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SECURITYANALYSIS AND

PORTFOLIOMANAGEMENT

Author : Dr. Dhanesh Khatri

Copyright © Macmillan Publishers India Ltd.



CHAPTER – 13

TECHNICAL ANALYSIS

Copyright © Macmillan Publishers India Ltd.



Technical Analysis

Technical analysis means analysis of shareprices and traded volume to predict the near

future price movement.It is 90 per cent psychological and 10 per

cent logical.

Market is driven by the psychology ofinvestors in 90 per cent of the times and for10 per cent of the times logical factors affectthe market.



Technical Analysis (Cont.)

Premises of technical analysis

Every kind of price-sensitive information is discountedinto prices.

Prices follow a particular path continuously.

Type of charts

Line Chart

Bar Chart

Point & Figure Chart

Candle Chart



Use of Technical Analysis

To Predict Overall Market Trends

To Predict for Individual Shares Trends

To predict overall market trends

Prediction about the overall market is based onthe movement of an index representing the trendof market.



Features of Index Constituents

Minimum impact cost

High value representation in marketcapitalization

Large number of trades per day

Large traded volume per day



Tools for analysis of overall market trends

Dow Jones Theory

Advance Decline Index

Client Account Position



DOW JONES THEORY

Developed by Charles Dow Jones

He was of the opinion that movement in share

prices is always supported by a definite activity – business trends, overall business transaction,fundamental factors affecting the shares, etc.

He created two averages (indices):

Dow Jones Industrial Average (DJIA) Dow Jones Transport Average (DJTA)



DOW JONES THEORY

With the help of movement of both of theseaverages following signals can be generated:

Buying signal

Selling signal

Signal of indifference

Trends According to Dow Jones TheoryUptrend

Downtrend

Horizontal Trend



UPTREND

Uptrend is formed when the subsequent peak andsubsequent trough get formed at a higher price level,as compared to price level of previous peak and trough.

Peaks

PeaksPeaks

Peaks

Trough

Trough

Trough

Trough

DATE

P

R I C E



DOWNTREND

Downtrend is formed when both subsequent peak and subsequenttrough get formed at a lower price level as compared to the pricelevel of previous peak and trough respectively.

Peaks

Peaks

Peaks

Trough

Trough

Trough

DATE

P R I C E



Horizontal Trend

Identified when every peak is almost at the same levelas the previous level of peak, and troughs are formed ina similar pattern.

DATE

P R I C E

PeaksPeaks Peaks Peaks

Trough Trough TroughTrough



Advance Decline Index

Advance decline index is the difference between thenumber of shares showing an advance and the numberof shares showing a decline on a particular trading day.

Signals about the market

If price index and advance decline index are rising, it indicatescontinuation of upward trend in the market

If price index and advance decline index are falling, it indicatescontinuation of down trend in the market

If price index is rising but advance decline index is falling, orvice-versa, it indicates divergence in the price trend in the nearfuture



Client Account Position

As per the requirements of market regulator,

every broker is required to maintain a separatebank account for keeping client money

The balance position of this account can be

used to indicate expected market movement.



Tools to Predict for Individual Shares Trends

Moving AverageAnalysis

Oscillators ChartPatterns

MACD ROS RSI



Moving Average Analysis

Moving average is simply the rolling average ofpast prices.

Following signals can be generated:

Buying Signals

Selling Signals



Oscillators

Oscillators are fine tools to predict futuremovements much before such movement takesplace; these leave a sufficient time gap to take

decisions. Prominent oscillators are as follows:

MACD (Moving Average Convergence &Divergence)

ROC (Rate of Change)RSI (Relative Strength Index)



MACD

MACD is the difference between short-term movingaverage and long-term moving average.

MACD = Short Period Moving Average – Long Period

Moving Average Buying signals: Whenever, MACD line is above the

moving average line of MACD; MACD line movestowards the average line and thereafter moves towardsupside. It is a buying signal.

Selling signals: Whenever MACD line is below the lineof moving average. At this point MACD moves towardsaverage line but fails to break through it, instead startsmoving towards downside; it is a sell signal.



ROC

In calculating ROC, the current days’ market price isdivided by the price that had prevailed few days ago forthe share.

ROC is an indicator, which helps in identifying ‘over brought’ and ‘over sold’ market.

Buying signals: When ROC is more than one (ROC >1)and moving upward continuously, it indicates that marketis likely to move upward.

Selling signals: When ROC line is increasing but thepace has declined, it indicates that market is about toreach the over-bought zone, after which it is likely todecline.





RSI

Under RSI, gains and losses of the prices overthe immediate previous days’ price for a certainperiod is calculated.



RSI

Buying signals:

When RSI is more than 50 and moving upwardcontinuously, it indicates that the market is likely to move

upward.

Selling signals:

When RSI line is increasing above the 50 mark but thepace of increase has declined, it indicates that market isabout to reach the over bought zone, after which, it islikely to decline.

One should take precaution at this level; or a risk averseinvestor should wait for more clear signals.



RSI Continued

Over Bought Zone : When RSI is at 70 or abovelevel it indicates over bought market which islikely to take a downward turn.

Over Sold zone : When RSI is at 30 or belowlevel it indicates over sold market which is likelyto take a upward turn.



Chart Patterns

These patterns are used to generate signalsabout the expected movement of the market

These chart patterns can be generated for theindex value as well for the prices of individualshares

These help in identifying the following:

Support Level is the lower price level at whichdemand for the shares gains momentum.

Resistance Level is the upper price level at whichsupply for the shares gains momentum.



Support & Resistance in Upward Moving Market



Support & Resistance in Downward Moving Market



Support & Resistance in Horizontal Trend



Type of Chart Patterns

Head and Shoulders

Inverse Head and Shoulders

Triangle

Flag



Head & shoulders

Head & Shoulders reflects resistance andsupport level in an upward-moving market.



Inverse Head & Shoulders

Inverse Head & Shoulders reflects resistanceand support level in downward-moving market.



Triangles

Triangles are the price patterns, which show themovement of shifting resistance and support level.

Upward Moving Triangle



Download Moving Triangle Horizontal Moving Triangle



Flag

A flag is identified as a narrow movement of themarket either after an up trend or a down trend.

Flag Inverted Flag



Confirmation through Traded Volume

Buying and selling signals generated with thehelp of different tools like Dow Jones Theory,Moving Average, Oscillators – MACD, ROC,

RSI, and Chart Patterns need to be confirmedwith the help of traded volumes.

A thin traded volume simply indicates lack ofsupport in the indicated trend by majority of the

investorsA heavy traded volume, indicates about

association of more and more investors for theindicated trend



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