TESTS OF TECHNICAL ANALYSIS IN INDIA

Sanjay Sehgal and Meenakshi Gupta

The study evaluates the economic feasibility of technical analysis in the Indian stock market. It discusses that technical indicators do not outperform Simple Buy and Hold strategy on net return basis for individual stocks. Technical indicators seem to do better during market upturns compared to market downturns. However, technical based trading strategies are not feasible vis--vis passive strategy irrespective of market cycle conditions. Technical indicators also do not provide economically significant profit for industry as well as economy based data. Combining fundamentals with technical information, we find, that technical indicators are more profitable for small stocks compared to big stocks and for high value stocks compared to low value stocks. However, the economic feasibility of fundamentals based technical strategies is still questionable. Our results seem to confirm with the efficient market hypothesis. Key Words : Technical Analysis, Bull Period, Moving Average, Oscillators, Size and Value Strategies. JEL Classification Codes: C10, C12, G11, G14

INTRODUCTION

HERE have been two main approaches to analyse the securities market - the fundamental approach and the technical approach. The fundamental approach stresses the influence of a firms basic earnings and risk on the market price of its shares, whereas the technical approach concentrates on the patterns of stock market prices. The technical approach states that past share prices and volumes tend to follow a pattern and they can be used to predict future price movements. Forces of demand and supply determine the share prices; however, the fundamentalists think that they are a function of rational factors, while technicians attribute it to psychological factors.

In this light, an empirical testing of technical indicators for Indian stock market is considered important. It is possible that the efficacy of technical tools may vary across mature and emerging market settings owing to differences in their relative efficiency. There is also a need to empirically evaluate whether technical analysis combined with fundamental analysis provides some extra normal returns. Fundamental analysis can be incorporated in the form of forming portfolios on the basis of certain company characteristics. The objective of the paper is to evaluate the following propositions. Do technical analysis based trading strategies are statistically feasible for individual stocks? Are the profits provided by technical indicators economically significant and hence outperform Simple Buy and Hold (SBH) benchmark? Does the success of technical tools vary across different phases of the market cycles? Does the success of technical analysis vary across different industries and old and new economy sectors? Do some of the technical indicators work better for portfolios formed on company characteristics? The present paper is divided in six sections including the present one. Data and its sources are described in section two. The

The technical analysis approach to capital market evaluation has received little attention and acceptance as compared to fundamental analysis. But in recent years the popularity of technical school of thought is increasing amongst academicians and practitioners. There has been some empirical research on technical analysis, for developed capital markets. 1 However similar empirical work for developing markets especially India2 is limited.

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results of technical indicators for individual securities and market cycle conditions are discussed in section three. Section four gives the results of business sectors along with an analysis of old and new economy stocks. In section five we discuss the results of technical indicators combined with fundamental analysis, while summary and conclusions are provided in section six. We find that technical analysis gives statistically significant returns for all the nine technical indicators on gross return basis at 5 per cent level during the entire study period. Majority of the technical indicators also do well on net return basis. However, technical based strategies do not seem to be economically feasible for individual securities as they are outperformed by SBH strategy over the study period. Technical indicators tend to do better during bull phases of the market compared to market downturns. However, they under perform the SBH strategy irrespective of the market cycle conditions. Technical indicators also do not seem to be economically feasible when used on industry as well as economic data. Combining value and size based strategies with technical analysis seem to enhance profits for small firm stocks and high value stocks but the superior performance of SBH again cast a shadow on the applicability of such strategies. DATA The data for the study consists of two parts: one to verify the efficacy of technical analysis based strategies and second for trading strategies which combines fundamental and technical analysis based information. For part one, initially we choose 75 companies (five large companies from fifteen major industries). However, six of the sample companies were dropped, as they did not have continuous trading record over our study period, which is warranted by study on technical analysis. The sample selection was balanced across sectors as we also intend to do technical analysis in industrial data. The data comprises of adjusted daily high, low, and closing prices and daily trading volumes for the period January 1, 1999 to December 31, 2004. Most of these shares belong to BSE-100 Index and are Category A stocks.3 The BSE-100 Index has been used as market surrogate. It is a broad based value weighted stock market index that has been constructed on the lines of Standard and Poor USA, and is highly popular amongst investment researchers in India. The data for part two consists of adjusted daily high, low, and closing prices and daily trading volumes of 180 companies from BSE-200 Index listed on Bombay Stock
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Exchange for the three calendar years 2002, 2003, and 2004. The bigger set of data is required to create company characteristic sorted portfolios. The sample securities are actively traded. The data also consists of size (market capitalisation) and value measures i.e. P/B ratios (inverse of BE/ME) and P/E ratios (inverse of E/P ratio) for 180 companies. The daily stock prices, trading volumes and stock index data for the sample companies for both the parts have been taken from Capital Market Line software. The data for the company characteristics have been collected from CMIE, widely used financial software. The implicit yields on 91- day treasury bills have been used as a risk free proxy and are collected from RBIs site. INDIVIDUAL SECURITIES, MARKET CYCLE CONDITIONS AND TECHNICAL ANALYSIS The study includes nine technical indicators broadly classified into three categories: trend following price indicators, price oscillators, and volume indicator, namely Exponential Moving Average (EMA, Trend following, 14 days), Moving Average Convergence Divergence (MACD, Trend following, 12-26-9 days), Volume Oscillator (VO, volume indicator,10-25 days), Smoothed Rate of Change (ROC, Price oscillator, 14-7 days), Relative Strength Index (RSI, Price oscillator, 7 days ), Commodity Channel Index (CCI, Price oscillator, 7 days), Stochastic (STO, Price oscillator, 7 days), Directional Indicator (DI, Trend following, 13 days) and Moving Average (MA, Trend following, 14 days). Based on the formulae and trading rules of technical analysis (Alexander Elder, 1993) we developed our own programmes for trading using FoxPro as programming language. Individual Securities The study period is from 1.1.1999 to 31.12.2004 having 1504 trading days. Mean return earned using a selected indicator during the entire period is calculated in two steps. In the first step the gross return is calculated for each company using a selected indicator as the percentage difference between amount realised at the end of the period and the amount invested at beginning of the period on the assumption of reinvestment of profits without considering the commission and slippage. The Return is calculated using the formula: Return = [(Amtt-Amtt-1)/Amtt-1]*100. Where Amtt =Amount at the end of the period Amtt-1=Amount at the beginning of the period
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In the second step equally weighted portfolio mean return is calculated for all the sample companies using a selected indicator. The net returns are calculated after taking into account the commission and slippage. Commissions are paid for entering and exiting a contract. Slippage is the difference in price at which the order is placed and the price at which it is executed. The slippage depends on companys trading activity, size and also on market conditions. As the sample stocks are Category A stocks which are characterised by large capitalisation and high trading activity, the slippage is low. Slippage rates for category A stocks are taken as 0.005 per cent on the recommendations of a survey of ten market practitioners in Delhi including stock brokers and investment analysts. The two-way commissions (both buying and selling) on BSE are .01 per cent for individual investor as suggested by a sample survey of practitioners. From July 2001 short selling was not allowed for inter day trading. So to maintain the uniformity in programming techniques short selling was ignored. The details relating to number of recommendations (each buy-sell pair is considered as one recommendation or a trade), and holding period using technical indicators are given in Table 1. In all, the study involves 25,379 trades for 69 companies using 9 technical indicators over a 6-year total period. The average number of trades for the total period for each stock using a given technical indicator varies from 22.83 for DI to 55.39 for MACD. The average holding period for a security varies from 19.61 days for MACD to 56.35 days for DI as given in Panel B Table 1. The correlation coefficient between number of trades and holding period is found to be 0.94 and is statistically significant at 5 per cent level, showing an inverse relation between number of trades and holding period. There is also a negative correlation between MR and number of trades (-0.37) showing a decrease in return with large number of trades due to high transaction costs. The results for technical analysis of individual stocks are shown in Table 2. Panel A of the table gives the gross returns (before deducting trading costs) for the entire study period for each of the technical indicator. Panel B provides the net returns (after deducting transactions). The t values are calculated at 5 per cent level on one tail basis, t1 is t statistic that provides statistical feasibility of the indicators at 5 per cent level i.e. whether the indicators earn a significant positive return or not and t2 is t statistic that gives the economic feasibility of the indicators over the Simple Buy and Hold (SBH) strategy i.e. the significance of difference in returns between an

active strategy vis--vis a passive strategy. The gross return is statistically significant for all the 9 technical indicators under study. But the return on active strategy when compared with SBH strategy is not statistically significant even without commission and slippage i.e. the values for t2 are not statistically significant. None of the indicators outperforms the SBH strategy. The trading reality, however does not allow trading without transaction costs. But for three indicators i.e. MACD, ROC and MA the difference in returns with SBH strategy is not statistically significant i.e. they are at par with SBH strategy. The net returns are statistically significant at 5 per cent level for six indicators namely ROC, DI, MA, MACD, STO and VO. Net return is highest for ROC followed by DI, MA, MACD, STO and VO. But the values for t2 are not significant for any of the indicators. None of the technical indicators outperform the SBH strategy. As technical analysis is an active strategy, it seems that most of the profits are wiped out by high transaction costs and slippage. Market Cycle Conditions The total sample period has also been divided into 12 half-yearly sub-periods. The average number of trades for each sub-period for a stock using a given technical indicator varies from 2.28 for DI to 4.67 for CCI as given in Panel A Table 1. The average holding period for a security varies from 18.21 days for CCI to 42.73 days for DI as shown in Panel B Table 1. The Net Returns for each of the sub-periods are calculated. The results are not reported for sub-period analysis. The net return is highest for DI followed by ROC, MACD, MA, VO, and STO. The t1 values are significant for five indicators. None of the t2 values are significant in sub-period analysis, as is also the case for the total period analysis. It means the passive strategy outperformed the active strategy. It may be possible that the overall results are influenced by different market phases i.e. Bull or Bear. Bull phase in the market is symbolized by prolonged rise in the prices of shares sustained by buying pressure from investors. In contrast bear phase experiences prolonged period of falling prices, dominated by selling pressure in the market place. Thus the 12 sub-periods are classified as bull or bear depending upon whether the weekly return on BSE100 (Rm) is more or less than the weekly return on 91 days Treasury bill rate (used as risk free rate Rf). If the weekly return for BSE100 index is more than 91
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days Treasury bill rate i.e. Rf then the sub-period is termed as bull period otherwise bear period. Using this criterion the 12 sub periods are divided into 6 bull periods and 6 bear periods. The average number of trades for bull-period for a stock using a technical indicator varies from 2.07 for DI to 4.77 for MACD as given in Table 1, panel A. The average holding period for a security for a bull period varies from 16.06 days for CCI to 44.59 days for DI as shown in Table 1 panel B. The average number of trades for bear period for a stock using a technical indicator varies from 2.49 for DI to 4.59 for CCI as given in Table 1, panel A. The average holding period for a security for a bear period varies from 20.26 days for MACD to 42.12 days for DI as shown in Table 1 panel B. The results for the market phases are given in Table 3. Bull period results are discussed in panel A and bear period results in panel B. The MR is statistically significant for all the indicators for the average bull period, but when compared with SBH strategy the returns are not significant for any of the indicators. The MR is not statistically significant either for indicators or for the SBH strategy in the bear period. This may be due to restriction on short selling. The results indicate that DI gives the best result in Bull period followed by ROC, MA, VO, STO, MACD, CCI, RSI, and EMA. The t2 values for some of the indicators in the bear period are positive but it indicates only smaller losses as compared to SBH strategy and not the significant values as all the MR values are negative by using all the technical indicators and also SBH strategy. The difference in return in bull period and bear period is statistically significant for all the indicators under study which implies that technical analysis based strategies are more successful during market up-trends. None of the technical indicators outperform the SBH strategy either in the bull period or in the bear period. BUSINESS SECTORS, OLD AND NEW ECONOMY STOCKS AND TECHNICAL ANALYSIS The total sample consists of fifteen different industries namely Capital Goods, Chemical and Petrochemicals, Consumer Durables, Diversified, Finance, Fast Moving Consumer Goods (FMCG), Healthcare, Housing Related, Information Technology, Media and Publishing, Metal and Mining, Oil and Gas, Power and Telecom, Tourism, Transport and Transport Equipments.
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The market is looking at a classification of new and old economy in the last decade due to rapid change in technology. New economy companies produce intangible products. These companies create ideas and concepts to manage intangibles. Creativeness and innovation are more important than mass production, and earnings are often reinvested in new ideas and not in new machines. New economy is characterized by globalization, communication, innovation, technology and vision. Old economy stocks represent large, well-established companies that participate in more traditional industry sectors and have little investment in the technology industry. They generally represent manufacturing industries and core lines of business activity, which is based on stable technology. Old economy stocks exhibit relatively low volatility and usually pay consistent dividends as they operate in mature industry sectors. In contrast the new economy stocks are heavily involved in the technology sector. Their stocks are generally more volatile and they do not pay dividends, opting to reinvest their cash into business expansions. Old and new economy stocks differ not only in their business activities but also in the way they are valued by the market. While analysing new economy stocks more focus is placed on growth expectations and earning estimates but for old economy stocks the emphasis is placed on their value. Business Sectors The MR for each industry is calculated as an equally weighted portfolio return consisting of all the securities belonging to that industry for the total study period. For each of the industry MR, SD, t1 and t2 values are calculated. The results are given in Panel A of Table 4. For Capital Goods industry DI and VO gives statistically significant return. MACD gives highest net return followed by ROC, RSI and DI for Chemical and Petrochemical industry. But only RSI provides statistically significant returns. ROC gives the highest return followed by MACD, DI and MA for Consumer Durables industry. But ROC does not provide statistically significant return and only MACD and DI give statistically significant return. In absolute terms MACD and ROC generates greater return than SBH strategy for Consumer Durables industry but these returns are not statistically different from that of SBH strategy. STO indicator performs best for Diversified industry followed by ROC, RSI, DI and VO indicator. But only STO, RSI and VO give statistically significant net returns. The returns for these indicators are not statistically different from that of SBH strategy.
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MA gives the highest net return for Finance industry to be followed by DI, ROC, STO, MACD and VO. Except MA indicator all of them provide statistically significant return. None of the indicators provide positive returns for Fast Moving Consumer Durables (FMCG) and Healthcare industries. SBH strategy also does not provide statistically significant returns for FMCG and Healthcare industries. DI gives the highest net returns followed by STO, ROC and RSI for Housing industry. ROC is the leading indicator followed by MACD for Information Technology (IT) and Media and Publishing industry. But only ROC gives statistically significant net returns for IT industry and MACD provides statistically significant net returns for media and Publishing industry. For Metal and Mining industry ROC provides the highest net returns in absolute terms followed by MACD and VO. But MACD and VO provide statistically significant returns. DI provides the highest net returns to be followed by MACD, ROC and RSI for Oil and Gas industry. But only DI gives statistically significant returns. For Power and Telecom industry DI provides the highest net returns to be followed by ROC, MACD and VO. But none of the indicators provide statistically significant returns. Only ROC and DI gives the positive returns for Tourism industry but the returns are not statistically significant. DI is the wining indicator for Transport industry followed by ROC and VO. But none of these indicators provide statistically significant returns for transport industry. Out of fifteen industries under study DI provides statistically significant net returns for 6 industries followed by MACD and VO for 4 industries, RSI and STO for three industries and ROC for two industries. DI appears to be most suitable indicator for the industries as it gives less but more powerful signals and hence the lowest probability of whipsaws and also the profits are not heavily eroded by market fluctuations. In five industries namely FMCG, Healthcare, Power and Telecom, Transportation, and Tourism none of the technical indicators could provide statistically feasible returns. But as we find for individual security analysis none of the technical indicators has outperformed the SBH strategy thus implying economical non feasibility of technical analysis while analysing the industrial data. Old and New Economy Stocks The sample companies are also divided into old and new economy stocks. The results are given in Table 4. Four technical indicators provide statistically significant net

returns i.e. MACD, VO ROC and DI for the new economy sector as given in Panel B of the Table 4. For old economy ROC and DI gave statistically significant net returns as shown in Panel C of the Table 4. But none of the technical indicators outperform the SBH strategy for old or new economy sectors. The MR for new economy sector is more than the MR for old economy sector for all the indicators as well as for the SBH strategy and this difference is statistically significant for MACD indicator. COMPANY CHARACTERISTICS AND TECHNICAL ANALYSIS We empirically evaluate whether technical analysis combined with fundamental analysis provides some extra normal returns. In the contemporary finance literature, certain company characteristics have been found to bear relationship with average stock returns. Prominent amongst these company characteristics are company size (measured in terms of market capitalization) [See Banz (1981), Cook and Roseff (1982)], Fama and French (1992) and Chui and Wei (1998)], book equity to market equity ratio [Stattmen (1980) Rosenberg Reid and Lanstein (1985), Chan, Hamao and Lakonishok: 1991)] and price-earnings ratio [Ball (1978), Basu (1983)]. According to Banz (1981), the small stocks (having low market capitalization) tend to outperform big stocks (having high market capitalization) resulting in a size effect in the stock market. The value effect implies that value stocks (having high BE/ME ratio or high E/P ratio) outperform growth stocks (having low BE/ME ratio or low E/P ratio). Ball (1978) shows that both BE/ME and E/P ratios can be used as value proxies and hence high BE/ME and high E/P ratios characterise value stocks while low BE/ME and low E/P ratios imply growth stocks. Basu (1983) confirmed that the common stock of high E/P firms earn, on average higher risk adjusted returns than the stocks with low E/P ratios. Using fundamental analysis we form portfolios on the basis of size (market capitalization) and two value measures (Book equity to market equity ratio and price earning ratio) and then buy-sell decisions are taken on the basis of technical indicators. Size and value factors are of special significance because of their strong presence in US and other developed markets4 and also in Indian Stock Market. 5 To study the effect of company characteristics on returns, stocks are ranked in ascending order at December end of each year t-1 on the basis of size and value
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characteristics, while size is measured in terms of market capitalization, and the value characteristics are measured using P/B ratio (inverse of BE/ME) and P/E ratio (inverse of E/P ratio). Thus low P/B and low P/E ratios will characterise value stocks and high P/B and high P/E ratios will characterise growth stocks. The ranked securities are then classified into three equal groups on the basis of size namely S1 (small), S2 (medium) and S3 (big). The same stocks are re-classified on the basis of their P/ B ratios into three equal groups i.e., V1 (high value), V2 (medium value), and V3 (low value) and P/E ratios viz. PE1 (high value), PE2 (medium value), and PE3 (low value). We formed the equally weighted portfolios on the basis of size and value variables. The equally weighted portfolios are more desirable as their parameters are less loaded with measurement errors (Lakonishok, Shleifer, Vishny (1994)). We estimated the returns provided by each of these portfolios using different technical indicators for three calendar years 2002, 2003, 2004. These returns are estimated net of transaction costs. The returns on company characteristic(s) sorted portfolios based on selected technical indicators are given in the Table 5 for the years 2002, 2003 and 2004. ROC, DI and MA indicators are found to give significant net returns at 5 per cent level on portfolios formed on the basis of company characteristics. These indicators provide positive returns even after adjusting for market effect. The net returns on small stock portfolios are very high as compared to big stock portfolios in all the three years. Similarly low P/B and low P/E portfolios (high value) perform well as compared to high P/Band high P/ E portfolios (low value) in all the three years. In 2002 all of the indicators give losses for low value portfolios whereas high value stock portfolios gave a return of 45.7 per cent using ROC indicator. In 2003 and 2004 the low P/B portfolio earns more than twice as that of high P/B portfolio. Similarly, low P/E portfolio earns a net return as high as 29 per cent in 2002 while high P/E portfolio provides a negative return. In 2003 and 2004 value stocks earn twice the return as growth stocks. However the magic wanes out when we compare the returns provided by different technical indicators with those on a Simple Buy Hold (SBH) strategy as shown in the table. The SBH strategy seems to outperform almost all technical indicators for all the portfolios. The returns are statistically significant at 5 per cent level for most of the indicators for small, low P/B and low P/E portfolios for the year 2002. For the year 2003 the returns on all types of portfolios whether small, big,
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low value, high value or low P/E or high P/E are statistically significant at 5 per cent level. This may be due to the fact that Indian market entered a bull phase in March 2003. However, for the year 2004 the returns are statistically significant at 5 per cent level for small and medium size portfolios (but not for big size portfolio) and also for low P/B and P/E ratio portfolios (value stocks). However the empirical success of size and value based technical investing becomes questionable, once we compare the returns on technical analysis with SBH strategy. The superior performance of SBH strategy probably suggests that technical analysis is more of a myth than a reality. The empirical result suggests that technical analysis being transaction extensive does not pay off after adjusting for transaction costs owing to frequent buying and selling of securities. Then we formed double sorted equally weighted portfolios based on size and value groupings i.e. S1V1, S2V1, S3V1, S1V2, S2V2, S3V2, S1V3, S2V3, S3V3, S1PE1, S2PE1, S3PE1, S1PE2, S2PE2, S3PE2, S1PE3, S2PE3, and S3PE3, where S1V1 is a portfolio of small stock with high value and S3V3 is a portfolio of big stocks with low value. Similarly S1PE1 is a portfolio of small stocks with high E/P ratio and S3PE3 is a portfolio of big stocks with low E/P ratio. The double-sorted portfolios will lead to better stock characterization compared to single sort portfolios. This should be reflected by higher return differential between corner portfolios (S1V1 - S3V3) formed on the basis of double sorts and compared to either of the criterion taken in isolation i.e. (S1-S3) and (V1-V3). The returns on double-sorted portfolios are given in table 6 for the years 2002, 2003 and 2004. Panel A for the Year 2002 shows that portfolio S1V1 provides better net returns as compared to portfolio S3V3. The net returns for S1V1 are statistically positive at 5 per cent level for most of the indicators. Within the same size portfolios the net return decreases as we move from high value to low value portfolio i.e. from S1V1 to S1V3 or from S2V1 to S2V3 and so on. The net return for small size and low PE (value stock) portfolios (S1PE1) is much higher than the return on big size and high PE (growth stock) portfolios (S3PE3).The S3V3 portfolio and S3PE3 portfolios provide losses for all the indicators while the portfolio S1V1 gives a net return of as high as 66.5 per cent using ROC indicator and S1PE1 provides a net return of 54.9 per cent using Directional Indicator. Panel B for the year 2003 shows that portfolio S1V1 provides almost three times return as compared to portfolio S3V3. The returns for all types of portfolios
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for the year 2003 are statistically positive at 5 per cent level for most of the indicators as is the case with single sorted portfolios. The tables also point out that within the same size portfolios the return decreases as we move from high value to low value portfolio i.e. from S1V1 to S1V3 or from S2V1 to S2V3 and so on. The net return for small size and low PE portfolio (S1PE1) is much higher than the net return on big size and high PE portfolio (S3PE3). Panel C for the year 2004 shows that portfolio S1V1 provides better returns as compared to portfolio S3V3. The returns for S1V1 are statistically positive at 5 per cent level for most of the indicators. The tables also points out that within the same size portfolios the return decreases as we move from high value to low value portfolio i.e. from S1V1 to S1V3 or from S2V1 to S2V3 and so on. The return for small size and low PE portfolio (S1PE1) is much higher than the return on big size and high PE portfolio (S3PE3).The S3V3 portfolio gives losses for most of the indicators under study and S3PE3 provides losses for all the indicators while S1V1 give a return of as high as 35 per cent using Directional Indicator and S1PE1 provides a return of 40 per cent using MA indicator. The economic feasibility of different investment strategies is also evaluated. It shows the difference in returns of small and big size portfolios, high value and low value portfolios along with their t statistics. All the indicators give a statistically significant difference in return at 5 per cent level for small minus big stocks (S1S3), high value minus low value stocks (V1-V3) and (PE1-PE3), and also for double sorted portfolios i.e. small and high value portfolio vs. big and low value portfolio. For the year 2002 the return difference is as high as 46 per cent for small minus big size portfolios (S1-S3) for MA and ROC indicator. Similarly the return difference is 63 per cent for (V1-V3) and 40 per cent for (PE1PE3) for Moving Average indicator. The return difference increases to 80 per cent from 46 per cent if we compare S1V1 and S3V3 instead of S1 and S3. But the return differential does not change if we compare S1PE1 and S3PE3. So we can follow a strategy of buying small size value stocks (S1V1) and selling big sized growth stocks (S3V3). For the year 2003 the return difference is as high as 105 per cent for small size minus big size portfolio (S1S3) for Directional Indicator. Similarly the return difference is 90 per cent for (V1-V3) and 45 per cent for (PE1-PE3) for Directional Indicator. The return difference increases to 142.9 per cent from 105 per cent if we compare S1V1 and S3V3 with that of S1 and S3

using Directional Indicator. But the return differential decreases if we compare S1PE1 and S3PE3 which indicate that investors may not prefer small stocks with high value using the price earning ratio as value measure. For the year 2004 the return difference is as high as 22 per cent for small size minus big size portfolio (S1S3) for Directional Indicator. Similarly the return difference is 21 per cent for (V1-V3) for Directional Indicator and 28 per cent for (PE1-PE3) for Moving Average indicator. The return difference increases to 32 per cent from 22 per cent if we compare S1V1 and S3V3 with that of S1 and S3. Thus return differences become more prominent if we compare size and value characteristics together. But the SBH strategy outperforms the technical analysis even after sorting the portfolios on size and value parameters together. SUMMARY AND CONCLUSION The study evaluates prominent technical tools for 69 large Indian companies for the period January 1, 1999 to December31, 2004. The empirical results suggest that technical analysis provides statistically significant returns for all the nine technical indicators on gross return basis during the entire study period. Six out of nine technical indicators also give statistically significant net returns during the study period. The technical tools perform better during bull phases compared to bear phases of market cycle; however, they do not beat SBH strategy in either of these phases. The returns generated by technical analysis are not economically feasible for any of the industries as none of the technical indicators could outperform the SBH strategy. However, DI gives statistically significant return in six industries followed by MACD and VO in four industries. The mean return using technical analysis for new economy sector is more than that for old economy sector, however; none of the technical indicators could provide superior returns as compared to SBH strategy. Combining corporate fundaments with technical analysis, we generate statistically significant returns for portfolios having small size and value stocks as compared to big size and growth stocks. However, none of the characteristics sorted portfolios were able to beat SBH strategy. Thus compared to SBH strategy the technical analysis is not found economically feasible during the study period, as trading costs erodes most of the profits. Another reason could possibly be the fact that there
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was restriction on short selling of equity shares on inter day basis for greater part of our study period making trading strategies infeasible during the downtrend market phases. There is a need for comprehensive evaluation of technical trading systems such as Triple Screen Trading

system and Channel Trading system in the Indian context. Time series forecasting models such as Auto Regressive Integrated Moving Average (ARIMA) and Vector Auto Regression (VAR) may provide better forecast of future returns compared to standard tools of Technical Analysis. Economic feasibility of technical trading tools for high

Table 1: Average Number of Share Recommendations and Holding Period For Each Co. Using a Technical Indicator Period Total Period Average Sub-Period Bull Period Bear Period Total Period Average Sub-Period Bull Period Bear Period EMA 46.86 4.14 4.03 4.25 22.61 20.61 17.72 23.49 MACD 55.39 4.58 4.77 4.4 19.61 18.22 16.65 20.26 VO 45.41 4.13 4.3 3.97 25.3 22.4 20.55 24.58 ROC 41.43 3.43 3.5 3.35 26.56 23.45 26.27 20.73 RSI 29.67 2.61 2.54 2.68 36.38 31.77 28.94 34.85 CCI 54.46 4.67 4.75 4.59 19.71 18.21 16.06 20.58 STO 32.45 2.92 2.98 2.86 37.98 31.67 29.17 35.32 DI 22.83 2.28 2.07 2.49 56.35 42.73 44.59 42.12 MA 39.32 3.58 3.63 3.52 29.7 24.81 26.48 23.36

Panel A: Average Number of Share Recommendations

Panel B: Average Holding Period (in days) Per Company

Table 2: Total Period Results for Technical Indicators using Individual Security Data EMA Panel A: Gross Returns MR(Gross) S.D. t1 t2 MR(Net) S.D. t1 t2 40.91 122.4 2.78 -4.92 -46.72 43.47 -8.93 -6.51 244.76 238.6 8.52 -1.47 40.3 102.25 3.27 -4.94 119.97 152.59 6.53 -3.57 27.73 82.79 2.78 -5.19 302.68 371.87 6.76 -0.52 133.1 226.91 4.87 -3.15 73.91 161.25 3.81 -4.29 -0.16 88.09 -0.02 -5.65 118.43 365.53 2.69 -3.02 -7.36 153.01 -0.4 -5.59 122.82 220.59 4.63 -3.36 31.82 128.9 2.05 -5.02 126.24 213.41 4.91 -3.33 108.57 190.48 4.73 -3.62 303.32 906.47 2.78 -0.31 85.32 383.18 1.96 -3.37 341.51 492.92 5.76 0 337.12 488.02 5.74 0 MACD VO ROC RSI CCI STO DI MA SBH

Panel B: Net Returns

Table 3: Empirical Results for Market Cycle Conditions EMA Panel A: Bull Period Results MR SD t1 t2 MR SD t1 t2 4.39 7.03 5.19 -9.84 -16.79 10.31 -13.52 -2.49 11.6 18.26 5.28 -7.35 -3.81 9.71 -3.26 4.42 16.05 11.2 11.91 -6.89 -10.35 9.83 -8.74 0.9
q

MACD

VO

ROC 18.47 18.46 8.31 -5.88 -4.65 6.31 -6.13 4.51

q

RSI 9.51 9.64 8.2 -8.48 -11.88 9.25 -10.67 0.09

q

CCI 9.57 18.78 4.23 -7.73 -14.44 9.9 -12.12 -1.28

STO 14.8 13.02 9.44 -7.06 -12.31 10.11 -10.12 -0.14

DI 21.13 20.22 8.68 -5.2 -7.12 10.91 -5.42 2.51

MA 17.5 28.51 5.1 -5.32 -10.34 6.29 -13.65 1.04

SBH 46.24 34.64 11.09 0 -12.04 11.47 -8.72 0

Panel B: Bear Period Results

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Tests of Technical Analysis in India 19

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frequency data such as intra day must be tested in the light of the fact that short selling is allowed in Indian market only on the intra day basis. Efficacy of technical tools for alternative financial assets such as Government and Corporate bonds, Currencies, Commodities, and Mutual Funds must also be checked. Technical tools should also be tested for Financial Derivatives such as Security and Index Options and Security and Index Futures. A study can be performed using a large sample of securities and over a longer time horizon to evaluate if the weak-form

efficiency of the Indian capital market has changed on period-to-period basis. The present study contributes to the literature on technical analysis as well as investment strategies. However, further research in the area is desirable so that one can have a better understanding about the determination of stock prices and returns and whether such information could be used to devise economically feasible trading strategies.

Table 4: Empirical Results for Business Sectors and Old and New Economy Sectors MR Capital Goods Chem. and Petrochem Consumer Durables Diversified Finance FMCG Healthcare Housing Related IT Media and Publishing Metal and Mining Oil and Gas Power & Telecom Tourism Transport & Transport Equip. MR SD t1 t2 MR SD t1 t2 EMA -61.36 -42.95 -76.83 -0.37 -20.67 -59.35 -43.1 -32.11 -65.37 -91.36 -67.37 -41.99 -53.55 -49.78 -52.87 MACD 9.57 64.87 130.73 88.86 116.87 -54.99 -12.27 57.88 55.05 56.61 70.75 86.78 41.63 -22.71 -21.82 VO 65.61 9.03 -56.31 122.55 93.88 -8 -1.24 34.96 23.51 -29.76 51.7 -22.95 20.42 -32.29 48.38 ROC 114.74 61.64 167.02 158.09 171.16 -27.2 68.46 74.15 316.23 332.27 565.83 57.59 100.51 35.23 57.51 RSI -34.98 32.73 -44.01 139.7 65.07 -29.25 14.36 58.78 -76.57 -90.51 -46.19 22.27 -0.71 -49.91 -47.15 CCI -33.3 -18.3 -58.45 103.96 133.1 -58.13 -10.26 -19.45 -38.39 -83.3 -67.56 -33.27 -30.54 -51.78 -44.6 STO -31.83 -14.71 -1.78 274.28 135.46 -36.02 66.67 177.86 -65.18 -89.48 11.28 -0.12 -19.81 -59.61 -12.46 DI 57.92 22.66 54.32 153.83 308.34 -4.73 177.8 193.24 2.18 -47.77 17.34 118.57 175.69 26.56 -1.7 MA -16.93 -4.2 19.02 74.78 451.4 -55.97 49.05 5.26 12.18 -68.62 5.79 41.56 21.12 -6.08 117.61 SBH 254.04 256.26 77.99 451.81 793.79 19.29 489.11 293.16 330.37 33.29 492.75 195.08 281.01 47.46 196.02

Panel A: Business Sectors

Panel B: New Economy Sector -40.94 56.71 -3.82 -4.36 -50.66 31.66 -10.25 -5.09 70.61 116.54 3.21 -3.32 19.6 86.73 1.45 -3.85 49.03 104.16 2.49 -3.52 13.18 61.59 1.37 -4 187.7 226.89 4.38 -2.19 95.81 221.96 2.76 -2.34 9.88 115.27 0.45 -3.85 -7.03 64.08 -0.7 -4.33 34.59 231.23 0.79 -3.45 -36.01 40.48 -5.7 -4.84 48.19 159.42 1.6 -3.46 20.64 103.81 1.27 -3.8 151.6 220.83 3.63 -2.5 79.18 163.05 3.11 -2.74 169.3 576.32 1.55 -1.8 27.96 130.75 1.37 -3.61 450.3 593.73 4.01 0 259.82 389.66 4.27 0

Panel C: Old Economy Sector

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20 Sehgal and Gupta

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Table 5: Net Returns for the Single Sorted (Size/Value) Portfolios EMA Panel A: Year 2002 S1 S2 S3 V1 V2 V3 PE1 PE2 PE3 S1 S2 S3 V1 V2 V3 PE1 PE2 PE3 S1 S2 S3 V1 V2 V3 PE1 PE2 PE3 1.03 -15.2 -15.48 -2.81 -9.35 -17.73 -3.35 -14.73 -13.96 22.33 17.75 11.37 22.7 15.75 13 21.92 14.99 13.48 1.06 -1.99 -10.4 0.06 -6 -5.38 -5.29 -0.2 -6.59 16.83 -3.11 -7.96 24.63 -3.43 -15.43 9.55 -3.52 -12.63 73.65 45.9 24.51 69.18 59.79 15.08 66.88 45.29 15.5 22.69 7.85 6.95 21.6 7.42 8.47 23.22 6.62 2.76 17.76 -9.47 -10.5 11.35 -3.8 -10.01 5.71 -7.26 -7.64 58.12 47.95 31.32 61.47 45.97 29.96 55.82 46.93 30.93 11.21 1.67 4.79 11.22 0.37 6.08 8.17 4.59 4.48 41.82 2.79 -4.03 45.77 3.08 -8.28 23.66 0.22 -5.33 107.86 89.19 53.36 109.05 90.76 50.6 95.65 91.3 48.59 27.38 10.91 2.88 20.97 5.24 14.96 22.3 7.6 8.46 24.88 -7.04 -7.83 20.36 -2.72 -7.81 11.13 -4.96 -6.55 29.08 25.81 19.3 31.88 23.11 19.21 31.26 23.83 17.24 15.65 0.88 -4.11 7.44 3.85 1.13 6.81 0.54 2.93 3.51 -10.05 -12.27 -0.75 -4.15 -14.16 0.26 -5.47 -12.74 22.87 22.41 14.91 21.48 23.53 15.19 21.73 21.8 15.81 3.11 1.01 -2.01 7.12 -3.27 -1.74 5.38 -0.46 -5.16 41.09 2.63 -3.89 40.35 4.78 -5.4 17.36 4.04 -3.55 48.46 36.12 25.84 50.88 37.53 22.01 46.52 40.62 20.88 10.47 2.79 -3.87 4.31 1.84 3.23 0.17 4.82 3.51 42.03 4.76 -0.35 39.53 8.98 -2.25 29.83 6.31 2.39 123.41 50.64 17.88 114.84 52.92 24.17 75.49 74.26 30 32.51 23.44 14.17 36.14 19.22 14.76 22.39 23.52 17.12 31.93 7.72 -14.76 45.38 -1.79 -18.29 23.86 4.16 -16.61 102.15 84.39 28.19 104.94 80.43 29.36 93.05 66.79 37.29 22.33 6.44 -0.07 22.09 2.68 3.93 25.17 3.23 -2.84 96.62 26.76 15.12 92.43 39.86 5.65 74.06 27.86 12.16 197.46 158.59 102.91 208.7 162.46 87.8 201.18 162.14 83.71 42.12 16.14 15.74 32.14 17.4 24.46 31.68 22.58 16.83 MACD VO ROC RSI CCI STO DI MA SBH

Panel B: Year 2003

Panel C: Year 2004

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Table 6: Net Returns for the Double Sorted Size and Value Portfolios MR Panel A: Year2002 S1V1 S1V2 S1V3 S2V1 S2V2 S2V3 S3V1 S3V2 S3V3 S1PE1 S1PE2 S1PE3 S2PE1 S2PE2 S2PE3 S3PE1 S3PE2 S3PE3 S1V1 S1V2 S1V3 S2V1 S2V2 S2V3 S3V1 S3V2 S3V3 S1PE1 S1PE2 S1PE3 S2PE1 S2PE2 S2PE3 S3PE1 S3PE2 S3PE3 3.01 -0.26 -4.84 -13.07 -9.91 -22.2 -1.11 -15.58 -17.79 -0.43 -4.86 2.63 -6.82 -20.29 -16.33 -4.83 -15.71 -18.5 26.3 19.44 11.31 19.33 16.65 17.6 15.98 10.75 10.4 26.35 15.88 19.58 17.74 19.32 18.1 20.1 7.85 9.17 32.55 -0.15 -14.25 16.54 -12.78 -12.51 3.58 2.04 -17.79 18.61 1.01 -5.27 6.22 -8.64 -3.9 -5.77 -0.23 -18.71 81.2 82.38 12.42 72.74 48.6 20.68 18.93 49.09 12.05 70.32 60.43 44.21 90.39 35.31 14.41 29.81 39.3 8.4 18.56 13.05 25.17 2.78 -12.97 -17.72 -3.05 -8.5 -13.33 15.72 -0.65 17.97 0.17 -13.21 -14.75 -8.52 -4.67 -13.22 60.81 63.76 29.18 77.22 36.07 36.11 34.33 38.82 26.18 54.37 62.27 33.51 74.05 47.21 26.58 33.93 26.49 32.74 66.53 7.54 10.65 21.13 -4.64 -7.47 4.24 6.29 -13.58 43.4 7.11 17.9 10.19 -0.91 -4.06 -0.76 -4.5 -13.6 110.06 127.03 42.95 138.07 74.64 63.82 50.99 71.38 43.74 81.1 128.46 75.18 141.07 76.59 53.85 59.35 63.07 38.41 34.97 9.86 14.55 -0.79 -4.3 -15.49 6.33 -10.65 -7.96 22.01 5.94 11.29 4.64 -10.54 -13.2 -3.66 -6.86 -9.72 32.35 23.84 28.08 25.63 25.9 25.87 41.88 19 13.02 36.48 30.13 19.58 20.11 25.87 21.82 37.44 12.77 13.96 1.88 -0.73 20.76 -4.62 -4.4 -20.47 -3.02 -6.46 -18.42 1.78 3.45 12.04 2.01 -12.83 -17.59 -5.65 -2.95 -18.97 24.77 21.61 17.3 21.17 26.07 19.58 10.12 22.55 11.91 21.21 28.67 7.14 21.6 19.26 27.97 22.77 16.31 11.12 59.03 20.18 9.15 13.34 3.62 -8.38 22.33 -5.59 -6.91 24.8 17.81 14.78 13.08 0.22 -7.79 7.03 -3.1 -7.9 51.08 45.51 44.15 53.9 37.03 20.34 44.48 29.66 18.34 46.51 55.19 42.52 48.01 38.2 17.95 44.54 24.93 16.73 58.34 25.62 6.96 16.78 2.23 -4.17 3.6 2.41 -3.19 54.92 25.2 20.88 14.11 -4.34 0.98 -3.22 4.45 -3.19 153.48 90.9 70.18 86.66 41.77 29.99 27.6 25.8 10.57 106.41 138.95 118.47 79.89 49.42 15.9 18.09 24.05 14.33 56.37 -1.02 -1.14 31.86 10.72 -17.82 25.22 -12.88 -22.9 36.13 15.5 -3.02 17.89 9.42 -10.12 5.22 -14.01 -23.84 115.06 106.52 27.35 126.46 84.75 48.96 27.91 47.58 17.19 93.9 92.42 75.34 124.84 69.03 58.72 49.24 30.18 14.69 121.65 65.24 57.24 46.22 35.75 -0.02 80.04 24.63 -3.23 98.14 57.49 65.1 57.46 13.08 7.46 44.52 22.1 -3.53 212.64 207.17 96.56 238.85 144.7 106.37 137.86 136.05 73.98 193.89 220 126.85 252.17 139.64 96.72 145.34 117.63 64.59 EMA MACD VO ROC RSI CCI STO DI MA SBH

Panel B: Year 2003

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MR S1V1 S1V2 S1V3 S2V1 S2V2 S2V3 S3V1 S3V2 S3V3 S1PE1 S1PE2 S1PE3 S2PE1 S2PE2 S2PE3 S3PE1 S3PE2 S3PE3

EMA -4.22 3.35 8.43 10.45 -12.41 -4.71 -6.42 -10.43 -12.61 -8.71 5.91 8.12 3.46 0.39 -7.58 -9.75 -9.31 -13.2

MACD 24.68 26.85 10.76 17.68 -7.3 10.97 21.33 -0.64 5.09 30.67 8.52 23.62 19.59 8.64 -0.94 18.36 2.06 -4.1

VO 14.29 8.39 9.58 6.88 -8.11 4.65 11.56 -0.94 5.71 10.73 10.41 11.38 4.72 0.34 1.02 8.58 0.42 4.66

ROC 28.98 26.02 26.38 21.37 -8.2 16.51 5.65 -5.32 8.08 38.25 10.9 32.83 21.18 9.08 4.53 5.64 1.61 -0.01

RSI 13.27 21.56 10.09 5.78 -7.83 3.32 -1.03 -4.97 -5.15 16.75 9.1 23.54 5.87 -2.27 -1.17 -3.35 -8.81 -3.36

CCI 5.38 0.67 2.58 13.1 -8.92 -1.78 2.07 -2.67 -3.78 0.17 3.25 4.2 13.66 -6.27 -6.12 3.36 -0.22 -9

STO 2.83 19.43 10.84 10.28 -11.82 7.51 -1.23 -5.16 -4.3 -2.65 15.61 22.57 8.72 -1.46 0.68 -4.76 -4.42 -3.37

DI 35.45 38.76 14.76 38.54 13.44 18.12 34.11 3.52 11.7 14.51 33.6 47.16 30.52 29.53 13.92 23.47 3.8 4.89

MA 30.96 17.73 11.87 20.86 -8.44 5.41 7.4 -3.79 -1.23 40.64 2.33 17.54 24.92 5.95 -6.65 8.23 1.94 -9.35

SBH 32.88 50.26 47.48 37.16 -10.52 18.43 23.8 6.32 18.96 41.57 34 54.19 33.29 13.25 5.03 19.19 15.31 10.18

Panel C: Year 2004

NOTES
1. For details refer to Sidney S. Alexander (1961); Paul Cootner and F.E. James Jr. (1962), Eugene F. Fama and Blume (1966), Robert A. Levy (1967), F.E. James Jr. (1968) Satish N. Neftci and Andrew Policano (1984), Steven M .Dawson (1985), William Brock, Josef Lakonishok and Le Baron (1992), Lawrence Blume, David Easley and Maureen, OHara (1994), Jonathan Batten and Craig Ellis (1996), Ryan Sullivan, Allan Timmermann, Halbert White (1999) and Andrew W. Harry Mamaysky and Jiang Wang (2000), Bondt and Thaler (1985), Bondt and Thaler (1987), Narasimhan Jegadeesh (1990), Andrew W. Lo and A Craig Mac Kinlay (1990), Jagadeesh and Titman (1993), Lakonishok, Shleifer and Vishny (1994), Chan, Jegadeesh and Lakonishok (1996), Porta, Lakonishok, Shleifer and Vishny (1997), Datar, Naik and Radcliffe (1998), Barberis, Shleifer and Vishny (1998), Daniel, Hirshleifer and Subrahmanyam (1998), Jennifer Conrad and Gautam Kaul (1998), K. Geert Rouwenhorst (1998), Hong and Stein (1999), Tobias J Maskowitz and Mark Grinblatt (1999), Lee and Swaminathan (2000), Grundy and Martin (2001), Jegadeesh and Titman (2001), Chordia and Shivakumar (2002), Timothy C Johnson (2002), Jegadeesh and Titman (2002), Thomas J. George and Chuan-yang Hwang (2004). For details refer to Sehgal Sanjay and Garhyan Anurag (2002) and Subrata Kumar Mitra (2002). The BSE-100 is a broad index of 100 companies. The criteria for selection of companies in BSE-100 had been market activity and due representation to various industry groups. BSE authorities have classified the securities traded on their exchange into various groups such as group A, group B1, Group B2, and group Z. Group A consists of high turnover and large market capitalization stocks with a proven profit
q q

record. Group B1 includes stocks of quality companies with equity above Rs 3 crore, with high growth potential and trading frequency. Group B2 consists of low trading volume stocks with equity below Rs. 3 crore. Group Z includes the stocks of those companies that do not meet the rules, regulations, and stipulations lay down by the exchange. 4. BE/ME effect has been documented for stocks trading on Tokyo stock exchange (Aggarwal, Rao and Hikaki (1989), Capaul, Rowley and Sharpe(1993), Chan Hamao and Lakonishok (1991)), the London Stock exchange (Capual Rowley and Sharpe (1993), Strong and Xu (1995)), and also on stock exchanges in France, Germany and Switzerland (Capual Rowley and Sharpe (1993)). The size and BE/ME effect for the Indian capital market is discussed in Sehgal and Muneesh Kumar (2004) and Sehgal and Tripathi (2004).

5.

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James, F.E. Jr. (1968), Monthly Moving Averages An Effective Investment Tool, Journal of Financial and Quantitative Analysis, 3, pp. 315 - 326. Jobman, Darrell R., (1995), The Handbook of Technical Analysis, Irwin Professional Publishing, New York. Kahn, Michael N. (2006), Technical Analysis Plain and Simple: Charting the Markets in Your Language, Pearson Education, USA. Kirkpatrick, Charles, D. and Dahlquist Julie, R. (2006), Technical Analysis: The Complete Resource for Financial Market Technicians, Pearson Professional Education, USA. Lakonishok, J., Shleifer, A. and Vishny, R. (1994), Contrarian Investment, Extrapolation and Risk, Journal of Finance, 49, pp. 1541 - 1578. Levy Robert A. (1967), Random Walks: Reality or Myth, Financial Analysts Journal, 23, pp. 69 - 77. Mitra, Subrata Kumar (2002), Profiting from Technical Analysis in Indian Stock Market, Finance India, 16, pp. 109 - 120. Neftei, Salih N. and Policano Andrew J. (1984), Can Chartists Outperform the Market? Market Efficiency Tests for Technical Analysis, The Journal of Futures Market, 4, pp. 465 - 478. Norden, Gary (2006), Technical Analysis and the Active Trader, McGraw Hill, New York. Pistolese, Clifford (2006), Select Winning Stocks Using Technical Analysis, McGraw Hill Education, Europe. Plummer, T (1989), The Psychology of Technical Analysis, Probes Publishing Company, Chicago, Illinois. Pring, M.J (1991), Technical Analysis Explained, McGraw Hill, 3rd Edition, New York. Pring, M.J (1993), Martin Pring on Market Momentum, Probes Publishing Company, New Delhi (India). Rosenberg, B., Reid, K. and Lanstein, R (1985), Persuasive Evidence of Market Inefficiency, Journal of Portfolio Management, 11, pp. 9 - 17. Sehgal, S. and Garhyan A. (2002), Abnormal Returns Using Technical Analysis: The Indian Experience, Finance India, 16, pp. 181 - 203. Sehgal, S. and Tripathi V. (2004), Size Effect in Indian Stock Market: Some Empirical Evidence, Presented at International Conference on Delegated Portfolio Management and Investor Behavior, Sichuan University, China. Statttman, D. (1980), Book Values and Stock Returns, The Chicago MBA: A Journal of Selected Papers, 4, pp. 25 - 45. Stronf N. and Xu X.G. (1995), Explaining the Cross Section of UK Expected Returns, working paper, University of Manchester. Sullivan, Ryan. Timmermann, Allan. and White, Halbert. (1999), Data- Snooping, Technical Trading Rule Performance and the Bootstrap, The Journal of Finance, 54, pp. 1647 1691.

Sanjay Sehgal (sanjayfin15@yahoo.co.in) is Professor of Finance at the Department of Financial Studies, University of Delhi, South Campus. He has a teaching experience of about 18 years in the field of investment management and corporate finance. He has written a research book and has two major research projects on Mutual Fund and Asset Pricing funded by Government of India. He has several national and internationally published papers to his credit. Meenakshi Gupta (mg_abc@rediffmail.com) teaches at Sri Aurobindo College, University of Delhi. She is also associated with postgraduate teaching at the Universitys department of Commerce. She has recently submitted her doctoral dissertation .

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