TECHNICAL ANALYSIS

BCOM DSE 603 SEMESTER VI

FUNDAMENTALS OF INVESTMENT

By Sagarika

Assistant Professor
Department of Commerce

Patna Women’s College (Autonomous)

Email Id:sagarika.com@patnawomenscollege.in
Technical analysis
Technical analysis is based on the premise that “history repeats itself ” and hence movement in stock
prices follow an established trend which can be ascertain from past price and volume data.
Technical analysis takes a completely different approach; it doesn't care one bit about the "value" of
a company or a commodity. Technical analyst is only interested in the price movements in the
market. Technical analysis really just studies supply and demand in a market in an attempt to
determine what direction, or trend, will continue in the future. Technical Analysis is a method
of share price movements based on a study of price graphs or charts on the assumption that share
price trends are repetitive, that since investor psychology follows a certain pattern, what is seen to
have happened before is likely to be repeated. A technical analysis believes that the share price is
determined by the demand and supply forces operating in the market. All financial data and market
information of a given stock is already reflected in its market price. A technical analysis concentrates
on the movement of share prices. he climes that by examining past share price movements future
share price can be accurately predicted. The basic premise of technical analysis is that prices move in
trends or waves which may be upward or downward.
A rational behind the technical analysis is that share price behaviour repeat itself over time
and analyst attempt to drive methods to predict this repetition.
Assumptions of technical analysis
1. The market value of a security is related to the demand and supply factors operating in the market.
2. There are both rational and irrational factors which surround the supply and demand factors of a
security.
3. The Security prices moves in trends or waves which can be both upward or downward depending
upon the sentiments, psychology and emotions of traders.
4. The present trends are influenced by the past trends and the projection of future trends is possible
by an analysis of past price trends.
5. Changes in trends in stock prices are caused whenever there is a shift in the demand and supply
factors. The shift in demand and supply can be detected through charts prepared
specially to show the market action.
6. Patterns which are projected by charts record price movements and these
recorded patterns are used price movements and these recorded patterns are
used by analysts to make forecasts about the movement of prices in future.

Principles of Technical Analysis

Technical analysis is based on the following three principals:

a. The market discounts everything.

b. Price moves in trends.

c. History tends to repeat itself.

a. The Market Discounts Everything: Many experts criticize technical analysis because it only
considers price movements and ignores fundamental factors. The argument against such criticism is
based on the Efficient Market Hypothesis, which states that a company’s share price already
reflects everything that has or could affect a company. And it includes fundamental
factors. So, technical analysts generally have the view that a company’s share price includes
everything including the fundamentals of a company.

b. Price Moves in Trends: Technical analysts believe that prices move in trends. In
other words, a stock price is more likely to continue a past trend than move in a
different direction.
c. History Tends to Repeat Itself: Technical analysts believe that history tends to repeat itself.
Technical analysis uses chart patterns to analyze subsequent market movements to understand
trends. While many form of technical analysis have been used for many years, they are still are
considered to be significant because they illustrate patterns in price movements that often repeat
themselves

Charting
Charring is the basic tool in technical analysis, which provides visual assistance in detect
changing pattern of price behaviour. It may be of various types such as Line chart, Bar chart, Point
and figure chart and candlestick chart. It must be noted that charts are useful both in the analysis of
individual securities as well as market movements analysis.
On a particular day, the price of a share varies many times. It is difficult to plot all the prices
prevailing for a particular stock on a particular day. Therefore, generally the following four prices are
of interest to an investor
a) Open Price – It is the price at which the trading on a share starts on a particular day
b) High price – It is the highest price at which the share has been traded on a particular day
c) Low price – It is the lowest price at which the share has been traded on a particular day
d) Close price – it is the price at which trading on a share closes on a particular day.

The essence of Chartism is the belief that share prices trace out patterns over time. These are a
reflection of investor behaviour and it can be assumed that history tends to repeat select the
stock market, A certain pattern of activity that in the past produced certain results is likely to give
rise to the same outcome should it appear in the future.

The various types of commonly used charts are:

a) Bar Chart: It is a simple charting technique. A Bar chart shows high, low and closing prices
of a stock every day. Open price of a day is generally equal to the close price of the previous
day. Hence it is generally not shown on a bar chart .But if required one can also show open
price of the share in a bar chart. On a bar chart, X axis shows time while Y axis shows stock
prices. The length of the bar shows the range of price i.e ( highest minus lowest price ,in a
particular day ) and hence if bar lengths increase overtime ,it may be regarded as a signal of
increasing stock volatility. One bar is placed every day and closing and opening prices
may be depicted with some signs such as – or X, The following figure shows a bar chart
b) Line Chart: - The simplest form of chart is a line chart. Line charts are simple graphs drawn
by plotting the closing price of the stock on a given day and connecting the points thus plotted over a
period of time. E.g. The stock prices on five days are Rs. 14,15,14,17 and 12.
c) Japanese candlestick Charts

The Japanese candle stick chart shows the highest price, the lowest price, the opening price and
the closing price of shares on a day-to-day basis. It is a combination of line chart and bar chart.
This chart type shows a candle for every day price movements. If close price is lower than open price
then the box is filled with black colour otherwise left empty. An increasingly dark candlesticks are
bearish indicators. On x axis we measure time and on Y axis we measure stock prices. This chart
pattern provides a bird’s view as to the movement of stock prices – both intraday and inter day .
d)Point and Figure Chart (PFC) : - Point and Figure charts are more complex than line or
bar charts. It is a chart made up of X and O’s. X is placed for increase and O for decrease in
stock price. A buy signal is implied when X lines are moving up after every O line. If O lines
are going down after every X line, then a sell signal is triggered. In this chart the axis do not
represent time or price level, rather they just show the directional movement of prices
irrespective of the quantity of change. It must be noted that whenever there is a change in price X
or O are placed. The columns are changed when there is a change in direction i.e from increasing
prices if the price starts declining then we switched to second column and indicator O. After that
the price starts increasing therefore, we shifted to third column and put X signs for every
increase. The main advantage of such chart pattern is that it can compress large volume of data in
a small group which can be used in analysis. The following figure shows point and figure chart:
e) Price and Volume Chart: Price – Volume chart shows the high ,low and close price of a
share along with its volume in the same chart. The utility of this chart is that it provides
information about the volume of trading regarding that share besides showing the relevant
prices.
Trends and trend reversal

A trend can be defined as the direction in which the market is moving. Trend is the movement of
share prices in the market. when the prices move upwards, it is a rising trend or uptrend. When the
prices move downwards, we have a falling trend or downtrend. We have a flat trend when the prices
move within a narrow range.
The change in the direction of trend is referred to as trend reversal. A share that exhibits a rising
trend may start to move narrowly or fall after sometime. This change in the direction of movement
represents a trend reversal.

Support Level & Resistance Level

Support level is that price, below which the price is not expected to fall.
Resistance level is that price, above which the price does not go.
e.g. Price of Reliance Industries share to decline when it reaches Rs. 3,000 and it starts to rise
whenever it approaches Rs. 2,000. The Reliance Industries share price have been moving in the
range of Rs. 2,000 to Rs. 3,000 for long. Then Rs. 2,000 may be considered as its support level
& Rs. 3,000 as its Resistance level.
If stock price breaches its support level, it indicates a bearish trend for the stock price. On the
other hand, is breaches the resistance level, it indicates a bullish phase.
Why Equity Valuation?
 To know intrinsic value of a stock.
 Evaluate performance of a stock.
 Evaluate performance of a portfolio.
 Make buying decision.
 Make selling decision.

Price Earnings Ratio (PE)

The price-earnings multiple (PE) is the most widely used ratio. Its simplicity makes it an attractive
choice in applications ranging from pricing initial public offerings to making judgments on relative
value, but its relationship to a firm's financial fundamentals is often ignored, leading to significant
errors in applications. This provides some insight into the determinants of price-earnings ratios and
how best to use them in valuation.

Definitions of PE ratio
The price earnings ratio the ratio of the market price per share to the earnings per share. It is also
known as the price multiple or the earnings multiple. As P/E ratio is the most common measure of
how expensive a stock is, it is essential to understand the basis & importance of its valuation. It can
be computed as follow: -

PE = Market Price per share / Earnings per share

Example 1: - Suppose, the market price per share of Tata Powers is Rs.150 and the earnings per share
are Rs.50, then the price-earnings ratio shall be as follows:

P/E Ratio = Rs.150(Market Price) / Rs.50 (Earnings) = 3.

Benefits to investor
The P/E ratio is useful in accessing the relative attractiveness of a potential investment. It helps
investor analyse how much they should pay for a stock on the basis of it current earnings and
also shows if the market is overvaluing or undervaluing of the company. It helps in predicting
future earnings per share through which the investors evaluate what a stock’s fair market value
should be.

P/E Ratio Analysis

Generally, the P/E ratio indicates how many times earnings, the investors are willing to pay for
the share. The P/E ratio analysis shows the direct relationship between the market price of the
share of a company and its earnings. Hence, if a company’s earnings per share rise; it leads to a
rise in its market price, while lower earnings per share indicate a fall in its market price. Thus, these
two factors mainly define the real performance and growth of a company. Similarly, a company with
a high P/E ratio are often considered to be growth stocks. This indicates higher earnings growth,
positive performance in the future and investors are usually willing to pay more for this company’s
shares. While on the other hand, a company with a lower P/E ratio indicates poor current and future
earnings growth, the stock is undervalued, etc. Investing in such company could prove to be a poor
investment.

It is important to note that companies with high P/E ratios are more likely to be considered as
risky investments than those with lower ones. It is because of the reason that a high P/E ratio
signifies high expectations. This ratio is useful only in comparing companies in the same industry.
Any such comparisons amongst companies of the different industry would provide an incorrect result
and thus, would mislead the investors.