Equity Research - Technical Analysis, Vol. I

7/27/2019 Equity Research - Technical Analysis, Vol. I

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Teaching Material

MBA - Capital Market , Year II

Equity ResearchTechnical Analyses - Volume I

Dr. Paritosh Basu


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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

Introduction


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Dow TheoryOldest and the most publicised method for identifying major trends

Evolved from the work ofCharles H Dow Published in Wall StreetJournal from 1900-02

Dow views about behaviour of the Stock MarketAs a barometer of business condition rather than basis for forecasting

stock prices

Majority of stocks follow the underlying trend of the stock market most ofthe time

Constructed two indices Dow Jones Industrial and Rail Road

William Peter Hamilton developed on Dows Principles and developedthe 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 trendAverages must be confirmed Industrial and Rail Road Indices


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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 factorFundamental, Economic, Geographical,Psychological, etc.

Price moves in trendsOnce a trend is formed future movements arelikely to be in the same direction

Market value is a reflection of supply and demand (Commodity)

History tends to repeat itselfMarket participants tend to provide samereactions to similar kind of stimulants and dampeners

Equity Research - Methods

Note: Technical Analyses can be used for Stocks, Commodities, etc.


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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)

SubjectiveCannot 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 isformed

Time horizon can be too small that of a week and even a day

* Most theoreticians question this Strong EMH

Equity Research - Methods

Most Analysts in Wall Street focuses more on Fundamental Analysis


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Technical Analysis Use of TrendA trend is the general direction towards which the equity market is heading

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, CurvilinearMovements - Primary, Secondary and Minor

Fig. - 1 Fig. - 2

Fig. - 3

Peak

Trough

If gap between P and T is not large,

it is called horizontal movement


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Technical Analysis Use of Trend 2Trend Length Analysis

A trend of any direction can be classified as a

Long-term Trend Longer than a year, with more than oneintermediate 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 anintermediate trend.

Fig. Long-term trend

with IntermediateShort-term trends


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Trend Length AnalysisImportant 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 3


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Technical Analysis Use of Trend 4 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 theidentification of trend reversals

Interim Support Levels

Trend of Support Level

Channel Two parallel trend lines, which acts

as strong areas of support and resistance

Can move in any direction

Resistance Line

Support Line

Two Important Conventions

1. The Trend is your Friend2. Dont buck the trend


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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

Technical Analysis Use of Trend 5

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


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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 Large volume change

with large price change indicates trend reversal

Divergence takes place if

volume and price

change is not in similar pattern

Technical Analysis Importance of Volume

Price by Volume

(PBV) Analysis

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


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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 datacompared to the high and low for the day

Accordingly only value is used in line charts.

Assessment of Price Movement - Scales for Chart


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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 2


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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 3


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Assessment of Price Movement - Scales for Chart 4Price 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 wayas 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


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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, thequality 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.

Volume and Chart Patterns Observations of Chartists

Candlestick Components


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Figure 1: A candlestick

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

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 andlow 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 beeither lon or short.


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To be Continued in Volume

II

Happy Learning!!

Equity Research - Technical Analysis, Vol. I

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