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We all know that future price of stock is the central concern of the
equity investment decision.
The principal decision variables take the form of earnings per share and
dividend pay-out.
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MEANING OF TECHINICAL ANALYSIS
The price of most the Indices and the stocks keep on varying in an
erratic fashion, so much so that the difference between the high and the
low during a year may exceed by a ratio of two or more, even though
the fundamentals do not change much.
For instance, in spite of the daily variation of price, the earnings of the
company do not vary during the year, the book value, the loans, the
profit margin, the taxes and other charges, depreciation, etc. may not
change from one annual report to the other.
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Technical analysis incorporates techniques to determine when:
o an equity is overbought,
o at which point of time it can be sold at a high price, or
o at which point of time it is oversold,
o at which point of time it may be bought at a low price.
And since the whole process involves much less time and data analysis,
compared with fundamental analysis, it facilitates timely decision.
But, if you buy such a share at the wrong time and then the price moves
down, you lose, in spite of the strong fundamentals.
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With technical analysis you can avoid this pitfall, because it tells you
the most appropriate time to buy a share and the most appropriate time
to sell the same.
It enables you to buy cheap and sell high regardless of the type of
company you choose.
Surveys indicate that 85 per cent of the investors lose money in the
stock market. The insiders, who comprise 15% of the total, win.
Some are tempted and buy, only to lose ultimately and blame their
kismet instead.
You would notice that on the eve of a new public issue, relatively
unknown companies come into pre-eminence.
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Big public campaigns are launched. Members of public are bombarded
with mail.
The shares of companies which remained unheard of for a long time are
traded actively on the stock market, at high prices.
Many such companies go back into oblivion, after the public issue is
over and leaves holes in many pockets.
But the insiders know the real truth. They do exactly the opposite of
what the crowd does.
They buy when the crowd sells and they sell when the crowd buys.
This is why the insider, the stock brokers, and the company directors
become multi-millionaires.
The Broker
The broker belongs to the insider club. He gets prior knowledge of the
inside working of a company.
He knows why a company share are going up, and the shares of another
company are going down.
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But, he may play against you in stock market. He makes money at the
expense of gullible investors.
It highlights the hidden features in the price movements and lay bare the
way the market is behaving and might behave in future.
This analysis of internal structure unfolds the insider action and brings
to the fore the true picture.
The investors are steered away from the crowd and are directed towards
that strategy they should follow to win.
We can say that technical analysis may be useful in timing a buy or sell
order while fundamental analysis may help in identifying undervalued
or overvalued stocks.
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It is perhaps for this reason the technical analysis is frequently used as
a supplement to fundamental analysis rather then as a substitute for it.
The technician views price changes and their patterns mainly through
price and volume statistics.
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We may here conclude by saying that fundamental analysis and
technical analysis are two alternative approaches to predicting stock
price behavior.
The Modern Technical Analysis was perfected in the later part of the
century.
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TECHNIQUES OF TECHNICAL ANALYSIS
What is a chart?
A Bar is formed by joining the highest price and the lowest price of a
particular share by a vertical line. The closing price of the day is marked
by a horizontal mark on this vertical line.
CLOSE 100
Price
100
90
LOW
80
Jan 5 6 7 8 9 10
This point is marked on the latest date for which prices bar has been
plotted.
This process is repeated for the previous dates. The points thus obtained
are connected together to give the Moving Average line.
CALCULATION OF FIVE –WEEK MOVING AVERAGE
2 25
3 26
4 24
6 29 132.5 26.5
7 28 135.5 27.1
10 25 136 27.2
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The points calculated in the last column of the above table are plotted
in Chart of moving average.
When the 10-week moving average line slopes up, the intermediate
term trend is rising.
When the 30-week moving average line slopes up, the long term trend
of the market is positive, i.e, the market is bullish.
Similarly, when the 10-week moving average line slopes down, the
intermediate term is falling.
When the 30-week moving average lines down, the log term trend of
the market is negative, i.e., the market is bearish.
What is an Oscillator?
The values of the 10-week moving average are subtracted from the
values of the 2-week moving average.
-1
-2
-3
1 2 3 4 5 6 7 8 9 10 11
Week
2 24 22 2
3 26.75 24 2.75
4 29 26 3
5 29.75 27 2.75
6 29.5 28 1.5
7 27.5 29 -1.5
8 28 30 -2
9 27 29 -2
12
10 27 28 -1
11 27.5 27 0.5
While values below the zero line indicates that selling is in progress.
When the Oscillator moves down from the positive towards the
negative, it indicates that selling may be considered.
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What is Rate-of-Change (Momentum) ?
CALCULATION OF RATE–OF-CHANGE
2 50
3 52
4 54
5 55
6 56
7 56 49 1.14 0.14
8 55 50 1.1 0.1
9 54 52 1.04 0.04
10 48 54 0.89 -0.11
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How does Rate-of-Change (ROC) help ?
When the ROC line is above the zero line, the price is rising and when
it is below the zero line, the price is falling.
Upside crossings (from below to above the zero line) indicate buying
opportunities and down side crossings warn you to sell.
When the price of stock advances, the closing price is higher than the
closing price of the previous day.
When the price of the stock declines, the closing price is lower than the
closing price of the previous day.
During the rising phase, the price falls several times, while during the
falling phase, the price falls several times.
Relatives Strength Index tells us whether the net difference between the
closing prices is increasing or decreasing.
During the rising phase of the market, the prices move up fast, and the
differences between the recent close and the previous close are large.
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When the market reaches the top, these differences reduce. When the
market declines, the difference again become large.
The formula for 14 – week Cutler’s Relative Strength Index (RSI) i9s
given Below:
RSI = 100 – [ 100/( 1 + RS ) ]
If the RSI has crossed the 30 lines from below to above and is rising, a
buying opportunity is indicated.
A firm line and a dotted line are plotted above or below a zero line.
If the lines are below the zero line and the firm line crosses the dotted
line from below to above, it indicates buying opportunities.
If the lines are above the zero line and the firm line crosses the dotted
line from above to below, it indicates selling opportunities.
MARKET INDICATOR
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The difference between the advances and declines is called ‘breadth of
the market’.
Normally, breadth and the stock market index will move in unison.
During a bull market if breadth declines to new lows while the stock
market index makes new highs a peak in the average is suggested.
This refers to selling shares that are not owned, can be useful indicator
of the market as well as for individual stocks.
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Short selling, or as it is called short interest also, can be related to
average daily volume.
The short interest for a period say a month, divided by average daily
gives a ratio.
This ratio indicates for many days of trading it would take to use up
total short interest.
In general when the ratio is less than 1.0, the market is considered weak
or weakening.
Values above 1.5 indicate bullish territory with 2.0 and above highly
favorable.
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Mutual-fund Cash as a percentage of net Assets on a daily or weekly
or monthly basis has been a popular market indictor.
The theory is that a low cash ratio, say about 5% would indicate a
reasonably fully invested position leaving negligible buying power
indicating that the market is due for climb down.
To start with Dow theory put forward six basic tenets as follows:
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The primary movements is the long range cycle that carries the
entire market up or down.
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