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Technical analysis
- 1. Technical Analysis Dr. MohammedArif Pasha Principal Brindavan College Bangalore - 560063
- 2. Concept of TechnicalAnalysis •Technical Analysis is the process of identifying trend reversals at an earlier stage • to formulate the buying and selling strategy with the help of several indicators • to analyze the relationship between Price, volume of supply- demand for the overall market and the individual stock. •Attempts to exploit stock price patterns for profit. •Assumes prices adjust slowly to their true equilibrium values
- 3. Assumptions of TechnicalAnalysis 1) The market value is determined by interaction of demand and supply. 2) The market discounts everything. (fears, hopes, inside information, right issue, bonus shares, earnings, loss etc.) 3) The market always moves in a trend. (increasing or decreasing) 4) In rising market, prices move up and falling markets, prices fall. 5) It assumes that past prices predict the future.
- 6. The Dow Theory •Usesprice and volume trends to predict stock prices. •Identifies primary, secondary, and tertiary trends. •Predicts support and resistance price levels. The theory has three types of market movements • the primary trend, the intermediate trend and the short term trend. • The primary trend may be the broad upward or downward movement which can often last a year or more. • The intermediate trend is corrective movement, which can move against the primary trend and may last for one month to several months. • The short term trend refers to day to day price movements testing for few hours to few days. • These trends are compared to tide waves and ripples of the sea, which are called fluctuations.
- 7. The Dow Theory •It employs two of the Dow Jones averages, • the industrial average and • the transportation average. • The theory is based on the assertion that • measures of stock prices tend to move together. • If the Dow Jones industrial average is rising, then the transportation average should also be rising. Such simultaneously price movements suggest a strong bull market. • Conversely, a decline in both industrial and transportation averages moving in the opposite direction, the market is uncertain as to the direction of future stock prices.
- 8. Dow Jones IndustrialAverages in 1988
- 9. Hypothesis of DowTheory Charles Dow developed this theory to explain the movement of indices on the basis of certain hypothesis. 1) No single individual can influence the major trend of the market. 2) Market discounts every thing (calamities, fire etc.) 3) It is not a tool but provides way to understand the theory better.
- 10. LIMITATIONS OF DOWTHEORY Following are the limitations of Dow Theory: • It is not a theory but only an interpretation of known data. • A theory should be able to explain why a phenomenon occurs. • No attempt is made to explain why the two averages should be able to forecast future prices. • Since it does not explain why two averages to forecast future stock prices, it is not acceptable in its forecast. • Because there was a considerable lag between the actual turning points and those indicated by the forecast. • The Dow Theory has poor predictive power and lack accuracy. • Therefore it has been subject to much criticism, as the results are less accurate.
- 11. Trend • A trendis a direction of movement. • Share prices can either increase or fall or remain flat • These directions are known as rising, falling and flat trend • But share prices do not rise or fall in straight line • The rise or fall in price experiences a counter move • If a share price increase, the counter move will be a fall in price and vice versa. • The share prices move in a zig zag manner
- 12. TREND LINE Y RISING TRENDLINE P FLAT TREND LINE R I C E FALLING TREND LINE X DAYS
- 13. PRIMARY TREND • Theprices of a stock may be either move up or come down. • Upward trend in the market is called “bull market” which shows three peaks. • Each peak is higher then the previous one. • Similarly the downward trend. • The reactions after peak halts before the previous bottom leading to revival after three peaks. • The upward trend is characterized by three stages namely • accumulative, gig and excess. • The phases leading to peaks improve the corporate profit margin and encourage more investors to buy stocks and attract speculation. • • Similarly in second phase, the corporate prices rise further and in the third phase, prices advance due to speculation and inflation. • The three phases of bull market are shown in the chart below, • If the market shows a downward trend, it is called “bear market” in the case of bear market, the reverse will happen.
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- 15. Bull Market Y T3 P T2 R ISpeculation C Phase 3 E T1 B2 Good corporate earning Phase -2 B1 Revival of Market confidence Phase – 1 X DAYS
- 16. Bear Market The firstphase of fall begins with loss of hopes where the increase in prices is much lower than previous high forcing the investors to sell the securities. In the second phase companies report low profits and declare lesser dividend which lead to selling pressure. In the final phase there is heavy sale of shares. The primary bear market is characterized by three stages namely distribution, big move and despair. Y LOSS OF HOPE (PHASE – 1) T1 RECESSION IN BUSINESS (PHASE -2) T2 B1 DISTRESS SELLING PHASE – 3) B2 B3 X DAYS
- 17. SECONDARY OR INTERMEDIATETREND The intermediate trend moves against the main trend and leads to correction. In the bull market, the intermediate trend results in fall while in the bear market, the intermediate trend carries the price upward and corrects the primary trend and the correction would be 33% to 66% of the earlier rise or fall. The intermediate trend is quicker compared to primary trend. SHORT TERM TREND The short term trend is the daily price fluctuation which tries to correct the intermediary trend movements, it should be noted that the investors should concentrate more on primary and intermediate trends and not on the minor trends. The above three are the three stages of primary bull market and primary bear market. Y BULL MARKET P R B I A C 33% to 66% of ‘B’ E 33% to 66% of ‘A’ X DAYS
- 18. SUPPORT AND RESISTANCELEVEL • Anybody who is interested in technical analysis should possess the knowledge of support and resistance level. • A support level exists at a price where considerable demand for that stock is expected to prevent further fall in the price level. • The fall in the price may be halted for the time being or it may result even in price reversal. • In the support level, demand for the particular scrip is expected. • In the resistance level, the supply of scrip would be greater than the demand and further rise in price is prevented. • The selling pressure is greater and the increase in the price is halted for the time being.
- 19. SUPPORT AND RESISTANCELEVEL Y SUPPORT LEVEL P R I C E SUPPORT LEVEL X DAYS
- 20. RESISTANCE LEVEL Y P R I RESISTANCELEVEL C E X DAYS Support and resistance usually occur whenever the turnover of a large number of shares tends to be concentrated at several price levels. When the stock touches a certain level and then drops, this is called resistance and if the stock reaches down to certain level and then rises there exists a support. The levels can switch from resistance to support or from support to resistance.
- 21. Technical Analysis andEMH • Technical analysis clashes with the EMH hypothesis. • EMH predicts rapid adjustment of prices with the onset of new information. • Evidence for the success of technical analysis is poor.
- 22. Charting: Elliott WaveTheory • Stock prices can be described by a set of wave patterns • Long-term and short-term wave cycles are super imposed on each other • By interpreting the cycles, one can predict broad movements
- 23. Point and FigureChart
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- 25. Charting: A Warning •Seeing patterns that don’t exists • After the fact, one can always find patterns and trading rules that would have generated enormous profits • What has worked in the past may not work in the future.
- 26. Figure 19-7 Actualand Simulated Stock Prices for 52 Weeks
- 27. Technical Indicators: SentimentIndicators • Market Volume: Higher volume gives strong confirmation to price trend. Trin>1: Bear Market; Trin<1: Bull Market • Odd-lot Trading (less than 100 shares): Small investors tend to miss key market turning points. - Odd-lot buying heavy investors should be bearish. - Odd-lot selling heavy investors should be bullish. advancing Number advancing/ Volume declining Number declining/ Volume Trin
- 28. Market Structure Indicators MovingAverages • Average price over some historical period (5 weeks or 200 days) • When current price crosses the average, a trading signal occurs • Bullish signal when the current price rises above the moving average • Bearish sign when the current price falls below the moving average
- 29. Technical Indicators: MarketStructure Moving Average: Average over a given interval, continuously updated. Price And M.A. Time Price Moving Average Averaging interval Bearish Signal Bullish Signal
- 30. Moving Average forMicrosoft
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Editor's Notes
- #7 Dow theory -- A technique that attempts to discern long- and short-term trends in stock market prices. The primary trend is the long-term movement of prices, lasting from several moths to several years. Secondary or intermediate trends are caused by short-term deviations of prices from the underlying trend line. (These deviations are eliminated via corrections when prices revert back to trend values). Tertiary or minor trends are daily fluctuations of little importance. Support level -- A price level below which it is supposedly unlikely for a stock or stock index to fall. Resistance level -- A price level above which it is supposedly unlikely for a stock or stock index to rise.
- #22 Perspective: Expect the question, “If you’re so smart, why don’t you make the money technical analysts make?” The answer is that many people will pay for the illusion of certainty. After all, palm readers have been around for a long time.
- #23 Kontradieff wave theory: Market moves in cycles of 50yrs…yeah right!
- #26 Show coin toss pattern. Show movie about who wins the superbowl. Perspective: An old exercise that Burton Malkiel has used might be helpful here. Have the students construct a chart of a hypothetical stock’s price changes using coin tosses. Start with a stock price of $50. Let the price rise by a dollar if a head is tossed. Let the price fall by a dollar if a tail is tossed. Construct these charts for 30 to 50 “days” (one toss per day). With 15 or more students in the class, the chances are good for getting some ”classic” patterns. (See A Random Walk Down Wall Street).
- #28 Market advances are a more favorable omen of continued price increases when they are associated with increased trading volume (see homework problem 2). Market reversals are considered more bearish when associated with higher volume. The trin statistic is the ratio of the average volume of a declining issue divided by the average volume of an advancing issue. Odd-lot trading – Assumes that small investor are stupid! The theory that net buying of small investors is a bearish signal for a stock. Assumption is that odd-lot traders don’t know what they are doing. Odd lot is fewer than a round lot of 100 shares.
- #30 When the market price breaks thorugh the moving average line from below, it is taken as a bullish signal . When prices fall below the moving average, it is considered time to sell. MA piercing price from below: bullish signal (shift from falling to raising) Price piercing MA from above: bearish signal (shift from raising to falling) Two popular moving averages are the 200-day and the 53 -week moving averages.