investment management technical analysis

8/13/2019 Investment Management Technical Analysis

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Technical Analysis

Jeet R.Shah

M.Com,CFPCM


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Approaches toInvestment Decision Making

Fundamental Approach Psychological / Technical Approach

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Eclectic Approach


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Fundamental Approach

It is a method of forecasting the future pricemovements of a financial instrument based oneconomic ,social , political and other relevant factors

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demand of whatever underlines the financialinstrument.

It is an answer to the question of what to buy and

why to buy.


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Technical Approach /Analysis

TA is an art that helps you to invest/trade along withthe direction of the trend and make the most of it.

TA can be defined as an art of identifying the trend

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the right time in the direction of the reversal to ridethe trend until there is enough evidence to suggestthat there will again be a change in the trend.


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Technical Analysis Definition Contd.

In his book Technical Analysis Explained , MartinPing explains :

The TA approach to investing is essentially areflection of the idea that rices move in trends

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which are determined by the changing attitudes ofinvestors towards a variety of economic,monetary,political & psychological forces.The art of TA for itis an art is to identify trend changes at an early

stage & to maintain an investment posture until theweight of the evidence indicates that the trend hasbeen reversed.


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Foundations of Technical Analysis: What

arethe assumptions?

Price is determined solely by theinteraction of supply & demand .

Supply and demand are governed by

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numerous ac ors o ra ona anirrational. The market continually andautomatically weighs all these factors. (Arandom walker would have no qualms aboutthis assumption either. He would point outthat any irrational factors are just as likely tobe one side of the market as on the other.)


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Assumptions contd.

Disregarding minor fluctuations in the market,stock prices tend to move in trends whichpersist for an appreciable length of time.(Random walker would disagree with this statement.

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For any tren to persist t ere as to e somecollective 'irrationality')

Changes in trend are caused by shifts indemand and supply. These shifts no matter

why they occur, can be detected sooner orlater in the action of the market itself. (In thefinancial economist's view the market (through theprice) will instantaneously reflect any shifts in the

demand and supply.


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Assumptions contd.

Because of the persistence of trends andpatterns,analysis of the past market data canbe used to predict future price behaviour.

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Fundamental v TechnicalAnalysis

Fundamental Analysis Focuses on what ought

to happen in the

Technical Analysis Focuses on what

actually happens in the

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mar e . It looks forward.

It regards stock marketbehaviour as 90 %logical and 10 %psychological

mar e . It looks backwards.

It regards stock marketbehaviour as 10 %logical and 90 %psychological


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Strengths Of TechnicalAnalysis

It can be used to follow a wide range of instrumentsin almost any market place.

Charts can be used to analyse data for time periods

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Industrial Average has been in constant use sinceMay 26 ,1896.

There are many Technical Analysis tools and

techniques available which have been developed tocater to the needs of different market sectors.


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Strengths Of Technical Analysiscontd..

The basic principles of TA are easy to understandand have been developed from the way marketsoperate TA is concerned with what is actually

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.

TA relies on the use of accurate and timely data,which is available real-time or with only a short timedelay when necessary.


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Weakness Of TechnicalAnalysis

Because TA has an element of subjectivity , it ispossible for even experienced analysts to disagree onwhat data means and it is easy for undisciplinedanalysts to see what they want to see in a chart or to

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c oose evi ence se ective y. TA is based on the idea that human nature is

constant and therefore that patterns tend to repeatthemselves; however,there are limits to the extent to

which the future can be simply extrapolated from thepast.

TA is concerned with the degree of probability thatan event will happen not the certainty of the event.


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Weakness Of Technical Analysiscontd.

Some modern TA techniques are based on complexmathematical and statistical concepts. Computerisedanalysis software has largely overcome the difficulties

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,

applying it correctly is not easy. It is vital for the success of technical analysis that the

data used is both accurate and timely.


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To Sum up

Neither FA nor TA should be used in isolation. It is better to use The Eclectic Approach.

This means-

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.

Do TA to assess the state of the market psychology .

Combine FA and TA to determine which securitiesare worth- buying, holding and disposing off.

Respect Market Price and do not show excessive zealin beating the market

Accept that for higher return there are higher risk.


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Trading Theories


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Theory A- Market Equilibrium

Indicators Oscillators, eg, Relative StrengthIndex (RSI)

Number Theory Fibonacci numbers, Gann

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numbers Waves Elliott Wave Theory

Gaps High/low , Open/Closing

Favoured by experts


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Theory B- Classical TechnicalAnalysis

Trends- following moving averages, etc Chart Formations Triangles ,Head &

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Trend Lines Channels

Cycles

Favoured by Public Advisors


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Theory C- Supply AndDemand Fundamentals

Spreads Months,Exchanges, cash/futures Flow of funds Volume and open interest

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Reports Expectations versus reality

Favoured by Floor Traders


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The Dow Theory

Charles Henry.Dow (1851 1902 ) Was a reporter in an financial news service.

1882 He and Edward D Jones founded Dow Jones

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an company.

July 1884 Dow produced his first market measurefrom the average of eleven stocks known asRailroad Average


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The Dow Theory contd.

Dow realised that two separate measures of theeconomy would provide confirmation of any broadmarket trend.

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Average(Average of the closing prices of 12 stocks)was published in the Wall Street Journal(published by Dow )along with the Railroad Average

Dow never wrote a book about his theories but hepublished them as a series of Wall Street Journaleditorials.


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The Dow Theory contd.

Dow had noted that a simple line plot of averageprice against time gave rise to zig-zag patterns whichdefined market Trends.It is these basic patterns

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,

many refinements.


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Six Principles of The DowTheory


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1 .Average prices discounts everything

Dow used Closing prices exclusively tocalculate his averages .He also assumed that

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underlying assumption of TA.


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2. The Market move in Trends

Uptrends have a pattern of rising peaks andtroughs- downtrends have the opposite.

Dow identified three distinct types of trends :

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1. r mary or ma or ren - ese as or ayearor more and could be considered to be like a tide

2. Secondary or intermediate trend These arelike waves and last for 3 weeks or 3 months.

3. Minor trends These are like ripples and lastedfor less than than 3 weeks


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The Dow Theory -Trends

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3.Major trends have ThreePhases

Phase 1This is an accumulation phase that moves side ways.

Phase 2

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This is an up trend period.Although the trend is up , themarket prices zig-zag during correction or pullbacks.

Phase 3

After a Peak there is another accumulation phase .

Fig 1


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4.Averages must confirm each other

Dow was convinced that both the Industrial andthe Railroad Average had to be moving in thesame direction to confirm the market trend.

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5.Volume must confirm the trend

Volume represents the total trading activity for afinancial instrument in a particular time period.Dowconsidered volume to be important additional

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.

should expand in the direction of the major trend.

Fig 2


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6.A trend is assumed to be in effect until itgives definite signals that it has reversed

This is the basis of trend analysis but it is not alwayseasy to identify a trend reversal.

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r y y v r -

-Support and resistance levels

-Trend Lines

-Moving Averages

investment management technical analysis

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