INVESTMENT MANAGEMENT

TECHNICAL ANALYSIS

SUBMITTED TO: Prof. Vipul

SUBMITTED BY: Group No. 8 (Section B) Atul Bhatia (PGP28318) Priyadarshini Kumari (PGP28315) Vishnu Khandelwal (PGP28166) Sandeep Rawat (PGP28016)

Contents
I. Price Volume Patterns.................................................................................................................. 3 Plot and Assumptions ..................................................................................................................... 3 Back-testing and insightful patterns ............................................................................................... 3 Recommendation: BUY or HOLD .................................................................................................... 3 Support and Resistance: ................................................................................................................. 4 II. Moving Average Convergence Divergence (MACD) ....................................................................... 4 Plot and Assumptions ..................................................................................................................... 5 Back-testing and Insightful patterns ............................................................................................... 5 Recommendation BUY ................................................................................................................. 5 III. Relative Strength Index (RSI)....................................................................................................... 5 Plot and assumptions ...................................................................................................................... 5 Back-testing and Insightful patterns ............................................................................................... 5 Recommendation BUY ................................................................................................................. 6 IV. Stochastic ........................................................................................................................................ 6 Plot and assumptions ...................................................................................................................... 6 Back-testing and Insightful patterns ............................................................................................... 6 Recommendation BUY ................................................................................................................. 7 V. Point and Figure Chart .................................................................................................................... 7 Plot and assumptions ...................................................................................................................... 7 Back-testing and Insightful Patterns ............................................................................................... 8 Recommendation - Hold ................................................................................................................. 9 VI. Bullish / Bearish Engulfing............................................................................................................... 9 Back-testing and Insightful Patterns ............................................................................................... 9 Recommendation BUY ............................................................................................................... 10 VII. Final recommendation .................................................................................................................. 11

I.

Price Volume Patterns

Price pattern analysis is the basis of technical analysis of stocks. Fundamental developments in a stock are followed by price movements. High, Low and Closing prices are used to analyze the price action of a stock. Volume is also an important indicator in technical analysis as it is used to confirm trends and chart patterns. Price movement with relatively high volumes is seen as a strong trend as compared with one with low volumes. Plot and Assumptions A rise in share price accompanied by increasing volumes indicates a sustained upward trend while a decline in price along with increasing volumes indicates a strong downtrend. As shown in the Chart 1, if the price of the stock is increasing but the volume declines, it signals a weakening of upward trend and a possible reversal. Back-testing and insightful patterns Average Volume decreased from around 10M (during Sep 17, 2012 - Oct 05, 2012) to 5M (during Oct 06, 2012 - October 18, 2012) while the stock was still going up. This decline in volume indicated the weakness in the bullish trend and on October 20, 2012 the stock price started declining. Similar patterns can be seen at other points as well as indicated in the chart below Chart 1

Recommendation: BUY or HOLD The recent trend of the stock price shows the reversal of downward trend as shown in the green circle. The upward movement is backed by increase in volumes. However, the increase in the price of the stock has been very marginal in the recent days, thus the trend is still not strong enough to confirm an upward movement in the coming days

Support and Resistance: Chart 2

Resistance

Resistance Support

Support

As shown in the chart above, ITC stock had a strong resistance at Rs 310 from Feb, 2013 to Mid-April, 2013. The stock broke the resistance in the third week of April, 2013 and reached a high of Rs 355 on May 11, 2013. Current resistance and support levels of the stock are Rs 355 and Rs 315 respectively as shown in the chart. RECOMMENDATION: BUY or HOLD with a stop loss of Rs 315

II. Moving Average Convergence Divergence (MACD)

Chart 3

Sell

Buy

Sell Sell Buy

Buy Sell Buy

Buy

Buy

MACD is a momentum indicator. The MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. The MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge. 4

Plot and Assumptions Standard parameters are considered for MACD as they seem to work well for this stock: o MACD Line (Green): 12-day EMA 26-day EMA o Signal Line (Blue) : 9-day EMA of MACD Line o MACD Histogram: MACD Line Signal Line The stock is expected to be bullish when the MACD line crosses the Signal Line upwards Bearish Crossover occurs when the MACD line crosses the Signal Line downwards Crossovers can last a few days or a few weeks depending on the strength of the move

Back-testing and Insightful patterns Single Line Crossovers: Since October 2012, MACD line has crossed the signal line 9 times 5 times in upward direction and 4 times in downwards. And as shown in the chart, the stock movement is as expected post crossover. Thus MACD(26,12,9) serves as a powerful indicator of this stocks momentum Center Line Crossovers: In the last 18 months, the MACD line has remained above the center line indicating a fairly continuous uptrend in the stock. Stock has gained around 42% during this period MACD line went below 0 on June 18, 2013 developing a bearish trend in the stock Recommendation BUY As on July 02, 2013 the MACD line is intersecting with the signal line and is expected to crossover the signal line in the upward direction thereby indicating bullishness in the stock. Also, the MACD line has turned upwards and is likely to cross the Center Line showing bullish trend in the stock

III. Relative Strength Index (RSI)

RSI is momentum indicator in the category of leading oscillator designed to lead the price movements. Plot and assumptions The first step in RSI is to identify overbought and oversold regions. Generally, the market considers below 30% and above 70% as the threshold limits for oversold and overbought region respectively However, these regions can be different based on overall nature of the market which could be bullish or bearish We assume bullish market for the given time period (1-Jan-2012 to 2-Jul-2013) and hence the range selected is: Overbought 70%, Oversold 40%

Back-testing and Insightful patterns For the given time period, the RSI line has crossed from overbought region to the normal region just thrice (shown in RED circles) but interesting point is that without exception the stock has lost some value every single time it happened. Though, one must mention that the overall fall in the price has not been significant due to very strong fundamentals and defensive nature of the stock even in bearish market sentiment 5

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Similarly, for the given time period, the RSI line has crossed from oversold to normal region 5 times and every time the stock has gained in price. Particularly, when this touches the lows of 30% area, the rally has been very strong like that indicated in the region marked (A)

Recommendation BUY We see this trend we see that RSI has very recently crossed from oversold region to the normal region. Going by this past trend marked by Green circles, it is very likely to go up from here as well

IV. Stochastic
Stochastic is similar to RSI as it is also a leading momentum indicator and falls in the oscillators category. Plot and assumptions Similar to RSI plotted above, the first step in Stochastic is to identify overbought and oversold regions. In line with the commonly followed trend, we consider below 20% and above 80% as the threshold limit for oversold and overbought region respectively Back-testing and Insightful patterns In the defined period from 1-Jan-2012 till date, the stochastic oscillator has entered the oversold region only 4 times. We know that in the oversold region if %K line crosses the %D (dotted blue) line, it indicates a BUY signal. We have observed that in all the 4 cases when this has happened the stock has moved up (indicated with blue circles). o One interesting observation is that if the upside movement is very steep and it does not change its direction any time till it hits the overbought region (above 80% threshold), it is a STRONG BUY signal. This has been indicated in the cases marked (A) The stochastic has entered the overbought region several times in the defined period (9 times). The trend here is not as strong as in the case of oversold region. We know that whenever %K line crosses %D (dotted blue) line in the overbought region, the stock is expected to fall. In line with the expectations, 7 out of the 9 cases in the past, whenever this 6

has happened, the stock has lost value (indicated with red circles). However, in 2 of the cases it has not shown much negative movement. An interesting observation is that whenever there is a break in the downward movement of %K line, one should be vigilant to hold on to the short position because the downward movement has been more pronounced only if the %K line directly enters the oversold region

Recommendation BUY The %K line crossed the %D line in the oversold region some 8-10 days prior to 2-Jul-2013. And, it has only moved in the upward direction since then indicating an upward trend. We would suggest BUY for the stock based on this trend. However, we should be very vigilant in tracking this line. Whenever, this line breaks this upward movement trend, one should reconsider this BUY position

V. Point and Figure Chart

Point and Figure Chart provides a better way of identifying the trends in the financial market as it ignores the minor fluctuations. Plot and assumptions The two key parameters to be considered in point and figure charting are as follows: Box size: A fixed scale has been considered on the y axis to plot the stock prices. Each box corresponds to 3 units of Stock Price.

Reversal size: Reversal size of 2 boxes has been taken which corresponds to a value of 6 units of Stock Price. The reason behind using 2 box reversal is to smooth out the minor fluctuation with respect to existing price which is around 300 INR.

Back-testing and Insightful Patterns Back Testing has been done on stock prices from 1st Jan 2012 to 30th April 2013. The patterns observed during the period and the decisions rules based on that are as follows. Double Top Patterns: Four Double Top patterns have been observed during this period. Every time this pattern has occurred, stock price has gone up by considerable amount. Three out of these patterns are followed by strong bullish trend. So, this pattern is a useful indicator for bullish trend and can be used to recommend Buy of the stock.

Triple Top Patterns: It has occurred twice during this period. As observed, this pattern has always been followed by increase in Stock prices trend which represents a bullish trend. So, this pattern can be used for recommending a Buy of the stock.

Double Bottom Pattern: It has been observed 3 times during this period. Every time this pattern has occurred a slight decrease in stock prices has been observed subsequently. But the decrease in stock prices has sustained only for a small time. Hence, although this pattern is an indicator of bearish trend but based on our observation for this Stock, it is not good enough to recommend a Sell.

Recommendation - Hold Although there was a bearish movement in the stock price around mid of June but subsequently stock prices has risen. The rise has not been great and also no reversal has been observed till 2nd July. As on 2nd July none of the previously described patterns i.e. Double Top, Triple Top & Double Bottom has been occurred. So we recommend a Hold of the stock. Investors should wait for change in stock prices and look for patterns before taking any further decision.

VI. Bullish / Bearish Engulfing

Bullish Engulfing: It occurs when bullish candle stick (shown in blue) engulfs the previous bearish (shown in red) candlestick in downtrend trend. Here engulfing refers to opening lower and closing higher than the previous day. It signifies that the buyers are overwhelming the sellers and the upside is expected in the future. Bearish Engulfing: It occurs when bearish candle stick engulfs the previous bullish candlestick especially in upward trend. Engulfing here means opening higher and closing lower than the previous day. It signifies that the sellers are overwhelming the buyers and the stock is expected to fall in the future. Back-testing and Insightful Patterns In the two figures shown below, bullish engulfing is shown by BLUE circles and bearish engulfing by RED circles. As is clearly visible, after every bullish engulfing pattern, there is an upside and after bearish engulfing patter, the stock has lost value.

1-Jan-2013 to 2-Jul-2013

6 months ending Dec-2012

Recommendation BUY The last closing number shows the mild bullish engulfing and is an indication of stock expected to move up from here. Though the intensity of engulf is not as high as observed in some instances in the history but the pattern has not shown any exceptions in the past. Therefore, we expect the stock to go up from here

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VII. Final recommendation

We suggest a BUY recommendation for the stock based on majority of the indicators indicating the bullish trend. Except for Point and Figure Chart and one price volume pattern, all other indicators indicate BUY signal on ITC. Summary recommendations: Price-Volume: BUY or HOLD MACD: BUY Relative Strength Index (RSI): BUY Stochastic: BUY Point & Figure Chart: HOLD Bullish / Bearish Engulfing: BUY

Our final recommendation based on above indicates is BUY. However, we should be cautious to quickly identify reversal of any / all of the patterns above.

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