SECURITY ANALYSIS AND

PORTFOLIO MANAGEMENT
UNIT IV
TECHNICAL ANALYSIS
A Technical Analysis believes that share prices
are determined by the demand and supply
forces operating in the market
These demand and supply forces in turn are
influenced by a number of fundamental
factors as well as certain psychological or
emotional factors
The combined impact of all these factors is
reflected in share price movements
Technical Analysis is the name given to
forecasting techniques that utilize historical
share price data
The basic premise of technical analysis is that
price move in trends or waves which may be
upward or downward
It is believe that the present trends are
influenced by the past trends and the
projection of future trends is possible by an
analysis of past price trends
Dow Theory
 It is generally being accepted today as
technical analysis has its roots in the Dow
theory
 It was formulated by Charles H.Dow who was
the editor of the wall street journal in USA
during 1900-1902
 Charles Dow formulated a hypothesis that
stock market does not move on a random
basis but is influenced by three distinct
cyclical trends that guide direction
These movements are the primary movements ,
secondary reactions and minor movements
The primary movement is the long range cycle
Secondary reactions is the opposite direction to
the primary movement
The third movement in the market is minor
movement which are day to day fluctuations in
the market
It is used for Line charts to explain primary and
secondary movements
Bullish Trend
Upward moving market
1st phase the prices would advance with the
revival of confidence in the future of business
This will prompt investors to buy shares of
companies
2nd phase prices advance due to the
improvements in corporate earnings
3rd phase prices advance due to inflation and
speculation
In Bull market the line chart would exhibit the
formation of three peaks
Each peak would be followed by a bottom
formed by the secondary reaction
Each peak would be higher than the previous
peak ,each successive bottom would be higher
than the previous bottom
According to Dow theory the formation of
higher bottoms and higher tops indicates a
bullish trend
Bearish Trends
The bear market is also characterized by three
phases.
1st phase prices being to fall due to
abandonment of hopes. Investors being to sell
their shares
2nd phase companies start reporting lower
profits and lower dividends. This causes
further fall in prices due to increased selling
pressure
In the final phase, prices fall still further due
to distress selling
A bearish market would be indicated by the
formation of lower tops and lower bottoms
The first hypothesis states that primary trend
cannot be manipulated. manipulation possible in
the day to day of short term movements in the
market
The second hypothesis states that the averages
discount everything. it means daily prices reflect
the aggregate and emotional of all stock market
participants. it will affect demand and supply of
the stocks.
The third hypotheses states that the theory is
not infallible
Elliot Wave Theory
The theory formulated by Ralph Elliot in 1934
He found market movement was followed a
pattern of waves
A wave is a movement of the market price
from one change in the direction to the next
change in the same direction
The waves are the results of buying and
selling impulses emerging from the demand
and supply pressures on the market
Pattern of 5 waves up and 3 waves down to
form a complete cycle of 8 waves
 Waves 1 , 3 and 5 are the impulse waves and waves 2
and 4 are the corrective waves
 The wave 1 is upwards and wave 2 corrects the wave
 Similarly waves 3 and 5 are those with an upward
impulse and wave 4 corrects wave 3
 The completion of wave 5 , there would come a
correction which would be labeled ABC.
 One complete cycle consists of waves made up of two
distinct phases bullish and bearish
 Its used for predicting future price changes and
deciding the time of investments
Limitations
 Not Perfect
 They are many limitations in its practical use
Price Charts
 Charting represents a Key activity in Technical
analysis(Graphical representation)
 Four Prices are Important
1.Highest price of the day
2.Lowest price of the day
3.Opening price
4.Closing price
Three Types of Price Charts
1.Line Charts
2.Bar Charts
3.Japanese Candlestick Charts
1.Line Charts
 It is the simplest Price charts
 The closing price of a share are plotted on the XY
graph on a day to day basis
 The closing price of each day would be
represented by a point on the XY graph
 All these points would be connected by a straight
line which would indicate the trend of the market
Indicators formation in line charts
1.Head and Shoulders (HST)
2.Inverse Head and Shoulders(IHST)
3.Double Top and Double Bottom
2.Bar Charts
Bar charts have a serious of vertical bars
representing each days price movement
Each bar has a range from the days lowest
price to the days highest price
A small cross on each bar signifies the days
closing price
3.Japanese Candlesticks
Developed in Japan more than 300 years ago
Candlesticks show the open , high , low and
close prices of security in a way that
emphatics the range between opening and
closing prices
Candle charts usually display daily prices
It is a combination of a line chart and bar
chart
It is most often used in technical analysis of
equity and currency prices patterns
Fundamental Vs Technical Analysis
Basis of Fundamental analysis Technical Analysis
Distinctions
Perspective The analyst perspective is long term The analyst outlook is
in nature short-term oriented

Policy It adopts a buy and hold policy It believes in making a

,investment less then a year quick buck

Type of Gain It consider total gains –dividends It is interested in short term

,long term gains

Basis of It forecasts stocks price on the basis Technical analysis is study

Forecasting of economic industry and company
statistics
Tools for Analysis It uses tools of financial analysis and
statistical forecasting techniques
of stock exchange
information
It is used mainly charts of
financial variables besides
some quantitative tools
Trend and Trend Reversal
 Trend is the direction of movement of share
price in the market
 When the price move upwards, it is rising trend
or uptrend
 When price move downwards , it is falling trend
or downtrend
 Flat trend when the price move with in a narrow
range
 The changes in the direction of trend is referred
to as trend reversal
Types of Trends
1.Upward Trend
2.Downward Trend
3.Sideways Trend
Support
 Support and Resistance are price levels at which
the downtrend or uptrend in price movements is
reversed
 Support occurs when price is falling but bounces
back or reverses direction every time it reaches a
particular level
 When all these low points are connected by a
horizontal line, it forms the support line
Resistance
 It is occurs when the share price moves upwards
 A horizontal line joining these tops forms the
resistance level
Moving Average Analysis(MMA)
Moving average are mathematical indicators
of the underlying trend of the price
movement
The closing prices of shares are generally used
for calculation of moving average
Normally 200 Day MA very useful method
Types
1.Single Moving Average
2.Exponential Moving Average
1.Simple Moving Average
An average is the sum of prices of a share for
a specific number of days divided by the
number of days
A set of averages are calculated for a specific
number of days, each average being
calculated by including a new price and
excluding an old price
Ex: 5 days Moving Average
(30+32+31+34+30)/5=31.4
2.Exponential Moving Average(EMA)
EMA=(Current Closing Price – Previous EMA)* Factor +
Previous EMA
2
Factor = -------
n+1
n=Number of days for which the average is to be
calculated
 5 to 10 day average would indicate the short-term
trend
 50 day average would indicate the medium term trend
 200 day average would represent the long term trend
Oscillators
Oscillators are mathematical indicators
calculated with the help of the closing price data
It is help to identify overbought and oversold
conditions and also the possibility of trend
reversals
Types
1.Rate of Change Indicator(ROC)
2.Relative Strength Index(RSI)
3.Moving Average Convergence Divergence (MACD)
1.Rate Of Change Indicator(Roc)
The rate of change of the current price as
compared to the price a certain number of
days of weeks back
To calculate a 7 day rate of change, each day’s
price is divided by the price which prevailed 7
days ago and then 1 is subtracted from this
price ratio
Current price
ROC=--------------------------- - 1
Price ‘n’ Period ago
2.Relative Strength Index (RSI)
RSI=100-(100/(1+RS))
Average gain per day
RS= ----------------------------
Average loss per day
Period of RSI Calculation 14 days
RSI value above 70 are considered to denote
overbought condition
Below 30 are considered to denote oversold
condition
3.Moving Average Convergence and Divergence
(MACD)
Long and short term to calculate with a help of
closing price
12 and 48 day popular combination
The difference between the short term EMA and
the long term EMA represents MACD
The MACD line would oscillate across the zero
line
If the MACD line moves above ,the trend can be
Bearish
If the MACD line moves below, the trend can be
Bullish
Market(Volume)Indicator
1.Breadth of the Market
 Comparison of advances and declines is means of
measuring breadth
 The difference between the advances and declines is
called the Breadth
2.Short Interest
 As a technical indicator short selling is called short
interest
3.Odd Lot Index
 An odd lot index can be calculated by relating odd lot
purchased to odd lot sales
4.Mutual Fund Cash Ratio
 Mutual funds keep cash as a percentage of their net
asset on a daily or weekly or monthly basis has been a
popular market indicator
Efficient Market Hypothesis(EMH)
 EMH is the idea that information is quickly and efficiently
incorporate into asset prices at any point in time
 Old information cannot be used foretell future price movements
 3 versions weak , semi strong and strong
Forms of EMH
1.Weak Form
 The weak form EMH stipulates that current asset prices already
reflect
 2.Semi-Strong Form
 The semi strong form EMH states that all publicly available
information is similarly already incorporated into asset prices
 It includes company’s financial statement, company
announcement, economic factors etc (Public information)
3.Strong Form
 The strong form EMH stipulates that private information or insider
information , is quickly incorporated by market price
Random Walk Theory
A change occurs in the price of a stock only
because of certain changes in economy ,
industry or company
Information about these changes alters the
stock prices immediately and the stock moves
to a new level either upwards or downwards
It used to stock markets are so efficient and
competitive that there is immediate price
adjustment
It is based on EMH
Empirical Test
Empirical Test of Weak Form
1.Simulation Tests
It generate a random serious of numbers as
returns and compare them with the actual price
changes in the market
2.Filter Tests
It is using Historical Prices, a price of a security
rises by at least X percent, investor should to buy
and hold the stock until its price declines by at
least X percent from a subsequent
3.Serial Correlation
Correlation co efficient in series of numbers with
the legging values of the same price
4.Run Tests
Run Tests examine the direction movement of
security prices
Empirical Tests of Semi-Strong Form
1.Earnings Announcements
2.Discount Rate Changes
The average security’s price changes a little
before the announcement of discount rate
changes
3.Stock Splits
Empirical Tests of Strong Form
1. Specialists
Specialists on the organized security exchanges
keep a book of unfilled limit orders to buy and
sell at different prices
2.Insiders
Federal Law in USA defines insiders as the
directors ,officers , significant shareholders and
any other persons who have access to valuable
inside information about a firm
3.Professionals
Access to valuable inside information before it is
fully published is mutual fund operator