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276 Security Analysis and Portfolio Management, Assumptions, Technical analysis has the following assumptions:, The loss of earnings and information regarding forthcoming labour problems may result in a Ses,, prices. These factors may cause a shift in demand and supply, changing the direction of trends, • The market always moves in a trend. Except for minor deviations, the stock prices move in trende, price may create definite patterns too. The trend may be either increasing or decreasing. It continues, some time and then reverses., • It is said that history repeats itself and this is also true of the stock market. In a rising market, investors' psychology is positive and they purchase shares in greater volumes, driving the prices hieher, In a downtrend, they may be especially keen to get out of the market by selling the shares, thus plunein, share prices. Technical analysts believe that past prices predict the future., History of Technical Analysis, The doctrine outlined by Charles H Dow in 1884, in the Wall Street Journal, is the basis for technical, analysis. He wrote a series of articles in the journal. A J Nelson, a close friend of Dow, formalized the Dow, theory for economic forecasting. The analysts used charts of individual stocks and moving averages in the, early 1920s. Later, with the advent of calculators and computers, sophisticated techniques came into, vogue., Technical Tools, The most common technical tools used are Dow theory, volume of trading, short selling, bar and candlestick, charts, indicators and oscillators. This chapter analyses some of these tools., DOW THEORY, Dow developed his theory to explain the movement of the indices of Dow Jones Averages. He developed it, on the basis of certain hypotheses. The first hypothesis was that no single individual or buyer can influence, the market's primary trend. However, an individual investor can affect the daily price movements by buying, or selling large quantities of a scrip. The intermediate price movement can also be affected to a lesser degree, by an investor., Dow's second hypothesis was that the market discounts everything. Even natural calamities such as an, earthquake, plague or fire get quickly discounted in the market. The global financial crisis of 2008 affected, the share market for a while before it returned to normalcy., Dow's third hypothesis was that the theory is not infallible. It is not a tool to beat the market but provides, a way to understand it better., The Theory, The Dow theory sees a trend as primary, intermediate and short-term. The primary trend may be a broad, upwards or downwards movement that may last for a year or two. The intermediate trends are corrective, movements, which may last from three weeks to three months. The primary trend may be interrupted by, the intermediate trend. The short-term trend refers to the day-to-day price movements. It refers to the, oscillations or fluctuations. These three types of trends can be compared to the tide, waves and ripples i, the sea., Scanned by CamScanner

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Technical Analysis 277, Trend, 10 ananied by a counter move. If a share price is increasing, the counter move will be a fall in price and, Trend lines are straight lines drawn connecting either the tops or bottoms of the share price movements., lines., Y, Rising trend line, my, Flat trend line, Falling trend line, Y, Days, Figure 12.1 Trend lines, Trend Reversal, The rise or fall in share prices cannot go on forever. The share price movement may reverse its direction., Before the change of direction, certain patterns in price movements emerge. Violation of the trend line, shows the change in the direction of the trend. Violation of the trend line means the penetration of the trend, line by the scrip's price. If a scrip price cuts the rising trend line from above, it is a violation of the trend, line and signals the possibility of a fall in price. Likewise, if the scrip pierces the trend line from below, it, signals a rise in prices., Primary Trend, The security price trend may be either increasing or decreasing. When the market exhibits an increasing, trend, it is referred to a bull market. The bull market shows three clear-cut peaks. Each peak is higher than, the previous one. The bottoms are also higher than the previous bottoms. The reactions following the peak, usually halt before the previous bottoms. The phases leading to the three peaks are rev val, improvement, corporate profits, and speculation. The revival period encourages more investors to buy scrips as their, expectations about the future are high. In the second phase, increased corporate profits result in a further, price rise. In the third phase, prices advance due to inflation and speculation. Figure 12.2 illustrates the, three phases of a bull market., The reverse is true with the bear market. Here, the first phase of fall starts with the abandonment of, nope. The chances of prices moving back to the previous high level appear to be low. This results in the sale, of shares. In the second phase, companies report lower profits and dividends. This leads to selling pressure., The final phase is characterized by the distress sale of shares. During the bear phase in the Bombay Stock, Exchange,, more than two-thirds of the stocks were inactive. Most of the scrips were sold below their par, Scanned by CamScanner

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278 Security Analysis and Portfolio Management, T3, Speculation, (phase-3), B2, Good corporate, earnings, (phase-2), Revival of B,, market, confidence, (phase-1), Days, Figure 12.2 Phases of a bull market, Y, Loss of hope (phase-1), T,, Recession in business (phase-2), T2, B,, Distress selling, (phase-3)., B,, B3, X, Days, Figure 12.3 Phases of a bear market, values. Figure 12.3 illustrates the three phases of a bear market. Here, the tops and bottoms are lower than, the previous ones. The bull and bear phases of the Indian stock market are given in Figure 12.5., Secondary Trend, The secondary or intermediate trend moves against the main trend and leads to correction. In a bull market,, the secondary trend can result in the fall of about 33-66 per cent of the earlier rise. In a bear market, the, secondary trend carries the price upwards and corrects the main trend. The correction would be 33-66 per, cent of the earlier fall. The intermediate trend corrects the overbought and oversold positions. It provides, breathing space to the market. Compared to the time taken for the primary trend, secondary trend is swift, and quicker. Figure 12.4 shows the secondary movement., Scanned by CamScanner, Price, Price

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Technical Analysis 279, 33% to 66% of 'B', A, 33% to 66% of 'A', Days, Flgure 12.4 Secondary corrections, 22000, BULL, BEAR, 20000, BEAR, 18000, 16000, BULL, 14000, 12000, 10000, 8000, 6000, 4000, 2000, 0., 2002, 2004, 2006, 2008, 2010, 2012, Figure 12.5 Bull and bear markets-Sensex, Minor Trends, Minor trends or tertiary moves are the random wriggles that occur in price movements. They are simply, the daily fluctuations. Minor trends try to correct the secondary trend movements. It is better for investors, to concentrate on the primary or secondary trends rather than on the minor trends. The chartist plots the, scrip's price or the market index each day to trace the primary and secondary trends., Scanned by CamScanner, Price

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280 Security Analysis and Portfolio Management, SUPPORT. AND RESISTANCE LEVELS, Support and resistance levels are an integral part of technical analysis. A support level exists at a price, where considerable demand for that stock is expected to prevent a further fall in the price level. The fall in, the price may be halted for the time being, or it may even result in a price reversal. In the support level, demand for the scrip is expected to remain., In the resistance level, the supply of scrip is greater than the demand and a further rise in price i., prevented. The selling pressure is greater, and the increase in price is halted for the time being., Support and resistance usually occur whenever the turnover of a large number of shares tends to be, concentrated, several price levels. When the stock touches a certain level and then drops, this is called, resistance, and if the stock goes down to a certain level and then rises, there exists a support. The levels, constantly switch from one to the other, i.e., from support to resistance or from resistance to support, Figures 12.6 (a) and 12.6 (b) show the support and resistance levels., This can be explained numerically. For example, if a scrip price hovers around {150 for some weeks, then it may rise and reach 210. At this point, the price halts and then falls back. The scrip keeps on falling, back to around its original price of 7150 and halts. Then it moves upwards. In this case, 150 becomes the, support level. At this point, the scrip is cheap, and investors buy it. Demand makes the price move upwards., The price 210 becomes the resistance level, and selling pressure results in a price decline., Y., Support level, Resistance level, Days, Days, Figure 12.6 (a) Support level, Figure 12.6 (b) Resistance level, If the scrip price reverses the support level and moves downward, it means that the selling pressure has, overcome the potential buying pressure, signalling the possibility of a further fall in the value of the scrip., It indicates the violation of the support level and a bearish market., If the scrip penetrates the previous top and moves above, it is a violation of the resistance level. At this, point, the buying pressure would be more than the selling pressure. If the scrip moves above the double top, or triple top formation, it indicates a bullish market. The support and resistance levels need not be formed, only on tops or bottoms. They can be on the trend lines or gaps of the chart., Scanned by CamScanner, Price