First Attempt on Tech Analysis (Part 1)

I have been talking fundamental all the while, actually since I started 2 years ago but a recent visit to iCap investor day in KLCC on 14th August 2010 made me think twice. Should I embrace value investing which is not only fundamental but takes into account the technical side? and to look into economic indicators. Putting aside economic indicators as out of this scope, I am going to show my first attempts into technical analysis.

Like financial ratios used in fundamental analysis, technical has its many various forms of indicators but only a handful are needed to paint a relatively good picture. You can get the charting tool here from TradeSignum. It took me 4 hours to learn plus writing this down so let's get down to the first indicator of the series. Not difficult, I bet you can do it too.

Relative Strength Indicator (RSI)

A momentum oscillator between zero and 100 that measures the speed and change of price movements. RSI is considered overbought when above 70 and oversold when below 30. Signals or trends can also be generated by looking for divergences, failure swings and centerline crossovers. RSI has weakness too as shown below example.

Overbought-oversold and Trend Identification

Chart Setting: SMA 1, RSI (14, 20), Jan'09 to Aug'10

A momentum oscillator like RSI can be misleading during strong trends, as you can see it shows many overbought signals when market is actually bullish and going up higher and higher. How do I counter-validate it, is by using the RSI itself looking at the 40-50 barrier as the support line. You can see there were 2 overshoots also. These are known as pullbacks that offer lower risk entry points during bullish times. Now you would ask me how do I know the overshoot might be signaling a reverse trend or just mere correction?

Failure swings

Is a strong indication of an impending reversal. Failure swings are independent of price action and the swings purely focus on RSI for signals and ignore the concept of divergences (I will explain this further down). Example below shows that it needs to fulfill these four criteria in order meet a bullish failure swing. In short the market is still being supported from falling down. (I know is small but I had to use KLCI as a good example).

Chart Setting: SMA 1, RSI (14, 20), Jan'10 to Aug'10

I will ignore the first overshoot and consider as minor correction. You can see a mini tiny swing so it is too small to show an impending reversal and just breached a small portion below 30. No concern there.

Divergence

Divergence signal is a potential reversal point because directional momentum which the the bottom one does not confirm price which is higher high. Just picture a car going uphill when there is no more momentum. How far can it go? Pretty common sense, this is why there was a correction at that time. With the help of the previous bullish failure signal and renewed momentum price is still supported moving forward after correction.

Chart Setting: SMA 1, RSI (14, 20), Jan'10 to Aug'10

So what about the current KLCI? It is trending up or down? From RSI alone it shows a few things.

1. Overbought signal still appearing but at levels nearer and nearer to 70 telling me lack of momentum to go higher at faster speeds.
2. 40-50 support line is still unbroken. Until it is broken it is not assumed to undergo another swing test.
3. Possible new divergence to bearish again as RSI is now at above 70 region. Perhaps another correction in sight.

KLCI is going to be boring unless there is a break in support line to keep investors on the edges of a correction or a full swing bear attack. In my opinion there is no more momentum to go up more. A speculated driven momentum will drive it higher only to see it go into correction very soon.

Need to sleep lio

The key in using technical indicators is to know how to use it, when to use it and how to interpret the meaning of the chart. I wouldn't want to use technical indicators for individual stocks yet but it looks worthwhile to further explore it by applying it on the KLCI. A value investor should be in my renewed understanding haha 80% fundamental, 20% technical. There are still two more tech indicators (stochastic and MACD) which I am studying and they are also widely used in the many analyst reports, mags and new cuts. Leave that for Part 2.

I am sure you would want to know if the KLCI can peak further or start to have some correction or even worse....I din say ah.