A Project Report On

Technical Analysis of Equity Market MBA(BE) 2009-11

Submitted To: Dr. Ganesh Kawadia HOD,SOE DAVV Indore

Submitted By: Pooja Sengar MBA(BE) III Sem SOE,DAVV

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ACKNOWLEDGMENT
Privilege is what I feel expressing my sincere respect to my guide, adviser and well-wisher Mr Akhilesh Rathi,SNR Securities, Indore. Apart from his technical guidance , his caring attitude and morel , encouragement has been very much crucial for me . During this project , he has inspired me through out the project period and has extended support at all possible juncture. At various stages in the project it is required to interact with real world and get info & help from all available sources . Many people have contributed towards making this project successful. Before we get in thick of things I would like to thanks him again.

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Contents Introduction
• • • • • Stock Market Participants Business Cycle Volatility Financial Crises

Objective Factors Affecting Stock Market
• •

Fundamental factors Technical factors

Model

Need Factors taken into Consideration Time range Desirability Rank Functioning Usage Assumptions Advantages and Limitations


• • • •

Conclusion Sources

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central banks tend to keep an eye on the control and behavior of the stock market and. or raise additional capital for expansion by selling shares of ownership of the company in a public market. analysts. Rising share prices. financial writers. This allows businesses to be publicly traded. a sale takes place. The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organizations specialized in the business of bringing buyers and sellers of the organizations to a listing of stocks and securities together. on the smooth operation of financial system functions. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. in general.Introduction Stock Market Stock Market is an exchange where security trading is conducted by professional stockbrokers. Actual trades are based on an auction market model where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. these are securities listed on a stock exchange as well as those only traded privately. The exchanges provide real-time trading information on the listed securities. Television commentators. thus providing a marketplace (virtual or real). With each passing year. The stock market is one of the most important sources for companies to raise money. for instance. An economy where the stock market is on the rise is considered to be an up and coming economy. tend to be associated with increased business investment and vice versa. When the bid and ask prices match. The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers. It is a public market for the trading of company stock and derivatives at an agreed price. Stock market performance is largely seen as an indicator of the development of a particular country and over expectations about its performance could lead to stock market bubbles which might burst any time. facilitating price discovery. compared to other less liquid investments such as real estate. This is an attractive feature of investing in stocks. Therefore. the stock market is often considered the primary indicator of a country's economic strength and development. Share prices also affect the wealth of households and their consumption. and market strategists are all overtaking each other to get 4 . on a first-come-first-served basis if there are multiple bidders or askers at a given price. the noise level in the stock market rises. In fact.

Despite being termed cycles. most of these fluctuations in economic activity do not follow a mechanical or predictable periodic pattern. pension funds. investor groups. despite all this available information. individual investors.g. Yet. are exchanging questionable and often misleading tips. Warren Buffett. These fluctuations occur around a long-term growth trend. Participants Participants in the stock market range from small individual stock investors to large hedge fund traders and Financial Institutions (FII’s and DII’s). as a percentage of 5 .investors' attention. who can be based anywhere. equivalently debt. banks and various other financial institutions). Stock prices skyrocket with little reason. exchangetraded funds. markets have become more "institutionalized". Business Cycle The term business cycle (or economic cycle) refers to economy-wide fluctuations in production or economic activity over several months or years. Their orders usually end up with a professional (Broker) at a stock exchange. and typically involve shifts over time between periods of relatively rapid economic growth (expansion or boom). index funds. hedge funds. immersed in chat rooms and message boards. who executes the order. insurance companies. and people who have turned to investing for their children's education and their own retirement become frightened.. only folly. then plummet just as quickly. At the same time. and periods of relative stagnation or decline (contraction or recession). buyers and sellers are largely institutions (e. investors find it increasingly difficult to profit. Sometimes there appears to be no rhyme or reason to the market. These fluctuations are often measured using the growth rate of real gross domestic product. Over time. mutual funds. One alternative theory is that the primary cause of economic cycles is due to the credit cycle: the net expansion of credit (increase in private credit.

In particular. its commercial dealings. In this model. The economy of the western world is a system of closely interrelated parts. consumer confidence.Recession (drops in prices and in output. In 1946. Austrian economist Joseph Schumpeter argued that a Juglar cycle has four stages: 1. in duration. French economist Clement Juglar identified the presence of economic cycles 8 to 11 years long. Later.Expansion (increase in production and prices. and this theory places finance and banks at the center of the business cycle. Burns: Business cycles are not merely fluctuations in aggregate economic activity. An especially prolonged recession may be called a depression. and prices. Negative GDP growth lasting two or more quarters is called a Recession. followed by similarly general recessions. He who would understand business cycles must master the workings of an economic system organized largely in a network of free enterprises searching for profit. 3. and its tangles of finance. F. contractions. the bursting of speculative bubbles is seen as the proximate cause of depressions. 2.Recovery (stocks recover because of the fall in prices and incomes).Crisis (stock exchanges crash and multiple bankruptcies of firms occur). recovery and prosperity are associated with increases in productivity. while the net contraction causes recessions. they are not divisible into shorter cycles of similar characteristics with amplitudes approximating their own. In 1860.GDP) yields economic expansions. The problem of how business cycles come about is therefore inseparable from the problem of how a capitalist economy functions. According to A. 6 . business cycles vary from more than one year to ten or twelve years. Mitchell provided the now standard definition of business cycles in their book Measuring Business Cycles: Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities. Burns and Wesley C. economists Arthur F. high interests rates). aggregate demand. depressions. The critical feature that distinguishes them from the commercial convulsions of earlier centuries or from the seasonal and other short term variations of our own age is that the fluctuations are widely diffused over the economy--its industry. while a long period of slow but not necessarily negative growth is sometimes called economic stagnation. low interests rates). 4. and revivals which merge into the expansion phase of the next cycle. although he was cautious not to claim any rigid regularity. and if it persists.

For example. it is also possible to trade volatility directly. through the use of derivative securities such as options and variance swaps. following the stability and growth in the 1980s and 1990s in what came to be known as The Great Moderation – which was followed by the Late-2000s recession. secondly in the early 2000s. merely how dispersed they are expected to be. In recent years economic theory has moved towards the study of economic fluctuation rather than a 'business cycle' . and culminating in the Great Depression of 1929–39. so that a number of particular cycles were named after their discoverers or proposers: • • The Kitchin inventory cycle of 3–5 years (after Joseph Kitchin). • • Volatility When investing directly in a security. For Milton Friedman calling the business cycle a "cycle" is a 7 . when Phillips curve was seen as being able to steer the economy – which was followed by stagflation in the 1970s. volatility is often desirable. The Kondratiev wave or long technological cycle of 45–60 years (after Nikolai Kondratiev). There were frequent crises in Europe and America in the 19th and first half of the 20th century. Volatility does not measure the direction of price changes. starting from the end of the Napoleonic wars in 1815.though some economists use the phrase 'business cycle' as a convenient shorthand. In this period the economic cycle – at least the problem of depressions – was twice declared dead. with other investing strategies. volatility is often viewed as a negative in that it represents uncertainty and risk. the profit will be greatest when volatility is highest. and long on the lows of a security. specifically the period 1815–1939. so that negative and positive differences are combined into one quantity. but the instrument with higher volatility will have a larger swing in values at the end of a given period of time. The Juglar fixed investment cycle of 7–11 years (often identified as 'the' business cycle). However. which was immediately followed by the Post-Napoleonic depression in the United Kingdom (1815–30). if an investor is short on the peaks. Schumpeter and others proposed a typology of business cycles according to their periodicity.In the mid-20th century. In today's markets. Two instruments with different volatilities may have the same expected return. all differences are squared. The Kuznets infrastructural investment cycle of 15–25 years (after Simon Kuznets). This is because when calculating standard deviation (or variance). first in the late 1960s. which lead into World War II. which discredited the theory.

they do not directly result in changes in the real economy. However. because of its non-cyclical nature. and sovereign defaults. Other global and national financial mania includes: 20th century: 1910 – Shanghai rubber stock market crisis Wall Street Crash of 1929-.misnomer. so it is hard to detect bubbles reliably. may indirectly do so. currency crises. it is difficult to tell in practice whether an asset's price actually equals its fundamental value. In the 19th and early 20th centuries. Financial Crises The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. Rational expectations theory states that no deterministic cycle can persist because it would consistently create arbitrage opportunities. causing the 1973–1974 stock market crash Secondary banking crisis of 1973–1975 – United Kingdom 1980s – Latin American debt crisis – beginning in Mexico in 1982 with the Mexican Weekend Bank stock crisis (Israel 1983) 1987 – Black Monday (1987) – the largest one-day percentage decline in stock market history 8 . this could be evidence that a bubble is present. If there is a bubble. and when many decide to sell the price will fall. notably if a recession or depression follows. Much economic theory also holds that the economy is usually at or close to equilibrium. If most market participants buy the asset primarily in hopes of selling it later at a higher price. excluding very large supply shocks. Financial crises directly result in a loss of paper wealth. These views led to the formulation of the idea that observed economic fluctuations can be modeled as shocks to a system. many financial crises were associated with banking panics. there is also a risk of a crash in asset prices: market participants will go on buying only as long as they expect others to buy. business declines are more of a monetary phenomenon. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles.followed by the Great Depression – the largest and most important economic depression in the 20th century 1973 – 1973 oil crisis – oil prices soared. Friedman believed that for the most part. instead of buying it for the income it will generate. and many recessions coincided with these panics.

Asian Financial Crisis – devaluations and banking crises across Asia 1998 Russian financial crisis 21st century: 2001 – Bursting of dot-com bubble – speculations concerning internet companies crashed 2007–10 – Financial crisis of 2007–2010. followed by the late 2000s recession.1989–91 – United States Savings & Loan crisis 1990 – Japanese asset price bubble collapsed Early 1990s – Scandinavian banking crisis: Swedish banking crisis. Finnish banking crisis of 1990s 1992–93 – Black Wednesday – speculative attacks on currencies in the European Exchange Rate Mechanism 1994–95 .economic crisis in Mexico – speculative attack and default on Mexican debt 1997–98 . 9 .

Investors' emotional responses to price movements lead to recognizable price chart patterns. If the intrinsic value is higher than the market price it is recommended to buy the share . Factors Affecting Stock Market Prices When the objective of the analysis is to determine what stock to buy and at what price. inflation. including both international and national economic indicators. there are two basic methodologies: 1Fundamental analysis maintains that markets may misprice a security in the short run but that the "correct" price will eventually be reached. Many technical investors use fundamentals to limit their universe of possible stock to 'good' companies. He narrows his search down to 10 . This is considered as the true value of the share. and energy prices. Investors can use any or all of these different but somewhat complementary methods for stock picking. Technical analysis does not care what the 'value' of a stock is. For example many fundamental investors use technicals for deciding entry and exit points. Trends 'are your friend' and sentiment changes predate and predict trend changes. Investors can use either a top-down or bottom-up approach: • The top-down investor starts his analysis with global economics. exchange rates.Industry analysis 3. Their price predictions are only extrapolations from historical price patterns. If it is equal to market price hold the share and if it is less than the market price sell the shares. Profits can be made by trading the mispriced security and then waiting for the market to recognize its "mistake" and reprice the security. such as GDP growth rates. interest rates.Company analysis On the basis of this three analysis the intrinsic value of the shares are determined. Fundamental Factors: Fundamental analysis includes: 1. 2Technical analysis maintains that all information is reflected already in the stock price.Economic analysis 2. productivity.Objective To combine the various factors (Technical or Fundamental) responsible for the stock market price fluctuations (Short term and Long term) at a common platform and create a “Desirability Rank” for each stock.

operating cash flow. War periods and periods of a stagflation and unemployment are likely to have telling effects on the stock market performance of the country and the economy may be headed towards a recession.regional/industry analysis of total sales. The analysis of a business' health starts with financial statement analysis that includes ratios. Only then he narrows his search to the best business in that area. the effects of competing products. Industry Index Prices. Volume of Trading. Technical Factors: Technical analysis is a security analysis discipline for forecasting the future direction of prices through the study of past market data. Corporate Profits. Short Interest Ratio. earnings of the company. which calculates the present value of the future: • dividends received by the investor. It can be quickly assessed using the debt to equity ratio and the current ratio (current assets/current liabilities). It looks at dividends paid. Mutual Fund Flows There are also some other extraneous factors affecting the movement of the stock market such as the political situation and stability in the economy. foreign competition. price levels. The simple model commonly used is the Price/Earnings ratio. along with the eventual sale price. primarily price and volume. Some of the deciding factors regarding Financial Market Forecast are:Interest Rates. or cash flows of the company. Index Prices. • The bottom-up investor starts with specific businesses. Money Supply. With the onset of globalization and the integration of the world financial markets global factors such as recession in another country may also adversely affect the stock markets in the home country. regardless of their industry/region. new equity issues and capital financing. 11 . Implicit in this model of a perpetual annuity (Time value of money) is that the 'flip' of the P/E is the discount rate appropriate to the risk of the business. The determined growth rates (of income and cash) and risk levels (to determine the discount rate) are used in various valuation models. • • The amount of debt is also a major consideration in determining a company's health. and entry or exit from the industry. Other determinants such as the government of a home country deregulating an industrial sector will have a positive impact on the stock market. The foremost is the discounted cash flow model.

Many more technical tools and theories have been developed and enhanced in recent decades. many technicians monitor surveys of investor sentiment. volume and. inter-market and intra-market price correlations. This leaves more potential sellers than buyers. study indicators such as moving averages. classically. market. Technical analysis "ignores" the actual nature of the company. and MACD. such as Put/Call ratios and Implied Volatility in their analysis. despite the bullish sentiment. through recognition of chart patterns.The principles of technical analysis derive from the observation of financial markets over hundreds of years. and is an example of contrarian trading. Technical analysts also extensively use indicators. and if it is. For example. such as the relative strength index. for example. its price direction. These surveys gauge the attitude of market participants. Recent research suggests that combining various trading signals into a Combined Signal Approach may be able to increase profitability and reduce dependence on any single rule. which are typically mathematical transformations of price or volume. pennants or balance days. market. currency or commodity. specifically whether they are bearish or bullish. Technical analysts seek to identify price patterns and trends in financial markets and attempt to exploit those patterns. currency or commodity and is based solely on "the charts. open interest. And because most investors are bullish and invested. 12 . Technicians use these surveys to help determine whether a trend will continue or if a reversal could develop. This suggests that prices will trend down. Other avenues of study include correlations between changes in options (implied volatility) and put/call ratios with price. Technical analysis is not limited to charting. regressions. such as the wellknown head and shoulders or double top reversal patterns. moving averages. Surveys that show overwhelming bullishness. are evidence that an uptrend may reverse – the premise being that if most investors are bullish they have already bought the market (anticipating higher prices). channels." that is to say price and volume information. Technicians also look for relationships between price. cycles or. Technical analysis stands in contrast to the fundamental analysis approach to security and stock analysis. resistance. they are most likely to anticipate a change when the surveys report extreme investor sentiment. whereas fundamental analysis does look at the actual facts of the company. the oldest example of technical analysis is thought to be a method developed by Homma Munehisa during early 18th century which evolved into the use of candlestick techniques. These indicators are used to help determine whether an asset is trending. Technical analysis employs models and trading rules based on price and volume transformations. In Asia. and more obscure formations such as flags. one assumes that few buyers remain. and look for forms such as lines of support. Technicians especially search for archetypal patterns. but it always considers price trends. with an increasing emphasis on computer-assisted techniques. Examples include the relative strength index. Other technicians include sentiment indicators. in the case of futures. and is today a main charting tool.

For example. Thus. The average of the first subset of numbers is calculated. it is often used in technical analysis of financial data. but it is a set of numbers. like 10 days. The fixed subset is moved forward to the new subset of numbers. and its average is calculated. A moving average may also use unequal weights for each data value in the subset to emphasize particular values in the subset. or 200 days. using both 'past' and 'future' data. Hence a central moving average can be computed. In technical analysis there are various popular values for n. It is also used in economics to examine gross domestic product. 13 . a moving average is not a single number. 40 days. or resistance in a falling market. such as short. The threshold between short-term and long-term depends on the application. the moving average can be obtained. The plot line connecting all the (fixed) averages is the moving average. or long term. returns or trading volumes. intermediate. but merely data obtained after the time at which the average is to be computed. The process is repeated over the entire data series. each of which is the average of the corresponding subset of a larger set of data points. For a number of applications it is advantageous to avoid the shifting induced by using only 'past' data. employment or other macroeconomic time series. and a fixed subset size.Some of the Technical tools are: • Moving Average A moving average is commonly used with time series data to smooth out short-term fluctuations and highlight longer-term trends or cycles. The 'future' data in this case are not predictions. Given a series of numbers. like stock prices. The period selected depends on the kind of movement one is concentrating on. and the parameters of the moving average will be set accordingly. In any case moving average levels are interpreted as support in a rising market.

A weighted average is any average that has multiplying factors to give different weights to different data points. − pM−n+1. then • Parabolic SAR 14 . In an n-day WMA the latest day has weight n.. in technical analysis. the second latest n − 1. it can be noted the difference between the numerators of WMAM+1 and WMAM is npM+1 − pM − . If we denote the sum pM + . + pM−n+1 by TotalM... When calculating the WMA across successive values. the moving average is the convolution of the data points with a moving average function. Mathematically. a weighted moving average (WMA) has the specific meaning of weights that decrease arithmetically. etc.. down to zero.

on a downtrend. while a parabola above is generally bearish. the SAR is calculated ahead of time.Buy.In the field of technical analysis. it should be liquidated. the SAR appears above the price and converges downwards. That is. The concept draws on the idea that time is an enemy. When the price is in an uptrend. to find trends in market prices or securities.. The Parabolic SAR is calculated almost independently for each trend in the price. Similarly. Welles Wilder. Parabolic SAR (SAR . A parabola below the price is generally bullish. respectively. It may be used as a trailing stop loss based on prices tending to stay within a parabolic curve during a strong trend. The general formula used for this is: Where SARn and SARn + 1 represent today's and tomorrow's SAR values. the SAR appears below the price and converges upwards towards it. and unless a security can continue to generate more profits over time.Sell. If Parabolic is above price . 15 .stop and reverse) is a method devised by J. At each step within a trend. tomorrow's SAR value is built using data available today. Jr. Trading rule for the Parabolic SAR is quite simple: If Parabolic is below price .

so that it never goes beyond that. The EP is then reset accordingly to this period's maximum. Usually. In other words." Upon a trend switch. The Parabolic SAR is also commonly used as a method of Trailing Stop Loss.The extreme point. it is preferable to set the acceleration factor to 0. • Bollinger Bands Bollinger bands are a technical analysis tool invented by John Bollinger in the 1980s. EP. The Parabolic SAR works well in trending markets. There are. but generates a lot of whipsaws in ranging markets. it should be used with indicators to filter the ranging periods from price. several things happen. For example. This factor is increased by 0.01. To keep it from getting too large.02 initially. For stocks trading.02 each time a new EP is recorded. in order to be less sensitive to local decreases.02. The acceleration factor is reset to its initial value of 0. if a new maximum (or minimum) is observed. the SAR must be set equal to that lower boundary.02. a new trend direction is then signaled. For commodity or currency trading. the SAR must be set to the closest price bound. is a record kept during each trend that represents the highest value reached by the price during the current uptrend — or lowest value during a downtrend. two special cases that will modify the SAR value: If tomorrow's SAR value lies within (or beyond) today's or yesterday's price range. The α value represents the acceleration factor. and the volatility of the market. Therefore. the new SAR value is calculated and it results to be greater than today's or yesterday's lowest price. Traders use the Parabolic values to set trailing stop loss. On each period. it is preferable to use a value of 0. The first SAR value for this new trend is set to the last EP recorded on the previous trend. 16 . a maximum value for the acceleration factor is normally set at 0. each time a new EP is observed. If tomorrow's SAR value lies within (or beyond) tomorrow's price range.20. if in an uptrend. the EP is updated with that value. it will increase the acceleration factor. this is set to a value of 0. however. The SAR is recursively calculated in this manner for each new period. It serves as an efficient trailing stop loss that is better than the constant-size stop loss that does not take into account the length of the trend. and the SAR must "switch sides. This will then quicken the rate at which the SAR converges towards the price. Having evolved from the concept of trading bands. Bollinger bands can be used to measure the highness or lowness of the price relative to previous trades.

Usually the same period is used for both the middle band and the calculation of standard deviation. but other types of averages can be employed as needed. Writing upperBB for the upper Bollinger band. and last for the last (price) value: %b = (last − lowerBB) / (upperBB − lowerBB) 17 . %b and BandWidth. Exponential moving averages are a common second choice. The default choice for the average is a simple moving average. respectively. is derived from the formula for Stochastics and tells you where you are in relation to the bands.Bollinger bands consist of: o o Kσ) o Kσ) a middle band being an N-period simple moving average (MA) an upper band at K times an N-period standard deviation above the middle band (MA + a lower band at K times an N-period standard deviation below the middle band (MA − Typical values for N and K are 20 and 2. lowerBB for the lower Bollinger band. This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators to arrive at systematic trading decisions. By definition. %b. %b equals 1 at the upper band and 0 at the lower band. prices are high at the upper band and low at the lower band. There are two indicators derived from Bollinger bands. pronounced 'percent b'. The purpose of Bollinger bands is to provide a relative definition of high and low.

expecting volatility to revert back towards the average historical volatility level for the stock. Writing the same symbols as before. Other traders buy when price breaks above the upper Bollinger band or sell when price falls below the lower Bollinger Band. options traders. It assumes that prices close higher in strong market periods. When the bands lie close together a period of low volatility in stock price is indicated. • Relative Strength Index The Relative Strength Index (RSI) is a trading indicator in the technical analysis of financial markets. the use of an oscillator like Bollinger Bands will often be coupled with a non-oscillator indicator like chart patterns or a trendline.BandWidth tells you how wide the Bollinger Bands are on a normalized basis. or middle Bollinger Band: BandWidth = (upperBB − lowerBB) / middleBB Using the default parameters of a 20-period look back and plus/minus two standard deviations. When the bands have only a slight slope and lie approximately parallel for an extended time the price of a stock will be found to oscillate up and down between the bands as though in a channel. Some traders buy when price touches the lower Bollinger band and exit when price touches the moving average in the center of the bands. It is intended to indicate the current and historical strength or weakness of a market based on the closing prices of completed trading periods. The use of Bollinger bands varies widely among traders. When they are far apart a period of high volatility in price is indicated. Moreover. 18 . Traders are often inclined to use Bollinger bands with other indicators to see if there is confirmation. in both instances. most notably implied volatility traders. Uses for %b include system building and pattern recognition. the use of Bollinger bands is not confined to stock traders. BandWidth is equal to four times the 20-period coefficient of variation. and lower in weaker periods and computes this as a ratio of the number of incrementally higher closes to the incrementally lower closes. and middleBB for the moving average. the trader will have greater evidence that what the bands forecast is correct. In particular. if these indicators confirm the recommendation of the Bollinger bands. Uses for BandWidth include identification of opportunities arising from relative extremes in volatility and trend identification. often sell options when Bollinger Bands are historically far apart or buy options when the Bollinger Bands are historically close together.

This can be rewritten as follows to emphasize the way RSI expresses the up as a proportion of the total up and down (averages in each case). Conversely. It is necessary either to go back far enough.The Relative Strength Index was developed by J. both U and D are zero. The ratio of those averages is the Relative Strength. in theory. An average for U is calculated with an exponential moving average using a given N-period smoothing factor. and in Commodities magazine (now Futures magazine) in the June 1978 issue. The RSI method may be classified as a momentum oscillator measuring the velocity and magnitude of directional price movements. Welles Wilder and published in a 1978 book. Momentum is the rate of the rise or fall in price. Up periods are characterized by the close being higher than the previous close. a down period is characterized by the close being lower than the previous period's (note that D is nonetheless a positive number). The EMA. The calculation of D is similar. and then continue from there with the usual EMA formula. uses an infinite amount of past data. . Calculations: For each trading period an upward change (U) or downward change (D) is calculated. or alternately at the start of data begin with a simple average of N periods instead. Note: If there should happen to be no losses during the period being analyzed. (which would otherwise cause a division by zero error) then the RSI value is defined as 100. 19 . New Concepts in Technical Trading Systems. If the last close is the same as the previous. . The Relative Strength is then converted to a Relative Strength Index between 0 and 100. and likewise for D.

and RSI readings lower than the 30 level are considered to be in oversold territory. Wilder posited that when price moves up very rapidly. it generally means that the stock's losses are greater than the gains. If the relative strength index is below 50. Traditionally. When the relative strength index is above 50. Wilder recommended a smoothing period of 14. Bullish divergence occurs when price makes a new low but RSI makes a higher low. Wilder felt a reaction or reversal is imminent. α = 1/14 or N = 27. It is usually plotted as lines along with two moving averages connecting the relevant values for each period. The distance traveled by the RSI is proportional to the magnitude of the move. i. Bearish divergence occurs when price makes a new high but the RSI makes a lower high. In between the 30 and 70 level is considered neutral. it generally means that the gains are greater than the losses. Wilder further believed that divergence between RSI and price action is a very strong indication that a market turning point is imminent. at some point it is considered oversold. In either case. RSI readings greater than the 70 level are considered to be in overbought territory.Interpretation: The RSI is presented in a graph below the price chart of a market. at some point it is considered overbought. Likewise. The slope of the RSI is directly proportional to the velocity of the move. The center line for the relative strength index is 50. thus failing to confirm.e. which is often seen as both the support and resistance line for the indicator. when price falls very rapidly. This is by his reckoning of EMA smoothing. 20 .

but the highs or lows showing strength are on the respective different bases. The zero crossings are the same in each. How high (or how low when negative) the indicators get shows how strong the trend is. The momentum and ROC indicators show trend by remaining positive while an uptrend is sustained. "Momentum" in general refers to prices continuing to trend. or a crossing down through zero as a signal to sell. One can choose between looking at a move in dollar terms. or proportional terms. relative point terms. Momentum is the absolute difference: Rate of change scales by the old close.25 for a 25% rise over the same period. of course.• Momentum or Rate Of Change (ROC) Momentum and rate of change (ROC) are simple technical analysis indicators showing the difference between today's closing price and the close N days ago. so as to represent the increase as a fraction. The way momentum shows an absolute change means it shows for instance a $3 rise over 20 days. A crossing up through zero may be used as a signal to buy. or negative while a downtrend is sustained. 21 . whereas ROC might show that as 0.

Need • Volatility in Equity markets. Parabolic SAR. • Time span of a Business cycle is getting reduced. • Indian economy is influenced by sentiments. The Business cycle usually varied from 7-10 yrs. • The lack of knowledge of an individual about the Equity market. The working of Relative Strength Index and Rate of Change has been described above. Bollinger Bands etc.Model The purpose of this model is to combine the various factors (Technical or Fundamental) responsible for the stock market price fluctuations (Short term and Long term) at a common platform and create a “Desirability Rank” for each stock. In fact. Factors taken into consideration For the purpose of determining a Desirability Rank.. in the past and Recession came and went many a times without leaving an impact. the volatility in the market has increased giving rise to uncertainty as well. • To plan safe and profitable investments. a large number of factors can be taken into consideration such as Relative Strength Index. The Rank would then change in accordance with change in either one or both the factors. larger the number of factors taken. 22 . greater will be the accuracy. Weighted Moving Average. for the sake of simplicity we have taken into consideration just two factors viz. Rate of Change. The objective is to combine the effect of these two factors on a stock at a particular time and create a Desirability Rank. But with the innovation in technology. • • Relative Strength Index (RSI) and Momentum or Rate Of Change (ROC). Here.. with the use of faster and cheaper means of communication.. • To encourage investments. • The arrival and duration of Recession cannot be determined.

A 200 days WMA is considered to be more accurate than the shorter period Moving Averages. the make predictions ahead of time after studying the past data. These indicators predict the short term trend for a period of 7 -14 days. 23 . Lagging indicator like Weighted Moving Average can also be taken.Time range The Indicators taken into consideration here are both leading indicators i.e.

5 Print DR=2 Y Y N N Print DR=2.5 24 .5 Is RSI< =30? Y Is ROC= 0? Y Print DR=3 N N Print DR=3.5 Is ROC< =10? Is RSI< =50? Y Y Print DR=5 Print DR=5.Desirability Rank(DR) The Algorithm for determining the DR can be described as follows: Sta rt Is RSI< =10? Y Is ROC< = -10? Y Print DR=1 N Is RSI< =20? Is ROC< = -5? N Print DR=1.5 N Is RSI< =60? N Y Is ROC> =5? Y Print DR=6 N Print DR=6.5 Is RSI< =40? Y Is ROC< =5? Y Print DR=4 N N Print DR=4.

The second step is to check whether the value of ROC is lower than or equal to -10. If second step is true. Lastly.5 is assigned. a Desirability Rank of 1 is assigned to the stock.5 Is RSI<= 100? Y Y Print DR=10 N N Print DR=10 Sto p Functioning: • • • The first step is to check the value of RSI. the respective RSI will be determined and the respective operations will be performed.5 N N Is RSI< =80? Y Is ROC >= -5? Y N Print DR=8 N Is ROC >= -10? Print DR=8. if the first step is false. a Desirability Rank of 1.5 Is RSI< =90? Y N Y Print DR=9 N Is ROC >= -15? Print DR=9. If it is false. let’s assume it is 10 with a standard deviation of 5.Is RSI< =70? Y Is ROC= 0? Y Print DR=7 Print DR=7. • • 25 .

etc. • • Assumptions: • • • • • ROC may vary in both positive and negative sides to any extent and the range given here is taken as per convenience. Check the Desirability Rank of each stock.5 are taken just to make the model simplified and avoid lengthy calculations. If the DR lies near 7. the stock is good to sell or short. RSI. • • • 26 . The variations in the Desirability Rank of 0. Plan your Investment accordingly. ROC. Stock selection made easier. Advantages: • • These Technical measures. Investments will increase giving rise to a stable and consistently prospering economy. Make a list of all the common Stocks these MF Companies have invested in. If the DR lies near 3. Combination of Technical factors reduces the Investment risk. The Desirability Rank will be given on the webpage of popular financial websites. but other measures can also be added.Usage: In order to make optimum benefits several strategies can be used to plan the investments. Only two measures are taken here (RSI and ROC) in order to make the model convenient to understand. Desirability Rank increases the accuracy of predictions. Parabolic SAR. The first preference is given to Relative Strength Index.sell. Weighted Moving Average. are already being used independently. A good strategy might be: • • • • Select the top 25 Mutual fund companies. the stock is good to purchase.

Work-in-progress for Commodity and Foreign Exchange Markets. 100% accuracy not guaranteed.Limitations: • • • Developed keeping only the Equity market in mind. The RSI and ROC of various NSE listed companies can be compared below: 27 .

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Conclusion The Desirability Rank offers 80-90% accuracy in Equity markets. Institutions and all the other players of the market as well. It eliminates the confusion an investor has while selecting a stock to invest. 33 . The Investor has just to check the Desirability Rank and plan his investment accordingly. It will boost confidence in Investors. finally leading to a prospering economy. I would like to recommend that Desirability Rank should be implemented in the Indian market as soon as possible. The Investor is assumed to possess the basic knowledge of the working of the Equity market. Lastly.

rediff.Dwivedi 34 .wikipedia.valuenotes.com  www.com Bibliography: Macroeconomics: Theory and Policy by D.com  www.References Web Sources:  www.moneycontrol.com  www.myiris.N.org  money.

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