Equity Research Technical Analyses - Volume I

Teaching Material MBA - Capital Market , Year II

Dr. Paritosh Basu

Introduction
Equity (Securities) Research Lexicon defines Research as Scientific or Scholarly Investigation Equity research is a disciplined scholarly investigation of equity Types of Security Researchers popularly known as Analysts Equity: Stocks and their issuers - Industry specific Fixed Income: Bonds and their issuers - Class (Conv., High Yield) What a Researcher / Analyst does with what objective? Seek to develop, and communicate to investors insights regarding i. Value ii. Risks and iii. Volatility of a security, Assist investors to decide whether to i. Buy, ii. Hold, iii. Sell, iv. Sell Short, or v. Avoid the security Reference for Research Annual Reports of Companies
Earnings Calls Data Base of Regulators and Research Organisations Managements conference calls Interviews and industry reports

Dow Theory

Oldest and the most publicised method for identifying major trends Evolved from the work of Charles H Dow Published in Wall Street Journal from 1900-02 Dow views about behaviour of the Stock Market
As a barometer of business condition rather than basis for forecasting stock prices Majority of stocks follow the underlying trend of the stock market most of the time Constructed two indices Dow Jones Industrial and Rail Road

William Peter Hamilton developed on Dows Principles and developed the theory in 1922 as is known today In 1932 Robert Rhea provided a more complete and formalised theory. Certain assumptions for these theories are
Daily closing prices and volumes to be recorded with averages

Three basic assumptions

Market discounts every thing Market has three movements Primary, Secondary and Minor Primary movements can be Bullish and Bearish Price-Volume Relationship provides background Price action determines trend Averages must be confirmed Industrial and Rail Road Indices

Equity Research - Methods

Methods of Research Fundamental Futuristic analyses of all attributes for valuation Technical Evaluation by analysing the statistics generated out of market activities including past trends (Price & Volume) Does not attempt to measure intrinsic value Considers Charts and other Tools to identify patterns that can indicate future movements in price and volume
Indicators Macro Econ., Sentiment , Convergence / Divergence, Fund Flow

Critical Assumptions - Since only price and volume movement is considered (These are criticisms also) Market discounts every factor Fundamental, Economic, Geographical,
Psychological, etc.

Price moves in trends Once a trend is formed future movements are likely to be in the same direction Market value is a reflection of supply and demand (Commodity) History tends to repeat itself Market participants tend to provide same
reactions to similar kind of stimulants and dampeners Note: Technical Analyses can be used for Stocks, Commodities, etc.

Equity Research - Methods

Advantages, Challenges and Criticisms of Technical Analysis Advantages Easy and quick to prepare using software Quick to understand and appreciate Does not require any financial statements Does not wait for intrinsic value to be reflected in financials Criticisms and Challenges (Considered as Black Magic) Subjective Cannot consider futuristic data Rely on efficient market hypothesis (EMH Weak > Strong* ) Completely disregards fundamentals of the company Cannot be used to make consistent decisions Signals, trends and oscillations can change even before a trend is formed Time horizon can be too small that of a week and even a day * Most theoreticians question this Strong EMH
Most Analysts in Wall Street focuses more on Fundamental Analysis

Technical Analysis Use of Trend

A trend is the general direction towards which the equity market is heading
Fig. - 1

Fig. - 2

Peak

Trough
If gap between P and T is not large, it is called horizontal movement

Fig. 1 - Easy to understand, perceive and appreciate Upward with intermittent variations Fig. 2 Virtually no trend is being perceived Fig. 3 Step Ladder Trend, each successive low may not fall below the previous low or form the same angle. Trend - Up, Down, Horizontal, Linear, Curvilinear Movements - Primary, Secondary and Minor

Fig. - 3

Technical Analysis Use of Trend

Trend Length Analysis A trend of any direction can be classified as a Long-term Trend Longer than a year, with more than one intermediate trend of any different direction Intermediate Trend One to three months Short-term Trend Any thing less than a month.
Note: If the major trend is upward with a downward correction in price movement
followed by a continuation of the uptrend, the correction is considered to be an intermediate trend.

Fig. Long-term trend with Intermediate Short-term trends

Technical Analysis Use of Trend

Trend Length Analysis Important dos and donts

Long Term Charts Constructed to best reflect the type of trend being analyzed. Weekly or daily charts spanning over five-year period are used Chartists to get a better idea of the long-term trend Long Term Daily Charts advisable with say opening and closing data

Note: 1. Longer the term of trend analysis better the conclusion 2. Chartist must validate and whether the market has discounted intermittent factors that have arisen in the business ecosystem 3. If answer to item 2 is no, Chartist to confirm reasons of history is not being repeated

Technical Analysis Use of Trend

A trend line is a simple charting technique

It adds a line to a chart to represent the trend in the market or a stock

These lines are used to clearly show the trend and are also used in the identification of trend reversals
Resistance Line

Support Line

Interim Support Levels Trend of Support Level Two Important Conventions 1. The Trend is your Friend 2. Dont buck the trend

Channel Two parallel trend lines, which acts as strong areas of support and resistance Can move in any direction

Technical Analysis Use of Trend

Support Level

Support Level is the level which historically a stock has found difficulty to go below

Level at which lots of buyers step in Either reconfirmed or breached upwards or downwards

Generally does not behave this way

What is charting? Charting is the task of predicting the direction of a price between significant Support and Resistance levels

Technical Analysis Importance of Volume

The higher the volume, the more active is the security
What Chartists Look at Volume underneath a price point Price points with higher volume indicates depth in support or resistance Volume as an indication of the enthusiasm or lack of it amongst investors to trade on a If measurement of price and volume movements is significant, it implies that Trend Reversal* is on the horizon Let us analyse the graph stock
with large price change indicates trend reversal Divergence takes place if volume and price change is not in similar pattern 1. Stock looses its legs if Price moves upward without corresponding change in volume. 2. Warning for Trend Reversal -if volume becomes dull on a price advance and expands on a decline Large volume change

Price by Volume (PBV) Analysis

Assessment of Price Movement - Scales for Chart

Line Chart The most basic of all charts Represents only closing prices over a set period of time. Line is formed by connecting closing prices over a time frame. Does not provide visual information of trading range for individual points, e. g., High, Low and Opening prices Closing Price considered to be the most important price in stock data compared to the high and low for the day Accordingly only value is used in line charts.

Assessment of Price Movement - Scales for Chart 2

Bar Charts Expands on the line chart Adds several more key information to each data point The chart is made up of a series of vertical lines representing each data point. Vertical line represents the high and low for the trading period along with the closing price. Close and open are represented on the vertical line by a horizontal dash.

Assessment of Price Movement - Scales for Chart 3

Bar Charts Opening price - Illustrated by the dash that is located on the left side of the vertical bar Closing Price - Represented by the dash on the right Black Coloured Bar - Left dash (open) is lower than the right dash (close) represents an up period for the stock, which means it has gained value Red Colored Bar - Stock has gone down in value . When this is the case, the dash on the right (close) is lower than the dash on the left (open).

Assessment of Price Movement - Scales for Chart 4

Price Scale of a chart can be taken in two ways
Liner (Arithmatic) Movement in price over two time periods Movements between Rs. 10 to 20 and Rs. 40 to 50 Linear Graph between these two range points will move same way as difference is Rs. 10 Percentage (Logarithmic movement)

Distance of price points between Rs. 10 to 20 and 40 to 50 will not be same as in %age term variation is 100% and 25%

Fig. 1 Linear Chart

Fig. 2 Percentage Chart

Volume and Chart Patterns Observations of Chartists

Chart Patterns
Chartists use movements to determine Chart Patterns like Head & Shoulders Triangles Flags In most chart patterns, there are several pivotal points that are vital to what the chart convey to chartists. If volume is not there to confirm the pivotal moments of a pattern, the quality of the signal formed by the pattern is weakened

Volume Precedes Price - An Important Idea

Price is preceded by volume Volume is closely monitored to form ideas on the ensuring trend reversals and / or further movement If volume starts to decline in a price uptrend - Usually a sign that the upward run is about to end.

Candlestick Components A first look at a candlestick chart, one may be confused. However, just like a bar chart, the daily candlestick line contains the market's open, high, low and close of a specific day. This is where the system takes on a whole new look: The Candlestick has a wide part, called the Real Body representing the range between the open and close of that day's trading. Real body filled in Colour - Means the close was lower than the open Real body Empty - Means the opposite: the close was higher than the open

Figure 1: A candlestick Just above and below the real body are Shadows. Chartists have thought of these as the Wicks of the Candle, and it is the shadows that show the high and low prices of that day's trading. Upper shadow on the filled-in body is short - Indicates that the open that day was closer to the high of the day. A short upper shadow on a white or unfilled body dictates that the close was near the high. The relationship between the day's open, high, low and close determines the look of the daily candlestick. Real bodies can be either long or short and either black or white. Shadows can also be either long or short.

To be Continued in Volume II

Happy Learning!!