Technical Analysis

Technical analysis is a methodology used by traders and investors to evaluate securities and make trading
decisions based on statistical trends and patterns observed in historical market data. Unlike fundamental
analysis, which focuses on company financials and macroeconomic factors, technical analysis primarily
examines price and volume data to forecast future price movements.

Technical Analysis is a method of evaluating by Market activity. It does not attempt to measure Indicators
on charts to determine future performance. Technical analysis tools are used to scrutinize the ways supply
and demand for a security will affect changes in price, volume, and implied volatility. It operates from the
assumption that past trading activity and price changes of a security can be valuable indicators of the
security's future price movements when paired with appropriate investing or trading rules.

What is technical analysis?

Technical Analysis is a method of evaluating securities by analyzing statistics generated by Market

activity. It does not attempt to measure intrinsic value. Instead look for patterns and indicators on charts to
determine future performance. Technical Analysis is concerned with a critical study of the daily or weekly
price and volume data of the index comprising several shares like Bombay Stock Exchange Sensitive Index
of a particular stock.

Technical Analysis is the forecasting of future financial price movements based on an examination of past
price movements. Like weather forecasting, technical analysis does not result in absolute predictions about
the future. Instead, technical analysis can help investors anticipate what is "likely" to happen to prices over
time. Technical analysis uses a wide variety of charts that show price over time.

Definition of Technical Analysis

John J. Murphy - "Technical Analysis is the study of market action, primarily through the use of charts, for
the purpose of forecasting future price trends".

Assumptions of Technical Analysis

1. The Market Discounts Everything

A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental
factors of the company. However, technical analysis assumes that, at any given time, a stock's price reflects
everything that has or could affect the company - including fundamental factors. Technical analysts believe
that the company's fundamentals, along with broader economic factors and market psychology, are all
priced into the stock, removing the need to actually consider these factors separately. This only leaves the
analysis of price movement, which technical theory views as a product of the supply and demand for a
particular stock in the market.

2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that after a trend has been
established, the future price movement is more likely to be in the same direction as the trend than to be
against it. Most technical trading strategies are based on this assumption.

3. History Tends To Repeat Itself

Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price
movement. The repetitive nature of price movements is attributed to market psychology, in other words,
market participants tend to provide a consistent reaction to similar market stimuli over time. Technical
analysis uses chart patterns to analyze market movements and understand trends. Although many of these
charts have been used for more than 100 years, they are still believed to be relevant because they illustrate
patterns in price movements that often repeat themselves.

FUNDAMENTAL VS. TECHNICAL

Fundamental = Qualitative analysis of a company's fundamental drivers driven by factual numbers and
industry analysis company's security

Technical = Quantitative (Charts) The quantitative performance of a Technical analysis enables traders to
gain a vision of the market and make the right move at the right time, while fundamental analysis should be
applied strategically, over longer periodsof time.

Fundamental vs. Technical Analysis

The major difference between technical analysis and fundamental analysis are:

1. Technical analysis primarily focuses on studying market share prices and volume movements,
analyzing the patterns in these movements, and making predictions about future share prices. This
approach requires less time and data analysis, enabling investors to make timely investment decisions. In
contrast, fundamental analysis involves evaluating the intrinsic value of a share by examining
fundamental factors affecting the economy, industry, and company. This framework is a more intricate
process and demands a significant amount of time for thorough analysis.

2. Technical analysis forecasts short-term price movements based on past share prices, while
fundamental analysis establishes long-term values within the Economy-Industry-Company (EIC)
framework.
3. Technical analysis helps in identifying the best timing of an investment i.e., the best time to hold,
buy or sell a security. On the other hand, fundamental analysis helps in identifying the securities that are
overvalued or undervalued.
4. Technical analysis focus mainly on internal market data viz., historical price and trading volume
data. On the other hand, fundamental analysis focus mainly on external data ie.. fundamental factors
related to the economy, the industry and the company
5. Technical analysis is most appealing to short term investors, while fundamental analysis appeals
mostly to long term investors.

Thus, it can be summarised that technical analysis may be used as a supplement to fundamental analysis
rather than its substitute.

Dow Theory.

The Dow Theory, named after its originator, Charles Dow, is considered to befirst theory of technical
analysis. It is still regarded as the basis of all other techniques used bytechnical analysts. In fact, it is the
Dow Theory from which much of the substance of the technical analysis has branched out.

Dow Theory is based on the hypothesis that the stock market does not perform on a random basis. Rather,
it is guided by some specified trends. The likely market trend in future can be predicted by following these
trends. Three types of specific trends have been named in Dow Theory. These are:
 (a) Primary Trend. It is a long-range trend in price and may carry on even for number of years. It takes the
entire market up or down. It may be characterised as bullish or bearish in nature.

(b) Secondary Trend. Secondary trend or trends appear within a primary trend and may last for few days or
few weeks or few months. Secondary trends show interruptions in primary trend and act as a restraining
force on the primary trend. The secondary trends tend to correct deviations from the primary trend
boundaries of price movements.

(c) Minor Trend. Minor trends refer to day-to-day trend or movements in prices over few days. The minor
trends, being of very short duration, have little analytical value

These three types of trends have been shown in Figure

The above figure shows that there are day-to-day movements, secondary movements (prices falling over a
period of, say, a month), and the primary trend (the prices are increasing over time. also shows that
secondary downtrend (decrease in prices) will be of a shorter duration then the following secondary
upswing (increase in prices). In terms of Dow Theory, the upwardprimary trend is known as bull market,
and the downward primary trend is known as bear market. Figure has shown a bull market as the
successive highs are reached after every secondary correction in prices. Opposite of bull market is the bear
market where the prices are successively going down.

In Figure, the primary trend is positive and upward despite three secondary movements that are downward.
The secondary trend or movement in prices is also known as technical correction. In case of bull market,
after a secondary correction, there is an upward movement and it penetrates previous heights. In case of
bear market, after a secondary correction (increase), there is a downward move which penetrates previous
lows. The day-to-day movements in prices, also known as ripples, depend upon the instant demand and
supply forces. The technical analysts usually do not pay attention to these minor trends.

Following points are worth noting about the Dow's Theory:

(i) No individual investor can affect the basic trend in the market, i.e., the primary trend cannot be
manipulated.

(ii) Signals given by Dow's Theory must be observed carefully. Investors must wait for the confirmation of
trend reversal. The Dow Theory helps in indicating a primary trend but it fails to tell when the trend will
come to an end or will reverse.

Elliot Wave Theory

The Elliott Wave Theory, named after Ralph Nelson Elliott, originated from his observations influenced by
the Dow Theory. Elliott posited that the stock market's movement could be anticipated by identifying a
repetitive pattern of waves.

Conducting a thorough study spanning nearly seventy-five years of stock price movements, he determined
that market movements adhered to a pattern of waves. Thus, he was able to analyze markets in greater
depth, identifying the specific characteristics of wave patterns and making detailed market predictions
based on the patterns he had identified.

A wave is a movement of the market price of a share from one change in the direction to the next change in
the same direction. They are the result of buying and selling activities that emerge from the demand and
supply forces in the market. Based on these forces, waves are generated in prices.

The whole theory of Elliott Wave can be classified into two parts:

Impulse waves

Corrective waves

The impulse pattern consists of five waves. The five waves can be in either direction, up or down. Of these
five waves, three waves are in the direction of the movement and are called impulse waves, while the two
waves are against the direction of the movement and are called corrective (reaction) waves. In the fig 9.2
waves 1, 3 and 5 are the impulse waves and waves 2 and 4 are the corrective waves.

Elliott waves describe the basic movement of stock prices. It states that in general there will be 5 waves in
a given direction followed by usually what is termed and ABC correction or 5 waves in the opposite
direction

Wave 1: The stock makes its initial move upwards. This is usually caused by a relatively small number of
people that all of the sudden feel that the previous price of the stock was cheap and therefore worth buying,
causing the price to go up.

Wave 2: The stock is considered overvalued. At this point enough people who were in the original wave
consider the stock overvalued and take profits. This causes the stock to go down. However in general the
stock will not make it to its previous lows before the stock is considered cheap again.

Wave 3: This is usually the longest and strongest wave. More people have found out about the stock, more
people want the stock and they buy it for a higher and higher price. This wave usually exceeds the tops
created at the end of wave 1.

Wave 4: At this point people again take profits because the stock is again considered expensive,
This wave tends to be weak because there are usually more people that are still bullish on the stock and
after some profit taking comes wave 5.

Wave 5: This is the point that most people get on the stock, and is most driven by hysteria. People will
come up with lots of reasons to buy the stock, and won't listen to reasons not to. At this point contrarians
will probably notice that the stock has very little negative news and start shorting the stock. And at this
point is where the stock becomes the most overpriced. At this point the stock will move into one of two
patterns, either an ABC correction or starting over with wave 1.

An ABC correction is when the stock will go down/up/down in preparing for another 5 way cycle up.
During this time frame volatility is usually much less than the previous 5 wave cycle, and what is generally
happening is the market is taking a pause while fundamentals catch up.

There are two distinct phases involved on completion of a cycle consisting of 8 waves (wave 1- wave 5, A,
Band C). On completion of 8 waves, a new cycle starts with identical impulses on account of trading in the
market. The theory is, however, criticized on several grounds. It is used in predicting the future change
inthe prices of shares and helps in market timing of the investment.

Charting Techniques:

Charts are one of the most fundamental aspects of technical analysis. There are four main types of charts
that are used by investors and traders depending on the information that they are seeking and their
individual skill levels. The chart types are: the line chart, the bar chart and the point and figure chart.

Line Chart

Line charts are the simplest price charts. It represents only the closing prices over a set period of time. The
line is formed by connecting the closing prices over the time frame. Line charts do not provide visual
information of the trading range for the individual points such as the high, low and opening prices.
However, the closing price is often considered to be the most important price in stock data compared to the
high and low for the day and this is why it is the only value used in the line chart.

Bar Chart

The bar chart expands on the line chart by adding several more key pieces of information to each data
point. The chart is made up of a series of vertical lines that represent each data point. This vertical line
represents the high and low for the trading period, along with the closing price. The close and open are
represented on the vertical line by a horizontal dash. The opening price on a bar chart is illustrated by the
dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on
the right. Generally, if the left dash (open) is lower than the right dash (close) then the bar will be shaded
black, representing an up period for the stock, which means it has gained value. A bar that is coloured red
signals that the stock has gone down in value over that period. When this is the case, the dash on the right
(close) is lower than the dash on the left (open).
Point and Figure Chart

The point and figure chart is not well known or used by the average investor but it has had a long history of
use dating back to the first technical traders.

A point and figure chart is a chart that plots day-to-day price movements without taking into consideration
the passage/efflux of time. They are composed of a number of columns that either consists of a series of
stacked Xs or Os. A column of Xs is used to illustrate a rising price, while Os represent a falling price. As
you can see from the chart below, this type of chart is used to filter out non-significant price movements,
and enables the trader to easily determine critical support and resistance levels. Traders will place orders
when the price moves beyond identified support/ resistance levels.

TREND ANALYSIS

Trend analysis is an analytical method that is commonly used to interpret any pattern in a set of data. It is
widely used in the field of economics, finance, marketing, etc. In this method, analysts the direction and
amount change that takes place in order to take informed decisions or make predictions

The market trend analysis is a friend, is a well-known quote in the trader's fraternity. The trader makes a
good profit by following the trend, and trend analysis is not an easy task. It required eyes on details and an
understanding of the market dynamics.

The trend analysis in accounting can be used by management or the analyst to forecast future financial
statements. Following blindly can be dangerous if a proper analysis of the past event is not done.
Historical pattern of any data set in a market trend analysis gives a lot off information by using trend
analysis. Companies, analysts and investors can use this process for financial decisions or design
investment strategies.

TYPES OF TREND

1. Uptrend

An uptrend or a bull market trend shows that the financial markets move upwards. In this trend, the prices
of assets and stocks are increasing. This shows that it is a time of economic growth. Typically, economic
growth ensures increased jobs because the economy moves into a positive market. Uptrends in an economy
might occur because of political influence or recent technological advancements. A financial analyst might
understand an uptrend depending on a graph's high and low points.

For instance, by looking at the trend line, analysts can understand that it might not be the time to purchase
raw materials as the prices increase. This prevents a business from incurring additional costs and increasing
the final customers' prices. Alternatively, an upward trend in the stock market is favourable because it helps
understand whether it is worth investing in a particular stock.

2. Downtrend

A downtrend or bear market shows that the financial markets move downwards. In a bear market, the value
of stocks and assets might decrease. For instance, when a company sees a decrease in sales in a downtrend,
it might close a particular product line and evaluate its business model. During a downtrend, companies
focus on reducing their exposure to market risks. In a bear market, prices might intermittently increase and
decrease

Analysts understand a downtrend occurs when lower troughs and peaks occur. In a bear market, investors
can save money if they decide to sell a declining stock or asset. Some investors might benefit from a
downtrend by purchasing stocks at an attractive valuation.

3. Horizontal trend

A horizontal or sideways trend occurs when stock or asset prices are not moving upward or downward. The
stock prices remain consistent during a horizontal trend. Here, investors cannot identify the trend's
direction and predict whether it is beneficial for a customer to make critical financial and business
decisions. Typically, financial professionals consider this trend challenging because they cannot forecast
long-term and short-term occurrences in the stock market.
 TREND REVERSAL PATTERN

A trend reversal is when the price direction of an asset has changed, and the change can be to the upside or
downside. A trend reversal signals the end of one trend and the beginning ofanother.

Thus, a reversal following an uptrend would be to the downside, while a trend reversal following a
downtrend would be to the upside. Reversals tend to be based on the general price direction rather than just
one or two periods or bars on a chart.

Since price trends can occur on any timeframe, trend reversals can also occur on any timeframe. Different
traders trade different timeframes, depending on their trading style, so anyone can make use of trend
reversal strategies, regardless of the timeframe on which theytrade.

Trend reversal patterns are formations on price charts that indicate the likelihood of a shifting the current
market trend. These patterns suggest that the forces driving the market are

undergoing a change, potentially leading to a reversal in the direction of price movements. Recognizing
these patterns is a key aspect of technical analysis as they can provide early indications of a trend change.

Traders use trend reversal patterns as part of their trading strategies to anticipate potential market turning
points. For example, recognizing a Double Top pattern after a prolonged uptrend might lead a trader to
consider selling or shorting positions. Conversely, identifying an Inverse Head and Shoulders pattern after
a downtrend could prompt a trader to consider buying or going long. The application of these patterns
depends on the trader's risk tolerance, time horizon, and overall market analysis.

The Trend Reversal Pattern are:

1. Head and Shoulders Pattern

The Head and Shoulders pattern is a classic reversal pattern consisting of three peaks: a higher peak (head)
between two lower peaks (shoulders). The formation typically signals a transition from a bullish trend to a
bearish trend. The neckline, drawn through the lows of the two troughs connecting the shoulders, is a
crucial level. A break below the neckline often confirms the trend reversal, and traders may use this pattern
to anticipate potential selling opportunities.
2.The support and resistance (S&R) line

It is a widely used technical analysis tool in the stock market. The S&R lines determine an asset’s high and
low prices on a price chart for the selected time frame. Furthermore, It is used for plotting the support and
resistance area, which is the portion lying between these lines. Therefore, investors and analysts use S&R
to identify future trend reversals and breakouts, set stop losses, and adjust to changing trends.

Thus, the rule for support and resistance lines says that when the asset price drops below a support level, it
becomes the resistance line. Similarly, when the asset price increases beyond the resistance level, it
becomes the new support line.Moreover, support and resistance lines can be applied to stocks by:

• Identifying the support level

• Recognizing resistance levels
• Confirmation and breakouts
• Volume and price action

Mathematical Indicators

It is well known that the prices of the shares do not move linearly. The movement is erratic, which makes
difficult for the analyst to gauge the underlying trend in the market. Mathematical indicators help to
smoothen out these erratic movements and thereby help in reflecting the underlying trend.

The most widely used mathematical indicators are:

(A) Moving Averages
(B) Rate of Change (ROC)
(C) Relative Strength Index (RSI)
(D) Relative Strength (RS)

1. Moving Averages

Moving averages are one of the oldest and most popular technical analysis tools. A moving average is the
average price of a security at a given time. When calculating a moving average, you specify the time span
to calculate the average price (e.g., 25 days). A Moving Average is an indicator that shows the average
value of a security's price over a period of time. When calculating a moving average, a mathematical
analysis of the security's average value over a predetermined time period is made. As the share price
changes, its average price moves up or down.

There are five popular types of moving averages: simple (also referred to as arithmetic), exponential,
triangular, variable, and weighted. Moving averages can be calculated on any data series including a
security's open, high, low, close, volume, or another indicator. A moving average of another moving
average is also common.
2. Price Rate of Change Indicator (ROC)

Prices drop and grow in an erratic way, in cycles. This cyclic movement is a result of change in investors'
expectations and the price control fight between bulls and bears.

Price Rate of Change (ROC) is one of the popular oscillators. It measures the rate of change of the current
price in relation to the price 'n' years ago. The margin between the present price and the one that existed n-
time periods ago are indicated by the oscillator called the Rate of Change. ROC increases when the prices
trend up whether it declines when they trend down. The scale of the prices changes calls the corresponding
ROC change.

3. Relative Strength Index (RSI)

The Relative Strength Index Technical Indicator (RSI) is a price-following oscillator that ranges between 0
and 100. It is one of the recent approaches to technical analysis proposed by Robert levy. It is a powerful
indicator that signals the buying and selling opportunities ahead of the market. The widely recommended
Relative Strength Index is 14-days RSI. Even 9-day and 25-day Relative Strength Index indicators have
also gained popularity.

4. Relative Strength (RS)

Relative Strength (RS) is a technical concept that describes how two stocks are related. RS differs from
Relative Strength Indicator (RSI), RS measures stock/asset strength in relation to an index/asset/sector,
whereas RSI is a momentum indicator, or oscillator, that measures relative internal strength of a stock or
market against itself, rather than comparing one asset to another or a stock to the market.

Relative Strength help us in determining how a stock is performing in respect to the general market. If, for
example, stock XYZ climbs 20% over a given time period while the nifty index rises 10%, this indicates that
XYZ is outperforming the general market (NIFTY).

Relative strength can be applied in a variety of ways. For example, comparing one asset class (gold) to
another (bonds) to determine which is on the rise. If RS was in an upward trend, it meant that gold was
outperforming bonds in terms of price and was thus the preferred asset.

Market Indicators

Market indicators are quantitative in nature and seek to interpret stock or financial index data in an
attempt to forecast market moves. Market indicators are a subset of technical indicators and are typically
comprised of formulas and ratios. They aid investors' investment/trading decisions.

The classifications of market indicators are,

1. Momentum

Momentum indicators are technical analysis tools used to determine the strength or weakness of a stock's
price trend. Momentum measures the rate of the rise or fall of stock prices. Common momentum
indicators include the relative strength index (RSI) and moving average convergence divergence
(MACD).

Momentum measures the rate of the rise or fall in stock prices. From the standpoint of trending,
momentum is a very useful indicator of strength or weakness in the issue's price. History has shown us
that momentum is far more useful during rising markets than during falling markets; the fact that markets
rise more often than they fall is the reason for this. In other words, bull markets tend to last longer
than bear markets.
2.Oscillator

Oscillating indicators, as their name suggests, are indicators that move back and forth as currency pairs rise and
fall. Oscillating indicators can help you determine how strong the current trend of a currency pair is and when
that trend is in danger of losing momentum and turning around.

When an oscillating indicator moves too high, the stock is considered to be overbought (too many people have
bought the stock and there are not enough buyers left in the market to push the stock higher). This indicates the
stock is at risk of losing momentum and turning around to move lower or sideways. When an oscillating
indicator moves too low, the stock is considered to be oversold (too many people have sold the stock and there
are not enough sellers left in the market to push the stock lower). This indicates the stock is at risk of losing
momentum and turning around to move higher or sideways.

3. Market Breadth

Market breadth refers to a set of technical indicators that evaluate the price advancement and decline of a
given stock index. Market breadth represents the total number of stocks that are increasing in prices as
opposed to the number of stocks that are undergoing a decline in their prices. The stocks belong to a
particular index on a stock exchange.

Traders and investors use market breadth in order to assess the index’s overall health. Market breadth can
be a reliable, if not an accurate, indicator of an upcoming price rise in the index. Similarly, it can also
provide early warning signs for a future price decline.Market breadth indicators, although useful, do not
always give an accurate picture of the market. Sometimes, they may fail to predict future changes in the
direction of price movements, which are also known as price reversals. Other times, market breadth may
signify a reversal way too early.

Market efficiency

Market efficiency refers to the degree to which market prices reflect all available, relevant information. If
markets are efficient, then all information is already incorporated into prices, and so there is no way to
"beat" the market because there are no undervalued or overvalued securities available.

The term was taken from a paper written in 1970 by economist Eugene Fama, however Fama himself
acknowledges that the term is a bit misleading because no one has a clear definition of how to perfectly
define or precisely measure this thing called market efficiency. Despite such limitations, the term is used in
referring to what Fama is best known for, the efficient market hypothesis (The efficient-market hypothesis
(EMH) is a hypothesis in financial economics that states that asset prices reflect all available information.

Behavioral Finance

Behavioral Finance is an area of study that combines psychological theories with conventional economics
and finance to provide explanations for why people make irrational financial decisions. It challenges the
traditional assumption that investors are rational actors, fully informed, and acting in their best interest.
Instead, Behavioral Finance suggests that cognitive biases and emotions significantly influence investors'
decisions, leading to anomalies in financial markets that cannot be explained by classical theories alone.
Concepts such as overconfidence, loss aversion, herd behavior, and mental accounting are central to
understanding how psychological factors affect financial markets and investment behavior.

RANDOM WALK

The Random Walk Theory, or the Random Walk Hypothesis, is a mathematical model of the stock market.
Proponents of the theory believe that the prices of securities in the stock market evolve according to a
random walk. A "random walk" is a statistical phenomenon where a variable follows no discernible trend
and moves seemingly at random. The random walk theory, as applied to trading, most clearly laid out by
Burton Malkiel, an economics professor at Princeton University, posits that the price of securities moves
randomly (hence the name of the theory) and that, therefore, any attempt to predict future price movement,
either through fundamental or technical analysis, is futile.

Random Walk Theory is practical and has proven correct in most cases. The theory says that if Stock
Prices are random, we need to waste money and hire fund managers to manage our money. It may happen
that a fund manager has managed to provide an alpha return, but it may be due to luck, and luck may not
sustain, and it may not provide an alpha return in the next year.

Alpha return is the extra return that a fund manager promises to pay over and above a benchmark return.
Suppose all the other theories that provide ways to predict future stock prices were true. How can so many
fund managers who apply both technical and fundamental analysis end up earning a negative or the same
return as the benchmark? Well, according to random walk theory finance, after applying all theories, the
stock prices can't be predicted, then obviously, it is random.

In a world where markets are efficient, the only way to earn a return is with the market itself. That
is to invest in ETFs or mimic an Index by buying the same stocks in the same quantities. In this way, the
cost of fund managers can be avoided, and you will end up earning the same return or maybe more because
fund managers charge fees for funds they manage.

EFFICIENT MARKET HYPOTHESIS

The Efficient Market Theory is based on the efficiency of the capital markets. It believes

that market is efficient and the information about individual stocks is available in the markets. There is
proper dissemination of information in the markets: this leads to continuous information on price changes.
Also, the prices of stock between one time and another are independent of each other and so it is difficult
for any investor to predict future prices.

Each investor has equal information about the stock market and prices of each security. It is, therefore,
assumed that no investor can continuously make profits on stock prices. Therefore, securities will prove
similar returns at the same risk level. The essence of portfolio theory as described portfolio's total
characteristics are not merely the characteristics particularly with respect to risk". In Jones Tuttle and
Heaton is that "a sum of the portfolio's single security

From the above, it is clearly established that the Portfolio analyst feels that the market cannot be influenced
by a single investor. He also feels that there is risk involved in managing a portfolio. His technique is,
therefore, to diversify between different risks classes of securities.

FORMS OF MARKET EFFICIENCY

1. Weak: This form reveals all past information about asset or security pricing. However, past pricing
details reflected in current prices are insufficient to assist investors in determining correct future trading
prices. As a result, the weak form market efficiency will only result in asset undervaluation or
overvaluation, affecting trade decisions.

2. Semi-Strong: It indicates that current prices consider all publicly available information about an
asset or security. It also offers previous price details. As a result, it discourages investors from benefitting
above the market by trading on the inside information.
3. Strong: It is the result of combining weak and semi-strong forms. This form shows market prices
based on all accessible information (public, insider, and private). This insider knowledge, however, is
neutral and available to all traders. As a result, despite having access to insider information, it ensures that
all investors profit equally.

Empirical test for different forms of market efficiency:

1. Simulation Test: Research was later conducted in 1959 by Roberts and Osborne. Roberts took the Dow
Jones Industrial Average and compared its level with a variable generated by a random walk mechanism. He
concluded that the mechanism of the random walk showed patterns which were very similar to the movements of
stock prices. He also showed that a series of cumulative random numbers closely resembled in actual stock
price series and that changes in the random principles series as expected do not exhibit pattern as it exhibits
in the case of stock price changes. Robert’s research is also called Simulation Test.

Osborne’s research showed that stock prices moved similar to Brownian Motion. Brownian Motion is the
method of movement of particles in solution where movements of different magnitudes occur at any time
independent of any previous movements.Brownian Motion ‘is described as a particular kind of random
walk. According to Osborne’s research, the security prices move constantly with the Brownian Motion
Model which showed that the price changes in one period were independent of the price changes in the
previous period.

2. Serial Correlation Test: Robert’s and Osborne’s articles became very popular about the study of
the stock market prices. Many more researches tried to test if security prices follow a random walk. In
1964, Moore took up a test called ‘Serial Correlation Test’.He found out the ‘Serial Correlation of Weekly
security prices. Serial Correlation is said to measure the association of a series of numbers which are
separated by some constant time period like the association of the level of Gross National Product in one
year with the level of Gross National Product of the previous year. Moore measured correlation of price
change of one week with the price change of the next week.His research showed average serial correlation
of -0.06 which indicated a very low tendency of security price to reverse dates. This means that a price rise
did not show the tendency to follow the price fall or vice versa.

3. Run Test: Run Test was also made by Fama to find out if price changes were likely to be followed
by further price changes of the same sign. He made the Run Test because correlation coefficient were too
often dominated by extreme values and they influence the results of calculations to determine the
correlation coefficient. Run Test ignored the absolute values of numbers in the series and took into the
research only the positive and negative signs. The Run Tests are made by counting the number of
consecutive signs or “Runs” in the same direction. For example, the sequence of +0+ is said to be have 4
runs. The actual number of runs are observed and compared with the number that are expected from the
price changes are randomly generated.

4. Filter Test: Filter Tests were made because the technical analysts believed that the serial
correlation tests were not of good measure as these were extremely narrow to prove the complex nature of
the stock price behaviour. According to them, such test did not prove the complex strategies to earn an
abnormal rate of portfolio return. They also argued that if there was no statistical significance in serial
correlation there could be no economic significance in price changes. The tests which were made showed
that the serial correlations were not significantly different from zero. The “Filter Rule Test” was made by
Alexander in 1961 to find out “if any abnormal return could be earned using past price data”.

The Filter Rule was made to work in the following manner when a stock price was administered by a
certain percentage over a previous point of its purchases. If the stock declined from the previous high point,
then it should be sold when the decline is in excess of the specified percentage.