TECHNICAL ANALYSIS

BY : DAKSHA PATHAK
ASSISTANT PROFESSOR
DEPARTMENT OF FINANCIAL STUDIES
IIS (Deemed to be University ), Jaipur
Contents :

• Meaning/Concept
• Assumptions
• Technical VS Fundamental Analysis
• Theories of Technical analysis: DOW THEORY AND WAVE THEORY
• Tools and Techniques of Technical Analysis
• Criticism or weakness of Technical Analysis
• Efficient Market Hypothesis
Security Analysis:

FUNDAMENTAL TECHNICAL
ANALYSIS ANANLYSIS

• The methods used to analyze securities and make investment decisions fall
into two very broad categories: fundamental analysis and technical
analysis. Fundamental analysis involves analyzing the characteristics of a
company in order to estimate its value. Technical analysis takes a
completely different approach; it doesn't care about the "value" of a
company or a commodity. Technicians (sometimes called chartists) are only
interested in the price movements in the market.
Meaning / Concept of Technical Analysis:
• 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.
• Despite all the fancy and exotic tools it employs, technical analysis really
just studies supply and demand in a market in an attempt to determine what
direction, or trend, will continue in the future. In other words, technical
analysis attempts to understand the emotions in the market by studying the
market itself, as opposed to its components.
• It aims to determine the right time to enter or exit the market by studying
technical indicators and charts capturing change in attitudes of investors
reflected in changes in demand and supply of securities.
• Technical analysis is the study of financial market action. The technician
looks at price changes thatoccur on a day-to-day or week-to-week basis or
over any other constant time period displayed in graphic form, called
charts. Hence the name chart analysis.
• A chartist analyzes price charts only, while the technical analyst studies
technical indicators derived from price changes in addition to the price
charts.
• Watching financial markets, it becomes obvious that there are trends,
momentum and patterns that repeat over time, not exactly the same way but
similar.
• A chart is a mirror of the mood of the crowd and not of the fundamental
factors. Thus, technical analysis is the analysis of human mass psychology.
Therefore, it is also called behavioral finance.
The field of technical analysis is based on three assumptions:

The market discounts

everything.

Price moves in trends.

History tends to repeat

itself.
 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.
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.
THEORIES OF TECHNICAL ANALYSIS:

DOW THEORY WAVE THEORY

Dow believed that the stock market as a whole was a reliable measure of overall
business conditions within the economy and that by analyzing the overall market,
one could accurately gauge those conditions and identify the direction of major
market trends and the likely direction of individual stocks.

Overall there are 3 broad market trends.

Primary Trend, Secondary Trend, and Minor Trends
• The Primary Trend: This is the major trend of the market that lasts from a year to
several years. It indicates the broader multiyear direction of the market. While the
long term investor is interested in the primary trend, an active trader is interested
in all trends. The primary trend could be a primary uptrend or a primary
downtrend

• The Secondary Trend: These are corrections to the primary trend. Think of this
as a minor counter-reaction to the larger movement in the market. Example –
corrections in the bull market, rallies & recoveries in the bear market. The
counter-trend can last anywhere between a few weeks to several months

• Minor Trends/Daily fluctuations:These are daily fluctuations in the market;

some traders prefer to call them market noise
The Dow Theory Principles
• The Dow Theory is built on a few beliefs. These are called the Dow Theory
tenets. Charles H Dow developed these tenets over the years of his
observation on the markets. 9 tenets are considered as the guiding force
behind the Dow Theory. They are as follows:

Tenet What does it mean?

• 01 Indices discounts everything The stock market indices discount
everything which is known & unknown in the public domain. If a sudden
and unexpected event occurs, the stock market indices quickly recalibrate
itself to reflect the accurate value
• 02 All Indices must confirm with each other. We cannot confirm a
trend based on just one index. For example, the market is bullish only if
CNX Nifty, CNX Nifty Midcap, CNX Nifty Smallcap etc. all move in the same
upward direction. It would not be possible to classify markets as bullish,
just by the action of CNX Nifty alone

• 03 Volumes must confirm The volumes must confirm along with the
price. The trend should be supported by volume. The volume must increase
as the price rises and should reduce as the price falls in an uptrend.
• 04 Sideway markets can substitute secondary markets. Markets may
remain sideways (trading between a range) for an extended period.
Example:- Reliance Industries between 2010 and 2013 was trading between
860 and 990. The sideways markets can be a substitute for a secondary
trend

• 05 The closing price is the most sacred. Between the open, high, low
and close prices, the close is the most important price level as it represents
the final evaluation of the stock during the day.
• Three trends according to Dow theory

UPWARD TREND: For a ,market each peak and trough must

be higher than the previous position respectively.
• DOWNWARD TREND: Each new peak and trough is lower
than previous position respectively.
• A sideways is horizontal price movement that occurs when the forces of supply
and demand are nearly equal . This occurs during a period of consolidation
before the price continues a prior trend or reverse into a new trend. This
commonly known as horizontal trend.
 Criticism of Dow theory
• It is not theory but interpretation of Data.

• It is based on Historical interpretation

• Fallible , as it depends on interpretative

ability of the analyst.
• This hypothesis says that stock price movements can be predicted because
they move in repeating up-and-down patterns called waves that are created
by investor psychology or sentiment.

• The theory identifies two different types of waves: motive waves (also
known as impulse waves) and corrective waves.
• Out of these the first , third and
fifth waves are called as Impulse
wave and are in direction of the
basic movement. Other two waves
second and forth are correction
waves and are ahainst the direction
of the basic movement.
Elloit wave theory contd:
• The basic Doctrine of this theory is that the stock price in the market can be
described as a set of five wave patterns .In case of bull market the set of five
waves is as: the first wave is upward , the second wave is downwards , the third
wave is upward , the forth is downward and the fifth wave is inward. In case of
bear market the reverse pattern follows .

• WAVE DESCRIPTION: Elliot Wave Theory states that there will be 5 waves in a
given direction (Going upward in bull market and downward in bear market ) .

• Wave 1: The stock Price make initial move upwards. This may be caused by a
relatively small number of people all of a sudden (For variety of reasons) feel that
the previous price of the stock was cheap and therefore it is worth buying and
thus causing the price to go up.
• Wave 2 :The stock is considered to be overvalued and enough investors who were in the
original wave to consider that the stock was overvalued take profits. This causes the
stock to go down . However the stock will not make it to the previous low.
• Wave 3 : This may be the longest and strongest wave , More investors find out about the
stock and they buy it for a higher and higher price .This wave usually exceeds the tops
created by the previous wave 1.
• Wave 4: At this point the investors again take profits because the stock is again
considered to expensive. This wave tend to be weak because there are more investors
who are still bullis on the stock.
• Wave 5 : This is the point that most investors are driven by hysteria . They willcome up
with lots of reasons to buy the stock which has very little negative news : Consequently
the stock becomes overpriced . At this point the stock will move into one or two patterns.
 Tools and Techniques
of TA

Charts Indicators

Price and Individual Stock

Chart patterns Market Indicators
Volume Charts Indicators

Moving Breath of
Bar Chart Trend Average market

Market
Line Head and MACD breath
Chart shoulders Index

Point and Double Relative

Odd lot
Figure Tops and Strength Ratio
Chart Bottoms Ratio

Relative
Candlesti Triangles Put Call
Strength
ck Chart ratio
Index

Flags Rate of Short sales

Change Position

Mutual
Support and
Fung
Resistance
Liquidity
 Price and Volume Chart
• A price chart is simple two Axis chart with time on X axis
and price on the Y axis . The price of securities are
plotted on graphs and charts. The volume data are
displayed by individual histograms just below the price
data.
• Different types of Price and price volume charts are
discussed here:
 Bar Chart
• One of the basic tools of technical analysis is the bar
chart, where the open, close, high, and low prices of
stocks or other financial instruments are embedded in
bars which are plotted as a series of prices over a
specific time period. Bar charts are often referred to as
OHLC charts (open-high-low-close charts)
A price bar shows the opening price of
the financial instrument, which is the
price at the beginning of the time period,
as a left horizontal line, and
the closing price, which is the last
price for the period, as a right horizontal
line.The high price is the highest price
traded during the day, while the low
price is the lowest price of the day.
• An up-day is when the close is higher than the day before. A down-
day is when the close is lower.
• Higher closes generally implies a bullish market sentiment whereas
lower closes indicates bearish market sentiment.
• An uptrend is a series of up-days where the highs are mostly higher
than the day before and the lows are also higher. Both the higher lows
and the higher closes (up-day) confirm the uptrend.
• A downtrend is the opposite pattern, where highs, lows, and closes are
usually lower on successive down-days.
• A continuation pattern is one where the trend is fully
confirmed. A continuation pattern is especially confirmed
when a series of prices closes at the high, or its downtrend
counterpart, when a series of prices closes at the low.
• daily trading range- Short bars, with only a small difference
between the high and the low, generally indicate
indecisiveness of the market. Often, this pattern forms an
inside day, where the low is higher than the previous low but
the high is lower than the previous high.
 Line Chart
• It is most basic type of chart. It represents only closing
prices over a set period of time. The line is formed by
connecting closing prices over the time frame.
• It does not provide information of trading range for
individual points such as high, low and opening prices.
• A line chart gives traders a clear visualization of where
the price of a security has travelled over a given time
period. Because line charts only show closing prices,
they reduce noise from less critical times in the trading
day, such as the open, high, and low.
 Candlestick chart
• Candlestick Charts were created in the 1700’s for tracking
rice prices.
• Candlestick charts are easier to read than bar charts.
• They also make easier to tell whether the open or close
price was higher.
 Point and Figure Chart
• It is one of the simplest systems for determining
solid entry and exit points in stock market trading.
• This charting system monitors supply and demand of each
issue while keeping an eye on developing trends.
• They do not account for the discrete passage of time as most
other types of chart do along their x-axis.
• The Xs illustrate rising prices, while Os represent a falling
price.
• Support and resistance levels, as well as breakouts, are
more clearly defined on a P&F chart since it filters out tiny
price movements and is less susceptible to false
breakouts.
 Head and Shoulder Components
Left Shoulder:
• Bulls push prices upwards making new highs; however
these new highs are short lived and prices retreat.
• Head: Prices don't retreat for long because bulls make
another run, this time succeeding and surpassing the
previous high; a bullish sign. Prices retreat again, only to
find support yet again.
 Right Shoulder:

• The bulls push higher again, but this time fail to make a
higher high. This is very bearish, because bears did not
allow the bulls to make a new higher or even an equal high.
The bears push prices back to support (Confirmation line).
Inverted heads and shoulders:
• This pattern is reverse of heads
and shoulders pattern .It occurs at
the end of downwards trend The
price of the stock falls and rises
makes an inverted right shoulder.
As the process of fall and rise in
prices continues , The head and
left shoulder are created.
connecting the tops of the inverted
heads abd shoulders gives the
neckline.
 How to identify a resistance?
 Draw a straight line connecting the reversal points.
If three or more points touches the line, then it becomes a
resistance.
 The number of times it has reversed is directly proportional
to its strength. Remember, when something happens twice
its a coincidence, but if it happens thrice, it becomes a
pattern.
 How to identify support?

• Draw a straight line from the bearish reversal points.

If the line connects more than 3 reversal points, then the line
becomes a valid historical support.
It becomes a critical point, in the future, as traders tend to
use it as reference for long trades.
Indicators and Oscillators
An oscillator is a technical analysis tool that constructs high and low bands
between two extreme values, and then builds a trend indicator that fluctuates
within these bounds. Traders use the trend indicator to discover short-term
overbought or oversold conditions.
MOVING AVERAGE CONVERGENCE AND DIVERGENCE
The broad rule is if the RSI crosses seventy there may be downtrend and its time to sell . If it falls
below thirty its time to pick up the scrip.
MARKET INDICATORS:
• Besides the above discussed indicators there are certain indicators which
are used to analyse the behaviour of the overall market .These are known as
market indicators .The overall market movements affects the individual
share price , Hence aggregate forecasting is also useful and can helpmore
than the insdividual forecasting.Some of the important market indicators
are :
• Breath of the market
• market breath index
• ODD lot Ratio
• Put-Call ratio
• Short sales position etc
Weakness of Technical Analysis
THANK YOU