SECURITIES ANALYSIS AND PORTFOLIO MANAGEMENT

Technical analysis
SHORT ANSWERS 100-150 WORDS
What is Technical Analysis?
Technical Analysis is concerned with the study of the past price behavior of shares as well as volume
of shares being traded in the past. One can study daily or weekly price and volume data of index
comprising several stocks like SENSEX or NIFTY.
A method of valuing securities by considering data produced by market movement, such as past
prices and volume.
Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and
other tools to identify patterns that can suggest future activity.
2. What are the various assumptions of Technical Analysis?
The various assumptions of Technical Analysis are:
Price discounts everything
A technical analyst focuses only on the prices of security as every information regarding
demand or supply of share is reflected in the prices of the security. Thus there is no need to
focus on various factors like financial results, political situation, trends for a particular
product of a company, seasonal factors etc. Only studying of trends in the movement of
prices will give a good idea about them.

 Prices usually always move in trends

The second principle of technical analysis is that the prices of securities tends to move in
trends. By this we mean that if the price is rising then it will in all likelihood continue to rise;
and when falling then it will keep going down; and when hovering at about the same level, it
will keep doing that.
History repeats itself over time!
The third principle of technical analysis is merely a statement that we don’t expect people to
change their behavior. In other words, we put our faith in on the fact ----history being
repeating itself, with patterns and actions that have happened in the past leading to the same
results when they happen in the future.

3. What are the various indicators of Technical Analysis?

Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open
interest of a security or contract used by traders who follow technical analysis. Technical indicators
are heuristic or mathematical calculations based on the price, volume, or open interest of a security or
contract used by traders who follow technical analysis.
 Technical analysts or chartists look for technical indicators in historical asset price data in order to
judge entry and exit points for trades.

There are several technical indicators than fall broadly into two main categories: overlays and
oscillators.

Overlays: Technical indicators that use the same scale as prices are plotted over the top of the prices
on a stock chart. Examples include moving averages and Bollinger Bands®.

Oscillators: Technical indicators that oscillate between a local minimum and maximum are plotted
above or below a price chart. Examples include the stochastic oscillator, MACD or RSI.

4. What are the Advantages of Technical Analysis?

Main Advantages of Technical Analysis

Trend Analysis:

The biggest advantage of technical analysis is that is helps investors and traders predict the trend of the
market. Up trend, downtrend, and sideways moves of the market are easy to predict, with the help of chart
analysis.

Entry/Exit Point

Timing plays an important role in trading and investing. With the help of technical analysis, traders and
investors can predict the right time to enter and exit a trade thereby enabling good returns. Chart patterns,
candlesticks, moving averages, Elliot wave analysis, and other indicators are very useful for traders to
make entry and exit points.

Provides Early Signal

Technical analysis gives early signals and also paints a picture about the psychology of investors and
traders regarding what they are doing. Price-volume analysis also indicates the movement of market
makers and their activities related to a particular market. Another main advantage of technical analysis is
that it gives an early signal when it comes to trend reversal.

Quick and Less Expensive

In currency trading, technical analysis is less expensive as compared to the fundamental analysis and
there are so many companies that provide free charting software. Technical analysis gives a quick result
for traders who use 1 minute, 5 minutes, 30 minutes, and 1 hour charts. For instance, the formation of a
head and shoulder on 1 minute and 5 minutes chart gives fast results, as compared to the daily chart.

Provides Lots of Information

 Technical analysis is helpful for short term trading, swing trading, and long term investing. Technical
charts provide a lot of information that helps the traders and investors build their positions and take
trades. Information like support, resistance, chart pattern, momentum of the market, volatility, and
trader’s psychology are just some examples of types of information provided by technical analysis and
used by traders in the Forex market.

LONG ANSWER QUESTIONS (450-500 WORDS)

1. Can technical analysis bring efficiency in the portfolio selection process?

Technical analysis has long been treated with a certain degree of scorn — or at least skepticism — by
the stock market cognoscenti. Perhaps it is the suggestion implicit in technical analysis that
something other than rigorous fundamental analysis is behind all the buying and selling. “Chartists,”
as they are known, see asset prices as a function of supply and demand, and while technical analysts
generally agree with the efficient market hypothesis (EMH) insofar as markets quickly reflect all
available information, it is at this point that the disciplines part ways. Technicians believe that price
patterns tend to repeat over time and, as a result, are somewhat predictable. The repetitive behavior of
markets is a result of the irrationality of investors. This irrationality manifests itself in behavioral
biases that are, in the view of technicians, exploitable.

Past studies of the efficacy of technical analysis came to a range of conclusions and no firm
consensus. technical analysis did not beat simple buy-and-hold strategies after transaction costs. More
recent studies suggest some benefit from trading on technical indicators, including moving averages
and trading range breaks.

Rather than testing individual technical trading rules, they simply relied on portfolio managers’
assertions about whether or not, and to what extent, they employed technical analysis in their
investment process. The investor can manage US equity, global equity, US balanced, and global
balanced portfolios. They find that technical analysis was utilized to some degree by about one-third
of the managers surveyed, with US equity fund managers the most avid users and US balanced fund
managers the least frequent users. There were no notable differences in the use of technical analysis
by market capitalization of holdings.

“[The] cross-section of portfolios managed using technical analysis shows remarkably

elevated skewness and kurtosis values relative to portfolios that do not use technical analysis. In the
presence of the former, the latter can be advantageous.”

2. How Trend Lines is associated with the process of Technical Analysis?

Trendlines are easily recognizable lines that traders draw on charts to connect a series of prices
together or show some data's best fit. The resulting line is then used to give the trader a good idea of
the direction in which an investment's value might move.

A trendline is a line drawn over pivot highs or under pivot lows to show the prevailing direction of
price. Trendlines are a visual representation of support and resistance in any time frame. They show
direction and speed of price, and also describe patterns during periods of price contraction.

Trendlines indicate the best fit of some data using a single line or curve.

A single trendline can be applied to a chart to give a clearer picture of the trend.
Trendlines can be applied to the highs and the lows to create a channel.

The time period being analyzed and the exact points used to create a trendline vary from trader to
trader.
The trendline is among the most important tools used by technical analysts. Instead of looking at past
business performance or other fundamentals, technical analysts look for trends in price action. A
trendline helps technical analysts determine the current direction in market prices. Technical analysts
believe the trend is your friend, and identifying this trend is the first step in the process of making a
good trade.

To create a trendline, an analyst must have at least two points on a price chart. Some analysts like to
use different time frames such as one minute or five minutes. Others look at daily charts or weekly
charts. Some analysts put aside time altogether, choosing to view trends based on tick intervals rather
than intervals of time. What makes trendlines so universal in usage and appeal is they can be used to
help identify trends regardless of the time period, time frame or interval used.

If company A is trading at $35 and moves to $40 in two days and $45 in three days, the analyst has
three points to plot on a chart, starting at $35, then moving to $40, and then moving to $45. If the
analyst draws a line between all three price points, they have an upward trend. The trendline drawn
has a positive slope and is therefore telling the analyst to buy in the direction of the trend. If company
A's price goes from $35 to $25, however, the trendline has a negative slope and the analyst should sell
in the direction of the trend.

3. What is EHM? Explain different forms of efficiency?

The Efficient-Market Hypothesis (EMH) contradicts the basic tenets of technical analysis by stating

that past prices cannot be used to profitably predict future prices. Thus it holds that technical analysis
cannot be effective. Efficient market theory as the name suggests is a theory which says that stock
markets are efficient and the securities prices fully reflect all the information that is available. This
theory was developed by Eugene Fama as a result of his Ph.D. thesis in the year 1960. This theory
says that the market participants will react to all the available information as soon as it becomes
available to them. The information about a stock that is available to one investor will be available to
others and thus all the investors react accordingly.
The efficient market hypothesis emphasizes that it would be difficult for an investor to regularly beat
the market which reveals the combined decision of lots of participants in an atmosphere regarded as
by many contending investors who have similar objectives and access to the same information.
An efficient market is the market which is actually capable of swiftly taking inane kind of new
information or any fact or data relating to the economy, an industry or it may be relating to the
company and then such information is precisely impounded in the price of the securities.
In this type of markets participants cannot expect to earn any more than a fair return for the risks
undertaken.
FORMS OF EHM
Efficient market is the one which promises only fair return to the investors.
It only states that the returns to an investor from investing in any type of securities in a market which
is highly competitive will be fair on an average.
Eugene Fama classified the market into three categories on the basis of the kind of information that is
available to the investors in a market.
There can be three sets of information that can be available to investors and market participants.
Information about past prices of the securities.
Information that is made available to public at large likes announcements by company about its
financial result etc.
Information that is not available to public at large i.e. .insider information.
On the basis of the availability of this information or the basis of absorption of such information in
the market the markets can be classified into three forms of efficiency.
The following are the three forms of efficiency given by efficient market hypothesis:
 Weak form of efficiency
 Semi strong form of efficiency
 Strong form of efficiency.

WEAK FORM OF EFFECIENCY

One of the forms of efficiency is the weak form of efficiency.
In this form of market only one set of information that is information about historical prices of shares
is publicly available.
It is asserted that in this form of market it is assumed that any movement in future prices of shares
cannot be predicted from the previous prices of shares.
Any development or changes in price is referred as random walk.
In short this weak form of efficiency says that future prices of shares cannot be predicted from the
past prices of shares.
In other this form of market totally disregards the role of the study of past prices and their behavior as
the tool for predicting the future value of share prices.
SEMI-STRONG FORM OF EFFECIENCY
The next form of efficiency is the semi-strong form. In this form of efficient market hypothesis it is
assumed that a market is efficient if all the relevant and openly or publicly available information is
swiftly reflected in the market price of the securities.
In semi strong form of market securities prices are assumed to be fully reflecting the all the publicly
available information.
In this form of market prices of securities not only reflect the information relating to past price
behavior or data but also the information relating to the profits made by the company, any
announcement relating to the dividends paid or to be paid by the company, any information relating
to the issue of bonus shares or the right shares by the company, any information regarding the merger
of the company, acquisition or amalgamation of the company, the financial situation of company’s
competitors, expectation regarding various economic factors such as inflation employment etc.
STRONG FORM OF EFFECIENCY
 The strong form of market efficiency states that the stock prices integrate all sort of information that
is obtainable about the stock including the public as well as private information.
So, if a market is strong form efficient, then even the traders with insider information cannot take
advantage of their information to make more profits than other investors with no private information
in the stock market.
As in this form of efficient market share prices all kinds of information whether public or private or
some insider information so no investor gets a chance to earn any kind of excess returns.
In such a form of market there are no legal barriers for the private information becoming public news.
All kinds of insider information are reflected very quickly in the share prices.
4. Explain different indicators associated with Technical Analysis?

Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open
interest of a security or contract used by traders who follow technical analysis. By analyzing historical
data, technical analysts use indicators to predict future price movements. Examples of common technical
indicators include the Relative Strength Index, Money Flow Index, Stochastics, MACD and Bollinger
Bands. technical analysis is a trading discipline employed to evaluate investments and identify trading
opportunities by analyzing statistical trends gathered from trading activity, such as price movement and
volume. Unlike fundamental analysts, who attempt to evaluate a security's intrinsic value based on
financial or economic data, technical analysts focus on patterns of price movements, trading signals and
various other analytical charting tools to evaluate a security's strength or weakness. Technical analysis
can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-
income, currencies, and other securities. In this tutorial, we’ll usually analyze stocks in our examples, but
keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is far
more prevalent in commodities and forex markets where traders focus on short-term price movements.
Technical indicators, also known as "technicals," are focused on historical trading data, such as price,
volume, and open interest, rather than the fundamentals of a business, like earnings, revenue, or profit
margins. Technical indicators are commonly used by active traders, since they're designed to analyze
short-term price movements, but long-term investors may also use technical indicators to identify entry
and exit points. Types of Indicator There are two basic types of technical indicators: 1. Overlays:
Technical indicators that use the same scale as prices are plotted over the top of the prices on a stock
chart. Examples include moving averages and Bollinger Bands. 2. Oscillators: Technical indicators that
oscillate between a local minimum and maximum are plotted above or below a price chart. Examples
include the stochastic oscillator, MACD or RSI. Traders often use many different technical indicators
when analyzing a security. With thousands of different options, traders must choose the indicators that
work best for them and familiarize themselves with how they work. Traders may also combine technical
indicators with more subjective forms of technical analysis, such as looking at chart patterns, to come up
with trade ideas. Technical indicators can also be incorporated into automated trading systems given their
quantitative nature. Example of Technical Indicators The following chart shows some of the most
common technical indicators, including moving averages, the relative strength index (RSI), and the
moving average convergence-divergence (MACD). In this example, the 50- and 200-day moving
averages are plotted over the top of the prices to show where the current price stands relative to its
historical averages. The 50-day moving averages is higher than the 200-day moving average in this case,
which suggests that the overall trend has been positive. The RSI above the chart shows the strength of the
current trend—a neutral 49.07 in this case—and the MACD below the chart shows how the two moving
averages have converged or diverged - slightly bearish in this case.

5. Explain Dow Theory.

The legend of technical analysis, Charles Dow, is the father of what is popularly known as the "Dow
Theory".
Though developed more than a century ago, his theory is used even today by analysts to evaluate
market behavior.
The Dow theory was developed to analyze the movement of indices and was based on the 'closing'
price of the indices.
The three assumptions underlying the Dow theory are:
The primary trend of the price movement cannot be influenced by external factors.
The market discounts everything.
The theory is not foolproof.
The Dow theory explains that there are three types of trends applicable in a market. These trends are
known as
 Primary trends
 Intermediate trends
 Short term trends

PRIMARY TREND
Primary trend is the long-term direction in the price movement and lasts for a year or a number of
years.
It can be bullish or bearish.
It also consists of three phases, wherein each phase is interrupted by an intermediate trend reversal
lasting up to two to three weeks.
INTERMEDIATE TREND
This intermediate trend takes away the earlier price movements, upward or downward.
This trend appears within the primary trend and may lasts for a period ranging from few days to
weeks or months.
These trends indicate interruptions in the primary trend and act as a preventive force on the primary
trend.
This trend generally retraces from 33% to 66% of the primary price change since the previous
medium swing or start of the main movement.
SHORT TERM TRENDS
Short term trends are also known as minor trends and can be witnessed intraday or during a few days.
These trends correct the overbought and oversold positions in the scrip caused by reversals made in
the secondary trends.
For the purpose of analysis, it makes sense to ignore short-term trends and analyses the primary and
secondary trends in prices.
The three movements may be simultaneous, for instance, a daily minor movement in a bearish
secondary reaction in a bullish primary movement.