sapm - technical analysis
TRANSCRIPT
FinancialMarkets –TechnicalAnalysis
NJ Jaissy
Objective: (Module 4)Understand Technical Analysis
Chart PatternsMoving AveragesRSI / ROC /MACD
Learn of the Efficient Market Hypothesis andthe Random walk theory
References: SAPM texts byPunithavathy PandianPrassana Chandra
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Fundamental Vs. TechnicalAnalysis
Fundamental Analysis looks at analysis thestock’s ‘intrinsic value’ ( using valuationtechniques & EIC methodologies).
If intrinsic value < market price – BUY,If intrinsic > market price – SELL
Technical Analysis – Analysis only of thestock’s market price trends
BUY if the stock price shows an ‘upward’ trendSELL if the stock prices shows a downward trend
Technical Analysis3
Technical Analysis: IntroBased on the assumption that there aretrends in the market prices – upward trendshows market is on the rise & vice versa
Assumes that the markets pricesmovements incorporates all informationabout the stock and reflects sentiments ofinvestors ( hope & fear) – reflects supplyand demand of shares
Technical Analysis4
DOW Theory: AssumptionsFather of technical Analysis: Charles DowAnalyzed stock movement charts, computedmoving averages to develop the ‘DOWtheory’ ( now implemented using computers)1. Assumption 1: No single investor can influence
market trends ( only a stock trend if traded inlarge quantities)
2. Assumption 2: Market factors in everything –natural calamities, global recession etc
3. Assumption 3: Theory can only be used tounderstand market, not beat it
Technical Analysis5
Dow theoryTrend = direction of movementShare prices moves up & down in a zigzag;trend lines connect either 2 tops / bottomThere are 3 types of trends1. Primary ( upward / downward – 1 / 2 years)…
( like TIDES of the sea)2. Intermediary ( corrective movements – 1 – 3
months)…(like WAVES of the sea)3. Short term ( day to day oscillations)…RIPPLES
Technical Analysis6
Trend LinesRising trend line : BULL market
Falling Trend line : BEAR market
Prices rises, thenfalls then rises evenmore.. B2 > B1Indicates revival,growth in profitsB1
B2
Prices falls, thenrises, then falls evenmore & rises again..B2 < B1Indicates decline
B1B2
speculation
Distress selling
Decline in profit
Good profit
Loss of faith
Hope!
Technical Analysis7
Trends
Technical Analysis
Primary Trend
Intermediate / SecondaryTrend = correction ofprimary trend by 1/3 to 2/3of original gain
Bull
Bear
Minor Trends(intra day)
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Support & Resistance LevelsPrices will go up / down till there is ademand / supply correction at that priceSupport level – lowest price the stock willdrop to before rising againResistance level – highest price the stockwill rise before falling again
Resistance level
Support level
Technical Analysis9
Chart Patterns - 1Capture stock price movements over timeStock price is plotted over daysDistinct patterns based on the trend:1. V formation ( and inverted V)
Technical Analysis10
Chart Patterns - 2
2. Double top / double bottom formation
3. Head & Shoulder formation / invertedhead & shoulder
Neckline
Bear market
Bull market
Technical Analysis11
Chart Patterns - 36. Triangles ( Symmetrical, Ascending,
Descending triangles)
Support level
Resistance level
Bull
Bear
Neutral
Technical Analysis13
INDICATORS & OSCILLATORSIndicator is a set of data points obtained byapplying a formula to the price data ( Open,close price, volume) of a stock / index.Technical indicators – used to find the overalldirection of the market.Oscillator – shows the stock price movementbetween two pointsOscillators show stock momentum &indication on a possible trend reversal
Technical Analysis14
Indicators: Volume of tradeindicates trend – bull or bear
Indicator 1: Volume; Volumes expand in a bullmarket & narrow in bear marketIndicator 2: Breadth of market : Diff betweenadvance & declines
Advances (# of shares that have risen in price)Declines (# of shares that have declined inprice) in volume
Indicator 3: Short sales ( in bear market) –selling shares that you don’t have hoping forfuture price decrease. # of short sales of amonths compared with avg daily volume forprevious month ( >1..oversold – bull trend)
Technical Analysis15
Indicator 4: Moving AveragesMoving averages = ( average of a bodyof data ( price) over time)Short term ( 10-30 days)/ medium term (50– 125 days) / long term ( 200 days) trendsof moving average studied to identifytrendsStock price moving avg. compared withindex moving avg. to identify trends
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Moving AveragesStock Price
Movingaverage
Sell
Buy
Cutting of the moving averagesSignals a trend reversal
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Types of moving averagesSimple moving average – equalweightage to each days priceExponential moving average – higherweightage to more recent prices.Moving averages are studied for ‘buy’and ‘sell’ signals.Rising moving average- rising trends anddeclining moving average -decliningtrend
Technical Analysis18
MACD ( Moving Averageconvergence & divergence
Oscillator 1: MACD= difference between 2exponential moving averagesMACD – difference between Short Term (SEMA - 12 days) & Long Term (LEMA - 26 days)exponential moving averagesMACD = SEMA - LEMA
Convergence = when the difference-> 0Divergence = when the difference-> highMACD: + = rising trendMACD: - = declining trend
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RSI- Relative Strength Index: Oscillator 2: RSI shows inherent strength or weaknessof a particular stock
RSI = 100 – 1001 + avg. daily gain
avg. daily loss
RSI avg. Gain / loss can be calculated for 9, 14 daysor more.. Higher the better.RSI >70 likely downturn – sell, RSI<30 likely upturn- buy
Technical Analysis20
ROC ( Rate of change)Oscillator 3: ROC measures rate of change betweencurrent price & price a number of days in past (could be 12days/ 12 weeks / 12 months)Used to indicate trend reversal
ROC = % change of current price vs. earlier price
ROC = Todays price * 100 - 100Price ‘n’ days ago
Current price – 210 and price 12 weeks ago – 230,ROC = 210/230 * 100 – 100= -8.69( negative sign meansdecline)
ROC plotted against time: highest peak – overboughtregion ( sell here) , lowest point – oversold region( buy here)
Overbought / oversold points indicate trend reversals
Technical Analysis21
Efficient Market TheoryIntroduced by Fama – Efficient market theorystates that stock price movements are randomand without any pattern ( unlike technical analysiswhich identifies chart patterns)This theory assumes that any information regardingthe stock will be factored into the stock prices.Higher the market efficiency, quicker will be theincorporation of future expectations / anyinformation into the stock price.Arbitrageurs look to make a quick profit in the timebefore the market prices adjust to newinformation; their actions cause the market toadjust.
Intense competition will ensure a fair price for securities in the market
Efficient Markets22
Efficient MarketsThis is a market in which market price of a securityis an unbiased estimate of its intrinsic valueThis means any deviation of market price fromintrinsic value is unbiased & random.What leads to efficient markets?
Investor rationality (investors respond rationally tonew information)Independent deviation from rationally ( even ifsome investors don’t behave rationally – this israndom & not correlated – will be net off finally)Arbitrage: Rational investors will try to exploit anyinefficiencies in the market – thereby correctingthe inefficiency.
Efficient Markets23
Random Walk TheoryIntroduced by Maurice Kendall, a statistician whostudied stock & commodity prices looking forregular cycles.He found that the security price movements arerandom and that the stock price movementsfollow a series of ‘random’ walks.At each point of time, the stock price isindependent of what it was before.The theory deals with successive changes in price(looks at absolute price delta for that security notrelative to other securities price delta)
Efficient Markets24
Random Walk & EfficientMarkets
Academicians state that the randomness ofstock prices is the result of the efficientmarket. i.e.:
All information is freely & quickly available to allmarket participantsKeen competition ensures that in time themarket prices will reflect ‘intrinsic values’Prices change only in response to newinformationNew information cannot be predicted so pricescannot be forecast & hence prices behave likea ‘random walk’
Efficient Markets25
Sem
Three forms of efficient markethypothesis
Efficient Market Hypothesis
Weak formefficiency
Semi strong form efficiency
Strong form efficiency
Security pricesfactor in all securitymarket info
Security prices factorin all public marketinfo as well as nonmarket info
Security prices factorin all available info –pubic & private
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Stock price factors in thefollowing info:
Weak Market HypothesisAll security market info: prices, trading volumes,rate of return, insider transactions, block trades,odd lot transactions
Semi Strong Market HypothesisAll public info– market & non market: macro-economic data, industry reports, corporateannouncements, P:E ratio, div yield
Strong Market HypothesisAll available info – public & private. Assumes thatno investor has monopolistic access to info thatwould lead to higher risk adjusted returns.
This means no one can getter returns than the market using info!
Efficient Market Hypothesis27
Contradiction to concept of‘efficient markets’1. Over reactions of the market – Stock
prices decline dramatically after badresults - and take time to come to‘normal’ – during which time investorcan buy at low rates & sell at high ratesmaking abnormal profit – againstefficient market theory
Efficient Market Hypothesis28
Contradiction to concept of‘efficient markets’2. Stock price will go back to ‘average’
return after low or high returns – therebygiving an investor a chance to ‘predict’price : against random walk theory
3. Delayed adjustment to new information:stock prices tend to continue to rise /decline for some time after corporateannouncements are positive / negative.
Efficient Market Hypothesis29
Contradiction to concept of‘efficient markets’4. Small firm: A theory that says small firms give
better returns than large firms – confirmed bya study done on the NYSE
5. Weekend effect: Stock prices tend to rise allweek reaching a peak on Friday. So it makessense to buy on Monday and sell on Friday –the ‘weekend’ effect contradicts theefficient market hypothesis
Efficient Market Hypothesis30