TRAINING REPORT ON

FUNCTIONING AND TECHNICAL ANALYSIS IN STOCK EXCHANGES IN INDIA

For the training under gone at

KARNAL BRANCH

In the partial fulfillment of MBA - 5 - Year Degree

SUBMITTED TO:
Dr. B. S. Bodla Director IMS, KUK

PRESENTED BY:
Harshul Nagpal 6th Semester Roll No: 50 Reg. No. 08 UD 1136 Batch 2008-13

Institute of Management Studies,

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Kurukshetra University, Kurukshetra.

DECLARATION

I, Harshul Nagpal hereby declare that I have completed the project, entitled Functioning and Technical Analysis in Stock Exchanges in India provided by the Branch Manager of SPA Securities at the training. This report is to be submitted in the partial fulfillment of MBA-5-Year Degree from Kurukshetra University. Further I declare that this is original work done by me and the information provided in the study is authentic to the best of my knowledge and belief. My training period was from 04-01-2011 to 28-01-2011. This study has not been submitted to any other institution or University for the award of any other degree or for any purpose. Dated: 11-03-2011

HARSHUL NAGPAL 6th Semester Roll No.-50

ACKNOWLEDGEMENT
First of all, Id like to thank the department, Institute of Management Studies, for giving us such a creative idea, of going through a training program and preparing a report on its basis, which will help us in developing our skill in corporate sector, beforehand. Further Id also like to mention the name of the Departments Library from where I got the books for having the matter for my Training Report. I am also thankful to all the authors and publishers whose works have been quoted in the present study. I would also like to mention the name of Dr. S. P. Sinha, retired professor in Geography, Kurukshetra University, Kurukshetra; under whose guidance and consultation I was able to do the needful for the creation of this Training Report. I am also thankful to my Training Executive, Mr. Vikas Nagpal, Branch Manager, SPA Securities, Karnal, who also guided me for the preparation of the training report and provided me the useful matter for the report. My sincere thanks are also due to my family who always motivated me throughout this project and especially my father, Dr. I. J. Nagpal, without whose guidance this work would not been possible. I am thankful to him for his valuable suggestions, ideas, ways and guidance. My heartiest gratitude is also due to my mother, Mrs. Neeta Nagpal and sister, Arunima Nagpal because without their support and motivation, any work of mine could not be a success. At last, and most importantly, Id like to thank my Seniors, because without their guidance about the preparation and presentation of report, I would not have been able to handle this project.

HARSHUL NAGPAL 6th Semester Roll No.-50 5

CONTENTS
Acknowledgement

4
1. Company

Profile

7
Introduction Milestones Services Other Services

2. Overview

of

Stock

Exchange

12
Introduction to Stock Exchange Stock Market Meaning of Stock Exchange Definitions of Stock Exchange Primary Markets Functions of Stock Exchange Services of Stock Exchange Evaluation of Stock Exchange Management of Stock Exchange Regulation of Stock Exchanges History of Stock Exchanges in India Trading Procedure in a Stock Exchange 6

How Business is Transacted in a Stock Exchange Speculation and Stock Exchange Major Defects in Trading in Indian Stock Exchanges Suggestions for Stock Exchange Reform

Introduction to Technical Analysis

Introduction Technical Analysis: The Basic Assumptions Difference between Fundamental Analysis and Technical Analysis The Use of Trend Support and Resistance The Importance of Volume What is a Chart? Chart Types Chart Patterns Technical Indicators Five Ways That Technical Analysis Can Fail Conclusion

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66
Bibliography

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Chapter - 1

COMPANY PROFILE

Introduction
SPA Group was promoted by a team of finance professionals in 1995 with an objective to provide value added financial services. Initially, the Group focused as a niche financial solutions provider in corporate finance and wealth management to Indian companies and high net worth individuals. In January 2000, the Group expanded its operations and the range of services. Today, SPA provides services for securities broking, merchant banking, wealth management, financial advisory, corporate finance, risk management and insurance broking. SPA is being managed by its promoters along with a young and dynamic team of over 1000+ professionals with rich experience, in their respective fields. The Group has established itself as one of Indias leading financial advisory house, offering various financial solutions to its Institutional, corporate and individual clients.

Customer centric approach of SPAs dedicated professional team has helped carve a niche for itself in financial services arena and won confidence of its clients. Clients of SPA are from a wide spectrum and comprise of Banks and other financial institutions, Mutual funds, Insurance companies, foreign institutional investors, public sector undertakings and government departments, private corporate, trusts and individuals. Milestones / Achievements Since 1994, with the coming into existence of the SPA Group, we have diversified into a complete financial solution providing house, catering varied needs of our clients ranging from investment advisory services to investment banking, corporate re-structuring, distribution and broking services, risk management and insurance advisory. Within a short span of time, the Group has made a place for itself in the midst of the top financial solutions provider in the country.

Securities Broking SPA Securities Ltd. is registered member of NSE-WDM segment, Capital Market segment and Futures and Options segment. The company is also a member of The Stock Exchange, Mumbai. SPA Comtrade Pvt. Ltd. is the commodities broking company of the group and is a member of NCDEX and MCX. The Company has dedicated teams operating from a state of the art dealing room in Mumbai for equity, debt and derivatives broking supported by a strong in-house research team. Debt Broking The division is engaged in providing debt advisory and broking services to institutional, semi-institutional and retail customers. The company caters to a wide range of investors across the country ranging from Provident Funds, Banks, Corporate Treasuries, Financial Institutions, Mutual Funds, Educational, Religious and Charitable Trusts, Insurance Companies, HNI's etc. The company deals in Government Securities, Treasury Bills, Commercial Papers, Certificate of Deposits, PSU, SLU and Corporate Bonds and other debt instruments. With its nationwide network providing institutional broking services the company has executed business of over Rs. 300 Billion in last 3 years. Equity Broking The Company is engaged in equity research and broking for its institutional clients. On strength of its research and impeccable servicing the Company in its first year of operation in equity broking is empanelled with all the major domestic institutional players and has achieved a turnover of over Rs. 1,600 crores. Commodities Broking SPA Comtrade Pvt. Ltd., the commodities broking arm of the group has recently commenced operations. The company is catering to existing customers of the group by providing research based commodity broking services. Insurance

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SPA Insurance Broking Services Ltd is the insurance broking company of the group providing life and general insurance advisory services. Life Insurance advisory services are process oriented, which include identification of the needs of the clients, offering the best product available, resolution of their queries and post sales service. The company has covered over 2000 lives in 18 months of business with sum assured of over Rs. 20 billion and premium collection of over Rs.3.5 billion. Mutual Funds The SPA Group, on strength of its research based customer centric approach and impeccable servicing, is recognized as one of the leading financial advisory service providers in the country. SPA Capital Services Ltd., the flagship company of the group provides investment advisory services. The company is engaged in advisory and distribution services of mutual funds and is ranked amongst top 10 intermediaries in the country. The Company provides customized solutions to the requirements of High Net worth Individuals and Corporate clients. Our strength lies in our ability to advice on investment strategies and structures, developing innovative products and distribute amongst a wide network of investors across the country. We have constantly endeavored to develop new instruments, tailor made to the requirements of our clients, enabling them to earn efficient post tax returns in accordance with their specific risk, return and maturity profiles. The company also has a distribution network of 200 sub-brokers across India being serviced by its eight branches. The company has mobilized more than Rs.7 trillion for various Mutual Funds during the last 7 years and is currently having Asset under Management of over Rs.50 billion with satisfied customers. OTHER ADVISORY SERVICES OF SPA Investments Mutual Funds Fixed Deposits Capital Gains & Other Bonds 11

Broking Services Equity Broking (NSE & BSE) Depository Services (CDSL) Currency Derivative (BSE, NSE & MCX-SX) IPO

Insurance Life o o o o o o o o o o Unit Linked Insurance Plan Retirement Plan Endowment Plan Single Premium Plan Children Plan

General Vehicle Insurance Mediclaim/Overseas Mediclaim Insurance Personal Accident Insurance Householder Policy All Other Risk Covers

Loan & Mortgages Housing Loan Personal Loan Loan Against Securities

Taxation Income Tax Planning & Advisory Income Tax Filing & Assessment Services for Permanent Account Number (PAN) 12

13

Chapter - 2

STOCK EXCHANGE

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INTRODUCTION TO STOCK EXCHANGE The stock exchanges provide an organized market-place for the investors to buy and sell securities freely. The market for these securities is an almost perfectly competitive one because a large number of sellers and buyers participate. The shares listed, however, are not really homogeneous like a commodity in a perfectly competitive market. They vary broadly in terms of credit rating and often involve carrying costs. In the stock exchange, there is active bidding and a two-way auction trading takes place. The bargains that are struck are the fairest price determined by the basic laws of supply and demand. The stock exchanges provide an auction market in which members of the stock exchange participate to ensure continuity of price and liquidity to investors. The financial system consists of the money market and the capital market. The capital market discharges the important function of transfer of savings, especially of the household sectors to the companies, governments and public sector bodies. PRIMARY MARKETS Households which are in financial surplus, exchange their savings for shares, debentures and securities of the financial deficit sectors such as the companies and governments. It is the primary market. The market consists of investors or buyers, sellers, dealers and brokers and does not reflect a physical location. The participants are regulated by formal rules for originating financial securities. The primary market in which public issue of securities is made through prospectus is a retail market and is reached through direct mailing. In the primary market, new issues of equity and debt are arranged in the form of a new flotation, either publicly or privately or in the form of a rights offer, to existing shareholders. Companies raise new cash in exchange of financial claims. The financial claims may take the form of shares or debentures. Public sector companies too issue securities. The transactions in the primary market result in capital formation.

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STOCK MARKET Capital market apart from the primary market also includes markets where securities which have been issued in the past are traded. These secondary markets are called stock markets or stock exchanges. The stock markets predominantly deal in stock or equity shares. They enable owners of shares to sell their holdings readily ensuring liquidity. The secondary market enables investors to continuously rearrange their assets if they so desire by divesting themselves of such assets while others can use their surplus funds to acquire them. Any trade of share subsequent to its primary offering is called a secondary transaction. The initial buyer in the primary market may re-offer the securities to any interested buyer at whatever price I mutually satisfactory prices may be determined. They offer opportunities primarily for trading risk and boost liquidity. The presence of an active secondary market actually promotes the growth of the primary market and capital formation because investors in the primary market are assured that a continuous market exits and should occasion arise they can liquidate their investment in the stock exchange. The participants in the secondary market are linked by formal trading rules and communication networks for trading in securities. MEANING OF STOCK EXCHANGE The stock exchange is a market where stocks, shares and other securities are bought and sold. It is the market where the owners may dispose of their securities as and when they like. In a modern capitalist economy, almost all commodities even the smallest, are produced on a large scale; and a large scale production implies large amount of capital. The joint stock company or the corporate form of organization is ideally suited to secure large amount of capital from all those who have surplus funds and who are willing to take risks in investing in companies. An investor who puts his savings in a company by buying its securities cannot get the amount back from the company directly. The only way the capital invested in stocks and shares of a joint stock company may be realized by its owners is through the sale of those stocks and shares to others. The stock market or exchange is a place where stocks and shares and other long-term commitments or investments are bought and sold.

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DEFINITIONS OF STOCK EXCHANGE Security Exchanges are marketing places where securities that have been listed there on may be bought and sold for either investment or speculation. -Pyle Securities or stock exchanges are privately organized markets which are used to facilitate trading in securities. -Husband and Dockeray It is an association or organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities. -The Securities Contracts Regulation Act, 1956 U/S 2(3) From the definitions cited above it will be seen that the stock exchanges are the institutions organized for providing the necessary facilities to carry on trading o dealings in securities representing claims on capital. The securities dealt on the stock exchanges include shares, debentures or bonds issued by the companies, the govt. securities, etc. Important ingredients of a stock exchange are the following: 1. Provision of the place for the buyers and sellers of securities for transacting their dealings; 2. Existence of brokers and other intermediaries to assist their client investors in finalizing their deals; 3. Scope of legitimate speculation so as to make the market continuously responsive to the basic forces of demand and supply; and 4. Framing of regulations as to avoid undue fluctuations and unfair dealings.

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FUNCTIONS OF STOCK EXCHANGE 1. Helpful in Distribution of New Securities: Stock exchanges aid in distribution of new security issues. Shares listed on the stock exchanges are more acceptable and may fetch higher market value. Costs of underwriting such issues are relatively less. Public response to new issues is easily secured if they are routed through stock exchanges. 2. Ensure Safety of Funds: Stock exchanges ensure safety of investible funds because they have to operate under set rules which seek to check over-trading, illegitimate speculation and manipulation etc. This would strengthen the investors confidence and stimulate larger investment in business securities. 3. Continuous Marketability to Securities: Stock exchanges provide continuous marketability and price continuity to the investors in respect of the securities they hold or intend to hold. Buying and selling of securities would tend to concentrate on exchanges where it listed. 4. Proper Direction to the Flow of Capital: Stock exchanges are regarded as a very sensitive barometer of business activity. The prices quoted for different securities on the stock exchange indicate their relative profitability or popularity. Funds tend to be attracted towards securities of greater market standing and securities having no status in the market have poor response from the investors and dealers. 5. Mirror of Business Cycle: Stock exchanges mirror the phases of business cycle, which are the changing conditions of economic health of a country. Booms and depressions find their echoes in the dealings of the stock exchanges.

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6.

Mobilization of Savings: Stock exchanges help in mobilization of savings, facilitate capital formation and assist the process of economic growth. The surplus funds available with individuals and institutions would not have found remunerative channels had there been no stock exchanges.

7.

Providing Liquidity: An investment in equity share capital is a perpetual or permanent commitment in contributing fixed capital of a company, thus blocking liquidity. It is the stock exchange which provides liquidity when needed.

8.

Rotating Contribution: Investment in equity share is fixed for the life of the company, the ability to shift the ownership to others during this course of period permits more individuals to participate in the long-term financing of the company.

9.

Reducing of Personal Risk: Through marketability, personal risk of investor is reduced by broadening the supply of equity and long-term debts capital for financing business enterprises.

10.

Transferring Ownership: Transaction in securities at a stock-exchange represents shifts in ownership from one to other of a long-term security, thus, widening ownership base.

SERVICES OF STOCK EXCHANGE Stock exchanges thus serve as effective agency whose operations, because of their growth orientation, would be beneficial to the community at large, apart from serving the interests of the investors and the company.

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Benefits to the Community 1. Financing economic growth through capital mobilization. 2. Portraying the prevailing economic situation. 3. Inculcation of saving habits and facilities for capital formation. 4. Providing medium of evaluation regarding the worth of different securities. 5. Diversification of investment on the criteria of stable and increasing yields. Services to Investors Stock exchanges are in fact a boon to the investors. They sustain their confidence by providing continuous marketing facilities: 1. Liquidity of securities is ensured by enabling the holders to sell them whenever they need liquid funds. 2. Information about the value of securities is imparted to the investors through daily quotations of listed securities. 3. Better price for securities dealt on the stock exchange can be ensured through the sensitive and continuous operations transacted by different dealers. 4. Undue fluctuations in security prices are avoided by the balancing operations of speculators (bulls and bears) and hedgers. 5. Guidance to the investors regarding the choice of securities to be bought is provided by the trends of dealings on the stock exchange. 6. Purchases of listed securities are less risky since listing presupposes their evaluation by stock exchange authorities. Services to Companies Companies raising their capital through stock exchanges will find better response to their security-issues. 1. Listed securities command quicker and better response from the investors. 2. Market for securities is enlarged if they are channeled through stock exchanges. 20

3. The credit-standing and goodwill of the company would be higher if its securities are listed on the stock exchange. 4. Market value of listed securities tends to be higher subject to asset-values of the company, its earnings, reserves and dividends. This would enhance the financial status and increase its bargaining power in any collective ventures, mergers etc. with other companies.

EVALUATION OF STOCK EXCHANGE Merits of Stock Exchange 1. Mobilization of Savings: Small savings of the people are mobilized in the productive channel of the country. 2. Industrial Growth of the country: Subscribing for securities helps in the industrial growth of the country. 3. Investment at Will: Purchase and sale of securities is always at will of the investors. It provides free markets to the securities. 4. Protection to Foreign Investors: Investment through stock exchange is safe hence foreign investors can invest in securities of the country. 5. Protection from False Securities: Stock exchange protects investors from false securities. Demerits of Stock Exchange 1. Economic Instability: Fluctuations in the price of securities adversely affect the economic world. 21

2. Encouragement to speculation: Many investors become the victims of speculation, because of the rise and fall of the prices of the securities. 3. Loss of innocent investors: Normally small investors are ignorant about the functioning of the stock exchanges. They invest on the advice of other investors. Generally, such persons are the losers. 4. Insider-Trading: Insider-Trading means operating on information which is price sensitive and hence, not available to the public. Insider-Trading violates level-playing field (i.e., a state where equal opportunity is not provided to all) 5. Limited Forward Trading: Trading in shares for clearing or forward trading is confirmed to selected slips under rolling settlement on the same day. 6. Oligopolistic Character: Indian stock market cannot be called truly comparative. It I largely dominated by large financial institutions, big brokers and operators.

MANAGEMENT OF STOCK EXCHANGE The stock exchange is managed by a Governing Body which consists of a President, a Vice-President, Executive Director, elected Directors, public representatives and nominees of the Government. The governing body is responsible for policy formulation and for ensuring smooth functioning of the exchange. The executive functions are discharged by the Executive Director or Secretary.

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REGULATION OF STOCK EXCHANGES The legislative jurisdiction over stock exchanges is vested in the Union Government by the Constitution of India. The Union Government enacted the Securities Contracts (Regulations) Act in 1956 (SCR Act) for the regulation of stock exchanges and contracts in securities traded on the stock exchanges. The SCR ct and the Securities Contracts (Regulation) Rules (1957) constitute the legal framework for the regulation of stock exchanges and protection of the interests of investors. The Securities Contracts Regulation Act, 1956 provides inter alia for recognition of stock exchanges and regulation of their functioning, licensing dealers, recognition of contracts, controlling speculation, restricting rights of equitable holders of shares and empowering government to compel any public limited company to get its shares listed. Under the Securities Contracts Regulation Act, Government has promulgated the Securities Contracts (Rules, 1957) for carrying into effect the objects of legislation. The rules are statutory and constitute a code of standardized regulations applicable to all recognized exchanges. The Securities and Exchange Board of India Act, 1992 provides for the establishment of the Securities and Exchange Board of India (SEBI) to protect the interest of investors in securities and to promote the development of and to regulate the securities market. Each exchange has bye-laws and regulations, which are more or less uniform in all exchanges, for regulation and control of transactions in the exchange.

HISTORY OF STOCK EXCHANGES IN INDIA The first organized stock exchange in India was started in Mumbai when the Native Share Stock Brokers Associationknown as the Mumbai Stock Exchange was formed by the brokers in Mumbai. In 1894, the Ahmedabad Stock Exchange was started to facilitate dealings in the shares of textile mills there. The Kolkata Stock Exchange was started in 1908 to provide a market for shares of plantations and jute mills. The Second World War saw great speculative activity in the country and the number of stock exchanges rose from 23

7 in 1939 to 21 in 1945. Besides these organized exchanges, there were a number of unorganized and unrecognized exchanges known as kerb markets which functioned under a set of usages and conventions and did not have any set of rules which could be enforces in courts of law. Under the Securities Contracts (Regulation) Act of 1956, the Government of India has so far recognized 24 stock exchanges. In addition, there are National Stock Exchange (NSE, Mumbai) and the Over the Counter Exchange of India (OTCEI). The Mumbai Stock Exchange is known as Dalal Street and the Kolkata Stock Exchange as Lyons Range. The Mumbai and the Kolkata Stock Exchange dominate the business from Indian investors. Kolkata Stock Exchange is more of an investment market while Mumbai Stock exchange is more of a speculative market. Mumbai is the premier stock exchange in the country and nearly 70 percent of all transactions in the country are done in that exchange.

TRADING PROCEDURE IN A STOCK EXCHANGE Unlike other markets wherein anybody can simply go and pick up what one want, pay for it and leave with their purchases; the stock markets are fortresses that allow entry only to their members, and therefore, if we wish to buy or sell securities, we need to contact a member. Transactions inside the stock exchanges take the form auction bids. The procedure of trading a business is as follows 1. Find the Broker:

Brokers are members of stock exchanges and they have the right to transact business on behalf of other people in a stock exchange. These people need to be contacted for purchase and sale of securities of the concerned stock exchange. 2. Find the Terms:

The securities (Shares, Debentures, Bonds, etc.) that one wishes to buy and sell needs to be decided before hand, as also the price at which the transaction would be acceptable. Such information should be given to the broker selected for the purpose. 24

3.

Place the Order:

At this stage the buyer and the seller of securities goes ahead and informs the chosen broker about his/her decision to buy/sell the desired securities and the terms that are acceptable to the buyer/seller. 4. Execute the order:

The broker then carries out the instructions of the buyer/seller in the course of purchase and sale of the desired security. 5. Contract Note:

Contract Note is prepared by the broker for the benefit of buyer/seller of the security and it serves as a proof of the transaction. Such a document contains information relating to the security transacted, the price involved, the amount of brokerage due to the broker and any other detail. 6. Payment:

This is the final stage of transaction, since once the payment is received or made, the contract is completed.

HOW BUSINESS IS TRANSACTED IN A STOCK EXCHANGE A typical investment transaction will consist of four stages: 1. Placing an order with a broker:

In a stock exchange, only members are entitled to transact business and outsiders must get the transactions carried out through a member-broker. The intending client should furnish bank or other references regarding hi financial position. 2. Execution of the order:

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As soon as an order is received from a client, the broker or his authorized clerk approaches that part of the stock exchange in which the particular share is traded. He asks for a quotation or may quote his own price. The bargain is struck by word of mouth and short notes are made in pencil in a small note-book as regards the number, description of shares and the name of the party from whom the shares are bought or to whom the shares are sold. 3. Reporting the deal to the client:

As soon as the deal is transacted, the details of the transaction are recorded in the books of the brokers, after which a contract note is prepared and sent to the client. The contract note gives details of the security bought or sold, the price, the brokers commission, the cost of the revenue stamp and the detail of settlement (unless the bargain is for cash). 4. Settlement of transactions:

There are two methods of settlement of transaction depending upon on the nature of the transaction. In the case of ready delivery (or cash) transactions, payment has to be made immediately on the transfer of the securities or within a period of one to seven days. The settlement may be made either through the clearing house or by hand delivery between the members without the intervention of the clearing house. SPECULATION AND STOCK EXCHANGE The essential idea of speculation is the purchase or sale of a commodity or security at one time, with the object of making a profit by its sale or purchase at another time. A high degree of speculation is associated with stock exchanges in India. There are two types of transactions in a stock exchange, viz., investment transactions and speculative transactions. Investment transactions refer to purchase or sale of securities undertaken with the long-term prospect relating to their yield and price. An investment transaction normally involves the actual delivery of the security and the payment of its full price. Actually, no stock exchange can operate purely on the basis of investment 26

buying and selling alone, since pure investors cannot provide the requisite volume of business or continuity of business which alone will ensure correct valuation of the shares according to their real worth. Investment transactions are, therefore, supplemented by speculative transactions. In a speculative transactionbuying or sellingthe delivery of securities or the payment of full price are rare: instead, only the differences in prices are paid. The predominance of speculative transactions over investment transactions in a stock exchange is due to the fact that the latter involve a larger volume of money (as securities bought have to be paid in full) while speculative transactions are possible with smaller amounts of money (as delivery of securities and payment of full price are rare). MAJOR DEFECTS IN TRADING IN INDIAN STOCK EXCHANGES There are certain serious defects in working of our stock exchanges, particularly the major stock exchanges such as Mumbai Stock Exchange (MSE): 1. Specified and non-specified shares: Major stock exchanges follow the

peculiar practice of classifying listed shares into specified group and unspecified group. The shares in the specified group are provided certain special facilities like settlement period, carry forward and clearing to promote speculation. 2. Investors Interests: The trading activity in our exchanges has been

designed and evolved to benefit only the brokers and the interests of the genuine investors are generally ignored. The investors confidence in market machinery is weak, as most of them have a suspicion that they are always cheated on price by the brokers. 3. Margins: The margins levied by Indian stock exchanges on speculative

transactions are wholly of discretionary character, varying from share to share and from day to day, ranging from zero to 40 percent. Higher margins ingeniously avoided. 27

4.

Lack of Integration: There are a large number of stock exchanges in the

country, though MSE dominates them with over 70 percent of all transactions in the country. There is nothing wrong in this, because in other countries too there are many small exchanges, with one dominating (New York SE in USA and London SE in England). But the real problem in India is that there is no proper integration between all the stock exchangeswith too much variation in prices of shares in the different markets. 5. Weakness of SE management: The management organization and structure

of Indian stock exchanges, in general, is weak and deficient. The stock exchange is still regarded as a private club, exclusively managed by and for the benefit of the member-brokers. The Governing Body (GB) of a stock exchange has not the concern or the will to introduce necessary reforms in trading. It does not call for detailed reports about investors complaints. 6. The system of settlement and carry forward (badla): The settlement

system varies from one stock exchange to another but MSE has a fortnightly system. This is responsible for high price fluctuations and high risk exposure to market participants. It is often responsible for excessive speculation. The Indian system of carry forward has been evolved with the sole objective of promoting speculation in a handful of shares in the specified group. It promotes a wholly spurious kind of share trading in which neither the buyer has the money to pay for the shares at the time of settlement nor the seller has the shares to deliver. Both of them or at least one of them is spurious. SUGGESTIONS FOR STOCK EXCHANGE REFORM

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In hisExpert Study of Trading in Shares in Stock ExchangesDr. L.C. Gupta has made very useful and practical suggestions for changing the current trade practices in our stock exchanges. These relate to the weaknesses we have already explained. 1. Marking to the market system: The system of margin trading is defective and

has failed to prevent over-speculation and default. Dr. L.C. Gupta has suggested two alternatives. The first is to adopt the margin trading system of U.S.A. under which commercial banks finance stock market trading. In this system, the buyer has to put up at least 50 percent of the value of the shares purchased and also pledge the share with a bank in actuality (for, the bank will pay the balance, and the seller will get the full payment). Under this system, there would be a better control over speculation if we can change to margin trading supported by bank financing. 2. Market making: In all leading stock exchanges, like London and New York,

there are market makers who are given market making responsibilities for specific shares. The market maker assumes the responsibility for both buying and selling a share at given prices. He is an integral part of the trading mechanism and arrangements. He protects the investors from being exploited by stock brokers and he ensures that the transactions are carried out at the best market rate. Besides. He ensures prompt execution of transactions and thus ensures liquidity. If this suggestion is accepted and implemented, the investors will be fully protected and all the listed shares get liquidity.

3.

Management Information System: It is essential that the information should be

available for each stock exchange about trading volume and prices, about trading concentration in individual securities, trading concentration by stock exchange members. 4. Introduction of uniform one week settlement: All stock exchanges in the

country should switch over to a uniform system of one week settlement. This will 29

unify all the SEs on a national basis. It will reduce risk exposure of market participants due to price movements in shares. Finally, it will check the strong tendency towards the excessive speculation and excessive concentration of trading activity in a few shares only. Uniformity will make inter-market transactions easier and reduce cost and delay. It will ensure markets financial integrity at all times and this will promote investor confidence. It will remove investors complaint of long delayin certain cases up to 3 monthsand exposure to greater risk of default in payment/delivery. 5. Abolish the system of carry forward: The system of carry forward has been

the most important factor for over-speculation in India and it has to be done away with. In fact, with one week settlement and with the adoption of the system of marking of the market, the rationale of the carry forward system disappears automatically. If the stock exchanges were to accept only the to suggestions of one week settlement and the abolition of the carry forward system, many of the problems of the stock exchanges would be over.

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Chapter - 3

TECHNICAL ANALYSIS

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Introduction To Technical Analysis

Technical analysis is a method of forecasting price movements by looking at purely market-generated data. Price data from a particular market is most commonly the type of information analyzed by a technician, though most will also keep a close watch on volume and open interest in futures contracts. The bottom line when utilizing any type of analytical method, technical or otherwise, is to stick to the basics, which are methodologies with a proven track record over a long period. After finding a trading system that works for you, the more esoteric fields of study can then be incorporated into your trading toolbox. Almost every trader uses some form of technical analysis. Even the most reverent follower of market fundamentals is likely to glance at price charts before executing a trade. At their most basic level, these charts help traders determine ideal entry and exit points for a trade. They provide a visual representation of the historical price action of whatever is being studied. As such, traders can look at a chart and know if they are buying at a fair price (based on the price history of a particular market), selling at a cyclical top or perhaps throwing their capital into a choppy, sideways market. These are just a few market conditions that charts identify for a trader. Depending on their level of sophistication, charts can also help much more advanced studies of the markets. On the surface, it might appear that technicians ignore the fundamentals of the market while surrounding themselves with charts and data tables. However, a technical trader will tell you that all of the fundamentals are already represented in the price. They are not so much concerned that a natural disaster or an awful inflation number caused a recent spike in prices as much as how that price action fits into a pattern or trend. And much more to the point, how that pattern can be used to predict future prices. The methods used to analyze securities and make investment decisions fall into two very broad categories: fundamental analysis and technical analysis. Fundamental analysis involves analyzing the characteristics of a company in order to estimate its value. 32

Technical analysis takes a completely different approach; it doesn't care one bit about the "value" of a company or a commodity. Technicians (sometimes called chartists) are only interested in the price movements in the market. Despite all the fancy and exotic tools it employs, technical analysis really just studies supply and demand in a market in an attempt to determine what direction, or trend, will continue in the future. In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components. If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor. In this tutorial, we'll introduce you to the subject of technical analysis. It's a broad topic, so we'll just cover the basics, providing you with the foundation you'll need to understand more advanced concepts down the road.

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Technical Analysis: The Basic Assumptions

What Is Technical Analysis? Technical analysis is a method of evaluating securities by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Just as there are many investment styles on the fundamental side, there are also many different types of technical traders. Some rely on chart patterns; others use technical indicators and oscillators, and most use some combination of the two. In any case, technical analysts' exclusive use of historical price and volume data is what separates them from their fundamental counterparts. Unlike fundamental analysts, technical analysts don't care whether a stock is undervalued - the only thing that matters is a security's past trading data and what information this data can provide about where the security might move in the future.

The field of technical analysis is based on three assumptions: 1. The market discounts everything. 2. Price moves in trends. 3. History tends to repeat itself. 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

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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. Not Just for Stocks Technical analysis can be used on any security with historical trading data. This includes stocks, futures and commodities, fixed-income securities, forex, etc. In this tutorial, we'll usually analyze stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is more frequently associated with commodities and forex, where the participants are predominantly traders. Now that you understand the philosophy behind technical analysis, we'll get into explaining how it really works. One of the best ways to understand what technical analysis is (and is not) is to compare it to fundamental analysis. We'll do this in the next section. 35

Technical Analysis: Fundamental vs. Technical Analysis

Technical analysis and fundamental analysis are the two main schools of thought in the financial markets. As we've mentioned, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals. Let's get into the details of how these two approaches differ, the criticisms against technical analysis and how technical and fundamental analysis can be used together to analyze securities. Technical Analysis operates on the theory that market prices at any given point in time reflect all known factors affecting supply and demand for a particular market. Consequently, technical analysis focuses, not on evaluating those factors directly, but on an analysis of market prices themselves. This approach theorize that a detailed analysis of, among other things, actual daily, weekly and monthly price fluctuations is the most effective means of attempting to capitalize on the future course of price movements. Technical strategies generally utilize a series of mathematical measurements and calculations designed to monitor market activity. Trading decisions are based on signals generated by charts, manual calculations, computers or their combinations. Fundamental Analysis is based on the study of factors external to the trading markets which affect the supply and demand of a particular market. It is in stark contrast to technical analysis since it focuses, not on price but on factors like weather, government policies, domestic and foreign political and economic events and changing trade prospects. Fundamental analysis theorizes that by monitoring relevant supply and demand factors for a particular market, a state of current or potential disequilibrium of market conditions may be identified before the state has been reflected in the price level of that market. Fundamental analysis assumes that markets are imperfect, that information is not instantaneously assimilated or disseminated and that econometric models can be constructed to generate equilibrium prices, which may indicate that current prices are inconsistent with underlying economic conditions, and will, accordingly, change in the future. 36

Another definition of Fundamental Analysis Fundamental Analysis is an approach to analyzing market behavior that stresses the study of underlying factors of supply and demand. It is done in the belief that such analysis will enable one to profit by being able to anticipate price trends. A Fundamentalist is a market observer-and/or participant who relies principally on Supply/demand considerations in price forecasting. Components of Fundamental Analysis: Supply:

Weather Acres planted to a crop Government Programs USDA Reports

Demand:

USDA Reports Domestic usage - Feed & processing Value of the Dollar Actions of Other Countries Exports Transportation

The Differences
1. Charts vs. Financial Statements At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements. By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company's value. In financial terms, an analyst attempts to measure a company's intrinsic value. In this approach, investment 37

decisions are fairly easy to make - if the price of a stock trades below its intrinsic value, it's a good investment. Although this is an oversimplification (fundamental analysis goes beyond just the financial statements) for the purposes of this tutorial, this simple tenet holds true. Technical traders, on the other hand, believe there is no reason to analyze a company's fundamentals because these are all accounted for in the stock's price. Technicians believe that all the information they need about a stock can be found in its 2. Time Horizon Fundamental analysis takes a relatively long-term approach to analyzing the market compared to technical analysis. While technical analysis can be used on a timeframe of weeks, days or even minutes, fundamental analysis often looks at data over a number of years. charts.

The different timeframes that these two approaches use is a result of the nature of the investing style to which they each adhere. It can take a long time for a company's value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until the stock's market price rises to its "correct" value. This type of investing is called value investing and assumes that the short-term market is wrong, but that the price of a particular stock will correct itself over the long run. This "long run" can represent a timeframe of as long as several years, in some cases. Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of time. Financial statements are filed quarterly and changes in earnings per share don't emerge on a daily basis like price and volume information. Also remember that fundamentals are the actual characteristics of a business. New management can't implement sweeping changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term timeframe, therefore, is because the data they 38

use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts. 3. Trading Versus Investing Not only is technical analysis more short term in nature that fundamental analysis, but the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price. The line between a trade and an investment can be blurry, but it does characterize a difference between the two schools.

The Critics
Some critics see technical analysis as a form of black magic. Don't be surprised to see them question the validity of the discipline to the point where they mock its supporters. In fact, technical analysis has only recently begun to enjoy some mainstream credibility. While most analysts on Wall Street focus on the fundamental side, just about any major brokerage now employs technical analysts as well. Much of the criticism of technical analysis has its roots in academic theory - specifically the efficient market hypothesis (EMH). This theory says that the market's price is always the correct one - any past trading information is already reflected in the price of the stock and, therefore, any analysis to find undervalued securities is useless. There are three versions of EMH. In the first, called weak form efficiency, all past price information is already included in the current price. According to weak form efficiency, technical analysis can't predict future movements because all past information has already been accounted for and, therefore, analyzing the stock's past price movements will provide no insight into its future movements. In the second, semi-strong form efficiency, fundamental analysis is also claimed to be of little use in finding investment 39

opportunities. The third is strong form efficiency, which states that all information in the market is accounted for in a stock's price and neither technical nor fundamental analysis can provide investors with an edge. The vast majority of academics believe in at least the weak version of EMH, therefore, from their point of view, if technical analysis works, market efficiency will be called into question. (For more insight, read What Is Market Efficiency? and Working Through The Efficient Market Hypothesis.)

There is no right answer as to who is correct. There are arguments to be made on both sides and, therefore, it's up to you to do the homework and determine your own philosophy. Can They Co-Exist? Although technical analysis and fundamental analysis are seen by many as polar opposites - the oil and water of investing - many market participants have experienced great success by combining the two. For example, some fundamental analysts use technical analysis techniques to figure out the best time to enter into an undervalued security. Oftentimes, this situation occurs when the security is severely oversold. By timing entry into a security, the gains on the investment can be greatly improved. Alternatively, some technical traders might look at fundamentals to add strength to a technical signal. For example, if a sell signal is given through technical patterns and indicators, a technical trader might look to reaffirm his or her decision by looking at some key fundamental data. Oftentimes, having both the fundamentals and technicals on your side can provide the best-case scenario for a trade. While mixing some of the components of technical and fundamental analysis is not well received by the most devoted groups in each school, there are certainly benefits to at least understanding both schools of thought.

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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. Take a look at the chart below:

It isn't hard to see that the trend in Figure 1 is up. However, it's not always this easy to see a trend:

There are lots of ups and downs in this chart, but there isn't a clear indication of which direction this security is headed. 41

A More Formal Definition Unfortunately, trends are not always easy to see. In other words, defining a trend goes well beyond the obvious. In any given chart, you will probably notice that prices do not tend to move in a straight line in any direction, but rather in a series of highs and lows. In technical analysis, it is the movement of the highs and lows that constitutes a trend. For example, an uptrend is classified as a series of higher highs and higher lows, while a downtrend is one of lower lows and lower highs.

Figure 3 is an example of an uptrend. Point 2 in the chart is the first high, which is determined after the price falls from this point. Point 3 is the low that is established as the price falls from the high. For this to remain an uptrend each successive low must not fall below the previous lowest point or the trend is deemed a reversal. Types of Trends There are three types of trend:

Uptrends Downtrends Sideways/Horizontal Trends As the names imply, when each

successive peak and trough is higher, it's referred to as an upward trend. If the peaks and troughs are getting lower, it's a downtrend. When there is little movement up or down in the peaks and troughs, it's a sideways or horizontal trend. If you want to get really technical, you might even say that a sideways trend is actually not a trend on its own, but a lack of a well-defined trend in either direction. In any case, the market can really only trend in these three ways: up, down or nowhere. 42

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 shortterm 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 4 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.

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

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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.

Figure illustrates a descending channel on a stock chart; the upper trendline has been placed on the highs and the lower trendline is on the lows. The price has bounced off of these lines several times, and has remained range-bound for several months. As long as the price does not fall below the lower line or move beyond the upper resistance, the range-bound downtrend is expected to continue. The Importance of Trend It is important to be able to understand and identify trends so that you can trade with rather than against them. Two important sayings in technical analysis are "the trend is your friend" and "don't buck the trend," illustrating how important trend analysis is for technical traders.

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Technical Analysis: Support and Resistance

Once 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)

As you can see in Figure, 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 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 trendlines 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. Round Numbers and Support and Resistance One type of universal support and resistance that tends to be seen across a large number of securities is round numbers. Round numbers like 10, 20, 35, 50, 100 and 1,000 tend be 46

important in support and resistance levels because they often represent the major psychological turning points at which many traders will make buy or sell decisions. Buyers will often purchase large amounts of stock once the price starts to fall toward a major round number such as $50, which makes it more difficult for shares to fall below the level. On the other hand, sellers start to sell off a stock as it moves toward a round number peak, making it difficult to move past this upper level as well. It is the increased buying and selling pressure at these levels that makes them important points of support and resistance and, in many cases, major psychological points as well. 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 example, as you can see in Figure, 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 example, as you can see in Figure 3, this phenomenon

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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.

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 48

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. Being aware of these important support and resistance points should affect the way that you trade a stock. Traders should avoid placing orders at these major points, as the area around them is usually marked by a lot of volatility. If you feel confident about making a trade near a support or resistance level, it is important that you follow this simple rule: do not place orders directly at the support or resistance level. This is because in many cases, the price never actually reaches the whole number, but flirts with it instead. So if you're bullish on a stock that is moving toward an important support level, do not place the trade at the support level. Instead, place it above the support level, but within a few points. On the other hand, if you are placing stops or short selling, set up your trade price at or below the level of support.

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Technical Analysis: The Importance of Volume

What is Volume? Volume is simply the number of shares or contracts that trade over a given period of time, usually a day. The higher the volume, the more active the security. To determine the movement of the volume (up or down), chartists look at the volume bars that can usually be found at the bottom of any chart. Volume bars illustrate how many shares have traded per period and show trends in the same way that prices do.

Why Volume is Important ? Volume is an important aspect of technical analysis because it is used to confirm trends and chart patterns. Any price movement up or down with relatively high volume is seen as a stronger, more relevant move than a similar move with weak volume. Therefore, if you are looking at a large price movement, you should also examine the volume to see whether it tells the same story. Say, for example, that a stock jumps 5% in one trading day after being in a long downtrend. Is this a sign of a trend reversal? This is where volume helps traders. If volume is high during the day relative to the average daily volume, it is a sign that the reversal is probably for real. On the other hand, if the volume is below average, there may not be enough conviction to support a true trend reversal. 50

Volume should move with the trend. If prices are moving in an upward trend, volume should increase (and vice versa). If the previous relationship between volume and price movements starts to deteriorate, it is usually a sign of weakness in the trend. For example, if the stock is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end. When volume tells a different story, it is a case of divergence, which refers to a contradiction between two different indicators. The simplest example of divergence is a clear upward trend on declining volume. Volume and Chart Patterns The other use of volume is to confirm chart patterns. Patterns such as head and shoulders, triangles, flags and other price patterns can be confirmed with volume, a process which we'll describe in more detail later in this tutorial. In most chart patterns, there are several pivotal points that are vital to what the chart is able to convey to chartists. Basically, if the volume is not there to confirm the pivotal moments of a chart pattern, the quality of the signal formed by the pattern is weakened. Volume Precedes Price Another important idea in technical analysis is that price is preceded by volume. Volume is closely monitored by technicians and chartists to form ideas on upcoming trend reversals. If volume is starting to decrease in an uptrend, it is usually a sign that the upward run is about to end.

Now that we have a better understanding of some of the important factors of technical analysis, we can move on to charts, which help to identify trading opportunities in prices movements.

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Technical Analysis: What Is A Chart?

In technical analysis, charts are similar to the charts that you see in any business setting. A chart is simply a graphical representation of a series of prices over a set time frame. For example, a chart may show a stock's price movement over a one-year period, where each point on the graph represents the closing price for each day the stock is traded:

Figure 1 provides an example of a basic chart. It is a representation of the price movements of a stock over a 1.5 year period. The bottom of the graph, running horizontally (x-axis), is the date or time scale. On the right hand side, running vertically (y-axis), the price of the security is shown. By looking at the graph we see that in October 2004 (Point 1), the price of this stock was around $245, whereas in June 2005 (Point 2), the stock's price is around $265. This tells us that the stock has risen between October 2004 and June 2005. Chart Properties There are several things that you should be aware of when looking at a chart, as these factors can affect the information that is provided. They include the time scale, the price scale and the price point properties used. The Time Scale 52

The time scale refers to the range of dates at the bottom of the chart, which can vary from decades to seconds. The most frequently used time scales are intraday, daily, weekly, monthly, quarterly and annually. The shorter the time frame, the more detailed the chart. Each data point can represent the closing price of the period or show the open, the high, the low and the close depending on the chart used. Intraday charts plot price movement within the period of one day. This means that the time scale could be as short as five minutes or could cover the whole trading day from the opening bell to the closing bell. Daily charts are comprised of a series of price movements in which each price point on the chart is a full days trading condensed into one point. Again, each point on the graph can be simply the closing price or can entail the open, high, low and close for the stock over the day. These data points are spread out over weekly, monthly and even yearly time scales to monitor both short-term and intermediate trends in price movement. Weekly, monthly, quarterly and yearly charts are used to analyze longer term trends in the movement of a stock's price. Each data point in these graphs will be a condensed version of what happened over the specified period. So for a weekly chart, each data point will be a representation of the price movement of the week. For example, if you are looking at a chart of weekly data spread over a five-year period and each data point is the closing price for the week, the price that is plotted will be the closing price on the last trading day of the week, which is usually a Friday. The Price Scale and Price Point Properties The price scale is on the right-hand side of the chart. It shows a stock's current price and compares it to past data points. This may seem like a simple concept in that the price scale goes from lower prices to higher prices as you move along the scale from the bottom to the top. The problem, however, is in the structure of the scale itself. A scale can either be constructed in a linear (arithmetic) or logarithmic way, and both of these options are available on 53 most charting services.

If a price scale is constructed using a linear scale, the space between each price point (10, 20, 30, 40) is separated by an equal amount. A price move from 10 to 20 on a linear scale is the same distance on the chart as a move from 40 to 50. In other words, the price scale measures moves in absolute terms and does not show the effects of percent change.

If a price scale is in logarithmic terms, then the distance between points will be equal in terms of percent change. A price change from 10 to 20 is a 100% increase in the price while a move from 40 to 50 is only a 25% change, even though they are represented by the same distance on a linear scale. On a logarithmic scale, the distance of the 100% price change from 10 to 20 will not be the same as the 25% change from 40 to 50. In this case, the move from 10 to 20 is represented by a larger space one the chart, while the move from 40 to 50, is represented by a smaller space because, percentage-wise, it indicates a smaller move. In Figure 2, the logarithmic price scale on the right leaves the same amount of space between 10 and 20 as it does between 20 and 40 because these both represent 100% increases.

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Technical Analysis: Chart Types

There are four main types of charts that are used by investors and traders depending on the information that they are seeking and their individual skill levels. The chart types are: the line chart, the bar chart, the candlestick chart and the point and figure chart. In the following sections, we will focus on the S&P 500 Index during the period of January 2006 through May 2006. Notice how the data used to create the charts is the same, but the way the data is plotted and shown in the charts is different. Line Chart The most basic of the four charts is the line chart because it represents only the closing prices over a set period of time. The line is formed by connecting the closing prices over the time frame. Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices. However, the closing price is often considered to be the most important price in stock data compared to the high and low for the day and this is why it is the only value used in line charts.

Bar Charts The bar chart expands on the line chart by adding several more key pieces of information to each data point. The chart is made up of a series of vertical lines that represent each data point. This vertical line represents the high and low for the trading period, along with the closing price. The close and open are represented on the vertical line by a 55

horizontal dash. The opening price on a bar chart is illustrated by the dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on the right. Generally, if the left dash (open) is lower than the right dash (close) then the bar will be shaded black, representing an up period for the stock, which means it has gained value. A bar that is colored red signals that the stock has gone down in value over that period. When this is the case, the dash on the right (close) is lower than the dash on the left (open).

Candlestick Charts The candlestick chart is similar to a bar chart, but it differs in the way that it is visually constructed. Similar to the bar chart, the candlestick also has a thin vertical line showing the period's trading range. The difference comes in the formation of a wide bar on the vertical line, which illustrates the difference between the open and close. And, like bar charts, candlesticks also rely heavily on the use of colors to explain what has happened during the trading period. A major problem with the candlestick color configuration, however, is that different sites use different standards; therefore, it is important to understand the candlestick configuration used at the chart site you are working with. There are two color constructs for days up and one for days that the price falls. When the price of the stock is up and closes above the opening trade, the candlestick will usually be white or clear. If the stock has traded down for the period, then the candlestick will usually be red or black, depending on the site. If the stock's price has closed above the 56

previous days close but below the day's open, the candlestick will be black or filled with the color that is used to indicate an up day.

Figure 3: A candlestick chart

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Technical Analysis: Chart Patterns

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 patterns 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. While there are general ideas and components to every chart pattern, there is no chart pattern that will tell you with 100% certainty where a security is headed. This creates some leeway and debate as to what a good pattern looks like, and is a major reason why charting is often seen as more of an art than a science. There are two types of patterns within this area of technical

analysis, reversal and continuation. A reversal pattern signals that a prior trend will reverse upon completion of the pattern. A continuation pattern, on the other hand, signals that a trend will continue once the pattern is complete. These patterns can be found over charts of any timeframe. In this section, we will review some of the more popular chart patterns. 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 58

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.

Figure: 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. Double Tops and Bottoms 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

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is unable to break through. This pattern is often used to signal intermediate and long-term trend reversals.

Figure: 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 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. trend and heads upward.

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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.

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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 trendlines, 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. 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-thanexpected 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.

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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.

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.

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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 handle, makes it a difficult pattern to trade. We have finished our look at some of the more popular chart patterns. You should now be able to recognize each chart pattern as well the signal it can form for chartists. We will now move on to other technical techniques and examine how they are used by technical traders to gauge price movements.

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Technical Indicators
Here are a few of the more common types of indicators used in technical analysis: Trend indicators

Trend is a term used to describe the persistence of price movement in one direction over time. Trends move in three directions: up, down and sideways. Trend indicators smooth variable price data to create a composite of market direction. (Example: Moving Averages, Trend lines) Strength indicators

Market strength describes the intensity of market opinion with reference to a price by examining the market positions taken by various market participants. Volume or open interest are the basic ingredients of this indicator. Their signals are coincident or leading the market. (Example: Volume) Volatility indicators

Volatility is a general term used to describe the magnitude, or size, of day-to-day price fluctuations independent of their direction. Generally, changes in volatility tend to lead changes in prices. (Example: Bollinger Bands) Cycle indicators

A cycle is a term to indicate repeating patterns of market movement, specific to recurrent events, such as seasons, elections, etc. Many markets have a tendency to move in cyclical patterns. Cycle indicators determine the timing of a particular market patterns. (Example: Elliott Wave) Support/resistance indicators

Support and resistance describes the price levels where markets repeatedly rise or fall and then reverse. This phenomenon is attributed to basic supply and demand. (Example: Trend Lines)

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Momentum indicators

Momentum is a general term used to describe the speed at which prices move over a given time period. Momentum indicators determine the strength or weakness of a trend as it progresses over time. Momentum is highest at the beginning of a trend and lowest at trend turning points. Any divergence of directions in price and momentum is a warning of weakness; if price extremes occur with weak momentum, it signals an end of movement in that direction. If momentum is trending strongly and prices are flat, it signals a potential change in price direction. (Example: Stochastic, MACD, RSI)

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Five Ways that Technical Analysis Can Fail

Below are the five ways that technical analysis can fail.

Geopolitical events

Any geopolitical event can move currencies. News that Iran intensified its nuclear program fueled the fall of the USD last April, 2007. On October 9, 2006, North Korea tested its first nuclear weapon, which moved the yen to triple-pip gains for a day. Elections, OPEC decisions, and G7 statements can also move currencies.

Economic data

Any economic news can cause currencies to move. Some of the most market-moving economic reports are the employment figures, Fed announcements (or even speeches made by central bank members), GDP report, and the manufacturing survey.

Natural disasters

Earthquakes in Japan, drought in Australia (affecting wheat production), tsunamis in the Asia-Pacific region, or any natural occurrence that affects commodity supply can move currencies contrary to the technical forecast. Commodity-linked currencies like the Australian Dollar (AUD) are particularly sensitive to natural disasters.

Acts of terrorism

Any act of terrorism can affect currencies. The Sept 11, 2001 attacks pushed the USD quite dramatically downward. The terrorist attacks in London in July, 2005 also moved the European currencies, particularly the Pound (GBP).

Internal Conflict or war

Any conflict can affect currencies, particularly in countries with commodities linked to oil or gold. Internal conflicts flaring up in oil-rich Nigeria can move currencies like the Canadian Dollar (CAD) and the US Dollar (USD).

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CONCLUSION
If you'd like to make profits in up markets, make profits in down markets and put these profits in your trading account over short periods of time, then the technique which can make this happen is Technical Analysis. Emotions can whipsaw a trader until all reason is lost, and buy and sell orders are made without a sound basis. This does not have to happen. Find stocks that are in position where big gains can be made, either up or down; in relatively short periods of time. We can apply detailed technical analysis to determine if it is time to be bullish or bearish. We can see whether a stock is overbought, oversold, basing, breaking out or breaking down. If you want to make money irrespective of whichever way the market goes-the key is doing the homework to determine what move is the right one so you can enter a trade with confidence and without hesitation, and exit with the same precision.

Strengths of Technical Analysis

Focus on Price If the objective is to predict the future price, then it makes sense to focus on price movements. Price movements usually precede fundamental developments. By focusing on price action, technicians are automatically focusing on the future. The market is thought of as a leading indicator and generally leads the economy by 6 to 9 months. To keep pace with the market, it makes sense to look directly at the price movements. More often than not, change is a subtle beast. Even though the market is prone to sudden kneejerk reactions, hints usually develop before significant moves. A technician will refer to periods of accumulation as evidence of an impending advance and periods of distribution as evidence of an impending decline.

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Support/Resistance Simple chart analysis can help identify support and resistance levels. These are usually marked by periods of congestion (trading range) where the prices move within a confined range for an extended period, telling us that the forces of supply and demand are deadlocked. When prices move out of the trading range, it signals that either supply or demand has started to get the upper hand. If prices move above the upper band of the trading range, then demand is winning. If prices move below the lower band, then supply is winning. Assist with Entry Point Technical analysis can help with timing a proper entry point. Some analysts use fundamental analysis to decide what to buy and technical analysis to decide when to buy. It is no secret that timing can play an important role in performance. Technical analysis can help spot demand (support) and supply (resistance) levels as well as breakouts. Simply waiting for a breakout above resistance or buying near support levels can improve returns. It is also important to know a stock's price history. If a stock you thought was great for the last 2 years has traded flat for those two years, it would appear that Dalal Street has a different opinion. If a stock has already advanced significantly, it may be prudent to wait for a pullback. Or, if the stock is trending lower, it might pay to wait for buying interest and a trend reversal.

Weaknesses of Technical Analysis

Analyst Bias Just as with fundamental analysis, technical analysis is subjective and our personal biases can be reflected in the analysis. It is important to be aware of these biases when analyzing a chart. If the analyst is a perpetual bull, then a bullish bias will overshadow the analysis. On the other hand, if the analyst is a disgruntled eternal bear, then the analysis will probably have a bearish tilt. 69

Open to Interpretation Furthering the bias argument is the fact that technical analysis is open to interpretation. Even though there are standards, many times two technicians will look at the same chart and paint two different scenarios or see different patterns. Both will be able to come up with logical support and resistance levels as well as key breaks to justify their position. While this can be frustrating, it should be pointed out that technical analysis is more like an art than a science, somewhat like economics. Is the cup half-empty or half-full? It is in the eye of the beholder. Too Late Technical analysis has been criticized for being too late. By the time the trend is identified, a substantial portion of the move has already taken place. After such a large move, the reward to risk ratio is not great. Trader's Remorse Not all technical signals and patterns work. When one begins to study technical analysis, he/she will come across an array of patterns and indicators with rules to match. For instance: A sell signal is given when the neckline of a head and shoulders pattern is broken. Even though this is a rule, it is not steadfast and can be subject to other factors such as volume and momentum. In that same vein, what works for one particular stock may not work for another. Even though many principles of technical analysis are universal, each security will have its own idiosyncrasies. Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. Psychological or logical may be open for debate, but there is no questioning the current price of a security. After all, it is available for all to see and nobody doubts its legitimacy. The price set by the market reflects the sum knowledge of all participants. These participants have considered (discounted) everything under the sun and settled on a price to buy or sell. These are the forces of supply and demand at work. By examining price

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action to determine which force is prevailing, technical analysis focuses directly on the bottom line: What is the price? Where has it been? Where is it going? Even though there are some universal principles and rules that can be applied, it must be remembered that technical analysis is more an art form than a science. As an art form, it is subject to interpretation. However, it is also flexible in its approach and each investor should use only that which suits his or her style. Developing a style takes time, effort and dedication, but the rewards can be significant.

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BIBLIOGRAPHY
Books
Avadhani V.K. (2007): Securities Analysis and Portfolio Management, Elder Alexander (1993): Trading for living, John Wiley and Sons Gupta O. P, Jain S. K (2007): Business Studies, Dinesh Publications. Murphy John J. (1999): Technical Analysis of the Financial Markets, New Nison Steve (1994): Beyond Candlesticks, John Wiley and Sons Pistolese Clifford (1989): Using technical analysis, Probus Publishing Pring Martin J. (1997): Technical Analysis, McGraw Hill

Himalayan Publishing House.

York Institute of Finance

Company

Web Resources
www.mapsofindia.com www.spasecurities.com www.spacapital.com www.stockcharts.com www.investopedia.com www.nseindia.com www.forextrading.about.com www.investopedia.com www.about.com For Graphs of Indian securities: www.indiabulls.com Charting Software: www.amibroker.com 72

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