PROJECT ON

TECHNICAL ANALYSIS OF EQUITIES

A PROJECT SUBMITTED IN PART COMPLETION OF MASTERS IN FINANCIAL MANAGEMENT

DANIEL BABU P MFM SEM V, ROLL NO. 41 BATCH 2008 2011

UNDER THE GUIDANCE OF PROF. A K PRADHAN

K J SOMAIYA OF MANAGEMENT STUDIES & RESEARCH Vidyanagar,Vidyavihar(E). Mumbai - 400077.

CERTIFICATE
This is to certify that the study presented by DANIEL BABU P to K J SOMAIYA INSTITUTE OF MANAGEMENT STUDIES & RESEARCH in part

completion of MASTERS IN FINANCIAL MANAGEMENT on TECHNICAL ANALYSIS OF EQUITIES has been done under my guidance in the year 2008 2011.

The Project is in the nature of Original Work that has not so far been submitted for any other course in this Institute or any other Institute. Reference of work and relative sources of information has been given at the end of the project.

Signature of the Candidate (Daniel Babu P)

Forwarded through the Research Guide

Signature of the Guide (Prof. AK Pradhan)

TECHNICAL ANALYSIS OF EQUITIES

DECLARATION

I Daniel Babu P, a Student of MFM SEM V of University of Mumbai, 2008 2011 Batch at SIMSR do hereby declare that this project report entitled Technical Analysis of Equities has been carried out by me during this semester under the guidance of Prof. A.K Pradhan as per the norms prescribed by university of

Mumbai & the same work has not been copied from any sources directly without authenticating for the part / section that has been adopted from published / non published work.

I further declare that the information presented in this project is true & original to the best of my knowledge.

Date: Place: Mumbai DANIEL BABU P

TECHNICAL ANALYSIS OF EQUITIES

ACKNOWLEDGEMENT

I wish to accord my sincere gratitude to the KJ Somaiya Institute of Management Studies & Research for their Support and cooperation.

I thank Prof. AK Pradhan for his Support and Guidance, without whom the Project would not have been possible.

Also, the support of my colleagues was indispensable as their points and approach has helped me to achieve success in my project.

DANIEL BABU P

TECHNICAL ANALYSIS OF EQUITIES

Contents
EXECUTIVE SUMMARY ........................................................................................... 6 INTRODUCTION TO TECHNICAL ANALYSIS....................................................... 7 BASICS OF TECHNICAL ANALYSIS ..................................................................... 11 CHARTS PATTERNS AND TRENDS. ..................................................................... 15 MOVING AVERAGES ............................................................................................... 25 INDICATORS AND OSCILLATORS........................................................................ 30 OVERLAYS ................................................................................................................ 39 REAL LIFE PREDICTION AND OUTCOMES ........................................................ 44 SELECTION OF INDICATORS/OSCILLATORS/OVERLAYS .............................. 55 STEPS IN TECHNICAL ANALYSIS ........................................................................ 59 CONCLUSIONS.......................................................................................................... 62 BIBLIOGRAPHY OF REFERENCES...................................................................... 62

TECHNICAL ANALYSIS OF EQUITIES

EXECUTIVE SUMMARY
The cornerstone of the technical analysis is the belief that all of the factors that influence market pricefundamental information, political events, natural disasters, and psychological factorsare quickly discounted in market activity. NEED FOR THE PROJECT: Stock analysis today is a combination of both the fundamental analysis and the technical or chart analysis. Fundamental analysis affects technical analysis. It is important to time entry and exits, and use spreads to manage risk. In this context, study and evaluation of various charting techniques is taken up with respect to its application area. OBJECTIVES : Study of reversal and continuation chart patterns, trends, gaps, indicators, market profiling using Elliot wave theory, Fibonacci sequences etc. Identifying the market condition and applying the appropriate indicator and tools. Usage of multiple such tools to finalize the strategy. Selection of tools (indicators and functions) for technical analysis. Survey and evaluation of various software tools for pointers, scaling etc, platforms available for technical analysis. Testing of historical charts of various companies in different sectors /segments. METHODOLOGY : Various indicators and functions for technical analysis were studied and suitable ones were selected for selection of economic environment of investing (market, micro and macro indicators). Next step involved selection of sectors and companies for investing. For individual equity analysis Excel Add-In tool Analyzer XL was used. For proving technical analysis Top 5 picks of the day appearing in Economic times are taken and the tools and functions used are applied. The market movements are followed and the success/failure reasons of the prediction are analyzed.

TECHNICAL ANALYSIS OF EQUITIES

INTRODUCTION TO TECHNICAL ANALYSIS

In finance, technical analysis is a security analysis discipline for forecasting the direction of prices through the study of past market data, primarily price and volume. Technical analysis is a method of evaluating securities by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Technical analysis can be used on any security with historical trading data. This includes stocks, futures and commodities, fixed-income securities, forex, etc. In fact, technical analysis is more frequently associated with commodities and forex, where the participants are predominantly traders. Just as there are many investment styles on the fundamental side, there are also many different types of technical traders. Some rely on chart patterns, others use technical indicators and oscillators, and most use some combination of the two. In any case, technical analysts' exclusive use of historical price and volume data is what separates them from their fundamental counterparts. Unlike fundamental analysts, technical analysts don't care whether a stock is undervalued - the only thing that matters is a security's past trading data and what information this data can provide about where the security might move in the future. The field of technical analysis is based on three assumptions: 1. The Market Discounts Everything A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of the company. However, technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company - including fundamental factors. Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market.
TECHNICAL ANALYSIS OF EQUITIES

2. Price Moves in Trends In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption. 3. History Tends To Repeat Itself Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends. Although many of these charts have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves. Technical analysis is a methodology to assist in deciding the timing of investments, which is very vital to make wise investment decisions. Few of the most commonly used technical analysis methods for capital market are Japanese Candlestick, Price Curves, Trend Lines, High Low Charts and Moving averages Need for technical Analysis. A logical question is: What does technical analysis do? The answer is that the ability to recognize when a stock has reached a support or resistance level, or a shift in perceptions takes place, can help investors know whether to use the: buy low, sell high approach, or buy high, sell higher approach, or whether to buy the stock at all. The ability to apply this one aspect of chart reading will reveal the market to investors with the same impact as understanding the colours of a traffic light. Once you know that green means go and red means stop, you will know when it is safe to buy or not.

TECHNICAL ANALYSIS OF EQUITIES

Weve touched upon some of the reasons to use technical analysis, such as the lack of data revisions, estimates and subjectivity in its inputs. But as important as it is to know when to buy a stock it is equally, if not more, important to know when not to buy a stock, or when to sell a stock already held. Technical analysis is the only investment decision-making discipline that lets you know when you are wrong sooner, rather than later, to minimize losses.

When not to use it? Since technical analysis is based on crowd psychology and actions of the masses, it works best when there is a crowd to analyze. That means the best analysis occurs on liquid stocks where there are plenty of bulls and bears at work and a critical mass of money value changes hands each day. What constitutes critical mass is subjective, but many investors use a rule of thumb of stock price above Rs.20 and average daily trading volume above 100,000 shares. Certainly we can tinker with these parameters as we gain experience. Technical analysis also needs relatively normal market conditions. War, terrorism, takeovers, legislation and litigation trump support and resistance, although it does help during these unusual conditions to know where investors found value in the past.

Everything supports price A diagram resembling a table is used to stock prices. The price of the stock or commodity is the top of the table. Indicators such as momentum, sentiment, volume and anything else we can create, are the legs of the table. Everything is there to support the price and as long as we keep this in mind we will be properly focused on what we are doing. The stronger the legs the better the table (investment).

Price is the only thing that matters at the end of the day. It is what we say when someone asks where a stock is today and it is the only way we judge our investing success. Price rules and it is entirely possible to analyze a chart without any of the other supporting indicators.

TECHNICAL ANALYSIS OF EQUITIES

Price The stuff you put in the bank. Clearly, this is the most important component as we measure our success in monetary terms. It only matters if we have more money after investing than when we started and that is measured by price.

Other parameters help in understanding the problem. Volume How much money is moving. If price tells us what is going on, volume tells us how much is going on. Chart analysis depends on liquidity and crowd psychology, so the more shares of stock that are traded, the more reliable the analysis can be. Momentum How fast it got there. It is important to know how eager the crowd is to buy and sell because if it gets over enthused it will push prices out of equilibrium. Prices that move too far, too fast are prone to snapbacks. Structure The structure of the market refers to how it got to where it is now and we understand that by studying trends and patterns. As stocks trade, their ups and downs form patterns on the charts. Analysis of trends and patterns help us sort it all out and give us clear guidelines to know when a trend changes to a pattern or a pattern changes into a trend. Sentiment How people feel about the market. Contrarianism is based on the idea that the crowd gets it wrong when bull markets are changing to bear and vice versa. The masses seem to pile into the market just at the wrong time, but we must look at it in reverse. Just when everyone is buying, for example, is the wrong time to own stocks. Demand becomes exhausted and without demand, prices must stop going up, if not fall. So, when sentiment indicators reach extreme optimism or pessimism, the prevailing trend is likely to be nearing its end.

TECHNICAL ANALYSIS OF EQUITIES

10

BASICS OF TECHNICAL ANALYSIS

SUPPORT & RESISTANCE Security prices are the result of a head-to-head battle between a bull (the buyer) and a bear (the seller). The bulls push prices higher and the bears push prices lower. The direction prices actually move reveals who is winning the battle. Using this analogy, consider the price action of Phillip Morris in Figure below. During the period shown, note how each time prices fell to the $45.50 level, the bulls (i.e., the buyers) took control and prevented prices from falling further. That means that at the price of $45.50, buyers felt that investing in Phillip Morris was worthwhile (and sellers were not willing to sell for less than $45.50). This type of price action is referred to as support, because buyers are supporting the price of $45.50.

Similar to support, a "resistance" level is the point at which sellers take control of prices and prevent them from rising higher. Consider Figure in right. Note how each time prices neared the level of $51.50, sellers outnumbered buyers and prevented the price from rising.

The price at which a trade takes place is the price at which a bull and bear agree to do business. It represents the consensus of their expectations. The bulls think prices will move higher and the bears think prices will move lower. Support levels indicate the price where the majority of investors believe that prices will move higher, and resistance levels indicate the price at which a majority of investors feel prices will move lower.
TECHNICAL ANALYSIS OF EQUITIES

11

But investor expectations change with time! For a long time investors did not expect the Dow Industrials to rise above 1,000 (as shown by the heavy resistance at 1,000 in Figure below). Yet only a few years later, investors were willing to trade with the Dow near 2,500.

When investor expectations change, they often do so abruptly. Note how when prices rose above the resistance level of Hasbro Inc. in Figure 9, they did so decisively. Note too, that the breakout above the resistance level was accompanied with a significant increase in volume.

Once investors accepted that Hasbro could trade above $20.00, more investors were willing to buy it at higher levels (causing both prices and volume to increase). Similarly, sellers who would previously have sold when prices approached $20.00 also began to expect prices to move higher and were no longer willing to sell.
TECHNICAL ANALYSIS OF EQUITIES

12

The development of support and resistance levels is probably the most noticeable and reoccurring event on price charts. The penetration of support/resistance levels can be triggered by fundamental changes that are above or below investor expectations (e.g., changes in earnings, management, competition, etc) or by self-fulfilling prophecy ( investors buy as they see prices rise). The cause is not as significant as the effect--new expectations lead to new price levels. Figure below in left shows a breakout caused by fundamental factors. The breakout occurred when Snapple released a higher than expected earnings report. How do we know it was higher than expectations? By the resulting change in prices following the report!

Other support/resistance levels are more emotional. For example, the DJIA had a tough time changing investor expectations when it neared 3,000 (see Figure above right).

Supply and demand There is nothing mysterious about support and resistance--it is classic supply and demand. Remembering "Econ 101" class, supply/demand lines show what the supply and demand will be at a given price. The "supply" line shows the quantity (i.e., the number of shares) that sellers are willing to supply at a given price. When prices increase, the quantity of sellers also increases as more investors are willing to sell at these higher prices. The "demand" line shows the number of shares that buyers are willing to buy at a given price. When prices increase, the quantity of buyers decreases as fewer investors are willing to buy at higher prices.
TECHNICAL ANALYSIS OF EQUITIES

13

At any given price, a supply/demand chart shows how many buyers and sellers there are. For example, the following chart shows that, at the price of 42-1/2, there will be 10 buyers and 25 sellers.

Support occurs at the price where the supply line touches the left side of the chart (e.g., 27-1/2 on the above chart). Prices can't fall below this amount, because no sellers are willing to sell at these prices. Resistance occurs at the price where the demand line touches the left side of the chart (e.g., 47-1/2). Prices can't rise above this amount, because there are no buyers willing to buy at these prices.

In a free market these lines are continually changing. As investor expectations change, so do the prices buyers and sellers feel are acceptable. A breakout above a resistance level is evidence of an upward shift in the demand line as more buyers become willing to buy at higher prices. Similarly, the failure of a support level shows that the supply line has shifted downward. The foundation of most technical analysis tools is rooted in the concept of supply and demand. Charts of security prices give us a superb view of these forces in action.

TECHNICAL ANALYSIS OF EQUITIES

14

CHARTS PATTERNS AND TRENDS.

CHARTS The foundation of technical analysis is the chart. In this case, a picture truly is worth a thousand words. Line charts A line chart is the simplest type of chart. As shown in the chart of General Motors in Figure below, the single line represents the security's closing price on each day. Dates are displayed along the bottom of the chart and prices are displayed on the side(s).

A line chart's strength comes from its simplicity. Line charts are typically displayed using a security's closing prices.

Bar charts A bar chart displays a security's open (if available), high, low, and closing prices. Bar charts are the most popular type of security chart. As illustrated in the bar chart in Figure below, the top of each vertical bar represents the highest price that the security traded during the period, and the bottom of the bar represents the lowest price that it traded. A closing "tick" is displayed on the right side of the bar to designate the last price that the security traded. If opening prices are available, they are signified by a tick on the left side of the bar.

TECHNICAL ANALYSIS OF EQUITIES

15

Volume bar chart Volume is usually displayed as a bar graph at the bottom of the chart (see Figure below). Most analysts only monitor the relative level of volume and as such, a volume scale is often not displayed.

Figure on left displays "zero-based" volume. This means the bottom of each volume bar represents the value of zero. However, most analysts prefer to see volume that is "relative adjusted" rather than zero-based. This is done by subtracting the lowest volume that occurred during the period displayed from all of the volume bars. Relative adjusted volume bars make it easier to see trends in volume by ignoring the minimum daily volume. Figure on right displays the same volume information as in the previous chart, but this volume is relative adjusted. OHLC "Bar Charts" Open-High-Low-Close charts, also known as bar charts, plot the span between the high and low prices of a trading period as a vertical line segment at the trading time, and the open and close prices with horizontal tick marks on the range line, usually a tick to the left for the open price and a tick to the right for the closing price.

TECHNICAL ANALYSIS OF EQUITIES

16

Candlestick chart Of Japanese origin and similar to OHLC, candlesticks widen and fill the interval between the open and close prices to emphasize the open/close relationship. In the West, often black or red candle bodies represent a close lower than the open, while white, green or blue candles represent a close higher than the open price.

Point and figure chart A chart type employing numerical filters with only passing references to time, and which ignores time entirely in its construction.

TRENDS A trend is the market in motion, and a pattern is the market at rest, deciding if it wants to continue its trend or change course.

A trend is really nothing more than a somewhat uniform change in price levels over time. For a rising, or bull trend, prices start low and through a series of fits and starts, advances and pullbacks, move to a higher level. Some trends are smooth and have
TECHNICAL ANALYSIS OF EQUITIES

17

small wiggles within. Others are choppy and are characterized by high volatility. Some are flat with little net gain over time, and others are steep with a sharp increase in relatively little time.

Support and resistance levels can be penetrated by a change in investor expectations (which results in shifts of the supply/demand lines). This type of a change is often abrupt and "news based."

A trend represents a consistent change in prices (i.e., a change in investor expectations). Trends differ from support/resistance levels in that trends represent change, whereas support/resistance levels represent barriers to change. As shown in Figure below, a rising trend is defined by successively higher low-prices. A rising trend can be thought of as a rising support level--the bulls are in control and are pushing prices higher.

Figure below shows a falling trend. A falling trend is defined by successively lower high-prices. A falling trend can be thought of as a falling resistance level--the bears are in control and are pushing prices lower.

TECHNICAL ANALYSIS OF EQUITIES

18

Just as prices penetrate support and resistance levels when expectations change, prices can penetrate rising and falling trend lines. Figure below shows the penetration of Merck's falling trend line as investors no longer expected lower prices. Note in Figure below how volume increased when the trend line was penetrated. This is an important confirmation that the previous trend is no longer intact.

Again, volume is the key to determining the significance of the penetration of a trend. In the above example, volume increased when the trend was penetrated, and was weak as the bulls tried to move prices back above the trend line.
Indicator Alert Trend Description

Long Term Upward A long term (6 months) upward sloping trading channel exists with the Sloping Trading highs and lows ->long term very bullish Channel Intermediate Term Upward Sloping Trading Channel A midterm (3 months) upward sloping trading channel exists with the highs and lows -> midterm very bullish

Trend

Trend

Short Term Upward A short term (1 month) upward sloping trading channel exists with the Sloping Trading highs and lows ->short term very bullish Channel Long Term Downward Sloping Trading Channel Intermediate Term Downward Sloping Trading Channel Short Term Downward Sloping Trading Channel Long Term Bullish Breakout Intermediate Term Bullish Breakout A long term (6 months) downward sloping trading channel exists with the highs and lows ->long term very bearish A midterm (3 months) downward sloping trading channel exists with the highs and lows -> midterm very bearish A short term (1 month) downward sloping trading channel exists with the highs and lows ->short term very bearish A long term (6 months) downward trend in the highs has been broken>Long term bullish A midterm (3 months) downward trend in the highs has been broken>Midterm bullish TECHNICAL ANALYSIS OF EQUITIES

Trend

Trend

Trend Trend Trend

19

Trend Trend Trend Trend

Short Term Bullish Breakout Long Term Bearish Breakout Intermediate Term Bearish Breakout Short Term Bearish Breakout

A midterm (1 month) downward trend in the highs has been broken>Short term bullish A long term (6 months) upward trend in the lows has been broken>Long term very bearish A midterm (3 months) upward trend in the lows has been broken>Midterm very bearish A short term (1 month) upward trend in the lows has been broken>Short term very bearish

PATTERNS. Rectangles (Trading Ranges)

Rectangle patterns contain the up and down wiggles of a sideways moving market. All chart patterns are derivatives of this basic trading range. Some have steady support levels but falling resistance levels over time. Others show support and resistance levels converging, forming a pennant shape. But no matter what the shape, all patterns are the same in that the stock is moving sideways rather than trending higher or lower, and breakouts above or below these patterns tell us that either demand or supply, respectively, has taken control. The bottom line is that patterns and trends on charts yield clues as to the relationship between bulls and bears and when that relationship changes. We do not have to know why it changed other than it did change, and when we can identify it we can take appropriate action either buy, sell or hold. Triangles This type of continuation pattern has converging lines of support and resistance. Many analysts refer to triangles as coils because the trading action gets tighter and tighter, storing energy until the market breaks out with great force. The breakout usually, but not always, occurs in the direction of the original trend.

TECHNICAL ANALYSIS OF EQUITIES

20

A long-term chart of Google shows a very clear series of rising bottoms and falling tops to create a triangle shape (see Chart above). Each swing higher and lower within the pattern is marked with increased uncertainly as both bulls and bears lose conviction. Bulls are taking short-term profits sooner and sooner on each rally and, conversely, bears are covering their short positions sooner on each decline. The market is waiting for something to unleash the energy building in this coiling action and in September 2006, Google finally got that spark. The rally from the breakout point was swift.

Flags The most common of the continuation patterns is called a flag because it resembles a flag flying on a flagpole. When a market is trending higher, it is more common for it to slowly give back some of those gains as the bulls take some profits. Since traders do not all do this at the same time, the market displays a small counter trend lower as more of them take their profits. When this is over, the market generally breaks out in the direction of the original trend as the bulls take over again.

TECHNICAL ANALYSIS OF EQUITIES

21

Goldman Sachs was participating in the broad market rally that began in March 2003 (see Chart above). In late April, it settled into a corrective decline that was relatively shallow and orderly. Lower highs and lower lows formed the pattern and when prices moved above the upper border, the rally resumed. The correction was over. REVERSAL PATTERNS The Head and Shoulders The head and shoulders is the best known and probably the most reliable of the reversal patterns. A head and shoulders top is characterized by three prominent market peaks. The middle peak, or the head, is higher than the two surrounding peaks (the shoulders). A trend line (the neckline) is drawn below the two intervening reaction lows. A close below the neckline completes the pattern and signals an important market reversal (See Figure below). Price objectives or targets can be determined by measuring the shapes of the various price patterns. The measuring technique in a topping pattern is to measure the vertical distance from the top of the head to the neckline and to project the distance downward from the point where the neckline is broken. The head and shoulders bottom is the same as the top except that it is turned upside down.

TECHNICAL ANALYSIS OF EQUITIES

22

Double and Triple Tops and Bottoms Another one of the reversal patterns, the triple top or bottom, is a variation of the head and shoulders. The only difference is bottom is that the three peaks or troughs in this pattern occur at about the same level.

Triple tops or bottoms and the head and shoulders reversal pattern are interpreted in similar fashion and mean essentially the same thing. Double tops and bottoms (also called Ms and Ws because of their shape) show two prominent peaks or troughs instead of three. A double top is identified by two prominent peaks. The inability of the second peak to move above the first peak is the first sign of weakness. When prices then decline and move under the middle trough, the double top is completed. The measuring technique for the double top is also based on the height of the pattern. The height of the pattern is measured and projected downward from the point where the trough is broken. The double bottom is the mirror image of the top

Saucers and Spikes

These two patterns arent as common, but are seen enough to warrant discussion. The spike top (also called a V-reversal) pictures a sudden change in trend. What distinguishes the spike from the other reversal patterns is the absence of a transition period, which is sideways price action on the chart constituting topping or bottoming activity. This type of pattern marks a dramatic change in trend with little or no warning. The saucer, by contrast, reveals an unusually slow shift in trend. Most often seen at bottoms, the saucer pattern represents a slow and more gradual change in trend from
TECHNICAL ANALYSIS OF EQUITIES

23

down to up. The chart picture resembles a saucer or rounding bottomhence its name.

TECHNICAL ANALYSIS OF EQUITIES

24

MOVING AVERAGES

Moving averages are one of the oldest and most popular technical analysis tools. This chapter describes the basic calculation and interpretation of moving averages. A moving average is the average price of a security at a given time. When calculating a moving average, you specify the time span to calculate the average price (e.g., 25 days).

A "simple" moving average is calculated by adding the security's prices for the most recent "n" time periods and then dividing by "n." For example, adding the closing prices of a security for most recent 25 days and then dividing by 25. The result is the security's average price over the last 25 days. This calculation is done for each period in the chart.

Since the moving average in this chart is the average price of the security over the last 25 days, it represents the consensus of investor expectations over the last 25 days. If the security's price is above its moving average, it means that investor's current expectations (i.e., the current price) are higher than their average expectations over the last 25 days, and that investors are becoming increasingly bullish on the security. Conversely, if today's price is below its moving average, it shows that current expectations are below average expectations over the last 25 days.

TECHNICAL ANALYSIS OF EQUITIES

25

The classic interpretation of a moving average is to use it to observe changes in prices. Investors typically buy when a security's price rises above its moving average and sell when the price falls below its moving average.

Time periods in moving averages

"Buy" arrows were drawn on the chart in Figure below when Aflac's price rose above its 200-day moving average; "sell" arrows were drawn when Aflac's price fell below its 200-day moving average.

Long-term trends are often isolated using a 200-day moving average. You can also use computer software to automatically determine the optimum number of time periods. Ignoring commissions, higher profits are usually found using shorter moving averages.

Merits The merit of this type of moving average system (i.e., buying and selling when prices penetrate their moving average) is that you will always be on the "right" side of the market--prices cannot rise very much without the price rising above its average price. The disadvantage is that one will always buy and sell late. If the trend doesn't last for a significant period of time, typically twice the length of the moving average, one will lose money.

TECHNICAL ANALYSIS OF EQUITIES

26

There are five popular types of moving averages: simple (also referred to as arithmetic), exponential, triangular, variable, and weighted. Moving averages can be calculated on any data series including a security's open, high, low, close, volume, or another indicator. A moving average of another moving average is also common. The only significant difference between the various types of moving averages is the weight assigned to the most recent data. Simple moving averages apply equal weight to the prices. Exponential and weighted averages apply more weight to recent prices. Triangular averages apply more weight to prices in the middle of the time period. And variable moving averages change the weighting based on the volatility of prices. Exponential Moving Average An Exponential Moving Average (EMA) takes a percentage of today's price and adds in the prior day's exponential moving average times 1 minus that percentage. For instance, to calculate a 10% EMA, take today's price and multiply it by 10% then add that figure to the prior day's EMA multiplied by the remaining percent: (today's close * .10) + (yesterday's exponential moving average * (1-.10)) Because most people think in terms of days (time periods) versus percentages, the following formula can be used to determine the percentage to be used in the calculation: Exponential Percentage = 2 /(Time Periods + 1).

TECHNICAL ANALYSIS OF EQUITIES

27

For a 20 period EMA you would use 9.52% (2/(20+1)) as your percentage for the calculation. By nature of its calculation, the EMA gives more weight to the recent periods. Weighted Moving Average The theory behind a weighted moving average (WMA) is that the recent data is more relevant than past data. Therefore, it puts more "weight" on the recent data and less weight on the older data. To calculate it, take the number of periods to analyze and that becomes the weight for today's price. Yesterday's price would use today's weight -1 and so on and so forth for the number of periods. Then divide the sum of the weighted prices by the sum of the weights. For example, suppose we took the last five "grades" we used in our first example and calculated a 5-period WMA. The calculation would be as follows:

Calculation of a Weighted Moving Average. The number of periods (in this case 5) becomes the "weight" for today. The weight for the remaining days is reduced by 1 until the last day is found. Therefore, the most recent period gets the highest weight and the oldest period gets the smallest. The summed weighted prices are then divided by the sum of the weights

Comparing the EMA,WMA and Simple Moving Averages The simple moving average gives equal weight to all data points. By nature, it is the "true" average. The exponential and weighted moving averages give the most recent
TECHNICAL ANALYSIS OF EQUITIES

28

data points the highest rankings or "weightings". Therefore, the simple moving average tends to lag (by representing all data points equally) the exponential and weighted moving averages during large price changes. However, during "normal" or "flat" markets the differences become negligible. This is illustrated in figure below.

March 2000 Bonds with 50-day Simple, Exponential and Weighted Moving Averages. Notice during "normal" or "flat" markets the averages tend to run together (a). However, once the market begins to make sharp moves (b) and (c) the EMA and WMA tends to catch up to price faster while the Simple Moving Average tends to lag.

Which One to Use? Deciding between the types of moving averages really becomes a matter of personal preference. Normally when you hear talk of moving averages, in the media it normally refers to simple moving averages. Therefore, due to widespread focus on these numbers, it's important to give them consideration. The 50- and 200-day (simple) moving averages are most commonly used here. As a trader, especially during large price moves, you might consider experimenting with exponential or weighted moving averages.

TECHNICAL ANALYSIS OF EQUITIES

29

INDICATORS AND OSCILLATORS

Indicators are calculations based on the price and the volume of a security that measure such things as money flow, trends, volatility and momentum. Indicators are used as a secondary measure to the actual price movements and add additional information to the analysis of securities. Indicators are used in two main ways: to confirm price movement and the quality of chart patterns, and to form buy and sell signals. There are two main types of indicators: leading and lagging. A leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price movement. A leading indicator is thought to be the strongest during periods of sideways or non-trending trading ranges, while the lagging indicators are still useful during trending periods. There are also two types of indicator constructions: those that fall in a bounded range and those that do not. The ones that are bound within a range are called oscillators these are the most common type of indicators. Oscillator indicators have a range, for example between zero and 100, and signal periods where the security is overbought (near 100) or oversold (near zero). Non-bounded indicators form buy and sell signals along with displaying strength or weakness, but they vary in the way they do this. The two main ways that indicators are used to form buy and sell signals in technical analysis is through crossovers and divergence. Crossovers are the most popular and are reflected when either the price moves through the moving average, or when two different moving averages cross over each other. The second way indicators are used is through divergence, which happens when the direction of the price trend and the direction of the indicator trend are moving in the opposite direction. This signals to indicator users that the direction of the price trend is weakening. Indicators that are used in technical analysis provide an extremely useful source of additional information. These indicators help identify momentum, trends, volatility and various other aspects in a security to aid in the technical analysis of trends. It is important to note that while some traders use a single indicator solely for buy and sell signals, they are best used in conjunction with price movement, chart patterns and other indicators.
TECHNICAL ANALYSIS OF EQUITIES

30

Indicators used in Technical Analysis

Accumulation/Distribution Line - Combines price and volume to show how money may be flowing into or out of a stock. Aroon - Shows whether a stock is trending or oscillating. Average Directional Index (ADX) - Shows whether a stock is trending or oscillating. Average True Range (ATR) - Measures a stock's volatility. Bollinger Bands %B - Shows the relationship between price and Bollinger Bands. Bollinger Bandwidth - Shows the distance between the upper band and the lower band. . Commodity Channel Index (CCI) - Shows a stock's variation from its 'typical' price. Chaikin Money Flow (CMF) - Combines price and volume to show how money may be flowing into or out of a stock. Alternative to Accumulation/Distribution Line. Chaikin Oscillator - Combines price and volume to show how money may be flowing into or out of a stock. Based on Accumulation/Distribution Line. Detrended Price Oscillator (DPO) - A price oscillator that uses a displaced moving average to identify cycles. Force Index - A simple price-and-volume oscillator. MACD - A momentum oscillator based on the difference between two EMAs. MACD-Histogram - A momentum oscillator that shows the difference between MACD and its signal line. Money Flow Index (MFI) - Combines a stock's 'typical' price with its volume to show how money may be flowing into or out of the stock. On Balance Volume (OBV) - Combines price and volume in a very simple way to show how money may be flowing into or out of a stock. Percentage Price Oscillator (PPO) - A percentage-based version of the MACD indicator. Percentage Volume Oscillator (PVO) - The PPO indicator applied to volume instead of price. Price Relative - Technical indicator that compares the performance of two stocks to each other by dividing their price data. Rabbitt Q-Rank - Paul Rabbit's proprietary indicator that rates a stock based on technical and fundamental factors. Rate of Change (ROC) - Shows the speed at which a stock's price is changing. Relative Strength Index (RSI) - Shows how strongly a stock is moving in its current direction. Slope - Measures the rise-over-run for a linear regression. Standard Deviation (Volatility) - A statistical measure of a stock's volatility. Stochastic Oscillator - Shows how a stock's price is doing relative to past movements. Fast, Slow and Full Stochastics are explained. StochRSI - Combines Stochastics with the RSI indicator. Helps one see RSI changes more clearly. TRIX - A triple-smoothed moving average of price movements. TECHNICAL ANALYSIS OF EQUITIES

31

Ultimate Oscillator - Combines long-term, mid-term and short-term moving averages into one number. Williams %R - Uses Stochastics to determine overbought and oversold levels.

Market Indicators
Arms Index (TRIN) - A breadth indicator derived from the AD Ratio and AD Volume Ratio. Advance-Decline Line - A cumulative breadth indicator derived from Net Advances. Advance-Decline Volume Line - A cumulative breadth indicator derived from Net Advancing Volume. Bullish Percent Index - A breadth indicator derived from the percentage of stocks on PnF buy signals. High-Low Index - A breadth indicator that shows new highs as a percentage of new highs plus new lows. McClellan Oscillator - A MACD type oscillator of Net Advances. McClellan Summation Index - A cumulative indicator based on the McClellan Oscillator. Net New Highs - A breadth indicator showing the difference between new highs and new lows. Percentage, cumulative and smoothed versions can be used. Percent Above Moving Average - A breadth oscillator that measure the percentage of stocks above a specific moving average. Put Call Ratio - A sentiment indicator found by dividing put volume by call volume. Record High Percent - A 10-day moving average of the High-Low Index, which is a breadth indicator. Volatility Indices - Indicators of implied volatility designed to measure fear and complacency for a range of indices and ETFs.

Important Indicators Accumulation/Distribution Line The accumulation/distribution line is one of the popular volume indicators that measures money flows in a security. This indicator attempts to measure the ratio of buying to selling by comparing the price movement of a period to the volume of that period.

TECHNICAL ANALYSIS OF EQUITIES

32

Calculated as: Acc/Dist = ((Close - Low) - (High - Close)) / (High - Low) * Period's Volume

This is a non-bounded indicator that simply keeps a running sum over the period of the security. Traders look for trends in this indicator to gain insight on the amount of purchasing compared to selling of a security. If a security has an

accumulation/distribution line that is trending upward, it is a sign that there is more buying than selling.

Average Directional Index

The average directional index (ADX) is a trend indicator that is used to measure the strength of a current trend. The indicator is seldom used to identify the direction of the current trend, but can identify the momentum behind trends.

The ADX is a combination of two price movement measures: the positive directional indicator (+DI) and the negative directional indicator (-DI). The ADX measures the strength of a trend but not the direction. The +DI measures the strength of the upward trend while the -DI measures the strength of the downward trend. These two measures are also plotted along with the ADX line. Measured on a scale between zero and 100, readings below 20 signal a weak trend while readings above 40 signal a strong trend.

Aroon The Aroon indicator is a relatively new technical indicator that was created in 1995. The Aroon is a trending indicator used to measure whether a security is in an uptrend or downtrend and the magnitude of that trend. The indicator is also used to predict when a new trend is beginning. The indicator is comprised of two lines, an "Aroon up" line (blue line) and an "Aroon down" line (red dotted line). The Aroon up line measures the amount of time it has been since the highest price during the time period. The Aroon down line, on the other hand, measures the amount of time since the lowest price during the time period. The number of periods that are used in the calculation is dependent on the time frame that the user wants to analyze.
TECHNICAL ANALYSIS OF EQUITIES

33

Aroon Oscillator An expansion of the Aroon is the Aroon oscillator, which simply plots the difference between the Aroon up and down lines by subtracting the two lines. This line is then plotted between a range of -100 and 100. The centerline at zero in the oscillator is considered to be a major signal line determining the trend. The higher the value of the oscillator from the centerline point, the more upward strength there is in the security; the lower the oscillator's value is from the centerline, the more downward pressure. A trend reversal is signaled when the oscillator crosses through the centerline. For example, when the oscillator goes from positive to negative, a downward trend is confirmed. Divergence is also used in the oscillator to predict trend reversals. A reversal warning is formed when the oscillator and the price trend are moving in an opposite direction.

The Aroon lines and Aroon oscillators are fairly simple concepts to understand but yield powerful information about trends. This is another great indicator to add to any technical trader's arsenal.

TECHNICAL ANALYSIS OF EQUITIES

34

Moving Average Convergence Divergence

The moving average convergence divergence (MACD) is one of the most well known and used indicators in technical analysis. This indicator is comprised of two exponential moving averages, which help to measure momentum in the security. The MACD is simply the difference between these two moving averages plotted against a centerline. The centerline is the point at which the two moving averages are equal. Along with the MACD and the centerline, an exponential moving average of the MACD itself is plotted on the chart. The idea behind this momentum indicator is to measure short-term momentum compared to longer term momentum to help signal the current direction of momentum.

MACD= shorter term moving average - longer term moving average

When the MACD is positive, it signals that the shorter term moving average is above the longer term moving average and suggests upward momentum. The opposite holds true when the MACD is negative - this signals that the shorter term is below the longer and suggest downward momentum. When the MACD line crosses over the centerline, it signals a crossing in the moving averages. The most common moving average values used in the calculation are the 26-day and 12-day exponential moving averages. The signal line is commonly created by using a nine-day exponential moving average of the MACD values. These values can be adjusted to meet the needs of the technician and the security. For more volatile securities, shorter term averages are used while less volatile securities should have longer averages. Another aspect to the MACD indicator that is often found on charts is the MACD histogram. The histogram is plotted on the centerline and represented by bars. Each bar is the difference between the MACD and the signal line or, in most cases, the nine-day exponential moving average. The higher the bars are in either direction, the more momentum behind the direction in which the bars point.

As you can see in Figure below, one of the most common buy signals is generated when the MACD crosses above the signal line (blue dotted line), while sell signals often occur when the MACD crosses below the signal.
TECHNICAL ANALYSIS OF EQUITIES

35

MACD Top Bearish Divergence MACD top Bullish Divergence MACD MACD MACD MACD Bottom Bullish Divergence Bottom Bearish Divergence

Increasing highs but decreasing macds for last two tops->short term bearish Decreasing highs but increasing macds for last two tops->short term bullish Decreasing lows but increasing macds for last two bottoms->short term bullish Increasing lows but decreasing macds for last two bottoms->short term bearish

Bullish MACD Crossover The MACD fastline has crossed over the MACD smoothed line at at Center center->short term very bullish Bearish MACD Crossover The MACD fastline has crossed below the MACD smoothed line at Center at center->short term very bearish The MACD fastline has crossed over the MACD smoothed line >short term bullish

MACD Bullish MACD Crossover MACD

Bearish MACD Crossover The MACD fastline has crossed below the MACD smoothed line at Center >short term bearish

Relative Strength Index The relative strength index (RSI) is another one of the most used and well-known momentum indicators in technical analysis. RSI helps to signal overbought and oversold conditions in a security. The indicator is plotted in a range between zero and 100. A reading above 70 is used to suggest that a security is overbought, while a reading below 30 is used to suggest that it is oversold. This indicator helps traders to identify whether a securitys price has been unreasonably pushed to current levels and whether a reversal may be on the way.
TECHNICAL ANALYSIS OF EQUITIES

36

The standard calculation for RSI uses 14 trading days as the basis, which can be adjusted to meet the needs of the user. If the trading period is adjusted to use fewer days, the RSI will be more volatile and will be used for shorter term trades.
RSI RSI Bullish Crossover RSI has crossed over 50 ->short term bullish RSI RSI Bearish Crossover RSI has crossed below 50->short term bearish RSI RSI Over Bought Buried The RSI has been above 70 for a minimum of 3 trading sessions->short term bullish The RSI has been below 30 for a minimum of 3 trading sessions->short term bearish The RSI is above 65 but not buried->short term bearish The RSI is below 25 but not buried->short term bullish

RSI RSI Over Sold Buried RSI RSI Over Sold RSI RSI Over Bought

On-Balance Volume The on-balance volume (OBV) indicator is a well-known technical indicator that reflect movements in volume. It is also one of the simplest volume indicators to compute and understand.

The OBV is calculated by taking the total volume for the trading period and assigning it a positive or negative value depending on whether the price is up or down during the trading period. When price is up during the trading period, the volume is assigned a positive value, while a negative value is assigned when the price is down for the period. The positive or negative volume total for the period is then added to a total that is accumulated from the start of the measure. It is important to focus on the trend in the OBV - this is more important than the actual value of the OBV measure. This measure expands on the basic volume measure by combining volume and price movement.
TECHNICAL ANALYSIS OF EQUITIES

37

Stochastic Oscillator The stochastic oscillator is one of the most recognized momentum indicators used in technical analysis. The idea behind this indicator is that in an uptrend, the price should be closing near the highs of the trading range, signaling upward momentum in the security. In downtrends should be closing near the lows of the trading range, signaling downward momentum, the price The stochastic oscillator is plotted within a range of zero and 100 and signals overbought conditions above 80 and oversold conditions below 20. The stochastic oscillator contains two lines. The first line is the %K, which is essentially the raw measure used to formulate the idea of momentum behind the oscillator. The second line is the %D, which is simply a moving average of the %K. The %D line is considered to be the more important of the two lines as it is seen to produce better signals. The stochastic oscillator generally uses the past 14 trading periods in its calculation but can be adjusted to meet the needs of the user.

Stoch Stoch Stoch Stoch

Stochastic Overbought Buried Stochastic Oversold Buried Stochastic Overbought Reversal Stochastic Oversold Reversal

The fast stochastic is above 80 and has averaged above 80 for the past 5 trading sessions->short term bullish The fast stochastic is below 20 and has averaged below 20 for the past 5 trading sessions->short term bearish The stochastic has fallen below 80 after being buried ->short term bearish The stochastic has crossed above 20 after being buried ->short term bullish

TECHNICAL ANALYSIS OF EQUITIES

38

OVERLAYS
Bollinger Bands - A chart overlay that shows the upper and lower limits of 'normal' price movements based on the Standard Deviation of prices. Ichimoku Clouds - A comprehensive indicator that defines support and resistance, identifies trend direction, gauges momentum and provides trading signals. Keltner Channels - A chart overlay that shows upper and lower limits for price movements based on the Average True Range of prices. Moving Averages - Chart overlays that show the 'average' value over time. Both Simple Moving Averages (SMAs) and Exponential Moving Averages (EMAs) are explained. Moving Average Envelopes - A chart overlay consisting of a channel formed from simple moving averages. Parabolic SAR - A chart overlay that shows reversal points below prices in an uptrend and above prices in a downtrend. Price Channels - A chart overlay that shows a channel made from the highest high and lowest low for a given period of time. Volume by Price - A chart overlay with a horizontal histogram showing the amount of activity at various price levels. Volume-weighted Average Price (VWAP) - An intraday indicator based on total dollar value of all trades for the current day divided by the total trading volume for the current day. ZigZag - A chart overlay that shows filtered price movements that are greater than a given percentage.

Bollinger bands Bollinger bands consist of a center line and two price channels (bands) above and below it. The center line is an exponential moving average; the price channels are the standard deviations of the stock being studied. The bands will expand and contract as the price action of an issue becomes volatile (expansion) or becomes bound into a tight trading pattern (contraction). A stock may trade for long periods in a trend, albeit with some volatility from time to time. To better see the trend, traders use the moving average to filter the price action. This way, traders can gather important information about how the market is trading. For example, after a sharp rise or fall in the trend, the market may consolidate, trading in a narrow fashion and criss-crossing above and below the moving average. To better
TECHNICAL ANALYSIS OF EQUITIES

39

monitor this behavior, traders use the price channels, which encompass the trading activity around the trend. We know that markets trade erratically on a daily basis even though they are still trading in an uptrend or downtrend. Technicians use moving averages with support and resistance lines to anticipate the price action of a stock. Upper resistance and lower support lines are first drawn and then extrapolated to form channels within which the trader expects prices to be contained. Some traders draw straight lines connecting either tops or bottoms of prices to identify the upper or lower price extremes, respectively, and then add parallel lines to define the channel within which the prices should move. As long as prices do not move out of this channel, the trader can be reasonably confident that prices are moving as expected. When stock prices continually touch the upper Bollinger band, the prices are thought to be overbought; conversely, when they continually touch the lower band, prices are thought to be oversold, triggering a buy signal. When using Bollinger bands, designate the upper and lower bands as price targets. If the price deflects off the lower band and crosses above the 20-day average (the middle line), the upper band comes to represent the upper price target. In a strong uptrend, prices usually fluctuate between the upper band and the 20-day moving average. When that happens, a crossing below the 20-day moving average warns of a trend reversal to the downside. While every strategy has its drawbacks, Bollinger bands have become one of the most useful and commonly used tools in spotlighting extreme short-term prices in a security. Buying when stock prices cross below the lower Bollinger band often helps traders take advantage of oversold conditions and profit when the stock price moves back up toward the center moving-average line.

You can see in this chart of American Express (NYSE:AXP) from the start of 2008 that for the most part, the price action was touching the lower band and the stock price fell from the $60 level in the dead of

TECHNICAL ANALYSIS OF EQUITIES

40

winter to its March position of around $10. In a couple of instances, the price action cut through the center line (March to May and again in July and August), but for many traders, this was certainly not a buy signal as the trend had not been broken

In the 2001 chart of Microsoft Corporation (Nasdaq:MSFT) (above), you can see the trend reversed to an uptrend in the early part of January, but look how slow it was in showing the trend change. Before the price action crossed over the center line, the stock price had moved from $20 to $24 and then on to between $24 and $25 before some traders would have confirmation of this trend reversal.

Parabolic SAR (SAR - stop and reverse) is a method used to find trends in market prices or securities. It may be used as a trailing stop loss based on prices tending to stay within a parabolic curve during a strong trend. The concept draws on the idea that time is the enemy (similar to option theory's concept of time decay), and unless a security can continue to generate more profits over time, it should be liquidated. The indicator generally works well in trending markets, but provides "whipsaws" during non-trending, sideways phases; as such, it is recommended establishing the strength and direction of the trend first through the use
TECHNICAL ANALYSIS OF EQUITIES

41

of things such as the Average Directional Index, and then using the Parabolic SAR to trade that trend. A parabola below the price is generally bullish, while a parabola above is generally bearish.

TECHNICAL ANALYSIS OF EQUITIES

42

TECHNICAL ANALYSIS IN PRACTICE.

Above chart shows use of trends, indicators, overlays for technical analysis

TECHNICAL ANALYSIS OF EQUITIES

43

REAL LIFE PREDICTION AND OUTCOMES

Application of technical analysis in real life situation is taken up as follows. Predictions by technical experts were taken up from Economic time archives epaper. Relevant technical charts were prepared using tools in websites like www.moneycontrol.com and www.in.finance.yahoo.com as well as using the Microsoft Excel Add In analyzer Trend Analyzer XL.

Charts are plotted using these tools till the date or range of prediction. About 25 cases were studied. The success rate of predictions was seen to be less than 50%. This is attributed to the abnormal market reactions. Technical analysis works on past history. It cannot take care of government policy changes in interest rates, taxation etc. International markets and commodities also cause sudden variation in pricing. Unexpected financial results of companies also changes trends.

Trend Analyzer in Action

TECHNICAL ANALYSIS OF EQUITIES

44

Date 15th April 2010

This is a typical case where financials were in postion and the technical charts also showed positive trends. The stock reached its target in two weeks time in this case.

TECHNICAL ANALYSIS OF EQUITIES

45

Date 3rd July 2010

The Axis bank case is again taken after two months when the RSI and MACD started turning positive. This was clear buy call and the ramp up in July shows that the analysis was correct.

TECHNICAL ANALYSIS OF EQUITIES

46

Date 1st July 2010

From mid July onwards the scrip was trading way above 50 day EMA and this is strong indication to buy. The ramp that followed led to nearly 33% growth.

TECHNICAL ANALYSIS OF EQUITIES

47

Date 3nd September 2010

High volumes along with sideways consolidation for long period was the indication for the ramp up which turned out to be correct

TECHNICAL ANALYSIS OF EQUITIES

48

Head and shoulder pattern formation is a good indicator which proved correct in this case.

TECHNICAL ANALYSIS OF EQUITIES

49

Here we see that the stochastic oscillator provided with good buy calls in the SBI growth line. Also the stock kept trading at levels above 200 day EMA which shows greater demand

TECHNICAL ANALYSIS OF EQUITIES

50

This is a 10 year chart. High volumes of SBI cause SBI shares to be overbought or oversold. This is why the RSI oscillators keep swinging above and below the 70% and 30% line continuously. When the MACD rises dramatically - that is, the shorter moving average pulls away from the longer-term moving average - it is a signal that the security is overbought and will soon return to normal levels.

TECHNICAL ANALYSIS OF EQUITIES

51

In the six month period the strong reversal patters are brought out by MACD and RSI along with spurts in volume.

TECHNICAL ANALYSIS OF EQUITIES

52

Again the huge volumes show the crowd behaviour and overbuying and selling in the market in the 10 year period of reliance.

TECHNICAL ANALYSIS OF EQUITIES

53

Tools Used AnalyzerXL is a library of 165 technical analysis functions, indicators and experts in the form of Microsoft Excel formulas. The AnalyzerXL Wizard makes it easy to implement a new function and simplifies the creation of trading systems. It is also easy to create charts from functions with numeric outputs - just click the Chart icon and select the type of chart one wish to create. Types of Functions An indicator is used to determine the trend of a market, the strength of the market and the direction of the market. An expert is a stock market system such as Bill Williams' Profitunity. Expert functions produce special outputs, such as Buy/Sell signals, trend directions and more. Types of Outputs All functions are categorized by the type of output they produce. There are two types of outputs: Formulas and Values. Formulas are automatically re-calculated when one change input data, whereas Values remain the same. With Formulas, one do not need to re-enter range references or function parameters when one update data. Macros For functions that output Values, AnalyzerXL provides a macro-building feature to improve the updating process. These macros can easily be called when one update oner data. There are two types of macros: Local and Global. Local macros can only be called from the workbook in which they were created, whereas Global macros can be called from any workbook.

Key features summary:

165 technical analysis functions, indicators, and experts Built-in charts for more accurate analysis Macro creation and management

TECHNICAL ANALYSIS OF EQUITIES

54

SELECTION OF INDICATORS/OSCILLATORS/OVERLAYS
A good rule of thumb is to restrict technical analysis to stocks that trade at least 100,000 shares per day so that there is a liquid market for the stock. 1) Objective: Every indicator has its own special feature and while choosing which one to use, one should be very clear about the objective. Lets For eg: to identify whether the market is consolidating or trending, the Bollinger Bands is a good choice as the width of the band will be able to tell one the answer. But for an entry decision while scalping the market, one may need the help of parabolic SAR. In short one need different tools for different strategy. 2) Variety: Some indicators like the Relative Strength Index (RSI), Stochastic and Commodity Channel Index (CCI) are oscillating in nature. They are able to tell whether the market is overbought or oversold. Therefore there is no point in having a RSI and a CCI together in one chart as they are of the same nature. A mix of indicators with different ability is used so that one can tell more things from them when doing my analysis. 3) Quantity: Some traders tend to use a lot of indicators as they believe that it can help them to have a better understanding of the market. In contrast, these traders usually have difficulties in getting into a trade as it is very hard for all the indicators to give them the same entry signal at the same time. Therefore stick to a maximum of 3 indicators for trading if one is able to get the same signal from them, one can enter my trade. When technical tools are used judiciously, their value cannot be overstated. And every time one apply a tool of technical analysis, one is calculating a consensus of bullishness or bearishness among all market participants. For example, the moving average convergence-divergence (MACD) is simply a tool that measures shifts in consensus from bullishness to bearishness, and vice versa. Extending the basic MACD to a deeper level, we find the MACD-histogram, which is actually a tool for determining the difference between long-term and short-term
TECHNICAL ANALYSIS OF EQUITIES

55

consensus of value. The measure tracks the difference between the fast MACD line (short-term consensus) and the slow signal line (longer-term consensus). The principles of market psychology underlie each and every technical indicator, so a good understanding of crowd behavior is crucial to the understanding of the fundamentals of particular technical indicators. How market psychology drives these individual tools is described below.

The Directional System The directional system (which one can read about in Directional Movement) was developed by J. Welles Wilder, Jr., as a means of identifying trends that are strong enough to be valid and useful indicators for traders. Directional lines are constructed to determine whether trends are bullish or bearish: when a positive directional line is above the negative line, bullish traders possess greater strength (and a bullish signal is given). The opposite situation indicates bearishness. More telling is the average directional indicator (ADX), which rises when the spread between the positive and negative lines increases. When the ADX rises, winners are getting ever stronger, and losers are getting weaker; furthermore, the trend is likely to continue.

Momentum and Rate of Change (RoC) Momentum indicators measure (which one can read about in Rate of Change) changes in mass optimism or pessimism by comparing today's consensus of value (price) to an earlier consensus of value. Momentum and RoC are specific measures against which actual prices are compared: when prices rise but momentum or rate of change falls, a top is likely near. If prices reach a new high but momentum or RoC reach a lower top, a sell signal is realized. These rules also apply in the opposite situation, when prices fall or new lows are reached.

Smoothed Rate of Change The smoothed rate of change compares today's exponential moving average (average consensus) to the average consensus of some point in the past. The smoothed rate of change is simply an enhanced version of the RoC momentum indicator - it is intended to alleviate the RoC's potential for errors in determining the market's attitude of bullishness or bearishness.
TECHNICAL ANALYSIS OF EQUITIES

56

Williams %R (Wm%R) Wm%R, a measure focusing on closing prices, compares each day's closing price to a recent consensus range of value (range of closing prices). If, on a particular day, bulls are able to push the market to the top of its recent range, Wm%R issues a bullish signal; and a bearish signal is issued if bears are able to push the market to the bottom of its range.

Stochastics Similar to Wm%R, stochastics measure closing prices against a range. If bulls push prices up during the day but cannot achieve a close near the top of the range, stochastic turns down and a sell signal is issued. The same also holds true if bears push prices down but cannot achieve a close near the low, in which case a buy signal is issued.

Relative Strength Index (RSI) RSI measures market psychology also in a fundamentally similar way to that of Wm%R. RSI is almost always measured with a computer, typically over a seven or nine-day range, producing a numerical result between 0 to 100 that points to oversold or overbought situations; the RSI therefore gives a bullish or bearish signals respectively.

Volume The total volume of shares traded is also an excellent way in which to ascertain the psychology of the market. Volume is actually a measure of investors' emotional state: while a burst of volume will cause sudden pain in losers and immediate elation in winners, low volume will likely not result in a significant emotional response.

The longest lasting trends generally occur where emotion is the lowest. When volume is moderate and both shorts and longs do not experience the roller coaster ride of emotion, the trend can reasonably be expected to continue until the emotion of the market changes. In a longer-term trend such as this, small price changes either up or down do not precipitate much emotion, and even a series of small changes occurring
TECHNICAL ANALYSIS OF EQUITIES

57

day-after-day (enough to create a major, gradual trend) will generally not generate severe emotional reactions. This is a classic example of how traders are lulled into a feeling of complacency - small losses (even a series of small daily or weekly losses) do not feel particularly devastating; but the series of small losses will, in a few weeks or months, aggregate into one very large loss.

Volume can be interpreted to predict trend reversals. While moderate and steady volume point to a sustained gradual trend due to the lack of emotion in the market, falling volume may indicate that losers have finally thrown in the towel and that the trend is near its top or bottom. Exceptionally high volume may demonstrate that a great many losers have given up and are selling at any cost. This is true collective psychology at work: amateur traders and investors who are holding losing positions typically reach their breaking point at roughly the same time. A huge burst of volume in a declining market may indicate that even the most patient stalwarts have raised the white flag, which is a classic signal that the bottom is high.

In the case of short selling, a market rally may serve to flush out those individuals holding short positions, causing them to cover and subsequently push the market higher. The same principle holds true on the flip side: when the longs give up and bail out, the decline pulls more losers with it (even the most resilient loser reaches his breaking point). At the most fundamental level of market volume, both short and long losers who collectively exit their positions are the primary drivers behind significant volume trends. Believe it or not, the preceding indicators are only a few basic examples of how market psychology is measured. There are a great number of additional indicators used in trading rooms everywhere, not to mention a near-infinite selection of variations and refinements possible.

TECHNICAL ANALYSIS OF EQUITIES

58

STEPS IN TECHNICAL ANALYSIS

Now that we have the theory and the tools, lets look at the process of going from a stock idea to an actual decision to buy or sell. 1. Look at the trend We want a rising trend or one that is just starting to do so. 2. Find nearby support and resistance levels We are trying to find stocks where demand exceeds supply and new supply is not likely to develop soon. 3. Determine if the current trend is healthy We want prices to be above a relevant moving average, but not so far that the stock is prone to a snapback decline as profit taking sets in. 4. Check volume and momentum indicators We need to be sure that they are not fading as the stock price rises: A falling indicator warns that there might be technical problems before price action sours. 5. Find out if the stock is leading a benchmark Is the particular stock at least matching the performance of the market and its peers? Find obvious patterns and trends Check an indicator or two Compare current condition to others

As has been said several times already, there are five major categories of tools in a complete technical toolbox, and novice chartists need only to have a basic understanding of what they do.

The three basic goals of the tools 1. Seeing where the stock is currently trading and figuring out how it got there This is where we explore charting tools such as: stock trends, support levels (that point at which a stock is trading at which demand is thought to be strong enough to prevent the price from declining further), and resistance levels (that price at which selling is thought to be strong enough to prevent the price from rising further).
TECHNICAL ANALYSIS OF EQUITIES

59

Well also try to find a pattern or a trend to help.

2. Determining the power of a trend This is also where we can find signs of an imminent end of a trend. For that, we will look at important technical concepts such as trading volume and momentum.

3. Making comparisons of the stock to the market, its peers in its own industry and even to its own history

This is where we look at relative performance and moving averages. We have not covered relative performance of a stock to its industry group yet, but it is simple enough to cover directly here.

If we know how fast a stock is moving, how much power is behind it and how it stacks up to the market, then well gain a huge advantage over other investors looking only at the fundamentals (such as price-to-earnings ratios, return on equity, or earnings growth).

A solid company with a solid chart is hard to beat.

Checklist for success In looking at a stock, here is a checklist of key technical tools. Any potential investment should meet most, but not necessarily all, of these criteria. Price structure Trends and trendlines There is no secret to finding a trend. If prices are generally rising and making higher highs as well as higher lows, then we have a rising trend. Most charting web sites also offer the ability to draw trendlines on the chart to clearly define the trend more objectively. Alternatively, the old-fashioned way of printing the chart and using a ruler and pencil works just as well. We want stocks that are in rising trends. Support and resistance These are terms that simply tell us what price levels are likely to bring out the buyers (demand) or the sellers (supply), respectively. What we want to see is a current price
TECHNICAL ANALYSIS OF EQUITIES

60

that has either just moved through resistance (demand overwhelmed supply) or one that is far from the next resistance level. Moving averages Moving averages (or simply price averages) are just average prices over a userdefined period of time, usually 50 or 200 days. They help us determine if a trend is turning, as prices cross the averages. They also help us determine if an existing trend is progressing in an orderly manner, or if it is accelerating in a frenzy. Clearly, we are looking for prices to be above selected averages but not too far above them. Relative performance Relative performance charts simply divide the price of a stock by a relevant market index or industry group. The theory is that we should buy strong stocks in strong sectors and this is how we find them. If the ratio is going up, then the stock is outperforming the market or industry and is thus a strong candidate for further gains. If the ratio is going down, then the stock is lagging and is often more vulnerable to bad news. We are looking for stocks whose relative performance is increasing. Volume The number of shares traded and when those shares trade either on days when prices rise or when they fall can confirm the health of a trend or warn of an impending change. We are looking to see if buying is spreading to other investors and for urgency for all to buy when prices start to rise. Fear of missing a good thing causes these surges. Momentum We also want to know if days when the stock rises outnumber those when it falls. Are the gains on these positive days greater than the losses on negative days? When the losing days are bigger and more frequent than the winning days we can surmise that the trend is weakening. We want to know if momentum is strong but not too euphoric. Sentiment Well just worry about obvious extremes in sentiment, as this portion of the analysis is tricky even for the pros. Is everybody thinking the same thing? Thats the time to go the other way. And as some traders will say, sometimes the best trades are the ones that make you sick as you leave the comfort of the crowd. We want to know if everyone is thinking the same thing.

TECHNICAL ANALYSIS OF EQUITIES

61

CONCLUSIONS
Technical analysis is based on evaluation of past prices and volume traded of the stock. Followers of technical analysis are known as chartist as they look at the past prices of the stock and identify patterns and trends. They do so to forecast through the charts and prices what the stock will do in the future. The methodology involves studying the supply and demand in the market to attempt what direction or trend will continue in the future. There are many useful tools that have been developed to help aid in this process. Most of them are automated and freely available for use.

Technical analysis can be a very valuable tool, but it is important to realize the benefits as well as the limitations before diving in. Lot of subjectivity is there in reading of patterns. It cannot take care of future events. However it can give a scientific reason for the prediction based on current and past positions. There is no definite answer about whether technical analysis should be used as a substitute to fundamental analysis, but many agree that it has its merits when used as a compliment to other investing strategies.

BIBLIOGRAPHY OF REFERENCES
Books: 1. 2. The Technical analysis Course: Thomas A Meyers. Tata McGraw Hill Technical Analysis Tools: March Tinghino, Bloomberg

Websites for data and analysis:

1. http://www.stockta.com 2. http://www.analyzerxl.com 3. http://in.finance.yahoo.com 4. http://www.moneycontrol.com 5. http://www.nseindia.com 6. http://stockcharts.com

TECHNICAL ANALYSIS OF EQUITIES

62