The bandwagon of the Stock market and trading gyaan continues, as we reach the land of trading techniques today! Notably, the Indian stock market has come a long way since its inception in the mid-19th century. What began as a group of brokers meeting under a banyan tree in Mumbai has now transformed into a technologically advanced trading platform that witnesses millions of dollars worth of trades every day. As the market evolved, so did the techniques used to analyze and trade it. Three such techniques that have stood the test of time and are widely used even today are the Dow Theory of trading, support and resistance, and the use of RSI/MACD indicators. The idea today is simple, with the Indian stock market continuing to attract investors from around the world, it is important to understand the tools and techniques used in trading. In this blog, we will delve deeper into these three techniques,
And so we begin, let’s start with Dow Theory 👉
The Dow Theory is a way of analyzing the stock market that was developed by Charles Dow in the late 19th century. The theory is based on the idea that the market moves in trends and that these trends can be identified and used to make trading decisions.
Breaking it down further, there are two types of trends: primary trends, which can last for months or years, and secondary trends, which can last for weeks or months. The Dow Theory is based on six basic principles, which include the idea that the market discounts everything, that there are three types of trends, and that trends are confirmed by volume.
Example: Let’s say that you are analyzing the stock market using the Dow Theory and you notice that the market is in a primary uptrend. This means that the overall trend is upward, and you may want to consider buying stocks that are likely to benefit from this trend.
Interesting right? For the curious souls, Charles Dow, who developed the Dow Theory, was also one of the founders of Dow Jones & Company, which publishes the famous Dow Jones Industrial Average (DJIA). The DJIA is a stock market index that tracks the performance of 30 large, publicly traded companies in the United States.
What’s support? Where do we see resistance in the market?
These are 2 basic yet extremely important terms – and people do get confused between them or use them interchangeably without getting the fundamentals right.
To make things interesting, Let’s say you are climbing the famous Half Dome mountain in Yosemite National Park. Half Dome is known for its steep ascent and challenging terrain, ( P.S: Adventure folks, make this your next destination 🙋)
Site 1: You climb Half Dome and you encounter several support levels, such as flat areas or ledges where you can rest and catch your breath. These support levels provide a temporary reprieve from the difficult climb and allow you to continue your ascent.
However, you soon reach Site 2, where you encounter several resistance levels, such as steep cliffs or overhangs that make it difficult to continue your ascent. These resistance levels force you to stop and reassess your strategy before attempting to continue.
In trading, support and resistance levels act in a similar way. Support levels provide a place for traders to buy and catch their breath before continuing their ascent, while resistance levels force traders to sell and reassess their strategy before attempting to continue.
And so, from a technical point of view, Support is a level at which buying pressure is strong enough to prevent the price of an asset from falling further, while resistance is a level at which selling pressure is strong enough to prevent the price of an asset from rising further.
Example: Let’s say that a stock has been trading in a range between ₹50 and ₹80 for several months. You notice that every time the stock approaches ₹50, there is a lot of buying activity that prevents the stock from falling further. This ₹50 level is a support level.
On the other hand, you notice that every time the stock approaches ₹80, there is a lot of selling activity that prevents the stock from rising further. This ₹80 level is a resistance level.
Circling back to where we started, like climbing Half Dome, navigating support and resistance levels in trading requires patience, strategy, and a willingness to overcome obstacles. By understanding these levels and how they impact price movements, traders can make informed decisions and successfully navigate the ups and downs of the market.
And so, what’s the RSI + MACD concept all about? 🤔
The Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) are two technical indicators that traders use to help identify potential buying and selling opportunities. The RSI measures the strength of a stock’s recent price movements, while the MACD measures the relationship between two moving averages of a stock’s price.
To put it simply, RSI helps traders identify overbought and oversold conditions of a particular stock ( or even a security/asset )
While the MACD helps traders identify changes in momentum and trend direction. These indicators can be used together or separately to help traders make informed decisions and improve their trading strategies.
Example: Let’s say that you are analyzing a stock using the RSI and MACD indicators. You notice that the RSI has been trending upward, indicating that the stock’s recent price movements have been strong. You also notice that the MACD has crossed above its signal line, which can be a bullish signal indicating that the stock’s price is likely to rise. Based on these indicators, you may want to consider buying the stock.
( P.S: not investment advice, always research by yourself)
Without a doubt, The RSI and MACD are critical indicators, however, they are just two of many technical indicators that traders use to analyze the financial markets. There are dozens of other indicators, each with its own unique approach and methodology. Ask a trader friend what he or she swear by!
The third act: Indicators strong together 💪
Let’s say that you are a pro trader who is using the Dow Theory, support and resistance levels, and technical indicators like the RSI and MACD to analyze the stock market.
One day, you notice that the market is in a primary uptrend and that there is a strong support level at ₹100 for stock XYZ Corp. on NSE. You also notice that the RSI and MACD are both indicating that the stock is oversold, which means that it may be a good time to buy.
Based on this analysis, you decide to buy this stock at ₹100 with a stop loss set at ₹95, just below the support level. Over the next few weeks, the stock continues to rise, and you notice that there is a strong resistance level at ₹120. You decide to sell the stock at ₹120, taking a profit of ₹20 per share. Master of the trades, eh?
Back to where we started, the Dow Theory helped you identify the overall trend of the market, support and resistance levels helped you identify potential entry and exit points, and technical indicators like the RSI and MACD helped confirm those entry and exit points. By combining all of these concepts together, you were able to make a profitable trade decision. And so, that is all we have today! If you’re keen on learning more – you can read these resources ↘️
A comprehensive article that focuses on charting support & resistance in assets https://school.stockcharts.com/doku.php?id=chart_analysis:support_and_resistance
A (very) deep dive into the tenets of Dow Theory and how it came into practice >
Want to see another implementation of RSI? Here you go >
Another take at calculating RSI >