A PROJECT ON

EQUITY RESEARCH- BANKING SECTOR

(ICICI Bank, SBI and Yes Bank)

SUBMITTED BY

MR. VIKAS RAGHUNATH WAGHMARE

IN FULLFILLMENT OF REQUIREMENT FOR

MASTERS OF MANAGEMENT STUDES
OF
UNIVERSITY OF MUMBAI
(2009-2011)

RAJEEV GANDHI COLLEGE OF MANAGEMENT STUDIES

1
 CERTIFICATE

This is to certify that Mr. VIKAS RAGHUNATH WAGHMARE student of

second year Masters of Management Studies (MMS) of Rajeev Gandhi
college of Management Studies has successfully completed the project work
titled “Equity Research” in fulfillment for the degree of Masters of
Management Studies of University of Mumbai.

This project is the record of authentic work carried out during the academic
year 2009-2011.

Date: _________________

Prof. Brijesh Sharma Menon Shridharan

(Internal Project Guide) (Director)

2
 DECLARATION

I hereby declare that the project entitle “Equity Research”

Is submitted in fulfillment of Masters of Management Studies degree of

University of Mumbai in the academic year 2009-2011 was carried with

sincere intension.

To the best of my knowledge it is an original piece of work done by me

and it has neither been submitted to any other organization nor published at

anywhere before.

(Vikas Raghunath Waghmare)

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 ACKNOWLEDGEMENT

By the grace of God who has provided me with the skills and abilities to be

able to complete this report and present a clear picture of what I have been

doing during the course of my internship. I would firstly like to thank the

Department of Capital Market, for making this learning experience a part of

our education and specifically thank Prof. Brijesh Sharma for his advice

and assistance in helping us avail this opportunity. Lastly I would like to

express my deepest and utmost thanks to my parents, who have made me

whatever I am today.

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 TABLE OF CONTENTS

CHAPTER NO. TITLE PAGE NO.

1 INTRODUCTION 1
1.1 Introduction to the Topic 2
1.2 Rationale of the study 3
1.3 Investment decision making 4
1.4 Changing Role of Equity Research 6
1.5 Role of Equity Research analyst 10
1.6 Objective of the study 12
1.7 Research Methodology & Design 13
2 TECHNICAL ANALYSIS 14
2.1 Introduction 15
2.2 Support & Resistance 19
2.3 Charts & Chart Patterns 22
2.4 Theories 29
2.5 Moving Average 32
2.6 Indicators 36
3 FUNDAMENTAL ANALYSIS 41
3.1 Introduction 42
3.2 Economy analysis 42
3.3 Industry 42
3.4 Company 43
4 BANKING SECTOR 49
4.1 Introduction to the Banking 50
4.2 Banking structure 55
5 RESEARCH & ANAYSIS 58
5.1 ICICI Bank 59
5.2 State Bank of India 65
5.3 YES Bank 71
6 FINDINGS & CONCLUSION 77

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 7 BIBLIOGRAPHY 78

EXECUTIVE SUMMARY

The field of equity research is very vast and one has to look into
various aspects of the functioning of the company to get to any
conclusion about the possible performance of the company in the market.
Investors like warren buffet made a fortune out of investments in the
stock market, which is quiet impossible without proper research about
the companies. The field of equity research is full of challenges. It is your
door to fame, fortune and, above all, professional challenge. In a world
that is shrinking in size due to information technology and blurring
boundaries between nations, the stock market (or the equities market),
which is considered to be in its infant stage, is all set to grow in size.
The project on “Equity Research” was carried out by self study. This
is limited learning and devoting time towards equity research but it also
provided an insight on what various services such broking houses
provide and what efforts are required to manage such organizations.

The reason behind choosing this project is that it provides hands on

experience with what goes on in the stock market on a day-to-day basis.
Some value investors only look at present assets/earnings and don't
place any value on future growth. Other value investors base strategies
completely around the estimation of future growth and cash flows.
Despite the different methodologies, it all comes back to trying to buy
something for less than its worth.

The project initiated with understanding the mannerisms of the

stock market trading followed by the dynamics of the banking sector.
Some of the major players in Banking sector were then chosen for further

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analysis. These companies were further studied in detail with respect to
their financials and the management’s future plans regarding the
functioning of the company, their expansion plans, and various news
about these companies and their global forays.

Based on the complete study of the companies and sector wise

analysis of banks, leading banks in private and public sector –ICICI
Bank ,SBI Bank, YES Bank and also giving recommendation on the for
“Buy or Sell or Hold” by analyzing the fundamental and technical’s of the
company.

LITERATURE REVIEW

Stocks & Markets are analyzed by using various methods by the learned
Researchers & Analysts. All these methods can be broadly classified into three
categories - Fundamental Analysis, Technical Analysis & Techno-Fundamental
(Tech-Funda) Analysis.

FUNDAMENTAL ANALYSIS

Fundamental Analysis aims at determining the intrinsic (in-built) worth of the

stock or financial security & comparing it with the market price to identify as to
whether it is overpriced or under priced. A Fundamentalist would buy a stock or
financial security if it is under priced & sell if it is over priced.

Fundamentalists firmly believe that sooner or later, market price will be equal to
the intrinsic worth of the stock or financial security. Global Market Analysis,
Economic Analysis, Industry Analysis & Corporate Analysis - are the levels at
which Fundamental Analysis is carried out. Balance Sheet Analysis, Profit & Loss
Account Analysis by using various ratios like EPS, PE, CR, IRRI etc are only the

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basic fundamentals used at the Corporate level Analysis, which are considered
by many as the basic indicators.

Foreign Institutional Investors (FII), Banks, Mutual Funds etc. have their teams of
researchers & trained fundamental analysts who are capable of carrying out
detailed fundamental analysis with the help of sophisticated information
systems. Similarly, these institutions have 5 to 15 years of long term investment
strategies. Therefore fundamental analysis is more suitable for them.

Individual investors are not capable of carrying out Global Market Analysis,
Economic Analysis, Industry Analysis & Corporate Analysis in details due to
limited resources. Similarly, individual investors can not wait for earning returns
after 5 to 15 years. Therefore, fundamental analysis has limited use for
individual & common investors.

TECHNICAL ANALYSIS

Technical Analysis aims at analyzing the Markets, Stocks & Financial Securities
by considering only two factors - Prices & Volume (Number of stocks / securities
bought & sold). Technical Analysis is more of an Art than a Science of Analyzing
Charts of the securities for identifying prevailing Trends.

Institutions create the trends (tides) because of their voluminous investments &
technicians (Technical Analysts) ride those tides, at the earliest, to make profits.
"Ride the tides to make profits and skip off the tides when there is a slide", is
the modus operendi of Technical Analysts.

The beauty of Technical Analysis is in its simplicity & effectiveness. Any

individual of even average educational background can learn Technical Analysis.
Technical Analysis is effective in analyzing stock markets, commodities markets,
debt markets, derivatives market & foreign markets. In the globalized urban

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 scenario, every intelligent investor must at least have working, if not expert,
knowledge of Technical Analysis.

Technical Analysis is not a flaw less Art of taking investment decisions. One of
the major drawbacks of this Art is delayed decisions. Unless the trend gets
established, a technician cannot take decision but one must admit that these
decisions are more reliable with exact entry & exit levels, which is not possible
with fundamental analysis. Timing the entry & exit is the real strength of
technical analysis.

For short and medium term trading and investment, there is no substitute to
Technical Analysis. For long term investments, Techno-Fundamental Analysis is
best suited for the common and individual investors.

TECH-FUNDA ANALYSIS

This approach is by far the best & more suitable to the common individual
investors, having long term perspective. In this approach, stocks or securities
are identified by using technicals but before taking the investment decisions a
few selected fundamentals are checked. The fundamentals such as size of
equity, owner's equity holding, institutional holding, floating stock, dividend and
bonus history, operating & net profit trend, position of free reserves are
considered. When technical’s are favorable and so are these fundamentals, the
investors can invest with conviction for long term.

The primary objective of equity research is to analyze the earnings persistence.

Some key aspects that affect the earnings persistence can be summarized as
follows:

- The stability of the equity under consideration

- The predictability of the value of the given equity under the given circumstances

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- The variability of the given equity, given the various variance factors

The general market trend influencing the market value of the given equity

- The earnings management

- And the accounting methods in use

Two ways in which you can facilitate the assessment of the earnings persistence
are by either recasting the income statement or adjusting the same.

Objectives of recasting include:

- Ensuring that the given earnings and their components are suitably recasted to
facilitate stable, consistent and maintainable elements. These elements are
composed of earnings. These earnings are distinctly separable from any random,
abnormal or unique elements.

- Whatever elements have been recast, and at the same time have also been
included as part of the current earnings, must subsequently get included within
the operating results of one or more of an earlier period.

- Determining the earning power

Objectives of adjusting include:

- Allocating the earnings component to the most appropriate period

On the other hand, the primary objectives of stock valuation include an

understanding of:

- The benefits and drawbacks of common stock. Here the common stock is
considered to be an investment, in addition to being a source of funds

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- The characteristics, the legal implications, the rights and the privileges if any, in
holding common stocks

- The different types of common stock existent

- The comprehension of various types of transactions or markets where common

stock is prevalent

- The valuation process used for common stock

- The conditions that lead up to a state of stock market equilibrium

- The efficient market hypothesis

- The general characteristics of a preferred stock

- The pre-requisites of a preferred stock or the conditions that a preferred stock

must satisfy, in order to be considered as an investment or a source of funds

- The legal implications and rights as well as the privileges of being a preferred
stock holder

- The valuation process of a preferred stock

Thus, you are now aware of the objectives behind the process of equity analysis
and stock valuation. These objectives have also made you aware of the goals to be
achieved or the results that are expected from a given equity analysis and stock
valuation process.

- Arrnica
Dayannandan

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OBJECTIVES OF THE STUDY

Primary Objective:

To understand the basics of equity research

Sub-Objectives:

a) To justify the current investment in the chosen securities.

b) To understand the movement and performance of stocks.

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c) To recommend increase/decrease of investment in a particular security.

RESEARCH METHODOLOGY & DESIGN

TYPE OF STUDY
The research has been based on secondary data analysis. The study has been exploratory as it aims at
examining the secondary data for analyzing the previous researches that have been done in the area of
technical and fundamental analysis of stocks. The knowledge thus gained from this preliminary study
forms the basis for the further detailed Descriptive research. In the exploratory study, the various
technical indicators that are important for analyzing stock were actually identified and important ones
short listed.

SAMPLE DESIGN
The sample of the stocks for the purpose of collecting secondary data has been selected on the basis of
Random Sampling. The stocks are chosen in an unbiased manner and each stock is chosen independent
of the other stocks chosen. The stocks are chosen from the Banking Sector.

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SAMPLE SIZE
The sample size for the number of stocks is taken as 3 for technical analysis and fundamental analysis of
stocks as fundamental analysis is very exhaustive and requires detailed study.

SCOPE OF THE STUDY

• The scope of this project is limited to only one sector i.e. Banking sector. This
project is concerned with only one sector of companies in the stock market. The
project does not extend its scope to any other sector of companies.
• Also, the project is concerned with only three banks among the major players in the
Banking sector i.e ICICI bank, State Bank India bank, YES bank

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 CHAPTER- 1
INTRODUCTION

15
1.1 INTRODUCTION

Investing, like marriage, isn't something that should be entered into lightly. Investing in equities gives
high returns but they correspondingly have higher risk also. Before we invest in a company, there are
more than a few things we need to know about it.

Securities Analysis

An analysis of securities and the organization and operation of their markets. The determination of the
risk reward structure of equity and debt securities and their valuation. Special emphasis on common
stocks. Other topics include options, mutual fluids and technical analysis.

Technical analysis is a method of predicting price movements and future market trends by studying
charts of past market action which take into account price of instruments, volume of trading and, where
applicable, open interest in the instruments.

Fundamental analysis is a method of forecasting the future price movements of a financial instrument
based on economic, political, environmental and other relevant factors and statistics that will affect the
basic supply and demand of whatever underlies the financial instrument.

Main differences between the two types of analysis:

Fundamental analysis Technical analysis

Focuses on what ought to happen Focuses on what actually happens

in a market in a market

Factors involved in price Charts are based on market action

analysis: involving:
1.Supply and demand 1.Price
2.Seasonalcycles 2.Volume
3.Weather 3.Open interest (futures
4.Government policy only)

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 1.2 RATIONALE FOR THE STUDY

In an industry plagued with skepticism and a stock market increasingly difficult to predict and contend
with, if one looks hard enough there may still be a genuine aid for the Day Trader and Short Term
Investor.

The price of a security represents a consensus. It is the price at which one person agrees to buy and
another agrees to sell. The price at which an investor is willing to buy or sell depends primarily on his
expectations. If he expects the security's price to rise, he will buy it; if the investor expects the price to
fall, he will sell it. These simple statements are the cause of a major challenge in forecasting security
prices, because they refer to human expectations. As we all know firsthand, humans expectations are
neither easily quantifiable nor predictable.

If prices are based on investor expectations, then knowing what a security should sell for (i.e.,
fundamental analysis) becomes less important than knowing what other investors expect it to sell for.
That's not to say that knowing what a security should sell for isn't important--it is. But there is usually a
fairly strong consensus of a stock's future earnings that the average investor cannot disprove

Fundamental analysis and technical analysis can co-exist in peace and complement each other. Since all
the investors in the stock market want to make the maximum profits possible, they just cannot afford to
ignore either fundamental or technical analysis.

1.3 INVESTMENT DECISION MAKING: APPROACHES

As investors we would have diverse investment strategies with the primary aim to achieve superior
performance, which would also mean a higher rate of return on our investments. All investment
strategies can be broadly classified under 4 approaches, which are explained below.

Fundamental approach: In this approach the investor is concerned with the intrinsic value of the
investment instrument. Given below are the basic rules followed by the fundamental investor.

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There is an intrinsic value of a security, which in turn is dependent on the underlying economic factors.
This intrinsic value can be ascertained by an in-depth analysis of the fundamental or economic factors
related to an economy, industry and company.

At any point in time, many securities have current market prices, which are different from their intrinsic
values. However, sometime in the future the current market price would become the same as its intrinsic
value. We as fundamental investors can achieve superior results by buying undervalued securities and
selling overvalued securities.

Psychological approach: The psychological investor would base his investment decision on the
premise that stock prices are guided by emotions and not reason. This would imply that the stock prices
are influenced by the prevalent mood of the investors. This mood would swing and oscillate between the
two extremes of “greed” and “fear”. When “greed” has the lead stock prices tend to achieve dizzy
heights. And when “fear” takes over stock prices get depressed to lower than lower levels.

As psychic values seem to be more important than intrinsic values, it is suggested that it would be more
profitable to analyze investor behaviour as the market is swept by optimism and pessimism. Which
seem to alternate one after the other. This approach is also called “Castle-in-the-air” theory. In this
approach the investor uses some tools of technical analysis, with a view to study the internal market
data, towards developing trading rules to make profits.

In technical analysis the basic premise is that price movement of stocks have certain persistent and
recurring patterns, which can be derived from market trading data. Technical analysts use many tools
like bar charts, point and figure charts, moving average analysis, market breadth analysis amongst
others.

Academic approach: Over the years, the academics have studied many aspects of the securities market
and have developed advanced methods of analysis. The basic rules are:

The stock markets are efficient and react rationally and fast to the information flow over time. So, the
current market price would reflect its intrinsic value at all times. This would mean "Current market
price = Intrinsic value".

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Stock prices behave in a random fashion and successive price changes are independent of each other.
Thus, present price behavior can not predict future price behavior.

In the securities market there is a positive and linear relationship between risk and return. That is the
expected return from a security has a linear relationship with the systemic or non-diversifiable risk of
the market.

Eclectic approach: This approach draws upon all the 3 approaches discussed above. The basic rules of
this approach are:

1. Fundamental analysis would help us in establishing standards and benchmarks.

2. Technical analysis would help us gauge the current investor mood and the relative strength of demand
and supply.

3. The market is neither well ordered nor speculative. The market has imperfections, but reacts
reasonably well to the flow of information. Although some securities would be mispriced, there is a
positive correlation between risk and return.

1.4 THE CHANGING ROLE OF EQUITY RESEARCH

In this interactive discussion of equity research, we will review the role of this research and how it is
impacted by bull and bear markets. We will also discuss fee-based research and its growing importance.
Your responses to the questions at the end of this article will be the basis for the last part of this article,
where you can observe what investors think is the role of equity research in today's market.

Research and the Stock Market

Actually, the title of this article is a bit misleading because the role of research has not changed since the
first trade occurred under the Buttonwood Tree on Manhattan Island. What has changed is the
environments (bull and bear markets) that influence research.

The role of research is to provide information to the market. An efficient market relies on information: a

19
lack of information creates inefficiencies that result in stocks being misrepresented (over or under
valued). Analysts use their expertise and spend a lot of time analyzing a stock, its industry and peer
group to provide earnings and valuation estimates. Research is valuable because it fills information gaps
so that each individual investor does not need to analyze every stock. This division of labor makes the
market more efficient.

Research in Bull and Bear Markets

If the role of research has always been so "noble", why is it currently in such a state of ill-repute? There
are two reasons: firstly the current bear market gives us a new perspective to evaluate the excesses of
the last bull market; secondly investors need to blame somebody.

In every bull market there are excesses that become apparent only in the bear market that follows.
Whether it is tulips or transistors, each age has its mania that distorts the normal functioning of the
market. In the rush to make money, rationality is the first casualty. Investors rush to jump on the
bandwagon and the market over-allocates capital to the "hot" sector(s). The most recent examples being
web-based grocery companies, online pet stores and fiber-optic capacity. This herd mentality is the
reason why bull markets have funded so many "me-too" ideas throughout history.

Research is a function of the market and is influenced by these swings. In a bull market investment
bankers, the media and investors pressure analysts to focus on the hot sectors. Some analysts morph into
promoters as they ride the market. Those analysts that remain rational practitioners are ignored, and
their research reports go unread. During the late 1990s the business media catered to the audience's
demands and gave the spotlight to the famous talking heads that are now under investigation.

Research in Today's Market

To discuss the role of research in today's market, we need to differentiate between Wall Street research
and other research. Wall Street research is provided by the major brokerage firms (both on and off Wall
Street). Other research is produced by independent research firms and small boutique brokerage firms.

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This differentiation is important. First, Wall Street research has become focused on big cap, very liquid
stocks and ignores the majority (over 60% based on our research) of publicly-traded stocks. This
myopic focus on a small number of stocks is the result of deregulation and industry consolidation. In
order to remain profitable, Wall Street firms have focused on big-cap stocks to generate highly lucrative
investment banking deals and trading profits.

Those companies that are likely to provide the research firms with a sizable investment banking deals
are the stocks that are determined worth being followed by the market. The stock's long-term investment
potential is secondary. The second reason to distinguish Wall Street from other research is that most of
the blame for the excesses of the last bull market is rightfully placed on Wall Street.

Other research is filling the information gap created by Wall Street. Independent research firms and
boutique brokerage firms are providing research on the stocks that have been orphaned by Wall Street.
Investors, now educated in the benefits of electronic trading, may not be willing to support boutique
brokerage firms for their research by opening an account and paying higher commissions.

Who Pays for Research? Big Investors Do!

The ironic thing is that while research has proven to be valuable, individual investors do not seem to
want to pay for it. This may be because, under the traditional system, brokerage houses provided
research in order to gain and keep clients. Investors just had to ask their brokers for a report and retained
it at no charge. What seems to have gone unrealized is that the commissions pay for that research.

A good indicator of the value of research is the amount institutional investors are willing to pay for it.
Institutional investors hire their own analysts to gain a competitive edge over other investors. They also
pay (often handsomely) independent research firms for additional research. Institutions also pay for
the sell-side research they receive (either with dollars or by giving the supplying brokerage firm trades
to execute). All this amounts to big money, but the institutions realize that research is integral to making
successful investment decisions.

If investors are unwilling to buy research how will the market correct the imbalance caused by the lack

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of coverage? The solution may be found by looking at the issue a slightly different way.

The Growing Role of Fee-Based Research

Fee-based research increases market efficiency and bridges the gap between investors who want
research (without paying) and companies who realize that Wall Street is not likely to provide research
on their stock. Fee-based research provides information to the widest possible audience at no charge to
the reader because the subject company has funded the research.

It is important to differentiate between objective fee-based research and research that is promotional.
Objective fee-based research is analogous to the role of your physician. You pay a physician not to tell
you that you feel good but to give you his or her professional and truthful opinion of your condition.
Legitimate fee-based research is a professional and objective analysis and opinion of a company's
investment potential. Promotional research is short on analysis and full of hype. An example is the fax
and email reports about the penny stocks that will supposedly triple in a short time.

Legitimate fee-based research firms have the following characteristics:

1. They provide analytical not promotional services.

2. They are paid a set annual fee in cash; they do not accept any form of equity, which may cause
conflicts of interest.
3. They provide full and clear disclosure of the relationship between the company and the research firm
so investors can evaluate objectivity.

Companies who engage a legitimate fee-based research firm to analyze their stock are trying to get
information to investors and improve market efficiency. Such a company is making the following
important statements:

1. That it believes its shares are undervalued because investor are not aware of the company.
2. That it is aware that Wall Street is no longer an option.
3. That it believes that its investment potential can withstand objective analysis.

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Perhaps more importantly, the reputations/credibility of the company and the research firm depends on
the efforts they make to inform investors. A company does not want to be tarnished by being associated
with disreputable research. Similarly, a research firm will only want to analyze companies that have
strong fundamentals and long-term investment potential.

Fee-based research has had to fight the stereotype of promotional research, but the market is starting to
realize that fee-based research is a viable source of information. The National Investor Relations
Institute (NIRI) was probably the first group to recognize the need for fee-based research. In January
2002 NIRI issued a letter emphasizing the need for small-cap companies to find alternatives to Wall
Street research in order to get their information to investors. More recently, the NIRI is conducting a
survey on research alternatives and will possibly have a session on this topic at their national conference
this year.

1.5 ROLE OF AN EQUITY RESEARCH ANALYST

Equity research analysts study the movements of the stock market, especially specific business stocks.
Companies constantly produce large amounts of information regarding their financial status, their
success in business markets and their current investments. Much of this information is required
for legal purposes, but it also provides necessary data for the stock market. Most investors do not have
the time or resources to follow this massive amount of company information. Equity research analysts
work to compile this data, along with relevant market information, to provide investors with useful
recommendations.
Definition

In stock market terms, "equity" refers to ownership of a business, which a business can sell as shares to
interested investors. An equity research analyst specializes in examining what shares are for sale, what
shares are selling well and what companies appear to be growing and will be worthwhile investments.
Equity research analysts also track which stocks are falling so they can point out trends and provide
useful information to brokers and investors.

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Process
Analysts spend much of their time analyzing individual stocks, especially stocks that have earned a lot
of interest due to changing value. They look at the company that issued the stock and its history, then
analyze the company's industry as a whole and what major changes are influencing it. The analyst will
then look at businesses similar to the company they are studying to find information about overall value
and average earnings for that kind of business.

Common Tasks

Equity research analysts have many different jobs. Once they have compiled information, many use
basic formulas and programs to create financial models of specific companies and industries, or ratios
that show important facts about a business's financial standing. Many follow up these models by writing
reports for investors summarizing their findings. Some may tap into independent sources and contacts to
keep up on recent events. All research analysts must ensure they use only publicly available knowledge
and not illegal, insider information.

Market Influence

Equity research analysts tend to be influenced by current events, and many tend to make
recommendations based on market activity. This means that as the market changes, analysts' attitudes
also change to mirror current interest. This can create a tendency for some analysts to become myopic,
only reporting on popular news and backing certain stocks because they are trendy in the short term.

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 CHAPTER- 2
TECHNICAL ANALYSIS
A CONCEPTUAL OVERVIEW

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 TECHNICAL ANALYSIS

2.2 INTRODUCTION

What is Technical Analysis?

We can define Technical Analysis as a study of the stock market considering factors
related to the supply and demand of stocks. Technical Analysis doesn’t look at underlying earnings
potential of a company while evaluating stocks {unlike fundamental Analysis}. It uses charts and
computer programs to study the stock’s trading volume and price movements in the hope of identifying
a trend. In fact the decision made on the basis of technical analysis is done only after inferring a trend
and judging the future movement of the stock on the basis of the trend. Technical Analysis assumes that
the market is efficient and the price has already taken into consideration the other factors related to the
company and the industry. It is because of this assumption that many think technical analysis is a tool,
which is effective for short-term investing.

History of Technical Analysis:

Technical Analysis as a tool of investment for the average investor thrived in the late
nineteenth century when Charles Dow, then editor of the Wall Street Journal, proposed
the Dow theory. He recognized that the movement is caused by the action/reaction of the
people dealing in stocks rather than the news in itself.
Walter Deemer was one of the technical analysts of that time. He started at Merrill Lynch
in New York as a member of Bob Farrell's department. Then when the legendary Gerry
Tsai moved from Fidelity to found the Manhattan Fund in 1966, Deemer joined him. Tsai
used to consult him before every major block trade, at the start of a time when large
volume institutional trading became the norm and the meal ticket for brokers. Deemer,
could recreate market history on his charts and cite statistics. He maintained contact with
the group of other pros around then, who shared their insights with each other in a collegial confidence
worthy of the priesthood.

A technical analysis is based on three axioms:

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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.

Technical Analysis: The Use Of Trend

One of the most important concepts in technical analysis is that of trend. The meaning in finance
isn't all that different from the general definition of the term - a trend is really nothing more than the
general direction in which a security or market is headed.

Types of Trend

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• Uptrend’s
• Downtrends
• Sideways/Horizontal

Trend Lengths
Along with these three trend directions, there are three trend classifications. A trend of any direction
can be classified as a long-term trend, intermediate trend or a short-term trend. In terms of the stock
market, a major trend is generally categorized as one lasting longer than a year. An intermediate
trend is considered to last between one and three months and a near-term trend is anything less than
a month. A long-term trend is composed of several intermediate trends, which often move against
the direction of the major trend. If the major trend is upward and there is a downward correction in
price movement followed by a continuation of the uptrend, the correction is considered to be an
intermediate trend. The short-term trends are components of both major and intermediate trends.
Take a look a Figure to get a sense of how these three trend lengths might look.

When analyzing trends, it is important that the chart is constructed to best reflect the type of
trend being analyzed. To help identify long-term trends, weekly charts or daily charts spanning a
five-year period are used by chartists to get a better idea of the long-term trend. Daily data charts
are best used when analyzing both intermediate and short-term trends. It is also important to
remember that the longer the trend, the more important it is; for example, a one-month trend is
not as significant as a five-year trend.

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Trendlines
A trendline is a simple charting technique that adds a line to a chart to represent the trend in the
market or a stock. Drawing a trendline is as simple as drawing a straight line that follows a
general trend. These lines are used to clearly show the trend and are also used in the
identification of trend reversals.
As you can see in Figure 5, an upward trendline is drawn at the lows of an upward trend. This
line represents the support the stock has every time it moves from a high to a low. Notice how
the price is propped up by this support. This type of trendline helps traders to anticipate the point
at which a stock's price will begin moving upwards again. Similarly, a downward trendline is
drawn at the highs of the downward trend. This line represents the resistance level that a stock
faces every time the price moves from a low to a high.

Figure 5
Channels
A channel, or channel lines, is the addition of two parallel trendlines that act as strong areas of
support and resistance. The upper trendline connects a series of highs, while the lower trendline
connects a series of lows. A channel can slope upward, downward or sideways but, regardless of
the direction, the interpretation remains the same. Traders will expect a given security to trade
between the two levels of support and resistance until it breaks beyond one of the levels, in
which case traders can expect a sharp move in the direction of the break. Along with clearly
displaying the trend, channels are mainly used to illustrate important areas of support and
resistance.

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2.2 SUPPORT AND RESISTANCE

nce you understand the concept of a trend, the next major concept is that of support and resistance.
You'll often hear technical analysts talk about the ongoing battle between the bulls and the bears, or the
struggle between buyers (demand) and sellers (supply). This is revealed by the prices a security seldom
moves above (resistance) or below (support).

Figure 1

As you can see in Figure 1, support is the price level through which a stock or market seldom falls
(illustrated by the blue arrows). Resistance, on the other hand, is the price level that a stock or market

30
seldom surpasses (illustrated by the red arrows).

Why Does it Happen?

These support and resistance levels are seen as important in terms of market psychology and supply and
demand. Support and resistance levels are the levels at which a lot of traders are willing to buy the stock
(in the case of a support) or sell it (in the case of resistance). When these trend lines are broken, the
supply and demand and the psychology behind the stock's movements is thought to have shifted, in
which case new levels of support and resistance will likely be established.

Role Reversal
Once a resistance or support level is broken, its role is reversed. If the price falls below a support level,
that level will become resistance. If the price rises above a resistance level, it will often become support.
As the price moves past a level of support or resistance, it is thought that supply and demand has
shifted, causing the breached level to reverse its role. For a true reversal to occur, however, it is
important that the price make a strong move through either the support or resistance. (For further
reading, see Retracement Or Reversal: Know The Difference.)

Figure 2

For example, as you can see in Figure 2, the dotted line is shown as a level of resistance that has
prevented the price from heading higher on two previous occasions (Points 1 and 2). However, once the
resistance is broken, it becomes a level of support (shown by Points 3 and 4) by propping up the price
and preventing it from heading lower again.

Many traders who begin using technical analysis find this concept hard to believe and don't realize that
this phenomenon occurs rather frequently, even with some of the most well-known companies. For

31
example, as you can see in Figure 3, this phenomenon is evident on the Wal-Mart Stores Inc. (WMT)
chart between 2003 and 2006. Notice how the role of the $51 level changes from a strong level of
support to a level of resistance.

Figure 3

In almost every case, a stock will have both a level of support and a level of resistance and will trade in
this range as it bounces between these levels. This is most often seen when a stock is trading in a
generally sideways manner as the price moves through successive peaks and troughs, testing resistance
and support.

The Importance of Support and Resistance

Support and resistance analysis is an important part of trends because it can be used to make trading
decisions and identify when a trend is reversing. For example, if a trader identifies an important level of
resistance that has been tested several times but never broken, he or she may decide to take profits as the
security moves toward this point because it is unlikely that it will move past this level.
Support and resistance levels both test and confirm trends and need to be monitored by anyone who uses
technical analysis. As long as the price of the share remains between these levels of support and
resistance, the trend is likely to continue. It is important to note, however, that a break beyond a level of
support or resistance does not always have to be a reversal. For example, if prices moved above the
resistance levels of an upward trending channel, the trend has accelerated, not reversed. This means that
the price appreciation is expected to be faster than it was in the channel.

2.3 CHARTS AND CHART PATEERNS

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There are main types of charts used in technical analysis:
• Line charts
• Bar charts
• Candlestick charts
• Point and figure charts

A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future
price movements. Chartists use these patterns to identify current trends and trend reversals and to trigger
buy and sell signals.
In the first section of this tutorial, we talked about the three assumptions of technical analysis, the third
of which was that in technical analysis, history repeats itself. The theory behind chart patters is based on
this assumption. The idea is that certain patterns are seen many times, and that these patterns signal a
certain high probability move in a stock. Based on the historic trend of a chart pattern setting up a
certain price movement, chartists look for these patterns to identify trading opportunities.

Head and Shoulders

This is one of the most popular and reliable chart patterns in technical analysis. Head and shoulders is a
reversal chart pattern that when formed, signals that the security is likely to move against the previous
trend. As you can see in Figure 1, there are two versions of the head and shoulders chart pattern. Head
and shoulders top (shown on the left) is a chart pattern that is formed at the high of an upward
movement and signals that the upward trend is about to end. Head and shoulders bottom, also known
as inverse head and shoulders (shown on the right) is the lesser known of the two, but is used to signal a
reversal in a downtrend.

33
 Figure 1: Head and shoulders top is shown on the left. Head and shoulders bottom, or
inverse head and shoulders, is on the right.

Both of these head and shoulders patterns are similar in that there are four main parts: two shoulders, a
head and a neckline. Also, each individual head and shoulder is comprised of a high and a low. For
example, in the head and shoulders top image shown on the left side in Figure 1, the left shoulder is
made up of a high followed by a low. In this pattern, the neckline is a level of support or resistance.
Remember that an upward trend is a period of successive rising highs and rising lows. The head and
shoulders chart pattern, therefore, illustrates a weakening in a trend by showing the deterioration in the
successive movements of the highs and lows.

Cup and Handle

A cup and handle chart is a bullish continuation pattern in which the upward trend has paused but will
continue in an upward direction once the pattern is confirmed.

Figure 2

As you can see in Figure 2, this price pattern forms what looks like a cup, which is preceded by an
upward trend. The handle follows the cup formation and is formed by a generally downward/sideways
movement in the security's price. Once the price movement pushes above the resistance lines formed in
the handle, the upward trend can continue. There is a wide ranging time frame for this type of pattern,
with the span ranging from several months to more than a year.

Double Tops and Bottoms

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This chart pattern is another well-known pattern that signals a trend reversal - it is considered to be one
of the most reliable and is commonly used. These patterns are formed after a sustained trend and signal
to chartists that the trend is about to reverse. The pattern is created when a price movement tests support
or resistance levels twice and is unable to break through. This pattern is often used to signal
intermediate and long-term trend reversals.

Figure 3: A double top pattern is shown on the left, while a double bottom pattern is shown
on the right.
In the case of the double top pattern in Figure 3, the price movement has twice tried to move above a
certain price level. After two unsuccessful attempts at pushing the price higher, the trend reverses and
the price heads lower. In the case of a double bottom (shown on the right), the price movement has tried
to go lower twice, but has found support each time. After the second bounce off of the support, the
security enters a new trend and heads upward.

Triangles
Triangles are some of the most well-known chart patterns used in technical analysis. The three types of
triangles, which vary in construct and implication, are the symmetrical
triangle, ascending and descending triangle. These chart patterns are considered to last anywhere from a
couple of weeks to several months.

35
 Figure 4

The symmetrical triangle in Figure 4 is a pattern in which two trendlines converge toward each other.
This pattern is neutral in that a breakout to the upside or downside is a confirmation of a trend in that
direction. In an ascending triangle, the upper trendline is flat, while the bottom trendline is upward
sloping. This is generally thought of as a bullish pattern in which chartists look for an upside breakout.
In a descending triangle, the lower trendline is flat and the upper trendline is descending. This is
generally seen as a bearish pattern where chartists look for a downside breakout.

Flag and Pennant

These two short-term chart patterns are continuation patterns that are formed when there is a sharp price
movement followed by a generally sideways price movement. This pattern is then completed upon
another sharp price movement in the same direction as the move that started the trend. The patterns are
generally thought to last from one to three weeks.

36
 Figure 5

As you can see in Figure 5, there is little difference between a pennant and a flag. The main difference
between these price movements can be seen in the middle section of the chart pattern. In a pennant, the
middle section is characterized by converging trend lines, much like what is seen in a symmetrical
triangle. The middle section on the flag pattern, on the other hand, shows a channel pattern, with no
convergence between the trendlines. In both cases, the trend is expected to continue when the price
moves above the upper trendline.

Wedge
The wedge chart pattern can be either a continuation or reversal pattern. It is similar to a symmetrical
triangle except that the wedge pattern slants in an upward or downward direction, while the symmetrical
triangle generally shows a sideways movement. The other difference is that wedges tend to form over
longer periods, usually between three and six months.

Figure 6

The fact that wedges are classified as both continuation and reversal patterns can make reading signals
confusing. However, at the most basic level, a falling wedge is bullish and a rising wedge is bearish. In
Figure 6, we have a falling wedge in which two trendlines are converging in a downward direction. If

37
the price was to rise above the upper trendline, it would form a continuation pattern, while a move
below the lower trendline would signal a reversal pattern.

Gaps
A gap in a chart is an empty space between a trading period and the following trading period. This
occurs when there is a large difference in prices between two sequential trading periods. For example, if
the trading range in one period is between $25 and $30 and the next trading period opens at $40, there
will be a large gap on the chart between these two periods. Gap price movements can be found on bar
charts and candlestick charts but will not be found on point and figure or basic line charts. Gaps
generally show that something of significance has happened in the security, such as a better-than-
expected earnings announcement.

There are three main types of gaps, breakaway, runaway (measuring) and exhaustion. A breakaway gap
forms at the start of a trend, a runaway gap forms during the middle of a trend and an exhaustion gap
forms near the end of a trend.

Triple Tops and Bottoms

Triple tops and triple bottoms are another type of reversal chart pattern in chart analysis. These are not
as prevalent in charts as head and shoulders and double tops and bottoms, but they act in a similar
fashion. These two chart patterns are formed when the price movement tests a level of support or
resistance three times and is unable to break through; this signals a reversal of the prior trend.

38
Confusion can form with triple tops and bottoms during the formation of the pattern because they can
look similar to other chart patterns. After the first two support/resistance tests are formed in the price
movement, the pattern will look like a double top or bottom, which could lead a chartist to enter a
reversal position too soon.

Rounding Bottom
A rounding bottom, also referred to as a saucer bottom, is a long-term reversal pattern that signals a
shift from a downward trend to an upward trend. This pattern is traditionally thought to last anywhere
from several months to several years.

Figure 8

A rounding bottom chart pattern looks similar to a cup and handle pattern but without the handle. The
long-term nature of this pattern and the lack of a confirmation trigger, such as the handle in the cup and

39
handle, makes it a difficult pattern to trade.

2.4 THEORIES

DOW THEORY– TRENDS:

The ideas of Charles Dow, the first editor of the Wall Street Journal, form the basis of technical
analysis. The Dow theory is a method of interpreting and signaling changes in the stock market
direction based on the monitoring of the Dow Jones Industrial and Transportation Averages. Dow
created the Industrial Average, of top blue chip stocks, and a second average of top railroad stocks (now
the Transport Average). He believed that the behavior of the averages reflected the hopes and fears of
the entire market. The behavior patterns that he observed apply to markets throughout the world.
Three Movements
Markets fluctuate in more than one time frame at the same time:
Nothing is more certain than that the market has three well defined movements which fit into each other.
• The first is the daily variation due to local causes and the balance of buying and selling at that
particular time.
• The secondary movement covers a period ranging from ten days to sixty days, averaging
probably between thirty and forty days.
• The third move is the great swing covering from four to six years.

• Bull markets are broad upward movements of the market that may last several years, interrupted
by secondary reactions. Bear markets are long declines interrupted by secondary rallies. These
movements are referred to as the primary trend.

40
 • Secondary movements normally retrace from one third to two thirds of the primary trend since
the previous secondary movement.
• Daily fluctuations are important for short-term trading, but are unimportant in analysis of broad
market movements.
Various cycles have subsequently been identified within these broad categories.
Primary Movements have Three Phases
The general conditions in the market:
Bull markets
• Bull markets commence with reviving confidence as business conditions improve.
• Prices rise as the market responds to improved earnings
• Rampant speculation dominates the market and price advances are based on hopes and
expectations rather than actual results.
Bear markets
• Bear markets start with abandonment of the hopes and expectations that sustained inflated
prices.
• Prices decline in response to disappointing earnings.
• Distress selling follows as speculators attempt to close out their positions and securities are sold
without regard to their true value.

Trends
Bull Trends
A bull trend is identified by a series of rallies where each rally exceeds the highest point of the previous
rally. The decline, between rallies, ends above the lowest point of the previous decline.
Successive higher highs and higher lows.

41
The start of an up trend is signaled when price makes a higher low (trough), followed by a rally above
the previous high (peak):

Start = higher Low + break above previous High.

The end is signaled by a lower high (peak), followed by a decline below the previous low (trough):

End = lower High + break below previous Low.

A bear trend starts at the end of a bull trend: when a rally ends with a lower peak and then retreats below
the previous low. The end of a bear trend is identical to the start of a bull trend.

ELLIOT WAVES THEORY BASICS

TRENDLINES

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Breaking through support or resistance levels results in a change of traders’ expectations (which causes
supply/demand lines to shift).
An Uptrend is defined by successively higher low-prices. A rising trend can be thought of as a rising
support level: the bulls are in control and are pushing prices higher. A Downtrend is defined by
successively lower high-prices. A falling trend can be thought of as a falling resistance level: the bears
are in control and are pushing prices lower.

2.5 MOVING AVERAGES

Most chart patterns show a lot of variation in price movement. This can make it difficult for traders to
get an idea of a security's overall trend. One simple method traders use to combat this is to
apply moving averages. A moving average is the average price of a security over a set amount of time.
By plotting a security's average price, the price movement is smoothed out. Once the day-to-day
fluctuations are removed, traders are better able to identify the true trend and increase the probability
that it will work in their favor.There are a number of different types of moving averages that vary in the
way they are calculated, but how each average is interpreted remains the same. The calculations only
differ in regards to the weighting that they place on the price data, shifting from equal weighting of each
price point to more weight being placed on recent data. The three most common types of moving
averages are simple, linear and exponential.
Simple Moving Average (SMA)
This is the most common method used to calculate the moving average of prices. It simply takes the
sum of all of the past closing prices over the time period and divides the result by the number of prices

43
used in the calculation. For example, in a 10-day moving average, the last 10 closing prices are added
together and then divided by 10. As you can

Linear Weighted Average

This moving average indicator is the least common out of the three and is used to address the problem
of the equal weighting. The linear weighted moving average is calculated by taking the sum of all the
closing prices over a certain time period and multiplying them by the position of the data point and then
dividing by the sum of the number of periods. For example, in a five-day linear weighted average,
today's closing price is multiplied by five, yesterday's by four and so on until the first day in the period
range is reached. These numbers are then added together and divided by the sum of the multipliers.

Exponential Moving Average (EMA)

This moving average calculation uses a smoothing factor to place a higher weight on recent data points
and is regarded as much more efficient than the linear weighted average. Having an understanding of
the calculation is not generally required for most traders because most charting packages do the
calculation for you. The most important thing to remember about the exponential moving average is that
it is more responsive to new information relative to the simple moving average.

Major Uses of Moving Averages

Moving averages are used to identify current trends and trend reversals as well as to set up support and
resistance levels. Moving averages can be used to quickly identify whether a security is moving in an
uptrend or a downtrend depending on the direction of the moving average. As you can see in Figure 3,
when a moving average is heading upward and the price is above it, the security is in an uptrend.
Conversely, a downward sloping moving average with the price below can be used to signal a
downtrend.

44
 Figure 3

Another method of determining momentum is to look at the order of a pair of moving averages. When a
short-term average is above a longer-term average, the trend is up. On the other hand, a long-term
average above a shorter-term average signals a downward movement in the trend.
Moving average trend reversals are formed in two main ways: when the price moves through a moving
average and when it moves through moving average crossovers. The first common signal is when the
price moves through an important moving average. For example, when the price of a security that was
in an uptrend falls below a 50-period moving average, like in Figure 4, it is a sign that the uptrend may
be reversing.

Figure 4

The other signal of a trend reversal is when one moving average crosses through another. For example,
as you can see in Figure 5, if the 15-day moving average crosses above the 50-day moving average, it is
a positive sign that the price will start to increase.

45
 Figure 5

If the periods used in the calculation are relatively short, for example 15 and 35, this could signal a
short-term trend reversal. On the other hand, when two averages with relatively long time frames cross
over (50 and 200, for example), this is used to suggest a long-term shift in trend.
Another major way moving averages are used is to identify support and resistance levels. It is not
uncommon to see a stock that has been falling stop its decline and reverse direction once it hits the
support of a major moving average. A move through a major moving average is often used as a signal
by technical traders that the trend is reversing. For example, if the price breaks through the 200-day
moving average in a downward direction, it is a signal that the uptrend is reversing.

Figure 6

Moving averages are a powerful tool for analyzing the trend in a security. They provide useful support
and resistance points and are very easy to use. The most common time frames that are used when
creating moving averages are the 200-day, 100-day, 50-day, 20-day and 10-day. The 200-day average is
thought to be a good measure of a trading year, a 100-day average of a half a year, a 50-day average of a
quarter of a year, a 20-day average of a month and 10-day average of two weeks.

2.6 INDICATORS

46
Accumulation/Distribution Line
The accumulation/distribution line is one of the more popular volume indicators that measures money
flows in a security. This indicator attempts to measure the ratio of buying to selling by comparing the
price movement of a period to the volume of that period.
Calculated:

Acc/Dist = ((Close - Low) - (High - Close)) /

(High - Low) * Period's Volume

This is a non-bounded indicator that simply keeps a running sum over the period of the security. Traders
look for trends in this indicator to gain insight on the amount of purchasing compared to selling of a
security. If a security has an accumulation/distribution line that is trending upward, it is a sign that there
is more buying than selling.

Average Directional Index (ADX)

The average directional index (ADX) is a trend indicator that is used to measure the strength of a current
trend. The indicator is seldom used to identify the direction of the current trend, but can identify the
momentum behind trends.
The ADX is a combination of two price movement measures: the positive directional indicator (+DI)
and the negative directional indicator (-DI). The ADX measures the strength of a trend but not the
direction. The +DI measures the strength of the upward trend while the -DI measures the strength of the
downward trend. These two measures are also plotted along with the ADX line. Measured on a scale
between zero and 100, readings below 20 signal a weak trend while readings above 40 signal a strong
trend.

Moving Average Convergence Divergence (MACD)

The moving average convergence divergence (MACD) is one of the most well known and used
indicators in technical analysis. This indicator is comprised of two exponential moving averages, which
help to measure momentum in the security. The MACD is simply the difference between these two
moving averages plotted against a centerline. The centerline is the point at which the two moving

47
averages are equal. Along with the MACD and the centerline, an exponential moving average of the
MACD itself is plotted on the chart. The idea behind this momentum indicator is to measure short-term
momentum compared to longer term momentum to help signal the current direction of momentum.

MACD= shorter term moving average - longer term

moving average

When the MACD is positive, it signals that the shorter term moving average is above the longer term
moving average and suggests upward momentum. The opposite holds true when the MACD is negative
- this signals that the shorter term is below the longer and suggest downward momentum. When the
MACD line crosses over the centerline, it signals a crossing in the moving averages. The most common
moving average values used in the calculation are the 26-day and 12-day exponential moving averages.
The signal line is commonly created by using a nine-day exponential moving average of the MACD
values. These values can be adjusted to meet the needs of the technician and the security. For more
volatile securities, shorter term averages are used while less volatile securities should have longer
averages.
As you can see in Figure 2, one of the most common buy signals is generated when the MACD crosses
above the signal line (blue dotted line), while sell signals often occur when the MACD crosses below
the signal.

Figure 2

The relative strength index (RSI) is another one of the most used and well-known momentum indicators
in technical analysis. RSI helps to signal overbought and oversold conditions in a security. The indicator

48
is plotted in a range between zero and 100. A reading above 70 is used to suggest that a security is
overbought, while a reading below 30 is used to suggest that it is oversold. This indicator helps traders
to identify whether a security’s price has been unreasonably pushed to current levels and whether a
reversal may be on the way.

Figure 3

The standard calculation for RSI uses 14 trading days as the basis, which can be adjusted to meet the
needs of the user. If the trading period is adjusted to use fewer days, the RSI will be more volatile and
will be used for shorter term trades.

On-Balance Volume
The on-balance volume (OBV) indicator is a well-known technical indicator that reflect movements in
volume. It is also one of the simplest volume indicators to compute and understand.
The OBV is calculated by taking the total volume for the trading period and assigning it a positive or
negative value depending on whether the price is up or down during the trading period. When price is
up during the trading period, the volume is assigned a positive value, while a negative value is assigned
when the price is down for the period. The positive or negative volume total for the period is then added
to a total that is accumulated from the start of the measure.
It is important to focus on the trend in the OBV - this is more important than the actual value of the
OBV measure. This measure expands on the basic volume measure by combining volume and price
movement

Stochastic Oscillator

49
The stochastic oscillator is one of the most recognized momentum indicators used in technical analysis.
The idea behind this indicator is that in an uptrend, the price should be closing near the highs of the
trading range, signaling upward momentum in the security. In downtrends, the price should be closing
near the lows of the trading range, signaling downward momentum.
The stochastic oscillator is plotted within a range of zero and 100 and signals overbought conditions
above 80 and oversold conditions below 20. The stochastic oscillator contains two lines. The first line is
the %K, which is essentially the raw measure used to formulate the idea of momentum behind the
oscillator. The second line is the %D, which is simply a moving average of the %K. The %D line is
considered to be the more important of the two lines as it is seen to produce better signals. The
stochastic oscillator generally uses the past 14 trading periods in its calculation but can be adjusted to
meet the needs of the user.

Figure 4

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 CHAPTER- 3
FUNDAMENTAL ANALYSIS
A CONCEPTUAL OVERVIEW

FUNDAMENTALANALYSIS

51
Fundamental analysis refers to the study of the core underlying elements that influence the economy
of a particular entity. It is a method of study that attempts to predict price action and market trends by
analyzing economic indicators, government policy and societal factors (to name just a few elements)
within a business cycle framework.

I. ECONOMIC ANALYSIS:

POLITICO-ECONOMIC ANALYSIS:
No industry or company can exist in isolation. It may have splendid managers and a tremendous
product. However, its sales and its costs are affected by factors, some of which are beyond its control -
the world economy, price inflation, taxes and a host of others. It is important, therefore, to have an
appreciation of the politico-economic factors that affect an industry and a company.

II. INDUSTRY ANALYSIS

The importance of industry analysis is now dawning on the Indian investor as never before.

1. BARRIER TO ENTRY
New entrants increase the capacity in an industry and the inflow of funds. The question that arises is
how easy is it to enter an industry ?
There are some barriers to entry:
a) Economies of scale
b) Product differentiation
c) Capital requirement
d) Government policy

2. THE THREAT OF SUBSTITUTION

New inventions are always taking place and new and better products replace existing ones. An industry
that can be replaced by substitutes or is threatened by substitutes is normally an industry one must be
careful of investing in. An industry where this occurs constantly is the packaging industry -bottles

52
replaced by cans, cans replaced by plastic bottles, and the like. To ward off the threat of substitution,
companies often have to spend large sums of money in advertising and promotion.

3. BARGAINING POWER OF THE BUYERS

In an industry where buyers have control, i.e. in a buyer's market, buyers are constantly forcing prices
down, demanding better services or higher quality and this often erodes profitability.

4. BARGAINING POWER FOR THE SUPPLIERS

An industry unduly controlled by its suppliers is also under threat.

5. RIVALRY AMONG COMPETITORS

Rivalry among competitors can cause an industry great harm. This occurs mainly by price cuts, heavy
advertising, additional high cost services or offers, and the like.

III. COMPANY ANALYSIS:

At the final stage of fundamental analysis, the investor analyzes the company. This analysis has two
thrusts:
How has the company performed vis-à-vis other similar companies and
How has the company performed in comparison to earlier years
It is imperative that one completes the politico economic analysis and the industry analysis before a
company is analyzed because the company's performance at a period of time is to an extent a reflection
of the economy, the political situation and the industry. What does one look at when analyzing a
company?
The different issues regarding a company that should be examined are:
The Management
The Company
The Annual Report
Ratios

THE MANAGEMENT:

53
The single most important factor one should consider when investing in a company and one often never
considered is its management.
In India management can be broadly
divided in two types:
Family Management
Professional Management

THE COMPANY:
An aspect not necessarily examined during an analysis of fundamentals is the company. A company
may have made losses consecutively for two years or more and one may not wish to touch its shares -
yet it may be a good company and worth purchasing into. There are several factors one should look at.

1. How a company is perceived by its competitors?

One of the key factors to ascertain is how a company is perceived by its competitors. It is held in high
regard. Its management may be known for its maturity, vision, competence and aggressiveness. The
investor must ascertain the reason and then determine whether
the reason will continue into the foreseeable future.

2. Whether the company is the market leader in its products or in its segment
Another aspect that should be ascertained is whether the company is the market leader in its products or
in its segment. When you invest in market leaders, the risk is less. The
shares of market leaders do not fall as quickly as those of other companies. There is a magic to their
name that would make individuals prefer to buy their products as opposed to others.

3. Company Policies
The policy a company follows is also important. What is its plans for growth? What is its vision? Every
company has a life. If it is allowed to live a normal life it will grow upto a point and then begin to level
out and eventually die. It is at the point of leveling out that it must be given new life. This can give it
renewed vigour and a new lease of life.

THE ANNUAL REPORT:

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The primary and most important source of information about a company is its Annual Report. By law,
this is prepared every year and distributed to the shareholders. Annual Reports are usually very well
presented. A tremendous amount of data is given about the performance of a company over a period of
time.
The Annual Report is broken down into the following specific parts:
A) The Director's Report,
B) The Auditor's Report,
C) The Financial Statements, and
D) The Schedules and Notes to the Accounts.

A. THE DIRECTOR’S REPORT

The Director’s Report is a report submitted by the directors of a company to its shareholders, advising
them of the performance of the company under their stewardship.
1. It enunciates the opinion of the directors on the state of the economy and the political situation vis-à-
vis the company.
2. Explains the performance and the financial results of the company in the period under review. This is
an extremely important part. The results and operations of the various separate divisions are usually
detailed and investors can determine the reasons for their good or bad performance.
3. The Director’s Report details the company's plans for modernization, expansion and diversification.
Without these, a company will remain static and eventually decline.
4. Discusses the profit earned in the period under review and the dividend. Recommended by the
directors. This paragraph should normally be read with some skepticism, as the directors will always
argue that the performance was satisfactory. If adverse economic conditions are usually at fault.
5. Elaborates on the directors' views of the company's prospects in the future.
6. Discusses plans for new acquisition and investments. An investor must intelligently evaluate the
issues raised in a Director’s Report. Industry conditions and the management's knowledge of the
business must be considered.

B. THE AUDITOR'S REPORT

The auditor represents the shareholders and it is his duty to report to the shareholders and the general
public on the stewardship of the company by its directors. Auditors are required to report whether the

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financial statements presented do, in fact, present a true and fair view of the state of the company.
Investors must remember that the auditors are their representatives and that they are required by law to
point out if the financial statements are not true and fair..

C. FINANCIAL STATEMENTS
The published financial statements of a company in an Annual Report consist of its Balance Sheet as at
the end of the accounting period detailing the financing condition of the company at that date, and the
Profit and Loss Account or Income Statement summarizing the activities of the company for the
accounting period.

Balance sheet
The Balance Sheet details the financial position of a company on a particular date; of the company's
assets (that which the company owns), and liabilities (that which the company
owes), grouped logically under specific heads. It must however, be noted that the Balance Sheet details
the financial position on a particular day and that the position can be materially different on the next day
or the day after.

SOURCES OF FUNDS
Shareholders Funds
Share Capital
(i) Private Placement
(ii) Public Issue
iii) Rights issues
RESERVES
i) Capital Reserves
ii) Revenue Reserves
LOAN FUNDS
i) Secured loans:
ii) Unsecured loans
FIXED ASSETS
Investments

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Stock Or Inventories
i) Raw materials
ii) Work in progress
iii) Finished goods
Cash And Bank Balances
Loans And Advances

PROFIT AND LOSS ACCOUNT

The Profit and Loss account summarizes the activities of a company during an accounting period which
may be a month, a quarter, six months, a year or longer, and the result achieved by the company. It
details the income earned by the company, its cost and the resulting profit or loss. It is, in effect, the
performance appraisal not only of the company but also of its management- its competence, foresight
and ability to lead.
RATIOS:
Ratios express mathematically the relationship between performance figures and/or assets/liabilities in a
form that can be easily understood and interpreted.
No single ratio tells the complete story
Ratios can be broken down into four broad categories:
(A) Profit and Loss Ratios
These show the relationship between two items or groups of items in a profit and loss account or income
statement. The more common of these ratios are:
(B) Balance Sheet Ratios
These deal with the relationship in the balance sheet such as :
1. Current assets to current liabilities.
2. Liabilities to net worth.
(C) Balance Sheet and Profit and Loss Account Ratios.
These relate an item on the balance sheet to another in the profit and loss account such as:
1. Earnings to shareholder's funds.
2. Net income to assets employed.
(D) Financial Statements and Market Ratios

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These are normally known as market ratios and are arrived at by relative financial figures to market
prices:
1. Market value to earnings and
2. Book value to market value.
(a) Market value
(b) Earnings
(c) Profitability
The major ratios that are considered:
(i) Market value
(ii) Price- earnings ratio
(iii) Market-to-book ratio
(iv) Earnings
(v) Earnings per share
(vi) Dividend per share

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 CHAPTER- 4
BANKING SECTOR

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4.1 BANKING IN INDIA

The Indian banking scenario witnessed a significant development in the recent years with the entry of
private banks and their focus on retail banking and convergence of services. The business models of
the leading players are adapting to this impending change as banks widen the spectrum of savings and
loan products they offer. Private Banks are the best positioned to acquire market share in the emerging
scenario: A change is expected to make mergers between banks and Foreign Institutional Investors
possible, which will. Benefit large private bank group(s).

Nationalization
A significant milestone in Indian Banking happened in the late 1960s when the then Indira Gandhi
government nationalized, on 19th July, 1969, 14 major commercial Indian banks, followed by
nationalization of 6 more commercial Indian banks in 1980. The stated reason for the nationalization
was more control of credit delivery. After this, until the 1990s, the nationalized banks grew at a
leisurely pace of around 4%-also called as the Hindu growth of the Indian economy.
After the amalgamation of New Bank of India with Punjab National Bank, currently there are 59
nationalized banks in India.

Liberalization
In the early 1990s the then Narasimha Rao government embarked on a policy of liberalization and gave
licenses to a small number of private banks, which came to be known as New Generation tech-savvy
banks, which included banks like ICICI Bank and HDFC Bank. This move along with the rapid growth
in the economy of India, kick started the banking sector in India, which has seen rapid growth with
strong contribution from all the three sectors of banks, namely, government banks, private banks and
foreign banks. However there had been a few hiccups for these new banks with many either being taken
over like Global Trust Bank while others like Centurion Bank have found the going tough.

The next stage for the Indian banking has been setup with the proposed relaxation in the norms for
Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could
exceed the present cap of 10%.

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4.2 CURRENT SCENARIO
The growth in the Indian Banking Industry has been more qualitative
than quantitative and it is expected to remain the same in the coming
years. Based on the projections made in the "India Vision 2020" prepared
by the Planning Commission and the Draft 10th Plan, the report forecasts
that the pace of expansion in the balance-sheets of banks is likely to
decelerate. The total assets of all scheduled commercial banks by end-
March 2010 is estimated at Rs 40,90,000 crores. That will comprise about
65 per cent of GDP at current market prices as compared to 67 per cent
in 2002-03. Bank assets are expected to grow at an annual composite
rate of 13.4 per cent during the rest of the decade as against the growth
rate of 16.7 per cent that existed between 1994-95 and 2002-03. It is
expected that there will be large additions to the capital base and
reserves on the liability side.
The Indian Banking Industry can be categorized into non-scheduled
banks and scheduled banks. Scheduled banks constitute of commercial
banks and co-operative banks. There are about 67,000 branches of
Scheduled banks spread across India. As far as the present scenario is
concerned the Banking Industry in India is going through a transitional
phase.
The Public Sector Banks(PSBs), which are the base of the Banking sector
in India account for more than 78 per cent of the total banking industry
assets. Unfortunately they are burdened with excessive Non Performing
assets (NPAs), massive manpower and lack of modern technology. On the
other hand the Private Sector Banks are making tremendous progress.
They are leaders in Internet banking, mobile banking, phone banking,
ATMs. As far as foreign banks are concerned they are likely to succeed in
the Indian Banking Industry.

In the Indian Banking Industry some of the Private Sector

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Banks operating are IDBI Bank, ING Vyasa Bank,SBI Commercial and
International Bank Ltd, Bank of Rajasthan Ltd. and banks from the Public
Sector include Punjab National bank, Vijaya Bank, UCO Bank, Oriental
Bank, Allahabad Bank among others. ANZ Grindlays Bank, ABN-AMRO Bank,
American Express Bank Ltd, Citibank are some of the foreign banks
operating in the India

FUTURE OUTLOOK

• Total banking assets are expected to double and grow to $915 billion by 2015 - a CAGR of 15%
• $70 billion additional equity needed for growth plus Basel II compliance
• Mutual Funds: Assets Under Management (AUM) are expected to grow by 15% till 2015
• Retail Finance is expected to grow at an annual rate of 18%, from $27.6 billion in 2003-04 to
$64.2 billion by 2011-12

4.3 FUTURE POTENTIALS

Loan growth of ~20%, operating leverage and fall in credit cost will drive banking sector's profitability
over FY12 and FY13. Margins, even with some moderation from their peaks in 3QFY11, would be
above/near the average level of FY04-09. Higher recoveries could provide positive surprise to earning
estimates (write-offs were aggressive over FY09 and FY10 to keep reported GNPAs lower). We expect
banks to report 20%+ earnings growth on an aggregate basis and return ratios to be healthy with RoA of
1.1%+ and RoE of ~18%. Valuations at P/E of 8x and P/BV of 1.3x for PSU banks and P/E of 16x and
P/BV of 2.3x for private banks are at the five-year average multiples, despite strong core operating
performance expected.

Margins robust; to remain above/near FY04-09 average levels

• Downward deposit re-pricing, fall in excess liquidity on the balance sheet, better

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 pricing power (led by a liquidity crunch and a higher CD ratio) and stronger CASA
growth led to a sharp improvement in margins in 9MFY11. Overall, FY11 blended
margins are expected to be ~50bp higher YoY, driving core operating profits.
• Given the tight liquidity and rising rates scenario, margins are unlikely to fall in a
hurry, and gradual moderations have been factored in estimates. As FY11 is amongst
the best year of margins for Indian banks, we expect margins to moderate 10-
20bp (bank specific), but to remain above/near the average margins of FY04-09.
• Banks that reported higher slippages over the past two years are likely to have
lower margin compression because of expected improvement in asset quality.
• Our sensitivity analysis suggests that for every 5bp change in margins, profits will
be impacted by ~3%. With a 1% fall in CASA ratio and a 1% fall in CD ratio,
margins are likely to compress by 5bp and 7bp, respectively.

Asset quality improvement; lower credit cost to drive earnings growth

• Banks added higher stressed assets over FY09-11 due to fall out of the financial
crisis and moderation in economic growth. However, incremental trends on asset
quality are positive. Over the last two quarters, the slippage ratio has been coming
down and we expect the trend to continue in 4QFY11 and FY12. In our view, large
corporate and retail delinquencies and slippages from restructured loans have
peaked.
• Private banks are well placed in terms of asset quality as retail delinquencies have peaked and
due to conservative restructuring policy adopted in the past.
• Banks like SBI, PNB and Union Bank, which posted higher slippages, can surprise positively
with a fall in slippages, higher up gradation and recoveries.
• Lower slippages, higher up gradations and recoveries should reduce credit costs and drive
earnings growth. Risk to our call is slowdown in industrial growth led by possible shocks on
crude oil prices and delay in project implementation. Technical slippages on account of CBS
implementation can also lead to negative surprise for PSU banks.
Operating leverage - a key driver for RoA improvement

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 • PSU banks' operating cost growth will peak in FY11 as full pension provisions for retired
employees and wage revision will be provided for. On a higher base, we expect opex growth to
be limited to 15%, providing banks with strong operating leverage.
• Private banks’ operating expenses will rise with wage and rental inflation, and large scale branch
expansion. However, due to strong core operating income, we expect C/I ratio to remain stable.
Valuations at five-year average multiples; inflation remains a key risk
• Banks' core operating performance is likely to be strong led by improving asset quality and
operating leverage. We believe valuations are attractive with stocks trading at five-year average
multiples.
• Correction in valuations from their peaks largely discount some of the macro headwinds such as
tight liquidity, a sharp increase in interest rates, high inflation and mixed key economic
indicators like IIP.
• Net market borrowing of Rs3.6t for FY12 (including T Bills of Rs150b) is below the market
estimates of Rs3.8t+. Lower-than-expected fiscal deficit is positive for domestic liquidity and
will allay fears of crowding out for private players.
• Food inflation, which is showing a decelerating trend, gives confidence of moderation in
inflation. However, turmoil in the MENA region and its resultant impact on oil prices and
inflation is a key risk.
• Some of the key regulatory headwinds, such as savings bank deregulation and change in the
status of certain loans granted by banks to NBFCs as priority sector loans (PSL) etc, are specific
risks.

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4.4 BANKING STRUCTURE IN INDIA

The banking institutions in the organized sector, commercial banks are the oldest institutions, some
them having their genesis in the nineteenth century. Initially they were set up in large numbers, mostly
as corporate bodies with shareholding with private individuals. In the sixties of the 20 th century a large
number of smaller and weaker banks emerged in the country. Subsequently there has been a drift
towards state ownership and control. Today 27 banks constitute a strong Public Sector in Indian
Commercial Banking.

Commercial Banks operating in India fall under the different sub categories on the basis of their
ownership and control over management.

1. Public Sector Banks: Public Sector Banks emerged in India in three stages. First the
conversion of the then existing Imperial Bank of India into State Bank of India in 1955,
followed by the taking over of the seven associated banks as its subsidiary. Second the
nationalization of 14 major commercial banks in 1969and last the nationalization of 6 more
commercial Bank in 1980. Thus 27 banks constitute the Public Sector Banks.

2. New Private Sector Banks: after the nationalization of the major banks in the private sector in
1969 and 1980, no new bank could be setup in India for about two decades, though there was
no legal bar to that effect. The Narasimham Committee on financial sector reforms
recommended the establishment of new banks of India. RBI thereafter issued guidelines for
setting up of new private sector banks in India in January 1993.

These guidelines aim at ensuring that new banks are financially viable and technologically up to
date from the start. They have to work in a professional manner, so as to improve the
image of commercial banking system and to win the confidence of the public.

Eight private sector banks have been established including banks sector by financially institutions
like IDBI, ICICI, and UTI etc.

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Fig 1: Banking Structure in India

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3. Local Area Banks: Such Banks can be established as public limited companies in the private
sector and can be promoted by individuals, companies, trusts and societies. The minimum paid
up capital of such banks would be 5 crores with promoters contribution at least Rs. 2 crores.
They are to be set up in district towns and the area of their operations would be limited to a
maximum of 3 districts. At present, four local area banks are functional, one each in Punjab,
Gujarat, Maharashtra and Andhra Pradesh.

4. Foreign Banks: foreign commercial banks are the branches in India of the joint stock banks
incorporated abroad. .

5. Cooperative Banks: Besides the commercial banks, there exists in India another set of banking
institutions called cooperative credit institutions. These have been made in existence in India
since long. They undertake the business of banking both in urban and rural areas on the
principle of cooperation. They have served a useful role in spreading the banking habit
throughout the country. Yet, there financial position is not sound and a majority of cooperative
banks has yet to achieve financial viability on a sustainable basis.

The cooperative banks have been set up under various Cooperative Societies Acts enacted by
State Governments. Hence the State Governments regulate these banks. In 1966, need was felt to
regulate their activities to ensure their soundness and to protect the interests of depositors.
Consequently, certain provisions of the Banking Regulation Act 1949 were made applicable to the
cooperative Banks as well. These Banks have thus fallen under dual control viz., that of the
State Government and tat of the RBI which exercises control over them so far as their banking
Operations are concerned.

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CHAPTER- 4

ANALYSIS

SBI

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 Brief Company Profile: ICICI BANK

ICICI Bank is India's second-largest bank with total assets of Rs. 3,634.00 billion (US$ 81 billion) at
March 31, 2010 and profit after tax Rs. 40.25 billion (US$ 896 million) for the year ended March 31,
2010. The Bank has a network of 2,529 branches and 6,102 ATMs in India, and has a presence in 19
countries, including India. ICICI Bank offers a wide range of banking products and financial services to
corporate and retail customers through a variety of delivery channels and through its specialized
subsidiaries in the areas of investment banking, life and non-life insurance, venture capital and asset
management.
The Bank currently has subsidiaries in the United Kingdom, Russia and Canada, branches in United
States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai International Finance Centre and
representative offices in United Arab Emirates, China, South Africa, Bangladesh, Thailand, Malaysia
and Indonesia. Our UK subsidiary has established branches in Belgium and Germany.

Key Executives
Mr. Kundapur Vaman Kamath
Chairman
Smt. Vishakha Mulye
Chief Financial Officer

Mrs. Chanda Kochhar

Managing Director & CEO

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 Brief Company Profile: STATE BANK OF INDIA

State Bank of India, the country’s largest commercial Bank in terms of profits, assets, deposits,
branches and employees, welcomes you to its ‘Investors Relations’ Section. SBI, with its heritage
dating back to the year 1806, strives to continuously provide latest and upto date information on
its financial performance. It is our endeavor to walk on the path of transparency and allow
complete access to all the stakeholders enabling total awareness about the Bank. The Bank
communicates with the stakeholders through a variety of channels, such as through e-mail,
website, conference call, one-on-one meeting, analysts’ meet and attendance at Investor
Conference throughout the world

Please find below Bank’s financial results, analysis of performance and other highlights which will
be of interest to Investors, Fund Managers and Analysts. SBI has always been fundamentally
strong in its core business which is mirrored in its results – year after year.

Key Executives
Mr. O. P. Bhatt
Chairman

Mr.R. Shridharan
Managing director

Mr.Dileep Choksi
Director

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 Brief Company Profile: YES BANK

YES BANK is a state-of-the-art high quality, customer centric, service driven, private Indian Bank
catering to the “Future Businesses of India”, and is an outcome of the professional & entrepreneurial
commitment of Rana Kapoor, Founder, Managing Director & CEO. As the Professionals’ Bank of
India, YES BANK has exemplified ‘creating and sharing value’ for all its stakeholders, and has created
a differentiated Banking Paradigm. Since inception, YES BANK has tried to play a catalytic role in
bridging the infrastructure and knowledge gap in various Sunrise sectors of the economy. As part of the
differentiated strategy, YES BANK has had a strong focus on Development Banking, and has tried to
play a catalytic role in bridging the infrastructure and knowledge gap in Sunrise sectors of the
economy, asis evident from cutting-edge work that the Bank has done in the area of Food &
Agribusiness, in most cases first-of-its kind in India, Infrastructure, Microfinance, and Sustainability.
Our focus onGovernanceand Good Corporate Citizenship, actualized through YES
BANK’s Responsible Banking approach, stands evidence of YES BANK’s strategic vision.

Key Executives
Mr. Rana Kapoor
Managing director& CEO

Mr. Sipko Schat

Vice Chairman
Mr. Bharat Patel
Independent Director

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 1. FINDINGS & CONCLUSION

Stock Target Price (Rs) Recommendation

ICICI Bank 1385 BUY

State Bank of India 3550 BUY

Yes Bank 380 BUY

Current scenario suggests, markets are on a bullish run, especially in case of Banking Industry.
Analysis suggests that all the chosen stocks i.e. ICICI Bank, State Bank of India and Yes Bank are
going to perform well, with huge potential of earnings for equity holders.

It is recommended to increase the investment in Banks.

Stock P/E ratio

ICICI Bank 30.48

State Bank of India 17.46

Yes Bank 16.71

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 BIBLIOGRAPHY

Websites Referred:

www.moneycontrol.com
www.myiris.com
www.indiaearnings.moneycontrol.com
http://finance.yahoo.com
www.wikipedia.org
www.reuters.com
www.valuenotes.com
www.icicibank.com
www.investopedia.com
www.statebankofindia.com
www.yesbank.in

Reports Referred:

Motilal Oswal report on banking sector

India Infoline report on ICICI Bank’s

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