TECHNICAL ANALYSIS

TECHNICAL ANALYSISThere are two approaches to security analysis;

1. Fundamental2. Technical

Technical analysis is a process of identifying trend and trend reversals at earlier stage to formulate the buying and selling strategy.

It is the study of market action for the purpose of forecasting future price trends.

It will give information regarding the most appropriate time to buy and to sell a share

A technical analysist believes that share price is determined by the demand and supply forces in the market

He concentrate on the movement of share prices(examines the past share price movements and make accurate prediction of future share prices)

Technical analysis is the name given to forecasting techniques that utilise historical share price data

The rationale behind this analysis is that share price behaviour repeats itself over time and analysts attempt to derive methods to predict this repetition

BASIC PRINCIPLES OF TECHNICAL ANALYSIS

The market value of security is related to demand and supply factors in the market

There are both rational and irrational factors which surround the demand and supply of securities

Security prices behave in a manner that their movement is continous in a particular direction for some length of time

Trends in stock prices have been seen to change according to the demand and supply factors

The shifts of demand and supply can be detected through charts prepared specially to show market action

Patterns which is projected by charts record price movements and these are used by the analyst to make forecasts about the movement of the share prices in future

TECHNICAL TOOLS Dow theory

Bars and line charts(Price patterns)

Short selling

Volume of trading

Moving averages

Oscillators

Elliot wave theory

Breadth of the market

1.DOW THEORY Technical analysis has its roots in the

Dow theory It was formulated by Charles H Dow The theory was presented in a series of

editorials in the Wall streey Journal in USA during 1900 – 1902

Charles Dow formulated a hypothesis that the stock market does not move on a random basis but is influenced by three distinct cyclical trends that guide its direction. According to Dow theory,the market has three movements and these movements are simultaneous in nature. They are;

Primary movements(primary trend) Secondary reactions(secondary trend) Minor movements(minor trend)

Primary movement: It is the long range cycle that carries the entire market up or down. This is the long term trend in the market and is considered to be more important movement which may last for one or two years

Secondary reactions: It act as the restraining force on the primary movement. These are in the opposite direction to the primary movement and it last only for a short while(3 weeks into 3 months)

Minor movements: These are the day to day fluctuations in the market. These are not significant and have no analytical value as they are of short duration. Also known as oscillations

Primary trend

Secondary trend

Days

price

2.PRICE CHARTSCharting represents a key activity in technical

analysis because graphical representation is the very basis of technical analysis. The security prices are charted on each day. The important four prices are charted they are highest price,lowest price,opening price,closing price

Line chart(closing chart) Bar chart Japaneese candle stick chart(white,black

and Doji candle sticks)

3.PRICE PATTERNS Support and resistance patterns:

Support occurs when share price is falling. It exists at a considerable price and prevents further fall in the price level. Resistance occurs when price moves upwards. It is exerted to prevent the ongoing rise in the share price

Reversal patterns: Head and shoulder formation Inverse head and shoulder formation

Continuation patterns Triangles Flags pennants

4.VOLUME OF TRADEIt is used as a technical indicator to find

out the direction of overall market. Technical analyst used volume as an excellent method of confirming the trend. Volume expands along with the bull market and narrows down in the bear market.

Large volume with rise in price indicates bull market

Large volume with fall in price indicates bear market

5.MOVING AVERAGEMoving averages are used to study the

movement of the market as well as the individual scrip price.

These are mathematical indicators of the underlying trend of the price movement.

The moving average indicates the underlying trend in the scrip. The period of average determines the period of trend that is being identified. For identifying short term trend,10 day to 30 day moving averages are used,medium term – 50 to 125 and for long term trend – 200 day moving averages are used

6.OSCILLATORSThese are the mathematical indicators calculated with the help of the

closing price data. They help to identify the overbought and oversold conditions and also the possibility of trend reversals.They are analyzed along with price charts. A technician will use oscillators when the charts are not showing a definite trend in either direction.

Rate of change indicator

CURRENT PRICE

ROC = ………………………. _ 1

PRICE ‘n’ PERIOD AGO

Relative strength index (RSI) = 100 – [100/1+RS]

AVERAGE GAIN PER DAY

RS = …………………………………..

AVERAGE LOSS PER DAY

7.SHORT SALES/SHORT INTERESTShort sales refers to the selling of shares

in the hope of purchasing it at a lower price in future to make profits. This sellers are known as short sellers usually bears.

The short positions of scripts are published in the business newspapers. The volume of short sales in the market can be used as a market indicator.

6. MOMENTUM Momentum is perhaps the simplest and easiest oscillator

to understand and use; it is the measurement of the speed or velocity of price changes.

"Market momentum is measured by continually taking price differences for a fixed time interval. To construct a 10-day momentum line, simply subtract the closing price 10 days ago from the last closing price. This positive or negative value is then plotted around a zero line. The formula for momentum is:

M = V – Vx Where V is the latest price, Vx is the closing price x number of days ago."Momentum measures the rate of the rise or fall in stock prices. 

8.ELLIOT WAVE THEORY Formulated by Ralph Elliot It was formulated in 1934 after

analysing 75 years of stock price movements and charts

He concluded from the study that the market movement was quite orderly and followed a pattern of waves.

The waves are the result of buying and selling impulses emerging from the demand and supply pressures on the market

Movement in a particular direction can be represented by 5 ditinct waves – 3 impulse waves and 2 corrective(reaction) waves

This theory is based on the principle that action is followed by reaction

It is used for predicting the future price changes and in deciding the timing of investment

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9. BREADTH OF THE MARKET By comparing the number of shares

which advanced and the number of shares that declined during a period, the trend of the market can be ascertained

The cumulative difference between advances and declines is called breadth of the market