TECHNICAL ANALYSIS

Technical analysis involves a study of market generated data like prices and volumes to determine the future direction of price movement.

Basic premises
Prices move in trends Trends are determined by the interaction of supply and demand forces Supply and demand are influenced by a variety of factors- rational and irrational. They may be economic, monetary, political or psychological forces

Barring minor deviations, stock prices tend to move in fairly persistent way shifts in demand and supply bring about changes in trends Irrespective of why they occur, shifts in demand and supply can be detected with the help of charts of market action With the help of trends and patterns analysis of past market data can be used to predict future price behavior The basic task for the investor is to maintain an investment posture till the time a particular trend changes

Differences between Technical and Fundamental analysis

Technical analysis

Fundamental analysis

Seeks to predict short-term Tries to establish long-term price movements values Focuses mainly on internal Focuses on factors relating market data particularly to the economy, industry & price and volume data the firm Appeals mostly to shortterm traders

Appeals primarily to long term investors

The Dow Theory

Charles Henry Dow- Editor of Wall Street Journal Based on the movements of Dow Jones Industrial average & Dow Jones Transport Average Three Movements
Minor Trend Secondary Trend Primary trend

 Primary Trend-Daily fluctuations- random day to day wiggles Secondary movements- corrections that last for few weeks to some months Primary trend-long range-represents bull or bear phase of the market (minimum 4 years)

Charting Techniques
Charts are simple graphs on which share prices are recorded.

Basic concepts underlying chart analysis

Trend Relationship between volume and trends Support and Resistance level

Different Types of Charts

Line Charts

Bar Charts
Point and Figure Charts Candlesticks

Line Chart
-Shows Line connecting closing prices

Line Chart
TCS- July-2008

Shows Line connecting closing prices

Bar Chart

Depicts the daily price change along with closing price Upper end represents highest price Lower end represents lowest price The cross across the bar represents closing price

Bar Chart TCS-July-2008

Point and Figure Chart

Indicates significant change in the price

Vertical scale represents the price Horizontal scale represents a significant reversal of price movement and not the trading day X is recorded to reflect increase O is recorded to reflect decrease

Point and Figure Chart

Candlestick Chart
Depicts the daily price change along with opening and closing price
The upmost point represents the highest price The lowest point represents the lowest price

The shaded portion represents the difference between the opening and closing price
If the shade is dark then it means that the stock has closed at a price lower than the opening price. (loss) On the other hand if the shade is light in colour then it means that the stock has closed at a price higher than the opening price (profit)

Candlestick Charts

Bullish Trend

Price Time

Bearish Trend

Price Time

Technical Indicators
The Advance-Decline Line Indicates the net result of all advances and declines occurred on the stock exchange
Day Advances Declines Net Advances Or Declines
103 215 322 -138 -335 -294

Breadth of The Market

103 318 640 502 167 -127

Tuesday Wednesday Thursday Friday Monday Tuesday

630 690 746 492 366 404

527 475 424 630 701 698

Relative Strength Indicator Chart

Buy RSI

Sell

If RSI crosses 70 it is time to sell If RSI goes below 30 it is time to buy

Relative Strength Index is calculated using the formula

100 - 100 + Rs Rs

 New Highs and Lows Volume

Short Interest RatioSort interest -No. of shares that have been sold short

Short Interest Ratio=

 Odd Lot Trading Moving Averages

Mutual Fund liquidity

Put/Call ratio

V & Inverted V- Shaped

Price Time

Double Top

Represents a bearish formation Prices are expected to decline

Price Time

Double Bottom

Represents a bullish formation Prices are expected to rise

Price Time

Head and Shoulders

Represents a bearish formation Any fall in the price below the neckline indicates a decline in the future price

Price Time

Inverted Head and Shoulders

Represents a bullish formation If the price breaches the neckline the indication is that the price will rise

Price Time

Triangle or Coil
Price Time

Represents an uncertain period Difficult to predict Price may move up or down

Up Flag

Down Flag

Down Pennant

Up Pennant

An extract from the commentary of a technical analyst

To sum up, we are in a state where the market is either poised to recover, or go into a long-term decline (a change in the major trend). A failure of the Head and Shoulder formation in the National Index, which could occur if the index clambers over 1,400 would be a good signal to suggest a Market recovery, while a breakdown below the support levels given for the leading Sensex stocks would mean harsher times ahead"

Arguments for Technical Analysis

1. Tools of technical analysis help in identifying trends which happen under the influence of crowd psychology. Early identification through technical analysis aids investment decision making

2. Shifts in demand and supply happen gradually and are not instantaneous. Through early detection of such shifts future price movements can be known.
3. It takes time for the fundamental information of the company to be absorbed and assimilated by the market. 4. Charts provide a picture of the past and hence let us know the kind of volatility to be expected from stock prices

Criticisms of Technical Analysis

1. Most technical analysts are not able to offer convincing explanations for tools employed by them 2. There is empirical evidence in support of Random Walk Hypothesis 3. A change in trend may happen before signalled by technical analysis

4. Claims for different chart patterns are untested assertions

5. Ambiguity in identification of change in trends and interpretations of chart lines

Quantsphysicists, computer Wall Street has attracted a lot of people scientists, engineers, mathematicians, statisticians, and so on - with highly developed quantitative skills, called as quants in the investment community. They employ sophisticated computer models based on chaos theory, neural networks, Kalman filters and "kitchen sink models that include every conceivable variable to explain stock price movements. The data-driven approach followed by the quanta often has no theoretical underpinnings. Put differently, quanta don't bother to explain why something has worked in the past. They try to figure out what has worked in the past and expect the same to work in the future. This approach sometimes generates profit in the Market; more often it does not. A quantitative model should be evaluated in terms of of it's ability to produce superior long term performance and not on it's statistical complexity. In this respect, quants do not seem to have been very successful