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UNIT IV
TECHNICAL ANALYSIS
A Technical Analysis believes that share prices
are determined by the demand and supply
forces operating in the market
These demand and supply forces in turn are
influenced by a number of fundamental
factors as well as certain psychological or
emotional factors
The combined impact of all these factors is
reflected in share price movements
Technical Analysis is the name given to
forecasting techniques that utilize historical
share price data
The basic premise of technical analysis is that
price move in trends or waves which may be
upward or downward
It is believe that the present trends are
influenced by the past trends and the
projection of future trends is possible by an
analysis of past price trends
Dow Theory
It is generally being accepted today as
technical analysis has its roots in the Dow
theory
It was formulated by Charles H.Dow who was
the editor of the wall street journal in USA
during 1900-1902
Charles Dow formulated a hypothesis that
stock market does not move on a random
basis but is influenced by three distinct
cyclical trends that guide direction
These movements are the primary movements ,
secondary reactions and minor movements
The primary movement is the long range cycle
Secondary reactions is the opposite direction to
the primary movement
The third movement in the market is minor
movement which are day to day fluctuations in
the market
It is used for Line charts to explain primary and
secondary movements
Bullish Trend
Upward moving market
1st phase the prices would advance with the
revival of confidence in the future of business
This will prompt investors to buy shares of
companies
2nd phase prices advance due to the
improvements in corporate earnings
3rd phase prices advance due to inflation and
speculation
In Bull market the line chart would exhibit the
formation of three peaks
Each peak would be followed by a bottom
formed by the secondary reaction
Each peak would be higher than the previous
peak ,each successive bottom would be higher
than the previous bottom
According to Dow theory the formation of
higher bottoms and higher tops indicates a
bullish trend
Bearish Trends
The bear market is also characterized by three
phases.
1st phase prices being to fall due to
abandonment of hopes. Investors being to sell
their shares
2nd phase companies start reporting lower
profits and lower dividends. This causes
further fall in prices due to increased selling
pressure
In the final phase, prices fall still further due
to distress selling
A bearish market would be indicated by the
formation of lower tops and lower bottoms
The first hypothesis states that primary trend
cannot be manipulated. manipulation possible in
the day to day of short term movements in the
market
The second hypothesis states that the averages
discount everything. it means daily prices reflect
the aggregate and emotional of all stock market
participants. it will affect demand and supply of
the stocks.
The third hypotheses states that the theory is
not infallible
Elliot Wave Theory
The theory formulated by Ralph Elliot in 1934
He found market movement was followed a
pattern of waves
A wave is a movement of the market price
from one change in the direction to the next
change in the same direction
The waves are the results of buying and
selling impulses emerging from the demand
and supply pressures on the market
Pattern of 5 waves up and 3 waves down to
form a complete cycle of 8 waves
Waves 1 , 3 and 5 are the impulse waves and waves 2
and 4 are the corrective waves
The wave 1 is upwards and wave 2 corrects the wave
Similarly waves 3 and 5 are those with an upward
impulse and wave 4 corrects wave 3
The completion of wave 5 , there would come a
correction which would be labeled ABC.
One complete cycle consists of waves made up of two
distinct phases bullish and bearish
Its used for predicting future price changes and
deciding the time of investments
Limitations
Not Perfect
They are many limitations in its practical use
Price Charts
Charting represents a Key activity in Technical
analysis(Graphical representation)
Four Prices are Important
1.Highest price of the day
2.Lowest price of the day
3.Opening price
4.Closing price
Three Types of Price Charts
1.Line Charts
2.Bar Charts
3.Japanese Candlestick Charts
1.Line Charts
It is the simplest Price charts
The closing price of a share are plotted on the XY
graph on a day to day basis
The closing price of each day would be
represented by a point on the XY graph
All these points would be connected by a straight
line which would indicate the trend of the market
Indicators formation in line charts
1.Head and Shoulders (HST)
2.Inverse Head and Shoulders(IHST)
3.Double Top and Double Bottom
2.Bar Charts
Bar charts have a serious of vertical bars
representing each days price movement
Each bar has a range from the days lowest
price to the days highest price
A small cross on each bar signifies the days
closing price
3.Japanese Candlesticks
Developed in Japan more than 300 years ago
Candlesticks show the open , high , low and
close prices of security in a way that
emphatics the range between opening and
closing prices
Candle charts usually display daily prices
It is a combination of a line chart and bar
chart
It is most often used in technical analysis of
equity and currency prices patterns
Fundamental Vs Technical Analysis
Basis of Fundamental analysis Technical Analysis
Distinctions
Perspective The analyst perspective is long term The analyst outlook is
in nature short-term oriented