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Subject COMMERCE

Paper No and Title 14. Security Analysis and portfolio Management

Module No and Title 22. TECHNICAL ANALYSIS: Trends and Indicators

Module Tag COM_P14_M22

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

MODULE No.22: TECHNICAL ANALYSIS: Trends and Indicators
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TABLE OF CONTENTS

1. Learning Outcomes
2. Introduction.
3. Technical Analysis
4. PRINCIPLES OF TECHNICAL ANALYSIS
5. DOW THEORY
6. ELLIOT WAVE THEORY
7. BAR CHART
8. LINE CHART
9. CANDLE STICK CHART
10. POINT AND FIGURE CHART
11. Summary

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

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1. Learning Outcomes

After studying this module, you shall be able to

 Understand the concept of depository

 Know why do we need depository
 Understand how depository system works
 Comprehend the need of depositories Act,1996
 Understand about NSDL and CDSL

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

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INTRODUCTION:

Technical Analysis

In any stock market an investor does a number of analysis before buying a stock.
Sometimes they hire professionals to guide them and analyses about which stocks to be
bought and sold. Among various methods of analyzing stock, one is Technical Analysis.
Technical Analysis is concerned with the study of the past price behavior of shares as
well as volume of shares being traded in the past.one can study daily or weekly price and
volume data of index comprising several stocks like SENSEX or NIFTY. A method of
valuing securities by considering data produced by market movement, 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.
Analysts who are using technical analysis believe that the historical performance of
stocks and markets are indicators of future performance.

Technical analysis is all about studying stock price graphs and a few momentum
oscillators derived thereof. It must be understood that technical studies are based entirely
on prices and do not include balance sheets, P&L accounts (fundamental analysis). In
technical analysis it is being assumed that the markets are totally efficient and all the
possible price sensitive information regarding a stock or shares are built into the graph of
price of the concerned security / index.

Therefore, technical analysis supports the efficient market theory as against the "random
walk theory" which supports the belief that stocks can be bought / sold on random events.
Technical analysis is not dependent on corporate events like quarterly results and special
announcements like earnings guidance and policy changes in operations to generate a buy
/ sell recommendation.

PRINCIPLES OF TECHNICAL ANALYSIS

It is generally recognized that there are three basic principles of technical analysis. The
three principles are as follows:
 Market discounts everything
 The Market Exhibits Trends
 History repeats itself

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

MODULE No.22: TECHNICAL ANALYSIS: Trends and Indicators
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1. Market discounts everything

The first is that the action of the market reflects everything. This is extremely important,
because underpinning technical analysis is the concept that just by studying market action
we can get a good idea of future movements.There are many things that can affect the
price. These include

 fundamental factors, such as how fine products are selling and what profit margin
can be achieved;
 political or corporate factors, such as legislation,
 the putting in place of a new CEO or changes in working practices;
 psychological factors, such as whether the latest garment will attract the attention
of people or not, or the Blackberry becomes a must-have for business reasons.
 By cutting across this, and declaring that all these factors which may or may not
be knowable become included in the price by market action, the technical analyst
can focus on the market alone, and doesn’t need a squad of research assistants.

In technical analysis it is believed that all the above factors are incorporated in the prices
of the securities.if a person has positive attitude towards a security then there will be an
increase in the demand of that security.On the other hand if there is a negative attitude of
people regarding a security then there will be a fall in the demand for buying that share
and increase in selling of such shares. In economics we have already studied that the
supply and demand for any product set its price. If demand is more than the supply, then
in time the price for a commodity will rise.If this happens for a share i.e. prices of shares
are increasing then we call it a bullish market. On the other hand, if demand for share is
less than the supply then there will be a fall in the prices of such shares.The market for
such shares is called as bearish market. Thus a technical analysts focuses only on the
prices of security as every information regarding demand or supply of share is reflected
in the prices of the security. Thus there is no need to focus on various factors like
financial results,political situation,trends for a particular product of a company,seasonal
factors etc.Only studying of tyrends in the movement of prices will give a good idea
about them.

2. The Market Exhibits Trends

The second principle of technical analysis is that the prices of securities tends to move
in trends. By this we mean that if the price is rising then it will in all likelihood continue
to rise; and when falling then it will keep going down; and when hovering at about the
same level, it will keep doing that. This sometimes is known as moving sideways. Of
course, none of these things goes on forever, but it is generally predictable that a trend
will go on for a though in the past changing. A lot of trading plans are based on this basis
that ‘let the trend be your friend’, which means you should trade to follow the existing
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trend. It is assumed that if you are not folloeing or going with a particular trend then it
might expose you to more risk than you could have been to.The trends can be seen by
drawing charts. Following is a chart that shows upward trend in the stock prices.

Most charts you will use have the same basic layout. The time is along the horizontal, or
X-axis, and the price is in the vertical or Y-axis. The time may show minutes or hours
during the day, or days, weeks, or months or years. Commonly the analysts use charts
with the time scale marked in days, and it is the custom to only include working days,
five days a week.

The chart that has been shown above shows an uptrend, with the price rising over time.
One should keep it in mind that the trend usually does not go straight up or straight
down, but goes up in a series of spurts, with what are called ‘retracements’ in between.
This chart shows a fairly clear uptrend overall. Sometimes it helps to look at different
time scales so you can identify which way the trend is going – for instance, if you looked
at a chart of the same stock as shown above, but with a different timescale that only
showed you a retracement, you might think the stock was in a downtrend.

When trading with the trend, your task reduces to identifying the trend as soon as
possible, so that you can enter the trade early, and keep on with it while waiting for until
it shows signs of failing, or reversing. Many traders try to capture the greatest gain as

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much they can, while being confident enough that what they have identified is a real
trend.

3. History Repeats Itself

The third principle of technical analysis is merely a statement that we don’t expect people
to change their behavior. In other words, we put our faith in on the fact ----history being
repeating itself, with patterns and actions that have happened in the past leading to the
same results when they happen in the future. Georg Hegel once said cynically that ‘We
learn from history that we do not learn from history. ‘ The task of the technical analyst is
to learn what history has to teach. The psychology of traders and investors has not
changed over decades, and this fact can be used to give advantage in the technical
analysis.it is believed that traders mentality remain same.Therefore they behave in the
same manner in similar situations as they did in the past.So if one can understand that
how a person behaves then he can make gains in this market by analyzing the trends.This
again is a central belief to trading using technical analysis. We rely on a study of history
to tell us what normally happens in a certain set of circumstances, and then we expect
that the same thing will happen again. The outcomes are seldom or never sure, but
trading is a percentage game. We stack the odds in our good turn, and then use wise
money management to make sure that the end result is a fully clad profit.

Tools of Technical Analysis

A technical analysts has and uses following tools for doing technical analysis.These tools
are:/

 Charting
 Market Indicators

Here we will discuss in detail about charting.

Charting is the one of the crucial activity in technical analysis.Till now we have
understood that basic motive in technical analysis is to identify the price trend.This trend
is to be found by studying the past data about the price behavior of a stock.And such past
data helps to predict the future behavior of stock.Thus the inputs for technical analysis is
the price and volume data.Charts and graphs are the basic tools that are used in
identifying the current trends in prices.These charts or graphs can be drawn either for a
specific share or for the market as a whole.If one is concerned with the specific share
then he is required to study the data for that particular share and in case he is doing the
analysis of the market then he will look for the ppast behavior of that market or an index.

Since in charting we are concerned with finding out price trends therefore one should
know what prices he has to look for.A security is traded at different price levels on any
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particular day.Out of these different price quotations,four prices are relevant and
important.These prices are as follows:

 Opening price
 Closing price
 High price
 Low price

Opening price – As the stock exchange opens on a day,the first price at which the trade
of a security takes place is called the opening price of the security. A security's opening
price is an important indicator for that day's trading activity, especially for those
interested in measuring short-term results, such as day traders.

Closing price – closing price is the last price at which the security was traded on a
particular day before the stock market closes for that day. The closing price signifies the
most up-to-date estimate of a security up to trading starts again on the next trading day.
closing prices make available a useful marker for investors to measure changes in stock
prices over time .The closing price of one day can be compared to the previous closing
price in order to measure market sentiment for a given security over a trading day.Stock
indices for a day are also calculated on the basis of closing price of the constituent
security.

Low Price – It is the lowest or the minimum price at which a particular stock was traded
on a day.

High Price – It is the highest or maximum price at which a particular share was traded on
a day.

Now before starting to understand different types of charts, it is first required to know
about the two theories that tells about how the trends can be shown in a chart.These two
theories are as follows :
 Dow Theory
 Elliott Wave Theory

DOW THEORY
The legend of technical analysis, Charles Dow, is the father of what is popularly known
as the "Dow theory". Though developed more than a century ago, his theory is used even
today by analysts to evaluate market behaviour.

The Dow theory was developed to analyse the movement of indices and was based on the
'closing' price of the indices.

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Assumptions .

The three assumptions underlying the Dow theory are:

1. The primary trend of the price movement cannot be influenced by external

factors.
2. The market discounts everything.
3. The theory is not foolproof..

Trends

The Dow theory explains that there are three types of trends applicable in a market. These
trends are known as

 Primary trends,
 Intermediate trends and
 Short term trends.

Primary trend

Primary trend is the long-term direction in the price movement and lasts for a year or a
number of years. It also consists of three phases, wherein each phase is interrupted by an
intermediate trend reversal lasting up to two to three weeks. This intermediate trend takes
away the earlier price movements, upward or downward.

Secondary trend

This trend appears within the primary trend and may lasts for a period ranging from few
days to weeks or months.theses trends indicate interruptions in the primary trend and act
as a preventive force on the primary trend.

Minor trend

Short term trends are also known as minor trends and can be witnessed intra day or
during a few days. These trends correct the over bought and over sold positions in the
scrip caused by reversals made in the secondary trends. For the purpose of analysis, it
makes sense to ignore short-term trends and analyses the primary and secondary trends in
prices.

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In the above diagram we can see that primary trend of this market is bullish as the trend is
downward.it means that the prices are successively going down. However the secondary
trend is both rising and then falling. The minor trend is being shown by the red line.
These are the daily fluctuations in the share prices. A technical analyst does not pay much
attention to them.

ELLIOT WAVE THEORY

This theory was given by Ralph Nelson Elliott.he observed that the the ever changing
path of stock market prices reveals a structural design that in turn reflects a basic
harmony found in nature. From this discovery, he developed a rational system of market
analysis. He gave the Wave Principle.He gave the principle of studying the market on the
basios of the five wave pattern. In markets, progress ultimately takes the form of five
waves of a specific structure.

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

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As we can see from the above diagram that the first wave is rising ,second wave is
showing a fall third again rising foruth wave is decreasing and finally fifth wave is
rising.This pattern indicates a bullish market.that is in bullish market first and fifth wave
are rising.But in bearish market.first and fifth wave show downward movement.The five
waves show pattern like this----first wave is falling,second rising,third falling, fourth
rising and fifth falling.
Both Dow theory and Elliot wave theory are important to understand trends.But there are
some other types of charts.Some of them are as follows:
BAR CHART
A bar chart is used by some technical analysts, on which, as illustrated below, the top of
the vertical line shows the highest price for which a security was traded at during the day,
and the bottom of this line represents the lowest price. The closing price is displayed on
the right side of the bar, and the opening price is shown on the left side of the bar. A
single bar like the one below represents one day of trading.

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Thus each bar has four basic elements –Open,high,low , close. That’s why it is also called
as OHLC bar.

LINE CHART
A line chart that is created by connecting a series of data points together with a line. This
is the simplest kind of chart used in finance and it is usually formed by joining a chain of
previous prices together with a line. A line chart is usually created by taking closing
prices for company’s shares on different days. A line chart can give the reader a fairly
good idea of where the price of an asset has traveled over a given time frame.

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

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CANDLE STICK CHART

A candlestick chart, have a data set that contains open, high, low and close values for
each time period one wants to display. The hollow or filled portion of the candlestick is
called “the body” (also referred to as “the real body”). The long thin lines above and
below the body represent the high/low range and are called “shadows” (also referred to as
“wicks” and “tails”). The high is marked by the top of the upper shadow and the low by
the bottom of the lower shadow. If the stock closes higher than its opening price, a
hollow candlestick is drawn with the bottom of the body representing the opening price
and the top of the body representing the closing price. If the stock closes lower than its
opening price, a filled candlestick is drawn with the top of the body representing the
opening price and the bottom of the body representing the closing price.

Following chart shows the trend for a week.One candle is shown to represent price
information for one month.

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POINT AND FIGURE CHART

A Point and Figure chart plots day-to-day price movements without taking into
consideration the passage of time. Point and figure charts are composed of a number of
columns that either consist of a series of stacked X's or O's. A column of X's is used to
illustrate a rising price, while O's represent a falling price.

One can study the pattern of movement and can do analysis regarding the price behavior.
For example in the chart drawn above one can see an upward movement or trend in
prices.

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

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Summary

Share prices are one of the important indicators of various factors that affect a company’s
performance. One can understand the price behavior of a particular stock is actually
displaying how the demand and supply for a stock is changing due to several factors.
Thus technical analysis focuses on the study of such price behavior. A technical analyst
uses this information regarding price behavior and its pattern to know how the shares, its
price and volume will behave in future. For such an analysis he uses various kinds of
charts and pattern analysis as well as indicator analysis. In the next chapter we will study
about pattern analysis and indicator analysis.

Questions
1. What is technical analysis
2. What are the principles of technical analysis?
3. What is charting?
4. Explain Dow Theory.
5. Explain Elliot wave theory
6. Explain some of the charts that are used in technical analysis of share prices.

COMMERCE PAPER No.14 : Security Analysis and portfolio Management

MODULE No.22: TECHNICAL ANALYSIS: Trends and Indicators