoothed moving averages. They oscillate above and below an equilibrium line.

Negative divergence

When two or more indicators, indices or averages fail to show confirming trends.

Relative strength index (RSI)

RSI is an oscillator first introduced in 1978 by Welles Wilder in Commodities (now Futures) Magazine.

The RSI compares the magnitude of a stock's recent gains to the magnitude of its recent losses on a scale from 0 to 100. When using RSI as an overbought/oversold indicator, Wilder recommended using levels of 70 or more as overbought and 30 and below as oversold. Generally, if the RSI rises above 70 it is considered bullish for the underlying stock. Conversely, if the RSI falls below 30, it is a bearish signal.

Relative strength

A comparison of an individual stock's performance to that of a market index. Most times the S&P 500 or the Dow Jones Industrial Index are used for comparison purposes. It is calculated by dividing the stock price by the index price.

A rising line indicates that the stock is doing better than the markets. A declining line indicates that the stock is not doing as well as the markets.

Resistance

A price level where a security's price stops rising and moves sideways or downward. It indicates an abundance of supply. Because of this, the stock may have difficulty rising above this level. There are short-term and longer-term resistance levels.

Support

A price level at which declining prices stop falling and move sideways or upward. It is a price level where there is sufficient demand to stop the price from falling.

Trendline

Constructed by connecting a series of descending peaks or ascending troughs. The more times a trendline has been touched increase the significance of a break in the trendline. It can act as either support or resistance.

Books recommended by experts

Market Wizards	by	Jack D Schwager
Stock Market Logic	by	Norman G Fosback
How To Make Money In Stocks	by	William J O'Neil
Street Smarts	by	Laurence A Connors and Linda Bradford Raschke
Smarter Trading	by	Perry J Kaufman
Winning On Wall Street	by	Martin Zweig
Technical Analysis Explained	by	Martin Pring
Beyond Candlesticks	by	Steve Nison
Elliott Wave Theory	by	Weiss Research, Frost and Pretcher
Dow Theory and Basics	by	Martin Pring, John Magee and John Murphy