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Module 3, Day 2

Technical analysis is the process of analyzing statistics generated from market activity, such as past prices and trading volumes, to evaluate securities and predict future price movements. It assumes stock prices are determined by demand and supply and that past price trends can be projected into the future. Two important theories of technical analysis are Dow Theory, which identifies long-term primary trends in markets, and Elliott Wave Theory, which predicts prices follow repetitive five-wave patterns.

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99 views15 pages

Module 3, Day 2

Technical analysis is the process of analyzing statistics generated from market activity, such as past prices and trading volumes, to evaluate securities and predict future price movements. It assumes stock prices are determined by demand and supply and that past price trends can be projected into the future. Two important theories of technical analysis are Dow Theory, which identifies long-term primary trends in markets, and Elliott Wave Theory, which predicts prices follow repetitive five-wave patterns.

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pravesh
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© © All Rights Reserved
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FUNDAMENTAL AND

TECHNICAL ANALYSIS

MODULE- 3
TECHNICAL ANALYSIS

MODULE- 3
Meaning of Technical Analysis
• It may be defined as a process of identifying
trend reversals at an early stage to formulate
the buying and selling strategy on the
expected changes.
• Technical analysis is a method of evaluating
securities by analyzing the statistics generated
by market activity such as past prices and
volume.
Assumptions of technical analysis
• The prevailing market price is determined by the force of demand and supply.
• Demand and supply forces are influenced by fundamental as well as
psychological factors.
• The prices of shares move in trends and waves which may be uptrend or
downtrend.
• All fundamental factors are discounted by the market and are reflected in share
prices.
• The present trends are influenced by the past trends and the projection of future
trend is possible by an analysis of historical price trends.
Difference between fundamental and technical
analysis

Fundamental analysis Technical analysis


• It refers to techniques which • It refers to techniques which
study companies profitability, study movements in market price
financial position, expected of share and trading volume of
growth to determine intrinsic share to predict the value of share
value of companies share. in future.
• It assumes that stock price are • It assumes that stock prices are
mainly determined by financial mainly determined by demand
performance of the company and supply stocks.
• It looks forward, since it • It looks backward, since it
discounts future earnings from analyses past price and volume
stock to give its present value trends.
• It generally takes long term view • It takes short term view point
point
Theories of technical analysis

1. DOW THEORY: Charles dow developed the Dow Theory and it is


regarded as the basis of all other techniques used by technical analyst. It is
based on the hypotheses that the stock market does not perform on a
random basis. Rather it is guided by some specific trends.
• Dow theory suggests that all information – past, current and even future- is
discounted into the markets and reflected in the prices of stocks and indexes.
• That information includes everything from the emotions of investors to
inflation and interest rate data, along with pending earnings announcements
to be made by companies after the close.
Continued…
• The theories suggested three market trends:-

a) The primary movements:- it shows the general and


long term trend in market prices of shares and securities.
They last from few months to many years. In the long
period, prices in securities markets show definite phases of
rise or fall. A consistently rising rend is called as bull
phase and consistently declining trend is termed as bear
phase.
Continued..
b) The Secondary movements:- they are relatively shorter in
duration. These may last for a few weeks to months. These
movements are opposite in direction to the primary movements.
They run counter to the primary trend.
c) The daily fluctuations:- they are in either direction. These are
minor character and of lesser significance. These are irregular
fluctuations and occur every day in the market. No definite trend
is shown by these fluctuations.
Continued..
• This theory is helpful in determining the timing of investment
decisions. An investor would like to invest in securities at such
a time when prices are at lowest levels and to sell these
securities when their prices reach the highest peak. Therefore
investor has to time his decisions for judicious management of
investment in his portfolio.
2. Elliott wave theory

• This theory is named after Ralph Nelson Elliott. Inspired by the


Dow Theory, he concluded that the movement of the stock market
could be predicted by observing and identifying a repetitive
pattern of waves. He further said that the stock prices in the
market can be described as a set of five wave patterns. In case of
bull market, the set of five waves is as: the first wave is
upward, the second is downward, the third is upward, the
fourth is downward and the fifth wave is inward. In case of
bear market the reverse wave pattern follows.
WAVE DESCRIPTION
• 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 and enough investors who were in
the original wave to consider that the stock was overvalued take profits. This
causes the stock to go down.
• Wave 3: this may be the longest and strongest wave. More investors find out
about 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.
Continued…
• Wave 4: at this point, investors again take profits because the
stock is again considered expensive. This wave tends to be
weak because there are usually more investors that are still
bullish on the stock.
• Wave 5: this is the point that most investors are driven by
hysteria. They will come up with lots of reasons to buy the
stock which has very little negative news; consequently, the
stock becomes overpriced.
Continued..

• Out of the above waves, 1,3,5 are known as


impulse waves and are in the direction of the
basic movement and the other two waves i.e. 2
and 4 are correction waves and are against the
direction of basic movement.

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