Technical Analysis

LECTURE NO.-18
TECHNICAL ANALYSIS

While fundamental analysis and security evaluation explain why share prices fluctuate, how they are determined and what to buy or sell, the technical analysis will help the decision when to buy and sell. The traditional theory of capital market efficiency postulates that entry into the market at any time would lead to the same average return as that of the market.
But in the real world of imperfections, there are investors who have burnt ehrifingers by entering the market at the wrong time. Investment timing is, therefore, crucial as the market is continuously jolted by waves of buying and selling and prices are moving in trends and cycles and are never stable. The Stock market is different from other markets, as there is a continuous buying and selling and bid and offer rates as under a system of auctions. The resultant prices, led by the sheer force of the market, may fluctuate either way ad may exhibit waves or trends. Entry and exit in the market will, therefore, make all the differece to the spread between buying and selling prices and the profits or losses.

Timing of investment is, therefore, of vital importance for trading in the stock market.
Basic Tenets of Technical Analysis Technical analysis of the market is based on some basic tenets, namely, that all fundamental factors are discounted by the market and are reflected in prices. Secondly, these prices move in trends or waves which can be both upward or downward depending on the sentiment, psychology and emotions of operators or traders. Thirdly, the present trends are influenced by the past trends and the projection of future trends is possible by an analysis of past price trends. Analysis of historical trends confirmed the above principles asnd the Random Walk theory explaining the randomness of price changes has been found to be not applicable by the technical analysis in practice.

Tools of Technical Analysis

1. Daily Fluctuation or Volatility
Open, High, Low and Close are quoted. Changes between Open and Close or High and Low can be taken in absolute points or in percentages to reflect the daily volatility. Such
fluctuation can be worked out on weekly, monthly or yearly basis also to reflect the general volatility of the market.

2. Floating Stock and Volume of Trade
Floating stock is the total number of shares available for trading with the public and volume of trade is any part of that floating stock. The higher this proportion, the higher is the liquidity of a share which is to be purchased or sold. Volume trends are also a supporting indicator to the price trends to interpret the market.

3. Price Trends and Volume Trends
The Chartist method and Moving average method can be used to depict these trends.

4. Rate of Change of prices and Volumes or the ROC Method
This is useful like the moving average method to idicate more clearly the buy and sell signals. The Chartist method is useful to indicate the directions and the trend reversals. ROC is calculated by dividing the today’s price by the price five days back or few days back. It can be expressed as percentage or positive or negative change. Thus they can be moving around 100, in the case of percentages or zero line, in the case of positive and negative percentage changes.

5. Japanese Candlestick Method
There are three main types of Candlesticks with each day’s trade being shown in the form of candlesticks. Each stick has the body of the candle and a shadow. The body shows the open and close prices while the shadow shows the high and low prices. the three main types are as follows :
a. Closing price is higher than open price (White candlestick).
b. Closing price is lower than the open price (Black stick).
c. Open and Close are at the same level (Doji candlestick).

This method will indicate any likely changes in trends in the short-run.

6. Dow Theory
There are three major trends in this theory. Minor, intermediate and major trends representing daily or weekly, monthly and yearly trends in prices respectively comparing the price trends to waves, tides and ripples.

7. Elliot Wave Theor
The market is unfolded by a basic rhythm or pattern of 5 waves up to be corrected by three waves down with a total of 8 waves - a phiolosophy of price trends.

8. Theory of Gaps
Gaps in price between any two days causing a discountinuity is called a gap. The high of one day may be lower than the low of the preiovus day when prices are falling. Gaps indicate the likely acceleration of the trend or reversal. Gaps are of different categories, namely :
a. Common gaps - When prices move in a narrow range, a gap can occur in prices.
b. Break out gaps - When price trend is likely to change, a gap can occur in either direction. This gives a break to congestion in any direction.
c. Runaway gaps - Thse gaps occur continuously in a downward phase or an upward phase, accelerating or decelerating the trends.
d. Exhaustion gaps - These occur when the rally is getting exhausted. When the runaway gap is coming to an end, there can be exhaustion gap to indicate the likely completion
of the uptrend.

9. Advance DEcline Line or Spread of the Market :
The ratio between Advances to declines will indicate the relative strength of upward or downward phase. When the advances are increasing over declines it is an upward phase and the reverse indicates the down ward phase.

10. Relative Strength Index (RSI) of Wells Wilder :
It is an oscillator used to identify the inherent strength or weakness
of particular scrip. R.S.I. is calcualted for one scrip while RSC or the relative
strength comparative, is the ratio of two prices of two different scrips, used for comparison of two or more scrips. RSI can be calcualted for any number of days say 5 or 10 etc. to indicate the strength of price trend.