EFFICIENT MARKET HYPOTHESIS

TESTS AND TECHNICAL ANALYSIS

FOR Avenue Supermarts (DMART)
Made by: Group Number 15
NALLAPU SRINIVAS (2018A4PS0658H)
V. NAGA BHARADWAJ (2018A2PS0834H)
VISSAMSETTY PRANAV (2018A4PS0135H)
A. SAI ANURAG REDDY (2018A4PS0059H)
VIJAY BHARATH A (2018A1PS0840H)
SUBHOJIT DHAR (2018A4PS0737H)
MANAS TIWARI (2018A4PS0971H)
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Presentation Roadmap

EMH TESTING THEORY Technical analysis Summary, Profit/Loss

Description calculations, Conclusions

1 3 5

2 4

InterpretatIon from results Candlestick Patterns

of tests of weak form of description and
EMH observations
 EMH Testing-Weak Form
● What is Weak form of efficiency?
Weak form efficiency claims that past price movements, volume and earnings data do
not affect a stock’s price and can’t be used to predict its future direction. Weak form
efficiency is one of the three different degrees of efficient market hypothesis (EMH).

● The Basics of Weak Form Efficiency

Weak form efficiency, also known as the random walk theory, states that future
securities' prices are random and not influenced by past events. Advocates of weak
form efficiency believe all current information is reflected in stock prices and past
information has no relationship with current market prices.

Weak form of EMH shows that the information available in the historical/past prices
have already been incorporated in current prices, and thus technical analysis cannot
help generate profits in the long horizon.
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Features of Weak Form of EMH

▫ The key principle of weak form efficiency is that the randomness of stock prices make it
impossible to find price patterns and take advantage of price movements. Specifically, daily
stock price fluctuations are entirely independent of each other; it assumes that price momentum
does not exist. Additionally, past earnings growth does not predict current or future earnings
growth.

▫ Weak form efficiency doesn’t consider technical analysis to be accurate and asserts that even
fundamental analysis, at times, can be flawed. It’s therefore extremely difficult, according to
weak form efficiency, to outperform the market, especially in the short term.

▫ For example, if a person agrees with this type of efficiency, they believe that there’s no point in
having a financial advisor or active portfolio manager. Instead, investors who advocate weak
form efficiency assume they can randomly pick an investment or a portfolio that will provide
similar returns.
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EMH Tests
Correlation Test
▫ Correlation test involves testing the dependence of price on previous days
price, by calculating a correlation coefficient between lagged returns and the
daily/weekly returns.
▫ If the correlation coefficient is lower than 1.96/√n, then it indicates that future
prices cannot be predicted by using previous prices, and hence we accept the
Random Walk Hypothesis or Weak form of EMH at 5% level of significance
▫ Weak form of EMH can be accepted if correlation is greater than 1.96/√n at
5% level of significance.
▫ Correlation test could be performed for shorter time frame (daily) or longer
time frame (weekly).
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EMH Tests
Runs Test:
▫ A run is defined as the sequence of time periods (daily, weekly, monthly) in
which the stock price changes in the same direction.
▫ We accept the Weak form of EMH if the |z|<1.96, with 5% level of significance
▫ We reject Weak for of EMH if |z|>1.96, with 5% level of significance.
▫ Let n=total no. of observations, n₁=number of days of positive runs,
n₂=number of days of negative runs.
▫ E(runs)=(2n₁n₂/n)+1, Var(runs)=[2n₁n₂(2n₁n₂-n)]/[n²(n-1)]
▫ z = [Runs-E(runs)]/S.D.(runs)
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Daily Correlation Tests

▫ For daily correlation test the daily return, and the lagged daily return were
calculated, and the correlation between these two sets of values was calculated
in excel.
▫ Excel Sheet is linked here: EMH_TEST&PROFITS.xlsx
▫ The relevant cells from excel that show the calculation of correlation are
linked below:
Correlation 0.0765
Critical value 0.1250
Absolute rho 0.0765

(Note: Clicking on the excel cells above will open the excel sheet with the relevant calculation)
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Weekly Correlation Test

▫ For weekly correlation test the weekly returns, and the lagged daily returns of
Dmart were calculated, and the correlation between these two sets of values
was calculated in excel.
▫ Excel Sheet is linked here: EMH_TEST&PROFITS.xlsx
▫ The relevant cells from excel that show the calculation of correlation are linked
below:
Correlation -0.0361
Critical value 0.1250
Absolute rho 0.0361
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Daily Runs Test

▫ For the daily runs test the excel sheet is linked here:
EMH_TEST&PROFITS.xlsx
▫ The relevant cells from excel that show the calculation for the daily runs test
are linked to the presentation below:
Runs 96.000
n1 98.000
n2 88.000
n 186.000
E(Runs) 93.731
Var(Runs) 45.980
z 0.335
Critical value of z 1.960
|z| < 1.96
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Weekly Runs Test

▫ For the weekly runs test the excel sheet is linked here:
EMH_TEST&PROFITS.xlsx
▫ The relevant cells from excel that show the calculation for the weekly runs test
are linked to the presentation below:
Runs 23.000
n1 20.000
n2 19.000
n 39.000
E(Runs) 49.421
Var(Runs) 9.481
z -2.787
Critical Value of Z 1.960
|z| > 1.96
 SUMMARY OF RESULTS 11

Daily correlation test

• ρ (rho) value is calculated to be 0.077.
• Correlation is less than the critical value 0.144. So, RW hypothesis holds true.

Weekly correlation test

• ρ (rho) value is calculated to be 0.036.
• Correlation is less than the critical value 0.318. So, RW hypothesis holds true.

Daily runs test

• |z| is calculated to be 0.335 for daily runs test.
• |z| < 1.96 Accept the RW hypothesis.

Weekly runs test

• |z| is calculated to be 2.787 for daily runs test.
• |z| > 1.96 Reject the RW hypothesis.
As most of the tests agree with the random walk model at 95% confidence interval, it means that
there is no use of historical data and technical analysis can not be used to generate profits.
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SUMMARY OF RESULTS
We observe the following results by testing Weak form of EMH:
▫ Using the daily correlation test, weekly correlation test and daily runs test for
DMART, it was confirmed that the weak form of EMH can be accepted, at 5%
level of significance.
▫ Hence the majority of the tests that have been performed for testing Random
walk hypothesis or weak form of EMH are in the favor of the hypothesis.
▫ Hence, we can conclude that the stock price for DMART follows random walk
and it is not possible to obtain abnormal profits by using past prices and
trading volumes to formulate buying and selling decisions.
Technical Analysis
Technical analysis is a means of examining and predicting price
movements in the financial markets, by using historical price
charts and market statistics. It is based on the idea that if a trader
can identify previous market patterns, they can form a fairly
accurate prediction of future price trajectories.
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2.1 Description of the Technical Indicators

CHOSEN TECHNICAL INDICATORS:

Lagging Indicators:
▫ Moving Average Convergence Divergence (MACD)
▫ Average True Range (ATR)

Leading Indicators:
▫ Relative Strength Index (RSI)
▫ On Balance Volume (OBV)
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Moving Average Convergence Divergence (MACD)

1) Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator

that shows the relationship between two moving averages of a security’s price.
2) MACD= 12-Period EMA − 26-Period EMA
3) The result of that calculation is the MACD line. A nine-day EMA of the MACD called the "signal
line," is then plotted on top of the MACD line, which can function as a trigger for buy and sell
signals.
INTERPRETATION:
▫ MACD line crossing signal line from below = Bullish
▫ MACD line crossing signal line from above = Bearish
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Average True Range (ATR)

1) The average true range (ATR) is a technical analysis indicator that measures market volatility
by decomposing the entire range of an asset price for that period. Specifically, ATR is a
measure of volatility.
2) The true range indicator is taken as the greatest of the following: current high less the current
low; the absolute value of the current high less the previous close; and the absolute value of
the current low less the previous close. The average true range is then a moving average,
generally using 14 days, of the true ranges.
INTERPRETATION:
▫ For buy order – Entry price = CMP-ATR
▫ For sell order – Entry price = CMP+ATR
▫ It is best used as a tool to find the right entry and exit prices while trading
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Relative Strength Index (RSI)

1) The relative strength index (RSI) is a momentum indicator used in technical analysis that
measures the magnitude of recent price changes to evaluate overbought or oversold conditions
in the price of a stock or other asset. The RSI is displayed as an oscillator (a line graph that
moves between two extremes) and can have a reading from 0 to 100.
2) RSI = 100 – [100/(1+RS)] ; RS = AVG. GAIN/AVG. LOSS
INTERPRETATION:
▫ RSI>70 = Overbought, RSI<30 = Oversold
▫ RSI can be used to find the right price point to enter and exit from trade
▫ RSI could also be considered as a signal that the stock price would go down if the RSI value is
in the overbought region, and could be considered as a signal that the price would go up if the
RSI value is in the overbought region.
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On-Balance Volume (OBV)

1) On-balance volume (OBV) is a technical trading momentum indicator that uses volume flow to
predict changes in stock price.
2) It is best to use it as a confirmational indicator after confirming the price action using other
technical indicators

INTERPRETATION:
▫ OBV increasing = Bullish
▫ OBV decreasing = Bearish
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2.2 Candlestick Patterns

Below is the candlestick chart of Avenue Supermarts Ltd.(DMART) for the month of October-2020
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Candlestick Patterns-Observations

•The stock has been in a bearish trend from the beginning of the month till 19 th October and has
reversed the trend after that point
•Candle bodies are long on average suggesting that the trading activity in the stock is high
•Volumes are high at the point of trend reversal, indicating the bullish trend has strength and will
sustain
•We can find several candlestick patterns from this chart which are shown in the next slide.
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Candlestick Patterns
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Candlestick Patterns
1) Bearish Harami
Indicates a trend reversal from bullish to bearish.

Conditions for the signal to be valid:

2) The stock must have been in a definite uptrend before this signal occurs. This can be
visually seen on the chart.
3) The second candle of the signal should be a red candle opening below the Close of the
previous candle and closing above the Open of the previous green candle.
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Candlestick Patterns
2) Falling three methods
▫ Indicates a bearish trend continuation.
▫ It occurs during a downtrend; confirmation is required by the candles that follow the pattern.
▫ The first and fifth candle are red and are longer than the other three candles of the pattern.
▫ The second, third and fourth candle are white(or they alternate the color: it only matters that they
represent a rise in prices; normally is the third candle that can be of any color).
▫ Moreover these candles are fully contained within the real body of the first candle (or within the
High-Low Range of the First Candle); while the Lows are below the open of the first candle and
the highs are above the close of the first candle.
▫ The close of the fifth candle is below the close of the first candle.
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Candlestick Patterns
3) Three white soldiers
▫ Indicates either weakening of the bearish trend or a trend reversal to bullish.
▫ Pattern is most potent when it occurs after an extended decline and a period of subsequent
consolidation.
▫ When a particular stock posts a decline followed by sideways movement, the appearance at that
point of three white soldiers signals that higher prices are likely ahead.
▫ The first of the three white soldiers is a reversal candle. It either ends a downtrend or signifies
that the stock Is moving out of a period of consolidation after a decline. The second candle may
open within the real body of first candle. The pattern is valid as long as the second candle opens
in the upper half of first candle’s range. By the end of closing of second candle, the stock should
close near its high leaving a very small or non-existent upper shadow. The same pattern is then
repeated on the third candle.
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Candlestick Patterns
4) Hammer
▫ Indicates a trend reversal from bearish to bullish trend
▫ Conditions for the signal to be valid:
▫ The stock must have been in a definite downtrend before this signal occurs. This can be visually
seen on the chart.
▫ The lower shadow must be at least twice the size of the body.
▫ The day after the Hammer is formed, one should witness continued buying.
▫ There should be no upper shadow or a very small upper shadow. The colour of the body does
not matter, but a green body would be more positive than a red body.

BUY AND SELL SIGNALS
STRATEGY- I
▫ Sell after the appearance of bearish
harami at the close of second candle i.e.,
at 2180
▫ Close the previous sell position by
buying the stock after the appearance of
three white soldiers pattern, near the
close of third green candle i.e, at 2090
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STRATEGY- II
▫ Buy after the appearance of hammer
and after crossing the resistance line R2
i.e., at 2099
▫ Close the previous buy position by
selling at the crossing point of the
resistance line R3 i.e., 2224
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2.3 Confirming signals using indicators

▫ First, we verify the signals using RSI and MACD. The figure below shows the same.
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Observations
▫ As seen from the above chart, our first sell signal indicated by no. ‘1’ after the bearish harami is
confirmed by the RSI since it crossed the oversold region i.e., above 70 and MACD too gave a
negative crossover after some time and this is because it’s a lagging indicator.
▫ The closing buy signal indicated by ‘2’ is slightly supported by the a small kink in the MACD line
but this is not satisfactory but RSI trading near the oversold region supports the signal
satisfactorily.
▫ The buy signal after the appearance of hammer indicated by ‘3’ is not clearly supported by the
MACD or RSI although RSI not being in the overbought region is favourable. Therefore, we
enter the buy position only after the confirmation by the next immediate green candle and stock
price crossing the resistance line R2.
▫ The final sell signal indicated by ‘4’ is clearly supported by RSI since it’s above the overbought
region while MACD doesn’t provide any clear indication.
▫ Furthermore, we confirm these signals with volumes using OBV and find the right entry and exit
prices using ATR in the next slides.
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2.3 Confirming signals using indicators

The chart below shows the confirmation of signals using OBV indicator
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Interpretation using OBV Indicator

▫ For any signal to be valid, the volumes must confirm it and we can do the same using OBV.
▫ The continued fall in the OBV post ‘1’ strengthens the signal since it shows continued selling pressure
from the traders.
▫ Although the buy signal ‘3’ is not satisfactorily supported by the OBV but a small kink in it shows a minor
buying in the stock.
▫ Increasing OBV post ‘4’ solidifies the bullish trend.
▫ Now that we have confirmed these four signals, we find the right entry and exit prices using ATR in the
next slides.
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2.3 Confirming signals using indicators

The chart below shows the ATR indicator along with its values
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Entry & Exit prices as per ATR

▫ From the previous chart, the right entry price for ‘1’ is 2180+32.20=2217.20 or approx. 2217
▫ From the previous chart, the right entry price for ‘2’/ exit price for ‘1’ is 2090-27.07=2062.93 or
approx. 2063
▫ From the previous chart, the right entry price for ‘4’ is 2099-36.61=2062.39 or approx. 2062
▫ From the previous chart, the right entry price for ‘5’/ exit price for ‘4’ is 2224+33.28=2257.28 or
approx. 2257
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Summary
Strategy I:
▫ Short DMART Ltd. At 2217 in the beginning of the month and square off the position by buying
at 2063 on 11th October.
Strategy II:
▫ Long DMART Ltd. At 2062 on 22nd October and sell at 2257
Profit and Loss Calculation
▫ Profit from Strategy I is, ((2217-2063)*100)/2063 = 7.465% profit
▫ Profit from Strategy II is, ((2257-2062)*100)/2062 = 9.457% profit
For an investor with 10,00,000 INR as the investible sum, Profits would be:
Strategy I: 7.465%*1000000 = 74,650 INR
Strategy II: 9.457%*1000000 = 94,570 INR
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Profit and Loss Calculation

▫ The relevant calculations in excel sheet for profit and loss using the strategies
are linked below:

Strategy I: Short DMART Ltd. at 2217 Rs. and close the position by buying at 2063 Rs.
Return 7.46%
Investible sum ₹ 1,000,000.00
Profit for I ₹ 74,648.57

Strategy II: Long DMART Ltd. at 2062 Rs. and sell at 2257 Rs.
Return 9.46%
Investible sum ₹ 1,000,000.00
Profit for II ₹ 94,568.38

▫ Link for Excel file: EMH_TEST&PROFITS.xlsx

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2.4 CONCLUSION FROM THE ANALYSIS

▫ For the technical analysis of DMART Ltd. , we first analysed the candlestick chart of the stock for
the month of October-2020 and understood the price action and trends.
▫ From the chart, we observed four key candlestick patterns namely Bearish Harami, Falling
Three Methods, Three White Soldiers and Hammer pattern.
▫ Buy and sell signals have been devised out of this and using the chosen four technical
indicators namely MACD,RSI,OBV and ATR, we confirmed the signals.
▫ Two strategies were designed out of this analysis which are as follows,
- Strategy I - Short:
- Short DMART Ltd. At 2217 in the beginning of the month and square off by buying at 2063
- Strategy II - Long:
- Long DMART Ltd. At 2062 on 22nd October and sell at 2257
▫ Profit from these two strategies is calculated to be 74,650 INR for I and 94,570 INR for II for an
investor with an investable sum of 10,00,000 INR
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References and Sources

▫ https://www.tradingview.com/chart/ER6YHHfS/
▫ https://www.investopedia.com/terms/t/technical-analysis-of-stocks-and-trends.
asp
▫ https://www.youtube.com/watch?v=_r808Lk3xLM&ab_channel=Groww
▫ https://in.finance.yahoo.com