VIT Business School

Assignment No: 2 Date of Submission: 29/08/2023 ___

Course Co de: BMT6176

BMT6135

Name of the Course: SECURITY ANALYSIS AND PORTFOLIO

MANAGEMENT
Slot No: A1+TA1

Name of the Course Teacher: DR. MOHD AFJAL

Name of the student: RAGHUL S

Register No: 22MBA0215

Dow theory:
According to the Dow Theory, the market is in an uptrend if one of its averages, such as the
transportation or industrials average, rises above a previous significant high and is
accompanied by or follows a similar rise in another average. An investor might watch the
Dow Jones Transportation Average (DJTA) rise to confirm an upward trend, for instance, if
the Dow Jones Industrial Average (DJIA) soars to an intermediate high.

Dow theory comprises six assumptions:

• The averages discount everything

Since the averages represent the combined activities of thousands, if not millions of
traders, speculators, and investors at any given time, they take everything into
account.
The price of a specific stock reflects all available information. Market players swiftly
share new information as it becomes available, and the price changes as a result.
As a result, every foreseeable and known event is discounted, as well as any
circumstance that might have an impact on the supply and demand for the specific
stocks.
• The Market Is Comprised of Three Trends
At any given time in the stock market, three forces are in effect: the Primary trend,
Secondary trends, and Minor trends.
→ The primary or major trend, which typically lasts at least a year, can last for
a very long time. This trend typically causes a price shift of at least 20%, either
up or down. When the Primary Trend becomes stretched out, the Secondary
Trend advances in the opposite direction to correct it. This causes the Primary
Trend to be disrupted.
→ The Secondary Trend, which is travelling in the opposite direction, breaks up
the Primary Trend's motion. However, it can be quite challenging to spot a
secondary trend when it is still developing. The Secondary Trend typically
retraces at least one-third of the prior price action, lasts at least three weeks,
but may last for several months. Although the Secondary Trend frequently
 stalls at 1/2 or 2/3 of the Prior Movement, it can occasionally entirely retrace
the Prior Movement.
→ The minor trend is the averages' daily fluctuations. It often lasts fewer than six
days and receives no weight according to Dow Theory.
• Primary Trends Have Three Phases
The Bull Market is characterized by an advancing Primary Trend and usually consists
of three phases:

→ The Accumulation Phase begins when savvy investors begin purchasing stocks
from sellers who are under pressure at cheap prices while the economy is still
struggling and frequently at its worst. During this period, trading activity is
typically still mild but is beginning to pick up.
→ The Accumulation Phase is followed by a phase that is characterized by steady
advances accompanied by increasing activity as improving corporate begins to
draw attention. This is usually the most profitable phase for the technical
analyst.
→ The final phase is characterized by phenomenal advances as more and more of
the public are drawn to the market.
→ The Distribution Phase occurs when the astute investors that bought during the
accumulation phase of the previous bull market start to sell their holdings.
Trading activity is usually still high during this phase but is starting to decrease.
→ The Panic Phase follows as buyers thin out and selling becomes more urgent.
The downward trend accelerates to a near-vertical drop characterized by
 climatic volumes. This phase is usually followed by a long recovery
(Secondary Trend) or sideways movement before the final phase begins.
→ The final phase is characterized by the discouraged selling of buyers that held
through the panic phase or bought during the recovery period. The discouraged
selling is not as violent as in the panic phase.
• The Averages Must Confirm Each Other
A genuine change in trend requires confirmation from both the Industrials and the
Transports.
For a shift in trend to be confirmed, both averages must surpass their prior secondary
peak (or trough).
→ To put it another way, the two averages need to be roughly going in the same
direction. The trend is not fully legitimate if the two averages do not follow the
same pattern.
• The Volume Confirms the Trend
The Dow Theory focuses primarily on price action. Volume is only used to confirm
uncertain situations.
Volume should expand in the direction of the primary trend.
→ If the primary trend is down, the volume should increase during market
declines.
→ If the primary trend is up, the volume should increase during market advances.
• A Trend Remains Intact Until It Gives a Definite Reversal Signal
A string of higher highs and lower lows characterises an uptrend. Prices must have at
least one lower high and one lower low for an uptrend to reverse; the opposite is true
for a downtrend.
The likelihood of the new trend enduring is highest when the Industrials and
Transports both indicate a reversal in the major trend.
However, the likelihood of a trend holding true decreases steadily the longer it
persists.
Elliott Wave theory
Elliott Wave Theory is a method of market analysis, based on the idea that the market forms
the same types of patterns on a smaller timeframe (lesser degree) that it does on a longer
timeframe (higher degree). These patterns provide clues as to what might happen next in the
market. According to the theory, it does not depend on what timeframe you are analyzing;
market movements follow the same types of patterns.

Elliott believed that every action is followed by a reaction. Thus, for every impulsive move,
there will be a corrective one.

The first five waves form the impulsive move, moving in the direction of the main trend.
The subsequent three waves provide the corrective waves. In total we will have seen one
five-wave impulse move, followed by a three-wave corrective move (a 5-3 move). We label
the waves within the impulsive wave as 1-5, while the three corrective waves are titled A, B
and C.

Once the 5-3 move is complete, we have completed a single cycle.

However, those two moves (5 and 3) can then be taken to form the part of a wider 5-3 wave.

Taking the moves in isolation, the first impulsive move includes 5 waves: 3 with the trend
and 2 against it. Meanwhile, the corrective move includes three waves: 2 against the trend
and 1 with the trend.
Interestingly, the fact that the corrective wave has three legs can have implications for the
wider use of highs and lows for the perception of trends. Thus, while the creation of higher
highs and higher lows will typically signal an uptrend, Elliott Wave theory highlights that
you can often see the creation of a lower high and lower low as a short-term correction from
that trend. This does not necessarily negate the trend, but instead highlights a period of
retracement that is stronger than the previous corrections seen within the impulsive move.

Efficient Market Hypothesis:

Efficient market hypothesis or EMH is an investment theory which suggests that the prices
of financial instruments reflect all available market information. Hence, investors cannot
have an edge over each other by analysing the stocks and adopting different market timing
strategies. According to this theory developed by Eugene Fama, investors can only earn high
returns by taking more significant risks in the market.

Types of Efficient Market Hypothesis

EMH has three variations which constitute different market efficiency levels. They are
discussed below –

• Weak from efficient market hypothesis

This is based on the assumption that the market prices of all financial instruments
represent all public information related to the market. It does not reflect any
information that is not yet disclosed publicly. Moreover, the efficient market
hypothesis assumes that historical data like price and returns have no relation with
the future price of a financial instrument.
This variation EMH also suggests that different strategies implemented by traders
cannot fetch consistent returns. This is owing to the assumption that historical price
points cannot predict future market value. Although this form of EMH dismisses the
concept of technical analysis, it provides the opportunity for fundamental analysis.
This helps all market participants to find out more information and earn an
aboveaverage return on investment.
• Semi strong form efficient market hypothesis
This version of EMH elaborates on the assumptions of the weak form and accepts that
the market prices make quick adjustments in response to any new public information
that is disclosed. Hence, there is no scope for both technical and fundamental analysis.
 • Strong form efficient market hypothesis
This form of EMH states that the market prices of securities represent both historical
and current information. This includes insider information as well as publicly
disclosed information. It also suggests that the price reflects information available
only to board members or the CEO of a company.

Impact of Efficient Market Hypothesis:

EMH is gradually gathering popularity among traders. Market participants who advocate
this theory usually tend to invest in index funds and exchange-traded funds (ETFs) which
are more passive in nature. This is one of the main advantages of the efficient market
hypothesis.

These traders are reluctant to pay the high charges imposed by the experienced fund
managers as they don’t even rely on the experts to outperform the market. However, recent
data suggests that there are a few fund managers who have been consistent in beating the
market.

Types of candlestick chart and indicators

Doji candlestick chart

A doji is a common candlestick pattern used in technical analysis of financial markets, such
as stocks, forex, and commodities. It's formed when the open and close prices of an asset
are very close to each other, creating a small or virtually nonexistent body for the
candlestick. In other words, a doji represents a trading day where the opening and closing
prices are almost identical or exactly the same.

The doji pattern reflects indecision or a potential reversal in the market. It suggests that the
forces of supply and demand are evenly matched, resulting in a standoff between buyers and
sellers. Traders often interpret the appearance of a doji as a signal to pay attention to the
market and look for potential changes in price direction.
Indicators

• Trend Reversal: A doji pattern can suggest a potential trend reversal. If it appears
after a prolonged uptrend or downtrend, it might signal a reversal in the price
direction.
• Confirmation: Traders often wait for confirmation from subsequent price action
before acting on a doji signal. A follow-up candlestick pattern that supports the
reversal can add validity to the potential reversal.
• Support and Resistance: Doji candlesticks can also act as support or resistance
levels. When a doji forms near a key support or resistance level, it might indicate a
potential bounce or breakout.
• Trading Strategies: Traders might use doji patterns as part of their trading strategies,
combining them with other technical indicators like moving averages, trendlines, and
oscillators to make more informed decisions.

Hammer and Inverted candlestick chart

Technical analysis uses candlestick patterns like the hammer and inverted hammer to spot
potential trend reversals. A small body at the high end of the trading range and a lengthy
lower shadow characterise the hammer, which happens during a decline. It shows that the
market's attitude may be shifting from buyers to sellers.

The red inverted hammer candlestick or the upside-down green hammer candlestick both
appear during a downturn and are made up of a single bar with a long upper shadow and a
short bottom body. It claims that consumers are gaining power.
Though their candlestick forms are similar, both patterns imply bullish reversals. Before
taking long positions based on these patterns, traders frequently look for confirmation.

Indicators

• Confirmation: As with other candlestick patterns, traders often wait for confirmation
from subsequent price action before acting on hammer or inverted hammer signals. A
confirming candlestick that follows the pattern can provide more confidence in the
potential reversal.
• Trend Reversal: Both patterns are used to identify potential trend reversals, with the
hammer indicating a reversal of a downtrend and the inverted hammer indicating a
reversal of an uptrend.
• Support and Resistance: Hammers and inverted hammers can act as support or
resistance levels. When these patterns form near key support or resistance levels, they
can indicate a potential bounce or breakout.
• Volume Consideration: Analyzing the volume accompanying these patterns can
provide additional insights. Higher volume during the formation of a hammer or
inverted hammer can add validity to the reversal signal.
• Confirmation Patterns: Traders often look for other technical signals to confirm the
validity of a hammer or inverted hammer, such as trendline breaks, moving average
crossovers, or other candlestick patterns.
Bullish and Bearish Engulfing candlestick

The Engulfing candlestick is multiple candlestick patterns that signal a reversal of the
ongoing trend in the market. This candlestick pattern involves two candles with the latter
candle 'engulfing' the body of the earlier candle. The 1st candle will always be the colour of
the prior trend and the second candle will be the reversal candle.

The bullish engulfing candle signals bullish reversal and indicates a rise in buying pressure
when it appears at the bottom of a downtrend. This pattern triggers a reversal of the ongoing
trend as more buyers enter the market and move the prices up further. The pattern involves
two candles with the second green candle completely engulfing the 'body' of the previous
red candle.

The bearish engulfing pattern is the opposite of the bullish pattern. It signals a bearish
reversal and indicates a fall in prices by the sellers who exert the selling pressure when it
appears at the top of an uptrend. This pattern triggers a reversal of the ongoing trend as more
sellers enter the market and they make the prices fall.

Indicators

Confirmation: While these patterns can be strong signals, traders often look for
confirmation from subsequent price action. Subsequent candlesticks
Shooting Star and Morning Star candlestick

The shooting star pattern suggests that buyers initially pushed the price higher during the
session but faced selling pressure, causing the price to retreat and close near the open. This
pattern indicates potential selling pressure and a possible reversal from the uptrend.

The morning star pattern suggests that sellers have lost control, and buyers are gaining
momentum, potentially signaling a reversal from the downtrend.

• Confirmation: As with other candlestick patterns, confirmation from subsequent

price action is important. Traders often wait for confirmation from the following
candlesticks to validate the pattern's signal.
• Trend Reversal: Both shooting star and morning star patterns are used to identify
potential trend reversals. Shooting stars indicate a shift from uptrend to downtrend,
while morning stars indicate a shift from downtrend to uptrend.
• Volume Consideration: Analyzing trading volume during the formation of these
patterns can add credibility to the reversal signal. Higher volume during a shooting
star or morning star pattern can indicate stronger potential reversals.
• Support and Resistance Levels: These patterns that form near key support or
resistance levels are often considered more significant, as they suggest potential
turning points.
 • Candlestick Size: The size of the candlesticks in relation to recent price action
matters. Larger shooting star or morning star candlesticks generally provide stronger
reversal signals.
• Confirmation Patterns: Traders often use other technical indicators and patterns to
confirm the validity of shooting star and morning star patterns.

Moving Average

a) Simple moving average

A moving average (MA) chart is a tool used by technical analysts to track the price
movements of a security. It plots average prices over a defined period of time, with the
moving average typically overlaid onto a candlestick or bar chart. The bars or candlesticks
show the price data for each time period.

b) Exponential moving average

An exponential moving average (EMA) is a type of moving average (MA) that places a
greater weight and significance on the most recent data points. The exponential moving
average is also referred to as the exponentially weighted moving average. An exponentially
weighted moving average reacts more significantly to recent price changes than a simple
moving average simple moving average (SMA), which applies an equal weight to all
observations in the period.
Moving average convergence/divergence candlestick

The moving average convergence/divergence (MACD, or MAC-D) line is calculated by

subtracting the 26-period exponential moving average (EMA) from the 12-period EMA.
The signal line is a nine-period EMA of the MACD line.

MACD is best used with daily periods, where the traditional settings of 26/12/9 days is the
default.

MACD triggers technical signals when the MACD line crosses above the signal line (to buy)
or falls below it (to sell).
MACD can help gauge whether a security is overbought or oversold, alerting traders to the
strength of a directional move, and warning of a potential price reversal.

MACD can also alert investors to bullish/bearish divergences (e.g., when a new high in price
is not confirmed by a new high in MACD, and vice versa), suggesting a potential failure and
reversal.

After a signal line crossover, it is recommended to wait for three or four days to confirm that
it is not a false move.
• Crossovers: The MACD line and the signal line generate buy and sell signals through
crossovers. When the MACD line crosses above the signal line, it generates a bullish
signal, suggesting potential upward movement. When the MACD line crosses below
the signal line, it generates a bearish signal, suggesting potential downward
movement.
• Divergence: MACD divergence occurs when the MACD indicator's direction
diverges from the direction of the price movement. Bullish divergence happens when
the price makes lower lows while the MACD makes higher lows, indicating potential
upward momentum. Bearish divergence occurs when the price makes higher highs
while the MACD makes lower highs, suggesting potential downward momentum.
• Overbought and Oversold Conditions: Traders use the MACD histogram to
identify overbought and oversold conditions. Large positive values (above the zero
line) may suggest overbought conditions, while large negative values (below the zero
line) may suggest oversold conditions.
• Zero Line Crossovers: When the MACD histogram crosses above the zero line, it
indicates potential bullish momentum. Conversely, when the histogram crosses below
the zero line, it indicates potential bearish momentum.
• Trend Confirmation: Traders often use MACD to confirm trends identified by other
technical indicators or chart patterns.
• Histogram Contraction and Expansion: The contraction and expansion of the
histogram can provide insights into changes in momentum. A contracting histogram
 suggests decreasing momentum, while an expanding histogram suggests increasing
momentum.

Relative Strength Index candlestick:

RSI means relative strength index. The candle is another term that is attached to the RSI. It
means this indicator will not plot a single line, but it will plot candlesticks on the RSI chart.

The RSI candle indicator will calculate the RSI value of each candlestick’s high, low, open
and close and then plot new candlestick using those calculated RSI values. RSI value ranges
from 0 to 100.

The function of red and green lines

When you add the indicator to the chart, you will see a red line at 70 levels and a green line
at 30.

Indicators:
• Overbought and Oversold Levels: As mentioned earlier, the RSI is typically
considered overbought when its value is above 70 and oversold when its value is
below 30. Traders often watch for RSI values reaching these levels as potential signals
for reversals or corrections in price.
• Divergence: RSI divergence occurs when the direction of the RSI line diverges from
the direction of the price movement. Bullish divergence occurs when the price makes
lower lows while the RSI makes higher lows, suggesting a potential upward reversal.
Bearish divergence occurs when the price makes higher highs while the RSI makes
lower highs, indicating a potential downward reversal.
 • Centerline Crossovers: Some traders also look for crossovers of the RSI line with
the centerline at 50. Crossing above 50 can suggest the potential for an uptrend
gaining strength, while crossing below 50 can suggest the potential for a downtrend
gaining strength.
• Failure Swings: A failure swing occurs when the RSI moves above 70, falls back
below 70, rises again but fails to reach 70, and then moves below the previous low.
This is a bearish signal suggesting potential price decline.
• Confirmation of Trends: Traders often use the RSI to confirm trends identified by
other technical indicators or analysis methods.

Bollinger Bands candlestick:

A Bollinger Band consists of a middle band (which is a moving average) and an upper and
lower band. These upper and lower bands are set above and below the moving average by a
certain number of standard deviations of price, thus incorporating volatility. The general
principle is that by comparing a stock's position relative to the bands, a trader may be able
to determine if a stock's price is relatively low or relatively high.
 • Volatility Measurement: Bollinger Bands expand and contract based on the
volatility of the asset's price. During periods of high volatility, the bands widen, and
during periods of low volatility, the bands narrow. Traders often watch for sudden
contractions followed by expansions, as they can indicate potential upcoming price
movements.
• Overbought and Oversold Conditions: When prices move close to the upper
Bollinger Band, it doesn't necessarily mean that the asset is overbought; it can indicate
strong upward momentum. Similarly, when prices approach the lower Bollinger
Band, it doesn't always imply oversold conditions; it can indicate strong downward
momentum. The bands serve as dynamic support and resistance levels.
• Bollinger Band Squeeze: A Bollinger Band squeeze occurs when the bands contract
to a narrow range. This often happens before significant price moves. Traders
interpret this as a potential period of consolidation followed by a breakout.
• Bollinger Band Width: The Bollinger Band width is calculated by taking the
difference between the upper and lower bands. A decreasing band width suggests
decreasing volatility, while an increasing width suggests increasing volatility.
• Confirmation of Trends: Traders often use Bollinger Bands to confirm trends
identified by other indicators or analysis methods. A strong trend can be supported by
the price consistently staying near one of the bands.
• Crossovers and Price Touches: Crossovers of the price with the bands or the middle
line can also provide trading signals. For instance, a price that touches or crosses the
upper band might indicate potential overextension and a reversal possibility.

Fibonacci Retracement and Extensions

Fibonacci Retracement: Fibonacci retracement levels are horizontal lines drawn on a price
chart to indicate potential support or resistance levels based on the Fibonacci ratios.
The key ratios used in Fibonacci retracement are 23.6%, 38.2%, 50%, 61.8%, and 78.6%.
These levels are derived from mathematical relationships within the Fibonacci sequence.
Fibonacci Extensions: Fibonacci extensions are used to project potential price targets
beyond the original trend. These levels are also derived from the Fibonacci sequence and
are often used by traders to identify where a trend might encounter resistance or achieve its
next price target. Indicators

Price Reversal Zones: Traders use Fibonacci retracement levels to identify potential areas
where price might reverse its current trend. For example, if an uptrend retraces to a Fibonacci
level (e.g., 38.2% or 50%), it might find support and resume its upward movement.

• Price Extension Targets: Fibonacci extension levels are used to project potential
price targets in the direction of the trend. Traders look for these levels to anticipate
where price might encounter resistance or reach its next target.
• Confluence with Other Indicators: Traders often look for confluence, where
Fibonacci levels align with other forms of technical analysis, such as trendlines,
moving averages, or support/resistance zones. This can provide stronger signals.
• Confirmation with Candlestick Patterns: Traders might use Fibonacci levels in
conjunction with candlestick patterns or other technical indicators to confirm
potential reversal points or trend continuation.
• Dynamic Levels: Some traders use dynamic Fibonacci levels that adapt to changing
market conditions by recalculating the levels based on recent price movements.
• Risk Management: Fibonacci levels can also be used in setting stop-loss orders to
manage risk. Placing stop-loss orders just beyond key Fibonacci levels can help
traders avoid getting stopped out due to normal price fluctuations.
 Case study
How did the appearance of the Doji in Week 1 reflect the market sentiment towards
NovaTech shares at the time?

The appearance of a Doji after a prolonged uptrend suggests potential indecision in the
market. It reflects a balance between buyers and sellers, with neither side gaining the upper
hand. This uncertainty could indicate that the uptrend might be losing momentum, and a
potential reversal or consolidation might occur.

In the context of the observed Hammer and Inverted Hammer patterns, what trading
strategies could investors have adopted during Week 2?

Investors could have adopted bullish trading strategies during Week 2. The Hammer pattern
suggests a potential bullish reversal after a minor downtrend, indicating that buyers might
be stepping in. The Inverted Hammer that followed further supports the idea of upward
movement, as it reflects a potential shift from sellers to buyers.

Given the consecutive appearance of the Bullish and Bearish Engulfing patterns in
Week 3, how should a trader interpret the conflicting signals?

The consecutive appearance of Bullish and Bearish Engulfing patterns in Week 3 creates
conflicting signals. The Bullish Engulfing suggests strong buying interest and continuation
of the uptrend, while the Bearish Engulfing indicates potential reversal and selling pressure.
This conflicting information highlights the importance of waiting for confirmation from
subsequent price action before making a decision.

How might the Shooting Star in Week 4 have influenced short-term traders' decisions?

The Shooting Star in Week 4 suggests a potential bearish reversal after a period of rising
prices. It indicates that although the price attempted to go higher during the trading session,
it closed near the open, implying potential selling pressure. The Morning Star that followed
hints at a new bullish momentum, possibly indicating a reversal of the bearish sentiment
from the Shooting Star.

Considering the Morning Star pattern at the end of Week 4, what are the potential
future price movements one might expect for NovaTech shares?

The Morning Star pattern at the end of Week 4 suggests a potential bullish reversal. If this
pattern holds true, it could indicate that NovaTech shares might experience a new uptrend
or a continuation of the previous uptrend.

How can a combination of the above patterns provide a comprehensive view of

potential trend reversals for a stock?

A combination of these patterns provides a comprehensive view of potential trend reversals.

Traders should consider the context, the sequence of patterns, and look for confirmation
from other indicators or price action before making trading decisions.

If you were an investor solely relying on these technical patterns, how would you have
adjusted your positions over the month?

As an investor solely relying on these technical patterns, your approach would depend on
your risk tolerance and trading strategy. You might have adjusted your positions by
considering the potential reversals indicated by the patterns. For instance, you might have
taken profits during potential bearish reversal signals (like Shooting Star) and added to your
positions during potential bullish reversal signals (like Morning Star). However, it's essential
to remember that no indicator or pattern is foolproof, and it's advisable to use them in
combination with other analysis techniques and risk management strategies.