Technical Analysis

What Is Technical Analysis?

Technical analysis is a method of evaluating securities by analyzing

the statistics generated by market activity, 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. Unlike fundamental analysts, technical
analysts don't care whether a stock is undervalued or overvalued the only
thing that matters is a security's past trading data and what information
this data can provide about where the security might move in the future.

Technical analysis involves a study of market-generated data like

prices and volumes to determine the future direction of price movement.
It is a process of identifying trend reversal at an earlier stage to formulate
the buying and selling strategy. With the help of several indicators, the
relationship between price –volume and supply-demand is analyzed for
the overall market and individual stocks.

Assumptions
1. The Market Discounts Everything

A major criticism of technical analysis is that it only considers price

movement, ignoring the fundamental factors of the company. However,
technical analysis assumes that, at any given time, a stock's price reflects
everything that has or could affect the company including fundamental
factors. Technical analysts believe that the company's fundamentals,
along with broader economic factors and market psychology, are all
priced into the stock, removing the need to actually consider these factors
separately. This only leaves the analysis of price movement, which
technical theory views as a product of the supply and demand for a
particular stock in the market.

2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends.

This means that after a trend has been established, the future price
movement is more likely to be in the same direction as the trend than to
be against it. Most technical trading strategies are based on this
assumption.

3. History Tends To Repeat Itself

Another important idea in technical analysis is that history tends

to repeat itself, mainly in terms of price movement. The repetitive nature
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of price movements is attributed to market psychology; in other words,
market participants tend to provide a consistent reaction to similar market
stimuli over time. Technical analysis uses chart patterns to analyze
market movements and understand trends. Although many of these
charts have been used for more than 100 years, they are still believed to
be relevant because they illustrate patterns in price movements that often
repeat themselves.

4. The market value of the scrip is determined by the interaction of

demand and supply.

5. Supply and demand is governed by numerous factors, both rational and

irrational. These factors include economic variables relied by the
fundamental analysis as well as opinions, moods and guesses.

Charting
It has already been noted that in technical analysis, the basic motive
is to identify the price trend on the basis of historical data. The trend is
then used to forecast the future behaviour. The price and volume data on
securities are the basic raw material used by a technical analyst and the
charts and graphs are used as the basic tools to identify the trends in
prices.

The technical analysts may also be called chartists because they

use charts and records of historical prices and volumes to identify the
trend and pattern in prices. It may be noted that the technical analysis
can be used either for a specific share or for the market in general. In
either case the relevant information is used, i.e., the price and volume
data are studied simultaneously.

Tools of Technical Analysis

 Dow theory
 Support and Resistance Level
 Volume of Trade
 Breadth of the market
 Short Selling
 Odd Lot Trading
 Moving Average
 Relative Strength Analysis
 Charts
 Mutual Fund Liquidity
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  Put/Call Ratio

Dow Theory

The Dow theory was originally proposed in the late nineteenth

century by Charles H Dow, the editor of Wall Street Journal, is perhaps
the oldest and best-known theory of technical analysis. It is considered to
be the first theory of technical analysis and is still regarded as the basis of
all other techniques used by technical analysts. In fact, it is the Dow
Theory from which much of the substance of the technical analysis has
branched out. Dow developed this theory on the basis of certain
hypothesis, which are as follows:

a. No single individual or buyer can influence the major trends in the

market. However, an individual investor can affect the daily price
movement by buying or selling huge quantum of particular scrip.

b. The market discounts everything. Even natural calamities such as earth

quake, plague and fire also get quickly discounted in the market. The
world trade centre blast affected the share market for a short while and
then the market returned back to normalcy.

c. The theory is not infallible and it is not a tool to beat the market but
provides a way to understand the market.

Explanation of the Theory

Dow described stock prices as moving in trends analogous to the
movement of water. He postulated three types of price movements over
time: (a) major trends that are like tide in ocean (Primary Trend), (b)
intermediate trends that resemble waves (Secondary Trend), and (c)
short run movements that are like ripples (Minor Trend).

Dow Theory is based on the hypothesis that the stock market

does not perform on a random basis. Rather, it is guided by some
specified trends. The likely market trend in future can be predicted by
following these trends. Three types of specific trends have been named in
Dow Theory:

(a) Primary Trend: It is the long-range trend in price and may carry on
even for number of years. It takes the entire market up or down. The price
trend may be either increasing or decreasing. When the market exhibits
the increasing trend, it is called bull market. The bull market shows three
clear-cut peaks. Each peak is higher than the previous peak and this price
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rise is accompanied by heavy trading volume. Here, each profit taking
reversal that is followed by an increased new peak has a trough above the
prior trough, with relatively light trading volume during the reversals,
indicating that there is limited interest in profit taking at these levels. And
the phases leading to the three peaks are revival, improvement in
corporate profit and speculation. The revival period encourages more and
more investors to buy scrips, their expectations about the future being
high. In the second phase, increased profits of corporate would result in
further price rise. In the third phase, prices advance due to inflation and
speculation.

The reverse trend is true with the bear market also. Here, first phase
starts with the abandonment of hopes. The chances of prices moving back
to the previous high level seemed to be low. This would result in the sale
of shares. In the second phase, companies are reporting lower profits and
dividends. This would lead to selling pressure. The final phase is
characterized by the distress selling of shares. The three phases of bull
market and bear market is shown clearly in the following figures.

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(b) Secondary Trend: These trends appear within a primary trend and
may last for a few days or few weeks or few months. Secondary trends
show interruptions in primary trend and act as restraining force on the
primary trend. The secondary trends tend to correct deviations from
primary trend boundaries of price movements. In the bull market, the
secondary trend would result in the fall of about 33-66 percent of the
earlier rise. In the bear market, the secondary trend carries the price
upward and corrects the main trend. Compared to the time taken for the
primary trend, secondary trend is swift and quicker.

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(c) Minor Trend: Minor trends are just like the ripples in the market. It
refer to day-to-day trend or movements in prices over few days. The
minor trends, being of very short duration, have little analytical value.
Minor trend tries to correct the secondary price movement. It is better for
the investor to concentrate on the primary or secondary trends than on
the minor trends.

 Support and Resistance Level

A support level is the price range at which technician would

expect a substantial increase in the demand for a stock. Generally, a
support level will develop after a stock has enjoyed a meaningful price
increase and the stock has begun to experience profit taking. When
the price reaches this support price, demand surges and price and
volume begin to increase again.
A resistance level is the price range at which the technician
would expect an increase in the supply of stock and any price increase
to reverse abruptly. A resistance level tends to develop after a stock
has experienced a steady decline from a higher price level. It is
reasoned that the decline in the price leads some investors who
acquired the stock at a higher price to look for an opportunity to sell it
near their break even points. Therefore, the supply of stocks owned by
these investors is overhanging the market. When the price rebounds
to the target price set by these investors, this overhanging supply of
stock comes to the market and dramatically reverses the price
increase on heavy volume.

 Volume of Trade

Dow gave special emphasis to volume. Technical analysts use

volume as an excellent method of confirming the trend. Therefore, the
analyst looks for a price increase on heavy volume relative to the stock’s
normal trading volume as an indication of bullish activity. Conversely, a
price decline with heavy volume is bearish.

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  Breadth of the market

The breadth of the market is the term often used to study the
advances and declines that have occurred in the stock market. Advances
mean the number of shares whose prices have increased from the
previous day’s trading. Decline indicates the number of shares whose
prices have fallen from the previous days trading. The net difference
between the number of stocks advanced and declined during the same
period is the breadth of market.

 Short Selling

Short selling refers to the selling of shares that you don’t have. The
short sellers are those who sell now in the hope of purchasing at a lower
price. A short seller behaves in this way because he feels that the price of
the stock will fall. And it is must for short sellers to cover their positions,
i.e. the purchase of shares. This buying activity increases the potential
demand for the stock. Therefore, rising short sales foretell future demand
for the security and increase the future prices rice in the future to make a
profit.

 Odd Lot Trading

Small investors quite often buy an odd lot (i.e. non tradable lot) and
such buyers and sellers are known as odd lotters. If we relate odd lot
purchases to odd lot sales, we get an odd lot index. It is generally
considered that the professional investor is more informed and stronger
than the odd lotters and they are less sensible to price change than retail
investor. When the professional investors dominate the market, the stock
market is technically strong. If the odd lotters dominate the market, the
market is considered to be technically weak.

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  Moving Average

The market indices don’t rise or fall in straight line. The upward and
downward movements are interrupted by counter moves. The underlying
trends can be studied by smoothening the data. To smooth the data,
moving average is used. The word moving means the body of data moves
ahead to include the recent observation. If it is the five-day moving
average, on the six day the body of data moves to include the sixth day
observation eliminating the first day observation.

 Relative Strength Analysis

Relative Strength analysis is an oscillator used to identify the

inherent technical strength and weakness of a particular stock or market.
It is based on the assumption that prices of some securities rise rapidly
during the bull phase but fall slowly during the bear phase in relation to
the market as a whole. Put differently, such securities possess greater
relative strength and hence outperform the market.

 Charts

Charts are the valuable and easiest tools in the technical analysis.
The graphic presentation of the data helps the investor to find out the
trend of the price without any difficulty. A large number of charts are used
to analyze the trend of the market.

 Mutual Fund Liquidity

According to the theory of contrary opinion, it makes sense to go

against the crowd because the crowd is generally wrong. Based on this
theory, several indicators have been developed. One of them reflects
mutual fund liquidity.

If mutual fund liquidity is low, it means that the mutual funds are
bullish. So contrarians argue that the market is at or near a peak and
hence is likely to decline. Thus low mutual fund liquidity is considered as a
bearish indicator. Conversely, when the mutual fund liquidity is high, it
means that the mutual funds are bearish. So, contrarians believe that the
market is at or near a bottom and hence is poised to rise because it is an
indication of potential purchasing power that can be injected into the
market to lift it upward. Thus, high mutual fund liquidity is considered as a
bullish indication.

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  Put/Call Ratio

Another indicator monitored by technical analyst is the put/ call

ratio. Speculators buy calls when they are bullish and buy puts when they
are bearish. Since speculators are often wrong, some technical analysts
consider the put/call ratio as a useful indicator.

A rise in put/call ratio means that speculators are pessimistic. For

the contrary technical analyst, however this is a buy signal because he
believes that the option speculators are generally wrong. Conversely,
when the put/call ratio falls, it means that the speculators are optimistic.
The contrary technical analyst, however, regards the same as sell signal.

Numbers of Puts purchased

Put/Call ratio = -------------------------------------
Numbers of calls purchased

Chart Types
There are four main types of charts that are used by investors and
traders depending on the information that they are seeking and their
individual skill levels. The chart types are: the line chart, the bar chart, the
candlestick chart and the point and figure chart.

Line Chart
The most basic of the four charts is the line chart because it
represents only the closing prices over a set period of time. The line is
formed by connecting the closing prices over the time frame. Line charts
do not provide visual information of the trading range for the individual
points such as the high, low and opening prices. However, the closing
price is often considered to be the most important price in stock data
compared to the high and low for the day and this is why it is the only
value used in line charts.

A line chart

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Bar Charts
The bar chart expands on the line chart by adding several more key
pieces of information to each data point. The chart is made up of a series
of vertical lines that represent each data point. This vertical line
represents the high and low for the trading period, along with the closing
price. The close and open are represented on the vertical line by a
horizontal dash. The opening price on a bar chart is illustrated by the dash
that is located on the left side of the vertical bar. Conversely, the close is
represented by the dash on the right. Generally, if the left dash (open) is
lower than the right dash (close) then the bar will be shaded black,
representing an up period for the stock, which means it has gained value.
A bar that is coloured signals that the stock has gone down in value over
that period. When this is the case, the dash on the right (close) is lower
than the dash on the left (open).

A Bar Chart

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Candlestick Charts
The candlestick chart is similar to a bar chart, but it differs in
the way that it is visually constructed. Similar to the bar chart, the
candlestick also has a thin vertical line showing the period's trading range.
The difference comes in the formation of a wide bar on the vertical line,
which illustrates the difference between the open and close. And, like bar
charts, candlesticks also rely heavily on the use of colours to explain what
has happened during the trading period. A major problem with the
candlestick colour configuration, however, is that different sites use
different standards; therefore, it is important to understand the
candlestick configuration used at the chart site you are working with.
There are two colours constructs for days up and one for days that the
price falls. When the price of the stock is up and closes above the opening
trade, the candlestick will usually be white or clear. If the stock has traded
down for the period, then the candlestick will usually be red or black,
depending on the site. If the stock's price has closed above the previous
day’s close but below the day's open, the candlestick will be black or filled
with the colour that is used to indicate an up day.

Point and Figure Charts

The point and figure chart is not well known or used by the
average investor but it has had a long history of use dating back to the
first technical traders. This type of chart reflects price movements and is
not as concerned about time and volume in the formulation of the points.
The point and figure chart removes the noise, or insignificant price
movements, in the stock, which can distort traders' views of the price
trends. These types of charts also try to neutralize the skewing effect that
time has on chart analysis.

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 When first looking at a point and figure chart, you will notice a series
of Xs and Os. The Xs represent upward price trends and the Os represent
downward price trends. There are also numbers and letters in the chart;
these represent months, and give investors an idea of the date. Each box
on the chart represents the price scale, which adjusts depending on the
price of the stock: the higher the stock's price the more each box
represents. The other critical point of a point and figure chart is the
reversal criteria. This is usually set at three but it can also be set
according to the chartist's discretion. The reversal criteria set how much
the price has to move away from the high or low in the price trend to
create a new trend or, in other words, how much the price has to move in
order for a column of Xs to become a column of Os, or vice versa. When
the price trend has moved from one trend to another, it shifts to the right,
signaling a trend change.

Conclusion
Charts are one of the most fundamental aspects of technical
analysis. It is important that you clearly understand what is being shown
on a chart and the information that it provides. Now that we have an idea
of how charts are constructed, we can move on to the different types of
chart patterns.

Technical Analysis: Chart Patterns

A chart pattern is a distinct formation on a stock chart that creates
a trading signal, or a sign of future price movements. Chartists use these
patterns to identify current trends and trend reversals and to trigger buy
and sell signals.

Head and Shoulders

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 This is one of the most popular and reliable chart patterns in
technical analysis. Head and shoulders is a reversal chart pattern that
when formed, signals that the security is likely to move against the
previous trend.

Cup and Handle

A cup and handle chart is a bullish continuation pattern in

which the upward trend has paused but will continue in an upward
direction once the pattern is confirmed.

Double Tops and Bottoms

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 This chart pattern is another well-known pattern that
signals a trend reversal - it is considered to be one of the most reliable
and is commonly used. These patterns are formed after a sustained
trend and signal to chartists that the trend is about to reverse. The
pattern is created when a price movement tests support or resistance
levels twice and is unable to break through. This pattern is often used
to signal intermediate and long-term trend reversals.

Triangles

Triangles are some of the most well-known chart patterns

used in technical analysis. The three types of triangles, which vary in
construct and implication, are the symmetrical triangle, ascending and
descending triangle. These chart patterns are considered to last anywhere
from a couple of weeks to several months.

The symmetrical triangle in the below Figure is a pattern in

which two trend lines converge toward each other. This pattern is neutral
in that a breakout to the upside or downside is a confirmation of a trend in
that direction. In an ascending triangle, the upper trend line is flat, while
the bottom trend line is upward sloping. This is generally thought of as a
bullish pattern in which chartists look for an upside breakout. In a
descending triangle, the lower trend line is flat and the upper trend line is
descending. This is generally seen as a bearish pattern where chartists
look for a downside breakout.

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Flag and Pennant

These two short-term chart patterns are continuation patterns that

are formed when there is a sharp price movement followed by a generally
sideways price movement. This pattern is then completed upon another
sharp price movement in the same direction as the move that started the
trend. The patterns are generally thought to last from one to three weeks.

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 As you can see in Figure, there is little difference between a
pennant and a flag. The main difference between these price movements
can be seen in the middle section of the chart pattern. In a pennant, the
middle section is characterized by converging trend lines, much like what
is seen in a symmetrical triangle. The middle section on the flag pattern,
on the other hand, shows a channel pattern, with no convergence
between the trend lines. In both cases, the trend is expected to continue
when the price moves above the upper trend line.

Wedge

The wedge chart pattern can be either a continuation or reversal

pattern. It is similar to a symmetrical triangle except that the wedge
pattern slants in an upward or downward direction, while the symmetrical
triangle generally shows a sideways movement. The other difference is
that wedges tend to form over longer periods, usually between three and
six months.

The fact that wedges are classified as both continuation and

reversal patterns can make reading signals confusing. However, at the
most basic level, a falling wedge is bullish and a rising wedge is bearish.
In the below Figure, we have a falling wedge in which two trend lines are
converging in a downward direction. If the price was to rise above the
upper trend line, it would form a continuation pattern, while a move below
the lower trend line would signal a reversal pattern.

Triple Tops and Bottoms

Triple tops and triple bottoms are another type of reversal
chart pattern in chart analysis. These are not as prevalent in charts as
head and shoulders and double tops and bottoms, but they act in a similar
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fashion. These two chart patterns are formed when the price movement
tests a level of support or resistance three times and is unable to break
through; this signals a reversal of the prior trend.

Confusion can form with triple tops and bottoms

during the formation of the pattern because they can look similar to other
chart patterns. After the first two support/resistance tests are formed in
the price movement, the pattern will look like a double top or bottom,
which could lead a chartist to enter a reversal position too soon.

Rounding Bottom

A rounding bottom, also referred to as a saucer bottom, is a long-

term reversal pattern that signals a shift from a downward trend to an
upward trend. This pattern is traditionally thought to last anywhere from
several months to several years.

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 A rounding bottom chart pattern looks similar to a cup
and handle pattern but without the handle. The long-term nature of this
pattern and the lack of a confirmation trigger, such as the handle in the
cup and handle, make it a difficult pattern to trade. We have finished our
look at some of the more popular chart patterns. You should now be able
to recognize each chart pattern as well the signal it can form for chartists.

Capital Asset Pricing Model (CAPM)

CAPM was developed by W. F. Sharpe. CAPM simplified
Markowitz‘s Modern Portfolio theory, and made it more practical. CAPM
uses the concept of Beta to link risk with return. Using CAPM, investors
can assess the risk return trade off involved in any investment decision.
Beta is a measure of non-diversifiable risk (Systematic Risk). It shows how
the price of a security responds to changes in market prices. The essence
of the CAPM is that the more systematic risk the investors carry, the
greater is his / her expected return.

Assumptions of CAPM

The CAPM being theoretical model is based on some important

assumptions:

 All investors look only one period expectations about the future;

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  Investors are price takers and they can’t influence the market
individually;
 There is risk free rate at which an investors may either lend (invest)
or borrow money.
 Investors are risk-averse,
 Taxes and transaction costs are irrelevant.
 Information is freely and instantly available to all investors.

Following these assumptions, the CAPM predicts what an

expected rate of return for the investor should be, given other statistics
about the expected rate of return in the market and market risk
(systematic risk Or Beta). The equation for calculation of Beta is

R i = α i + β iR m + e i

Ri = Estimated return on ith stock

α = Expected return when market return is zero (intercept)

βi = Beta, a measure of stock’s sensitivity to the market index

Rm = Return on market index

ei = the error term

Using the Beta concept the Capital Asset Pricing Model will help
to define the required return on a security. Normally the higher is the risk
we take, the higher should be the return as otherwise we avoid risk. So,
the higher the β, the higher should be the return. The equation for CAPM
is

Ri = Rf + βi (Rm – Rf)

Ri is the required return

Rf is the risk free return

Rm is the average market return

Bi is the measure of systematic risk which is non-diversifiable.

Presently, the risk free return is 6% as the Treasury bill rate and
market return is expected to vary with the β chosen. Let us take β as 1.2
and expected market return is 18%, then the return on the stock i is as
follows:

Ri = 6% + 1.2 (18 – 6)

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 = 0.06 + 1.2 (0.12)

= 0.06 + .144

= 20.4%

If the investor is risk taker and chooses a Beta of 1.8, then the expected
return will be higher as shown below.

Ri = 6 + 18 (18-12)

= .06 + 1.8 (.12)

= .06 + .216 = .276

= 27.6

Criticisms of CAPM

Several of the assumptions of CAPM seem unrealistic. Investors

really are concerned about taxes and are paying the commissions to the
broker when buying or selling their securities. And the investors usually do
look ahead more than one period. Large institutional investors managing
their portfolios sometimes can influence market by buying or selling big
amounts of the securities. All things considered, the assumptions of the
CAPM constitute only a modest gap between the theory and reality. But
the empirical studies and especially wide use of the CAPM by practitioners
show that it is useful instrument for investment analysis and decision
making in reality.

Security Market Line (SML)

When the Capital Asset Pricing Model is drawn graphically, we get

the S.M.L., which is shown in the chart below. If the investor wants to
decide on an investment with an expected return he would know the level
of risk he has to take or alternatively given the level of risk, he has
preferred to take, he would know the expected return from this chart. The
investor has to assess whether it is worth taking a level of risk, if he has a
target return which involves that risk, as he is assumed to be generally
risk averse. Thus, CAPM and SML help the investor in evaluating risk for a
return, in making any investment decision. The principle of the higher the
risk, the higher is the return is embodied in this Model.

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Arbitrage Pricing Theory (APT)

APT was propsed ed by Stephen [Link] and presented in his

article “The arbitrage theory of Capital Asset Pricing”, published in
Journal of Economic Theory in 1976. Still there is a potential for it and it

may sometimes displace the CAPM. In the CAPM returns on individual

assets are related to returns on the market as a whole. The key point
behind APT is the rational statement that the market return is determined
by a number of different factors. These factors can be fundamental factors
or statistical. If these factors are essential, there to be no arbitrage
opportunities there must be restrictions on the investment process. Here
arbitrage we understand as the earning of riskless profit by taking
advantage of differential pricing for the same assets or security. Arbitrage
is is widely applied investment tactic. APT states, that the expected rate
of return of security J is the linear function from the complex economic
factors common to all securities and can be estimated using formula:
E(r ) = E(ŕJ) + β1 J I1J + β2J I2J + ... + βnJ InJ + εJ
J

Where: E(rJ) - expected return on stock J;

E(ŕJ) - expected rate of return for security J, if the influence of all

factors is 0;

IiJ - the change in the rate of return for security J, influenced by

economic factor i (i = 1, ..., n);

Market efficiency theory

The concept of market efficiency was proposed by Eugene Fama in
1965, when his article “Random Walks in Stock Prices” was published in
Financial Analyst Journal.

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Notes prepared by: P. Subash Assistant Professor, MBA Dept, Global Business School,
Melvisharam.
 An efficient Capital market is one in which security prices equal
their intrinsic values at all times, and where most securities are correctly
priced.

In other words Capital market is efficient, if the prices of securities

which are traded in the market, react to the changes of situation
immediately, fully and credibly. It reflect all the important information
about the security’s future income and risk related with generating this
income.

Efficient market theory states that the price fluctuations are random
and do not follow any regular pattern. Fama suggested that efficient
market hypothesis can be divided into three categories. They are:

• Weak form of efficiency;

• Semi- strong form of efficiency;

• Strong form of the efficiency.

The level of information being considered in the market is the basis

for this segregation.

 Weak form of EMH

The weak form hypothesis says that the current prices of
stocks already fully reflect all the information that is contained in the
historical sequence of prices. Therefore, there is no benefit in examining
the historical sequence of prices forecasting the future. The new price
movements are completely random. They are produced by new pieces of
information and not related or dependent on past price movements.
Therefore there is no benefit in studying the historical sequence of prices
to gain abnormal profit. If there is no value in studying past prices and
past price changes, there is no value in technical analysis. The weak form
of the efficient market hypothesis is thus a direct repudiation of technical
analysis.

Empirical tests of the weak form

• Serial correlation test

• The Runs Test

• Filter tests

 Serial correlation test

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SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
Notes prepared by: P. Subash Assistant Professor, MBA Dept, Global Business School,
Melvisharam.
 Since the weak form postulates independence between
successive price changes, such independence or randomness in stock
price movement can be tested by calculating the correlation between
price changes in one period and changes for the same stock in another
period. The correlation coefficient can take on a value ranging from -1
to 1. A positive number indicates a direct relation, a negative value
implies an inverse relationship an a value close to zero implies no
relationship. Thus if the correlation coefficient is close to zero the price
changes can be considered to be serially independent.

 The Runs Test

The runs test is a statistical technique used to detect whether a

time series is random or not. The computational procedure of runs test is
that it ignores the absolute values in a time series and deals only with the
signs, plus or minus. The test is essentially concerned with the direction of
changes in a given time series. Since it is a non-parametric test, there is
no need to predefine the nature of probability distribution of the time
series data.

 Filter tests

Filter test have been developed as direct tests of specific

mechanical trading strategies to examine directly their validity and
usefulness of specific systems. It is based on the premise that once a
movement in price has surpassed a given percentage movement, the
security’s price will continue to move in the same direction.

Semi-strong form of EMH

The semi-strong form of the efficient-market hypothesis says that

current prices of stocks not only reflect all informational content of
historical prices but also reflect all publicly available knowledge about the
corporations being studied. Further-more, the semi-strong form says that
efforts by analysts and investors to acquire and analyze public information
will not yield consistently superior returns to the analyst. The tests that
will summarize briefly all publicly available information and corporate
news, corporate announcements, such as quarterly earnings reports,
changes in accounting information, stocks splits and stock dividends are
quickly and adequately reflected in stock prices.

Strong form of EMH

The strong form of the efficient-market hypothesis represent the

extreme case of market efficiency. The strong form of efficiency
hypothesis says that the current prices of stocks reflect all information
both publicly available information as well as private or inside information
This implies that no information whether public or inside can be used to
earn superior returns consistently.
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SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
Notes prepared by: P. Subash Assistant Professor, MBA Dept, Global Business School,
Melvisharam.
Evaluation of Technical Analysis

Technical analysis appears to be a high controversial approach to

security analysis. The analysts offer arguments as well as disarguments
for this alternative of security analysis. Among them, few are as follows:

Arguments

 Under the influence of crowd psychology, trends persist for quite

some time. Tools of technical analysis that help in identifying these
trends early are helpful in investment decision-making.
 Shifts in demand and supply are gradual rather than instantaneous.
Technical analysis helps in detecting these shifts rather early and
hence provides clues to future price movements,
 Fundamental information about a company is absorbed and
assimilated by the market over the period of time. Hence, the price
movement tends to continue in more or less in the same direction
till the information is fully assimilated in the market.
 Charts provide a picture of what has happened in the past and
hence give a sense of volatility that can be expected from the stock.
Further, the information on trading volume, which is ordinarily
provided at the bottom of a bar chart, gives a fair idea of the extent
of public interest in the stock.

Disagreements

 Most technical analysts are not able to offer convincing explanations

for the tools employed by them.
 Empirical evidence in support of the random walk hypothesis casts
its shadow over the usefulness of technical analysis.
 By the time an uptrend or downtrend may have been signalled by
the technical analysis, may already have taken place.
 Ultimately, technical analysis must be a self-defeating proposition.
As more and more people employ it, the value of such analysis
tends to decline.
 There is a great deal of ambiguity in the identification of
configurations as well as trend lines and channels on the charts. The
same chart can be interpreted differently.
Despite these limitations, technical analysis is very popular. It is only in
the rational, efficient and well ordered market where technical analysis
has no use. But given the imperfections, inefficiencies and irrationalities
that characterize real markets, technical analysis can be helpful. Hence, it
can be concluded that technical analysis may be used, albeit to a limited
extent, in conjunction with fundamental analysis to guide investment
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SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
Notes prepared by: P. Subash Assistant Professor, MBA Dept, Global Business School,
Melvisharam.
decision making, as it is supplementary to fundamental analysis rather
than substitute for it.

Basis Technical analysis Fundamental Analysis

Time horizon: Technical analysis mainlyFundamental analysis tries
seeks to predict short term
to establish a long term
price movements. values.
Focus: The focus of technical The focus of fundamental
analysis is mainly on analysis is on fundamental
internal market data,
factors relating to the
particularly price and
economy, the Industry and
volume data. the firm.
Users: Technical analysis appeals
Fundamental analysis
mostly to short term
appeals primarily to long
traders. term investor.
Vision: Technical analyst looks Fundamental analysis looks
backward. forward as well as backward.
Thinking: Technical analyst thinks Fundamental analyst thinks
that stocks market
that the stocks market is
behaviour is 10% logical 90% logical and 10%
and 90% psychological psychological.
Estimation: The technician believes The fundamental analyst
that there is no real value
estimates the intrinsic value
to any stock. According to
of the shares and purchases
him, stock prices depend them when their market
on demand and supply price is less than the intrinsic
forces which in turn
value and sells the share
governed by rational and when the market price is
irrational factors. more than the intrinsic value
and earns profit.
Assumptions: Technical analysis works There are no assumptions in
on the basis of various Fundamental analysis
assumptions.
Data gathered Financial statements Charts
from:

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SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT
Notes prepared by: P. Subash Assistant Professor, MBA Dept, Global Business School,
Melvisharam.