EQUITY SHARES: FUNDAMENTAL AND

() Active or Primary
TECHNICAL ANALYSIS 159
and then selecting the
Approach. Active approach involves studying the individual securities
specific securities for investment. An investor may attempt to improve
upon the performance and to earn a higher return than the market. Active
that the investor has more information than the other approach assumes
participants.and he can earn more
thanothers. On the basis of security specific analysis, an investor likes to identify
buying) up undervalued.equity investment and attempts to beat the market. He may and picking
identify
high growth shares which are expected to show higher growth than other shares. Fundamental
analysis and technical analysis, as discussed later, provide the basis for active or primary
approach to equity analysis.
(i) Passive or Secondary Approach. A passive approach to equity analysis attempts to go P
with the marketand to 'buy the market. The investor would like to invest in such a way to Tech
earn as much as the market as a whole is earning. He
may not devote time for equity analysis.
Passive approach to equity analysis may be employed in
twoways S h e r t

(a) Buy and Hold Approach. An investor may make investment in someselectedsharesand and
holdthe investments for some time. By holding the investment, the investor would be able to
save on acount of transaction costs (brokerage on sales/purchases of shares), etc. Such a Pm.

passive approach may or may not bring as much net return to the investor as available from
(e
active approach (which involves a lot ofcosts regarding research, etc.). Sometimes, adjustments
may be made in the buy and hold' approach to suit the change in risk preference of the
investor.
6)Index Fund Approach. Anindex fundisamutualfundthatinvestsita corpusinthoseEgiv
Sensex is the
equity shares which arecomprising in the benchmark index. For example,
benchmark for index fund scheme of Tata Mutual Fund. An investor buying the units ofTata po
oefs
es s
Mutual Fund, is actually investing in 30 shares of Sensex in the sameproportion as they are
included in the Sensex. The return from his investment will be as much as from Sensex.
However, there are different index funds available and a investor has to carefully select a
discussed in Chapter 8.
particular benchmark. Mutual funds have been

Part l
FUNDAMENTAL ANALYSIS
idend income and a capital gain. For any investor,
Investors buy shares in expectation of di
investment are: (a) What will determine
the dividends to be
the primary questions in share
future? To answer these questions, an
share? (6) What will be the share price in
paid on a There are two
in respect of expected performance of a share is required.
indepth analysis These two approaches are: Fundamental Analysis
basic approaches to the indepth analysis. and latter is taken
two is being discussed in this part
and Technical Analysis. Former of the
up in the next part.
worth which 1S basea The analysis ofthe determinants of |
Equity shares have an economic
an existing and expected
earnings capacity. the fair value ofa security is called
out the true
Fundamental analysis attemptsto find can to
the fundamental analysis.
decide
value ofsecuritiessothat the investors market prices. It encompasses a logical
and
current
buyor not tobuy the securities at the
estimate
and their true values. In
the returns from shares
order to
systematic approach to and analysis of the dividends
and
find out the true value, what
is required is the forecast
 INVESTMENT MANAGEMENT
160 analysis of the determinants of the fair
aarnings that can be expected from the firm. The
is called the fundamental analysis.
value of a security
The basic philosophy underlying the fundamental analysis is that if an investor invests
rupee buying a share ofa company, how
in
much
expected returns from this
investment
ane

he has. These expected future returns when discounted at the required rate of return of the
investor, give the fair value of the share. A fundamental analyst compares the true value of
theshare with its market price, In casetheformer 1s higher than the latter,it denotes the
under-valuation ofshare inthemarketandsignalsthebuyingofshare. On the other hand, if
fairyalue islessthanthe market price,the share isconsideredtobeover-priced and signals
theselling ofthe share. The basic premise is that in the long run, the market price tends to
move towards its fair or intrinsic
value.
Dividends, earnings and the market price of a share are determined by the performance
of the company. The performance and success, in turn, depend upon broader industry economic,
political and socialfactors. In fact, the overall business environment in which a firm operate,
determines and affect the performance of a company.
Small investors can take a narrow approach to fundamental analysis. They may start
with the company to focus and analyse only the basic information about the company. The
earnings capacity of the company is estimated in view of the market share, competitive position,
new product lines, etc. Detailed financial analysis of the financial statements may be made to
find out the long-term growth prospects of the company and the expected earnings in
This approach may be known as 'bottom-up approach. The basic premise of the bottom-up füture.
approach is that the under-valued shares would provide superior and better returns
ofthe overall economic and industry position. irrespective
However, a broader framework for fundamental analysis is known as
This approach attempts to study the economiç scenario,industry top-down approach'.
expectations, and is also known as Economic-Industry-Companyposition (EIC)
and the company
Approach,
approach, the investor starts with the economy and overall market and then moves to In EIC
prospects. On the basis of positive signalsgiven by economic analysis and industry
industriesidentified by the industry analysis, the inVestor maves to the specific
sectors
andthe specific sectors/industries identified by specific company analysis
the industry analysis, the investor moves to
specificcompany analysis.
The EIC Approach has been
presented in Figure 6.1.

ECONOMY
INDUSTRY

cOMPANY

Figure. 6.1
Economy-Industry-Company Analysis.
 EQUITY SHARES FUNDAMENTAL AND
TECHNICAL ANALYSIS 161
The rationale for the 3-tier
analysis is that share value depends on the company
performance which is affected by the general economic and
top-down approach to fundamental analysis have been industry factors. The elements ot
explained below.
CONCEPT
CHECK
TEST YOURSELF-1
() Mr. A buys 100 shares of Reliance Industries Ltd. What
values he is entitled to |
Monetary as well as Non-monetary?
(i) What he is expected to earn from this investment over next
year?
(i) What is the maximum loss, he would suffer in the extreme economic situation?

ECONOMIC ANALYSIS
Economic analysis deals with the analysis
of forces Economic analysis has an
operatingin the overall econamy. In the security analysis, | important role to play in the
the expected course of the economy must be enquired into | investment decisions.
because overall economic conditions
and economicactivities
affect corporate profits and investors expectationsand thereby affect the security prices in
the capital market, Economic analysis has an important role to play in the investment decisions
Ifthe economicanalysisshowsa strong and vibrant economic conditions,investors will buy
p
e
theshares in expectation ofearningcapital profits at alaterstage. An expectation of sagging
economic conditions can lead to lower corporate profits and the security price will fall resulting
from the selling pressure.
In the current scenario of globalisation, it makes sense to examine the state ofinternational
y economic conditions as well. The international economy might afect the firm's export
commitments, the price competition it faces internationally and the profits its makes on its
foreign investments. In the wake of international division of labour and specialisation, the
global economy should also be looked into. For example, a number of Indian software companies
sis
are procuring orders from overseas market. In view of the expected economic conditions
to
overseas, the profitability of Indian companies may be expected to go up or down. An important
factor that affects the international competitiveness of economy is the exchange rate between
two currencies. When the exchange rates fluctuate, the rupee value of Indian exports and the
dollar value of Indian imports also fluctuate, and thereby it affects the profitability of Indian
companies.
The economic analysis helps to identify whether the economic climate is conducive or not
for the growth of the business in general. It is imperative to note that when economy grows,
all industries are expected to be benefited. In case of weak economies, industries struggle to
Survive.
With referenceto national economy, important variables to be looked into ae: ti) Gross
Domestic Product, (i) Inílation, (üi) InterestRates, (iv) Fiscal Policy (v) Monetary Policv.
oi) Busines Cycles, ete., Forecasting and analysing these variables is a difficult exercise and
a lot of data and expertise is required.
The national and international conditions afect the various industries differently The
economic analysis must precede the industry analysis which is the next element oft EIC
approach.
economic analysis, an investor is interested in forecasting the expected
In
performance of
the economy, in general, and its eltect on the perlormance of a particular industrv ar
particular firm. So, economie torecasting gains a place of primne relevance in the ecano
162
INVESTMENT MANAGEMENT EQUITY
analysis. A security
analyst may start with the forecast of Gross Domestic Product
which is a measure of national income and is defined as (GDP) (6) Opera
the value of total goods and
produced in the economy over a period of one year. An analysis of services a result of
how these components are related to the components
of the GDP and
degree of
performance of the industry and companies is also costs, will
required. Economic forecasting may be undertaken on the following lines:
(i) Atrend analysis of the basic economic indicators fall, reduc
the basic economic environment.
(GDP, etc.,) should be made to identify will swing
(i) Leading indicators of the economic environ ment be (c) Financ
phases of business eycles.
analysed to forecast the change in the capital
il) Analysis of lagging indicators be made to study impact of change in business cycle. leverage.
Profits of tE
those firmns
INDUSTRY ANALYSIS profits can
In the economic analysis, as above, the direction 1or the change Investoz
in capital market may be identified.
However, the analyst must
The analyst must realise Investment
realise that different industries
respond differently in the capital that different industries Key Factor
market. For example, in case of good economic respond differently in
goods industries prospects, COnsunerthe
may show relatively higher growth than the heavy capital market. characterist
industries. Every investment analyst intends to isolate investment Some of the=
favourable risk-return features. He may have several opportunities that have
queries answer
to 1. The pase
) Are the risk levels of various industries different? be analy
(i) Does the risk level of a particular industry vary or remain constant? analysed
(üi) Does the return from various industries differ over a
(iu) Would an industry continue to perform well in future?
specific period? 2. The perr.
the dema
(u)Would the performance of a firm in an industry be constant over time? made in
Industry analysis is relevant and important for the same reasons that the economic permane
is. As it is dificult for an industry to analysis
perform well if the economy is ailing, it is also difficult
firm to do well if the industry is in troubled for a 3. Role of
position. So, after an economic
analysis, what is governm
required is the industry analysis. The industry analysis requires an
and (ü) The relative strength and weakness of a insight into (i) The key sectors, supports
An industry may be defined as a
particular sector about the economic activities. was rest
another with a similar type of homogeneous group of firms which compete with one manufac
different groups on the basis of :
products, goods and services. Industries may be classified into
4. Labour o
i) Product line:
Automobiles, Steel, Cement, Textiles, etc. 5. Competi
(i) Sector wise
Agriculture, Mining, Construction, Manufacturing, IT, barriert
Transportation, ete. Services,
6. Industry
(ii) Business cycle wise:
Growth, Cyclical, etc. cycle. A
After forecasting the state of
the economy, it is vanishe-
that forecast for the determine the implications of
specific industry. It is alreadynecessary
to
sensitive to the economic noted that
not all industries are any ind
conditions and equally
independent and some are highly sensitivebusiness cycles. Some industries are virtually
to the business
stagnat
spices industry is virtually independent of the business cycles. For example,
food and in stags
luxury products is highly volatile. cycle. On the other hand, demand for IT indu
determined by three factors: Sensitivity of a particular industry to a business a lot.
(a) Sensitivity of Sales. eyele is
Some industries such as Life cy
necessities have low
sensitivity whereas luxury goodsfood,
have
drugs, medical services and other phases in
high sensitivity to business of industr
cycles.
 EQUITY SHARES FUNDAMENTAL AND TECHNICAL ANALYSIS 163
(6) Operating Leverage. Operating leverage refers to degree ofchange in operating profits as
a result of change in sales. For any firm,
higher the percentage of fixed cost, greater is the
degree of operating leverage. Industries which have higher variable costs as opposed to fixed
costs, wil be less sensitive to business cycles. If the economie recession appears, output will
fall, reducing the total variable costs. Profits in those industries which have high fixed costs
will swing more widely with saes because costs do not move to offset saleschanges
() Financial Leveroge. Financial leverage of a firm depends upon the use of debt fundsin
the capital strucbure. Higher the proportion of borrowed funds, greater is the degree of financial
leverage. Interest payment on borrowings have to be made irrespective of the sales level.
Profits of those firms which have high borrowing are more sensitive to business cycles than of
those firms which have lesser borrowings. The effect of financial leverage on the variability of
profits can be analysed in the same way as done for operating leverage.
Investors should prefer those industries which have lower sensitivity to business cycles.
Investments in higher sensitivity industries will be riskier.
Key Factors in Industry Analysis. In an industry analysis, number of key factors and
characteristics should be considered to identify the industries where investments can be made
Some of these factors are
1. The past performance ofthe industry. Past sales and past earnings for certain years may
be analysed to forecast future eamings. The cost structure of the industry may also be
analysed to look into the leverages of the industry.
2. The permanence of the product and technology of the industry. If the analyst feels that
the demand for the product for a particular industry would soon vanish, no inyestment be
made in that industry. In the age of rapid technological obsolescence, the degree of
permanence has become an important consideration in the industry analysis.
3. Role of Government in the Industry. Investor should try to assess
the probable role of
Will it provide financial or other
government. Will it restrain the industry's growth?
of several electronic items
supports? For example, in India, till a few years ago, the import
was restricted but allowed at a later stage
which has severally affected the Indian

manufacturers
4. Labour conditions relating to the industry.
5. Competitive conditions in the market. Investor should find out whether there is any

barrier to entry.

6. Industry life cycle is another factor. It is firmly believed that every product has a life
cyele. A product comes into existence, it grows in demand, it faces decline and ultimately
vanishes. Similar is the case with industries, which also go through ditferent stages. For
any industry, the life span may be demarcated into pioneering stage, expansion stage,
stagnation stage and decline stage, No investment be made in those industries which are
in stagnation or decline stage. For example, those investors who have made investment in
If industry, about 20-25 years ago when it was in the pioneeringstage, have been benefited
a lot.
Life cyele approach to industry analysis suggests that every industry passes through four
phases in sequence and provides an insight into the prevailing state of affairs. Different stages
ofindustry life cycle have been shown in Figure 6.2.
164 INVESTMENT MANAGEMENT EQL
Ana
Eamings info
the

Bef
Per
Time (rat

Figure. 6-2: Different Stages in Life Cycle of an Industry.

COMPANY ANALYSISs
(iv)
Third element of the EIC equ
approach to fundamental analysis is the company analysis. The
basic objective of the of t
company analysis is to identify specifie companies or specific shares
which are expected to perform well in calc-
feture. The company analysis presupposes that the
economic analysis and industry analysis have in
objectives of company analysis are to
already been made. It may be noted that the
find out the intrinsic value (fair value) of a share, and
(i) find out the expected earnings the
of company.
The intrinsic value of a
share depends upon the earnng The intrinsie
capacity of the firm besides other factors. The value of a |
in turn, depends upon the variables such as earning capacity, share depends
sales, profit margin,
tax rate, asset utilisation, debt proportion, etc. Finding out theearning capacity of the
upon the|
fair value of a share is the ultimate
objective and it has been firm besides other factors. alsc
taken up in details in next chapter. At
present, the discussion is restricted to forecasting the not.
expected earnings of the company. This has been taken up in 2 wit
information and the estimation of future dividends and steps, i.e., the sources of
Sources of Information. Information
earnings. follc
required for estimating the future earnings of a firm is (v)
primarily available in the annual financial statements. These financial statements fune
include:
i) Balance Sheet, or the Position Statement; be r
(i) Income Statement, or the Profit
Statement divi-
ii) Cash Flow Statement, or the Statement of Sources and
Uses of Cash; and
iv) Notes to Financial Statements.
Researchers and investment analysts have an inclination to base
their
on the information
contained in these statements. The primary reason company analysis
statements are audited and conform to the set of rules and being that these or de
statements must be in line with the regulations. In India, these
provisions given in different Accounting Standards (vi)I
prescribed by the Institute of Chartered Accountants of India. ICAI, so the !
Accounting Standards (AS-1 to AS-32) which are to be followed while far, has issued 31 divic
statements. Details of these statements and preparing financial
are not being discussed here for the
procedures to be adopted for their
preparation
may
sake of brevity.
 EQUITY SHARES: FUNDAMENTAL AND TECHNICAL
ANALYSis 165
Analysing Company's Earnings. In the annual reports, the company usually
information for last several (generally up to 10) provides financial
years. This information can be used to analyse
the
(i) Profitability of the company,
(i) Liquidity of the company,
i ) Solvency of the company, and
(iv) Activity level of the company.
Some of the variables used in the analysis of profitability of a
company are Earnings
Before Interest and Taxes (EBIT), Profit Before 'Taxes (PBT), Profit After Taxes
(PAT), Earnings
Per Share (EPS), Dividend Per Share (DPS), Return on
Equity (ROE), etc. These variables
(ratios) can be calculated as follows:
i) EBIT=Sales -Variables Cost-Fixed Cost
G) PBT = EBIT - Interest Cost

(ii) PAT =PBT- Tax

(iv) Return on Equity (ROE). The ROE examines profitability from the perspective of the
equity investors by relatingprofits available for the equity shareholderswith the book value
of the equity investment. The return from the point of view of equity shareholders may be
calculated by comparing the net profit less preference dividend with their total contribution
in the firm.

Return on Equity = PAT-Preference Dividend,100

Equity Shareholders Funds
Return on Equity = PAT-Preference Dividend 100
Net Worth

The ROE indicates as to how well the funds of the owner have been used by the firm. It
also examines whether the firm has been able to earn satisfactory return for the owners or
not. Therefore, the investors would probably be most interested in the ROE analysis. Together
with ROE analysis, the profitability can also be assessed with the help of other measures as
follows:
(o) Earn ngs Per Share (EPS). The ROE measures the profitability in terms of the total
funds and explains the return as a percentage of the funds. The profitability of a firm can also
be measured in terms of number of equity shares. This is known as EPS which is derived by
shares.
So,
dividing the PAT by the number of equity
PAT-Preference Dividend
Earning Per Share
Number of Equity Shares

The EPScalculations in a time series analysis indicate whether the firm's EPS is inereasing
S
e or decreasing.
(vi) Dividend Per Share (DPS). Sometimes, the equity shareholders may not beinterested in
s the EPS but in the return which they are actually receiving from the firm in the form of
dividends. The amount of profits distributed to shareholders per share is known as DPS and
al may be caleulated as
follows:

on Total Profits Distributed

Dividend Per Share =

Number of Equity Shares

 INVESTMENT MANAGEMENT

166 capital. For

in terms of percentage of paid-up
declare dividends of 100 each,
Generally, companies on equity
shares of face value
of 25%
value of the share is 7 80
declares a dividend
example,ifa company this if the paid-up
25% of F100. In case,
the analyst
time series analysis DPS,
then the DPS is 25, i.e., of
of 780. In the
is 20, i.e., 25% noted earlier.
only, then the DPS bonus share, etc, in the same way as
should make adjustments
for the DPS and the
Ratio). The DP Ratio is the ratio between
Ratio (DP distributed by the
(vii) Dividend Payout BPS which has been
firm, ie., it refers to the ofthe
proportion
DPS ofT5and73 respectively,
BPS ofthe For example, ifthe firm has an EPS and
as dividends.
company
then the DP Ratio is

DP Ratio =
Dividend Per Share, 100
Earnings Per Share

100
5
= 60%
its shareholders. It may be
firm has distributed 60% of its PAT as dividend among
So, the relating to
both depend upon the statutory provisions
noted that the DPS and the DP Ratio
etc.
compulsory appropriation of profits,
This i the ratio which established the relationship
(vii) Price Earnings Ratio (PE Ratio).
share and is calculated as follows:
between the EPS and the market price of a
Market Price Per Share
PE Ratio Earning Per Share

The PE Ratio indicates the expectations ofthe equity investors about theearningsofthe
the market price of the share and therefore
firm. The investor's expectations are reflected in is one of the
the PE Ratio gives an idea of investors' perception of the EPS. The PE Ratio
most widely used measure of financial analysis in practice. Companies having high and growth
prospectshave higher PE Ratio as compared to n0-growth or slow-growth firms.
Thus, a high PE Ratio may indicate (i) that the share has a low risk andtherefore the
investors are content with low prospective return, or (i) the investors ex pect high dividend
growth and are ready to pay a higher priee for the share at present.
(ix) Yield. The yield is defined as the rate of return on the amount invested. With reference to
the equity shares, the yield may be defined as the rate of return on the market price of equity
shares. In order to find out the yield of an equity share, the market price may be compared
with the EPS or the DPS to find out the Earnings Yield or Dividend Yield respectively as
follows:

Earnings Per Share

Earnings Yield = -

Market Price Per Share

Dividends Yield = Dividends Per Share

Market Price Per Share
It may be observed that the Earnings Yield is the inverse the PE Ratio.
Yield is also known as Earnings Price Ratio. The
of The Earnings
Earnings Yield and the Dividend Yield
evaluate the profitability of the firm in terms of the market
price 'of the share and are useful
EQUITY SHARES: FUNDAMENTAL AND TECHNICAL ANALYSIS 167
measures from the point of view of a prospective investor who is evaluating a share's worth to
take a buy or not to buy decision.
Example 6-1 explains the calculation of these ratios from the point of view ofa prospective
investor.
Example 6.1
The following are the Income Statement and the Balance Sheet (Partial) of ABC Lid. for
theyear 2019:
INCOME STATEMENT 0F ABC LTD.
For the year ending Dec. 31, 2019
Operating profit (BBIT) 8,36,000
Less:Interest charges 1,76,000
Profit before tax (PBT) 6,60,000
Less: Provisions for tax(30%) 1,98,000
Net Profit (PAT) 4,62,000
Less: Preference Dividend 20,000
Earnings for Equity Shareholders 4,42,000
Less: Dividend Paid 1,96,000
Retained Earnings 2,46,000

BALANCE SHEET (PARTIAL) OF ABC LTD.

as on Dec.31,2019
59% Preference Share Capital (of? 100 each) 4,00,000
Equity Share Capital (38,200 Shares of 10 each) 3,82,000
Total Share Capital 7,82,000
Add: Share Premium Alc 8,56,000
Profit and Loss A/e 22,70,000
Shareholders Fund 39,08,000
Add: Long-termLoans 20,46,000
59,54,000
Capital Employed
Additional Information:
(i) Market price of the share on 31.12.19 was 80.
(i) No final dividend has been proposed.
You are required to analyse the profitability from the point of view of a prospective
investor.
Solution:
Different ratios for the year 2019 have been calculated as follows
PAT- Pref. Dividend
Earning Per Share Number of Equity Shares
4,42,00011.57
38,200
168 INVESTMENT MANAGEMENT
Profits Distributed
Dividend Per Share =
Number of Shares
1,86,00
38,200
5.14
Dividend Payout Ratio Dividend Per Share 100
=

Earnings Per Share

5.14 x 100 = 44%
11,57
Eamings Per Share
Earnings Yield =

Market Price
100
711.57
x 100 14.46%
80
Dividends Yield Dividend Per Share y100
Market Share
5.14
5.14 100=6.42%
80
Price Earnings Ratio Market Price
Earnings Per Share
80
6.91
11.57
PAT- Pref. Div.
Return on Equity 100
Eanity Shareholders Fund
4,42,000
x100 12.6%
39,08,000-4,00,000
Return on Shareholders Funds Profit After Tax
=
Total
Total Shari
Shareholders Funds 100

4,62,000
x 100 11.82%
39,08,000
Economic Value Added. Economie Value Added (EVA) is based
return which refers to the excess of the after tax upon the concept of econ
operating
employed. The concept of EVA, as developed by Stern Stewartprofits
over the cost of funds
& Co. of U.S.,
after tax operating profits with cost of compares the
capital. What is earned over and above the cost of funds
employed, is known as EVA. Higher the EVA, more is the wealth added to the shareholders
networth. Companies which have EVA command better
values among the investors. EVA
may be calculated as follows:
EVA= EBIT Taxes Cost of Funds
Employed
-
-

Net Operating Profit after Tax -Cost of

Funds Employed
EVA measures the profitability of the company after
employed. So, EVA represents the value added in excess having
of the
met the costs of all funds
Cost of Capital
EVA increases if: employed.
(0) Operating profits
(i) New projects
grow through greater efliciency;
give higher return than the cost of procuring new funds, and
(ii) Unproductive capital is liquidated.
EVA can be used as
profitability measure by an investor.
a
 EcHNICA LANALYSIS
EiiCAL ANALY SIS
169
Part l
TECHNICAL ANALYSIS
In
Part
which makesIIof
an
the Chapter, the
fundamental
company analysis.attempt to forecast the securityanalysis to security analysis has been
and
earnings Investment decision as per prices on the basis of economic, discussed,
expectation and the risk returnfundamental analysis is based on industry and
approach to examine the securities framework of the investor. the dividends
Technical analysis is prices behaviour is the Technical The alternative
past suggest their based on the Analysis.
supply of securitiesfuture price proposition that the
securities
volume can be are
reflectedbehaviour.
in their
The technical analysts believeprices and volume in
prices and volume and the that the
analysis is basedused to
on the
predict whether prices would be past pattern
demand and
of prices and
and volume can give an concept that past information moving higher or lower. Technical
that securities idea of what lies ahead. It on priCesA
prices
studying the market data.and changes
therein can be emphasises
trend in prices is
rena
unless there is some definite Atrend in prices is forecast by believed to continue |
information believed to continue unless there is some
this trend in prices can leading ldefinite information
be used to predict the to change, and |leading
Technical analysis aims at future. to change.0
stockmarket activities, past evaluating securities by analysing information
intrinsic value, rather it looksprices and volume. It does not generated by*
the at charts and attempt to measure the
price-behaviour. Technical graphs patterns and other indicators securities
for
time reflect all known analysis operates on the premise that to forecast
information affecting demand and market
supply of securities. prices
at any
Technical
analysis-may also be called the market analysis
record and market information to predict the volume and prices.because it uses the
that let the It is based on the market
the
market narrates its own story. Technical analysis is a reflection principle
capital markets move in trends. It attempts to of the
so that investors can rely their identify changes in trends at an idea that
decisions on the expected early
mic basic assumption is that an investment changes. In technical analysis,stage
posture should be maintained until a
nds existing trend is indicated. The job of a technical reversal of the
the analyst is
(i) To identify the trend in
nds prices, and
(i) To identify when the trend will end and the
ders Of course, he should be able to prices would move in the opposite direction.
EVA differentiate the reversal within the
R change in the trend. trend and real
andamental Analysis and Technical Analysis. Fundamental Analysis and Technical
Analysis
are two types of
security analysis. Technical
prices and a few oscillators derived thereof, and not analysis is all about studying securities
unds and income statement, the taking any reference to the balance sheet
yed. assumption being that the markets are etficient and all
price sensitive information is reflected in price possible
movements. These two differ in their
assumptions and the methods of analysis. Some of the differences approaches,
analysis are: between the two types of
1. Sources of Information. Fundamental
economy, industry and the analysis is based on the information relating to
particular company. This information is generally available in the
170
INVESTMENT MANAGEMENT
publications of the Government, other agencies and company itself. On the
technical analysis is based on the information other hand, the
the capital market. This information is relating to prices and volume of
transactions in
analysed by the technical analysts to
predict behaviour.
So, the fundamental analysis is based on iníormation external to market whereas
analysis is based on the information internal to market. the technical
2. Type of Information. In
fundamental analysis, the data used are related to sales, growth,
earnings, etc., whereas the data used in technical analysis are related to
volume of transactions, market index, securities prices,
ete.
3. Objectives. In fundamental
analysis, the objective of the analysis is to assess the intrinsic
value of the share based on
expected performance of the company and other related variables.
However, a technical analyst attempts to identify the trend in
there could be a reversal in the trend. prices and to indicate where
4. Types of Techniques Used. The fundamental analysis is based on (i) the
techniques of ratios, and (ü) valuation models based on discounted cash flow accountingto
produce an estimate of the intrin_ic value. On the other hand, technical techniques,
analysis is based on
charting technique (discussed later in the chapter).
5. Emphasis. In the fundamental
analysis, the emphasis is on the cause of price movements.
If the earnings expected to grow, the prices will also increase. However, in technical
are

analysis, the emphasis is on what should be the trend and behaviour of prices in near
Moreover, in fundamental analysis the price movement is performance based whilefuture in the
technical analysis, the price movement is based on market forces of
demand and supply.)
6. Basic Philosophy. The basic philosophy in fundamental
real worth
analysis is that the share hás a
would have a real worth in near future. An investor can
or
beat the market by
taking early decision. On the other hand, the basie philosophy in technical
an
the share prices show identifiable trends that can analysis is that
be exploited by investors by
identification of changes. The fundamental early
analysis is designed to answer the gquestion: What
to invest in ?whereas, the technical analysis answers the
question: When to invest in?
However, the above differences need not be taken to imply that the
technical analysis are mutually exelusive. The technical fundamental and
information generated by a fundamental analysts do not ignore the value of
analyst. Share prices
eventually"close in on' the intrinsic or fundamental values, AThe technical analysts do
change in market fundamentals would result in change in price not ignore the value of
but before the market |
adjust to a new equilibrium level., an normation generated by
investor can exploit the market.
a fundamental analysts
In fact, the technical
analysis is used to supplement the fundamental analysis. Fundamental
analysis allows the analyst to assess the share return and
the risk attached with the
return, but these figures do not n fact, the technical analysis
ndicate any
investment decision. However, the technical Ls used to supplement the
analysis can help to time the investment actions of buying
and selling the shares. undamental analysis.
Basie Tenets and Premises
of Technical Analysis: Technical analysis is based on certain
premises, such as
) Market price of a security is related to and
and
determined by the interaction of demand
supply forces operating in the stock market.
EQUITY SHARES FUNDAMENTAL AND TECHNICAL ANALYSIS 171
(i) Stock prices tend to move in trends for a long period, nevertheless there may be minor
fluctuations in between. This implies that the movement in prices is continuous in a
particular direction for some time.
ii) Reversal or shift in trend in prices may occur because of change in demand and supply
factors.
(iv) The change in demand and supply factors can be detected earlier with the help of
charts and graphs.
(o) Price patterns projected by price movements in the market tend to repeat themselves
and can be used to forecast future price behaviour.
Various tools and techniques are used by technical analysts to predict the price behaviour.
These can be broadly classified into:
1. Charting, the basic tool of technical analysis, and
2. Select Market Indicators.
These have been discussed hereunder.

CHARTING: THE BASIC TOOL OF TECHNICAL ANALYSISS

Charting is the key activity in the technical analysis. It is The charts and graphs are
already noted that in technical analysis, the basic motive is to
the basie tools to
dentity the price trend on the basis ofhistorical data. The trend Sea as the trends in
1s then used to forecast the future behaviour. The price and entify
volume data on securities are the basic raw material used P e s
tools to identify the
by a technical analyst and the charts and graphs are used as the basic
trends in priçes. The technical analysts may also be called chartists because theyuse charts
and records of historical prices and volumes to identify the trend and pattern in prices.

It may be noted that the technical analysis can be used either fora specific share or for
themarket in general. In case of aspecific share, the past data of that security are used to
usedto
showcharts while in case of market, the aggregate data on prices and volumes are
technical analysis, both the price data and the volume data are studied
prepare charts. In shares as well as for the market.
simultaneously. This is true for specific
thepricesofsecuritiesthat are plotted
Prices and Price Charts: In the chartingA activity, itisistraded at different price levels on any
andshown in the graphs and_charts. security four prices are relevant and important.
particular day. Out of these different price quotations,
These are: thefirst transactionfor theday has taken place.
() Opening Price: It is the rate at which
the closing price for the previous day.
This may be equal to, less than or more than
the
(i) High Price: It is the highest rate at which some transaction has taken place for
day. the day.
which a transaction has taken place during
(ii) Low Price : It is the lowest rate at
(iv) Closing Price: It is the rate at which the last transaction hastaken place
for theday.
closing price is relevant for two reasons
The
calculated on the basis of closing prices of the
la-The stock indices for the day are
constituent securities; and
with the
with the opening price for the day or

bY Closing price can be compared a trend in prices.

to
closing price for the previous day identily
 172 INVESTMENT MANAGEMENT
In charting, generally the closing prices are shown. A price chart shows the closing prices
for a security over several trading days. X-axis shows the time and Y-axis is taken to represent
the prices for the day.
CONCEPTTEST YOURSELF 2
) Closing price for yesterday of shares ofX Ltd. was 73 while the opening price today
is 76. How is the opening price higher? Can it be lower also? Explain.
(n) Explain OHLC.
Dow Theory. The Dow Theory, named after its originator, Charles Dow, is considered to be
first theory of technical analysis. It is still regarded as the basis of all other techniques used
by technical analysts. In fact, it is the Dow Theory from which much of the substance of the
technical analysis has branched out.
Dow Theory is based on the hypothesis that the stockmarket hee
does not perform on a random basis. Rather, it is guided by some Three types ofspecific |
specitied trends. The likely market trend in future can be predictedrenas have been
Ramed in Dow Theory.
by following these trends. Three types of specific trends have been
named in Dow Theory. These are:
(a) Primary Trend. It is a long-range trend in price and may carry on even for number of
years. It takes the entire market up or down. It may be characterised as bullish or bearish
in nature.
(6) Secondary Trend. Secondary trend or trends appear within a primary trend and may last
for few days or few weeks or few months. Secondary trends show interruptions in primary
trend and act as a restraining force on the primary trend. The secondary trends tend to
correct deviations from the primary trend boundaries of price movements.
(c) Minor Trend. Minor trends refer to day-to-day trend or movements in prices over few
days. The minor trends, being of very short duration, have little analytical value.
shown in Figure 6:3.
LAn
N K These three types oftrends have been
MAR
ewM, Price

K Primary Trend
MinorTrend

Teno

SecondaryTrend
(Corrections)

-Time

Figure. 6-3: Different types of Trends as per Dow Theory

Figure 6-3 shows that there are day-to-day movements, secondary movements (prices
falling over a period of, say, a month), and the primary trend (the prices are increasing over
time. It also shows that secondary downtrend (decrease in prices) will be of a shorter duration
then the following secondary upswing (increase in prices). In terms of Dow Theory, the upward
 EQUITY SHARES: FUNDAMENTAL AND TECHNICAL ANALYSIS 173
primary trend is known as bull market, and the downward primary trend is known as
market. Figure. 6-3 has shown a bull
hear
maket as the successive highs are reached
after
secondary correction in prices. Opposite of bull market is the bear market where the every prices
are successively going down.
In Figure 6.3, the primary trend is
positive and upward despite three secondary movements
that are down ward. The secondary trend or movement in
corrcction. In case of bull market, after asecondary
prices is also known as technical
and it penetrates previous heights. In case bear
correction, there is an upward movement
of market, after a secondary correction
increase), there is a downward move which penetrates previous lows. The day-to-day
movements in prices, also known as rippies,
forces. The technical analysts usually do not
depend upon the instant demand and supply
pay attention to these minor trends. Following
points are worth noting about the Dow's Theory:
G) No individual investor can affect the basic trénd in the
cannot be manipulated. market, ie., the primary trend
(ü) Signals given by Dow's Theory must be observed
conformation of trend reversal. The Dow carefully. Investors must wait for the
fails to tell when the trend will come to an
Theory helps in indicating a primary trend but it
end or will reverse.
Eliott Wave Theory. Another theory that
long-term pattern in price benaviour
attempts to explaimt states that the long-term
is the Elliott Wave
Theory. Basic proposition of this major paterns, may consist
inthe market can be described theory is that the stoCK pricesof
as a set of wave patterns. It five suecessive steps or five
states that the long-
term major patterns may consist of
five suecessive steps or five waves. In case bull
the first wave is upward, the
of market, the set of five waves is as follows
and thefifth wave is
second is downward, the third is upward, the fourth is downyard
upward. In case of bear
market, reverse pattern follows i.e., downward,
upward, downward, upward and downward. Figurethe6.4. shows the Eliott Wave
Bull Market (A) and Bear Market (B). Theory in

Prices Prices|

Time
(A) Time
(B)
Figure. 6-4 Elliott Wave Theory Bull Market and
Dow Theory and Elliott Wave (A) Bear Market (B).
Theory fairly simple and help
are
deviations around those trends. Over theidentilying
term trends with short-term the simple long-
patterns and charts have been developed. All these years, several other intense
future prices can be patterns have the common objective that the
extrapolated from current prices. Some of these charts and
related to price pattern, some are
related to price and volume techniques are
prices, some other variables. There is a
or data, some are related to average
used by technical long list of these new
techniques being adopted and
analysts. However, only the more common of these are being discussed here.
174
1. Bar Chart. This INVESTMENT MANAGEMENT
technique, borrowed from statistical theory, is
EQUITY SHARES
showing the price variation popular a

volume on a particular day andtechnique

and of
comparative presentation over a accompanied
period of l month or half year or so. In a bar then the
For example,
price was7540."
day s price boundaries (high and low) are chart, each have shown tha
on that shown
day are shown as a horizontal tick on theas a bar. The closing price and opening price
also shown as vertical bars in the lower high-low bar. The volume of transactions upward trend in.
is Bar charts a
and the information portion of the chart. Figure 6-5 shows the bar chart
depicted by it. presentation an
2. Line Chart.
High presentation of
High variable is take=
on the graph. A
- Close Open- The variable fo
totalvolume at.
inthe particul
In of s
case

Open différent days."

-Close the Line Chart
Low
about the beha
Low
different lines
(A) (B) different varia
Figure. 6.5 Elements of a Price Bar.
Figure 6.5 shows that each price bar has four element i.e., Open, High, Low and Close
Price. It is also called OHLC Bar.
The open tick is shown on the left side and closing tick is
shownon the right side. In Figure 6.6, price and volume bar chart has been shown for a
particular security for 14 days.

Price
Volume
(No. in '000)
700
3. Point-and
behaviour in
600 some analysta
is based on th
prices only. "
500
changes and
is ignored, th
400 -
In order 1
significant p
300- around 1 0
30
running arou
0
changes are .
200 axis impliedl
In Figur
100 10
change (incr
it is shown a
Date
12 3 45 67 8 9 10 11 12 13 14 32.25 on th
another X i-
that the pric
Figure. 6-6 Bar Chart with Price and Volume Data.
EQUITY SHARES
For example,
FUNDAMENTAL AND TECHNICAL ANALYSIS 175
on Date1, the highest price was 650, lowest
price wasR 540. The total volume on that was price was7 500 and the closing
have shown that volume day 18,000 shares. Studies based on bar charts
goes with the price trend, i.e.,
upward trend in prices and volume decreases with the generally volume increases with
Bar charts are downward trend is prices.
popular among technical analysts because these charts have a lot of visual
presentation and, moreover, are easy to dra.
2. Line Chart. Line chart is
another type of a basic chart.
presentation of movement in any variable. On the horizontalThe axis,
ine chart is a simplest
time is taken and the
variable is taken on the vertical axis. The value of the
on the
variable for different dates are platted
graph. All the points are then joined by a line. This line is known as the
The variable for the line chart can be price of a security, variable line.
volume of
total volume at the exchange, etc. Line chart can be prepared even for a security, Index Number,
in
the particular variable Line Chart. intra-day fluctuations
In case of securities prices, the line charts are
drawn by taking the closing prices for
different days. These closing prices are joined by a
the Line Chart. Line Chart has a lot of visual
line,Figure 6-7 has been prepared adopting
power and even a layman can make an idea
about the behaviour of the variable. Sometimes more than one variable can be shown
by
different lines (may be different colours/patterns) to make a comparative presentation of
different variables.

Share
Price

Time

Figure. 6:7: Line Chart for a Share.

3. Point-and-Figure Chart. The technical analysts attempt to identify the future price
volume. However, there are
behaviour in terms of the past data for prices, timing and the
some analysts who consider only the past prices
and ignore the timing and the volume. This
behaviour can be predicted on the basis of past
is based on the proposition that future price
volume are not useful. Rather, significant price
prices only. The time dimension and the
changes and reversals should be noted to predictchart future price behaviour. As the time dimension
is a bit different than the bar chart.
is ignored, the preparation of point-and-figure
the analyst has to decide as to what is a
In order to prepare the Point-and-Figure Chart, whose price is running
reversal. For example, for a share
significant price change or price whose price is
considered significant but for a share
around 100, a change of F5 may be
The significant price
ofT 20 may be considered as significant.
running around 500, a change time dimension is ignored, the
horizonal
shown on the vertical axis and though
changes are
shows a point-and-figure chart.
axis impliedly shows time. Figure 68
decrease. A price
increase and '0' represents price
In Figure 6-8 X represents price the initial price is ? 30,
(increase or decrease) of? 2 is considered significant. Suppose,
change on the same day
and touches
shown X' in the first column. It increases to 31.50
it is as the levelof 30,
increased by?2 (paise ignored) from
32.25 on the next day. As theprice has first column showing
in the first column. Now, there are two X in the
another X is entered
over which such
to732 but the period (numberof days)
that the price has increased from30
 176
INVESTMENT MANAGEMENT
change has been recorded is ignored. Another will be EQU
'X'
price increases by another 72, i.e., reaches 734
added to the same column when the
and so on. A reversal (
shown in the Figure 6:8. Suppose, price increases up to 33.60 but trend has also been
the number of X in (ii
first column would remain 2 only. 2 Xs would the
In case, the price remain so long as the price does not reach34.
goes down to 29.80 after a few days, a O will be
column, against the price bend of R30, and so on.
The share is now in the
marked in the next amo
will remain there unless a reversal of downward eycle and Wee
goes down up to
72 occurs. For example, over next few
days, the price may
25.75,total 3'0' wouldappear. Thereafter, if the prices again start mon
the X would be written in the increasing,
next column, and so on.
will be shown by Alternative reversals of price trend
successive X' and 'O' columns.
Price 44-

36

40-

32

28

24-

20 Wed
lowem
cand
lowe
Figure. 6-8:Point-and-Figure Chart. stick
Figure6-8 shows that even if
the time dimension is
forces are at work. It ignored, the
depicts
months), the price increased that in the initial
period (may be number demand and supply ANA
gradually but then of days weaksor
decreased. there was a downward trend and the or
It
may be noted that in the
price visua
either Xs or Os, but not
both. Thesepoint-and-figure
charts
chart, any column in the chart can
contain
prov
and spot buy and sell allow investors to whic-
signals. analyse various price movements stud
4. Candlestick
Chart. Candlestick Chart
addition to the price data can be considered
chart), the candlestick chartextension
as an
(shown
prices for the day. In candlestick in bar of bar chart. In
PA
with a vertical line chart, the also shows the trend in
drawn through it. The price data for a day is shown by a yertical
candle
represents candle may be shaded or
the increasein clearA
opening price for the day). Aprice during
shaded
the day (i.e., the
closing price
clear candle
is higher than the
The
price lesser than the
is candle represents the decrease in price (i.e., the of p
passing through the candle, opening price for the day). The closing
candlestick for the day represent the high and low top and bottom points of the line, ider
represents following prices respectively for the of t
) price information: day) A
Opening closing prices for the day,
and ag

pr
ENT EQUITY SHARES FUNDAMENTAL AND
the
(i)
TECHNICAL ANALYSIS 177
een Highest and lowest prices for the day, and
i) Increasing or decreasing trend in price during the
the day.
34. Thus, a candlestick chart represents a
ext
amount of price information
for day.a
considerable
It can be prepared
weekly or monthly basis also. For example, one on| Acandlestick chart represents
and may. represent the price information for candlestick considerable amount of price
a

ce month. Figure 6:9 shows one week or one information for a day.
ng,
a candlestick chart.
end Price
High Price, 108
Closing Price, ? 107

Opening Price, 104

Low Price, 103

Monday Tuesday Wednesday Thursday Friday Days

Figure. 6:9 Candlestick Chart for- Five

Working Days.
In
Figure 6:9, one candle represents price information
Wednesday, the candlesticks are shaded representing for one day. For
Monday ànd
lower than the opening prices for that that the closing prices on that day are
day. Detailed price information is
candlestick for Friday. For Friday, the candlestick is clear. It means that the
provided for the
lower than the closing price. Other
stick.
price data are also visible from the positionopening price is
of the candle-

ly ANALYSIS OF PRICE-VOLUME CHARTS

or
Various price-volume charts presented in the
ce visual communication to the investors. The foregoing paragraphs have a high degree of
past and present price-volume informations
provided by these charts can be used by the investors to make reasonable and
which can be used to take wiser decisions. There are logical predictions
two ways in which these charts can be
ts studied and analysed. These are : Pattern
Analysis and Indicator Analysis.
PATTERN ANALYSIS
n
The price-volume charts can be used to analyse the patterns of price behaviour. Dow
Theory Elliot Wave Theory concentrated on the analysis of price
and
of primary trend, patterns. Identilication
secondary trend and minor fluctuations (as in Dow Theory) was in fact the
identification of price patterns over a time
of the price movements in a
period. The pattern analysis emphasises the tendeney
particular direction or to repeat the same formation over and over
again. These patterns can be categorised to reflect a bullish or bearish trend over
years.
In order to assess and forecast the share
price movements, technical analysts believe that
prices move in patterns which can be identified and standardised. Based on a particular
178
formation of price movements or INVESTMENT MANAGEMENT
predicted. In general, the shareprice patterns, the likely
behaviour of prices in future can
phase to the prices not
do
bearish phase or vice versa. change overnight from being in the de
The price There bullish
pattern can give an advance idea of is usually a transitional phase in between.
patterns can be used to forecast likely change in direction of
(a) End of bullbear
prices. These price
phase,
(b) Reversal of trend in
c) Direction of the new
prices,
d) Confirmation of the
change, and
new trend.
Some of the common
Irend. Trend is a
price patterns are as follows:
long-term
tendency of the prices can beprice pattern. Over a period of one year to three
identified as inereasing or years, the basic
Head and Shoulders. At the
end of a long trend, a
decreasing trend.
signalled by a head and shoulders formation. reversal may turn up. This reversal
can be
At
humps (middle one being higher than the two the end of an increasing trend, a set of 3
to identify the base
of the formation. others) may appear. A neck-line be drawn
trend is expected to occur. The three When the prices fall below the neck-line,may
a downward
Inverted Head and Shoulders. As humps show the short-term rallies in prices.
the name suggests, this
shoulders pattern. It occurs at the end
of a downward trend pattern
is the reverse
or inverted
of head and
and is consisting of three
humps (middle one troughs
joining the tops of the inverted being
humps.
deeper than the two others). A neckline
When may drawn by
start of a rising trend. the prices breach the neckline, it indicates the
Double Tops and-Bottoms. A doubletop appears when a share hits a
again pulls back but fails to hit the earlier high, comes lower,
prior high and comes down. When the high. So, price rise fails to breach the immediately
move, a downward trend starts. On
price ecomes below the lower level
the other hand, a double created by earlier
bearish trend and indicates the start of bottom appears at the end of
a bull
small rally in price after first phase. It is quite possible that there
Similar to double tops and double peak in double top or after first troughs in double may be
bottoms, there may be triple tops and bottom.
Triangles. Out of the different continuation triple bottoms also.
is formed when each patterns, triangles are more popular. A
succeeding peak is lower than the preceding triangle
bottom is higher than the peak and each succeeding
preceding bottom. The series of
line which
converges and form a shape of a triangle. When peaks the
and bottoms are
joined bya
the triangle, there may be a sharp reversal of prices break out of the sides of
either during a bull phase or a bear phase. prices. The triangle formation
known as ascending, Triangle may take different forms may and
appear
be
descending, may
triangle is known as the resistancesymmetrical expanding. In any case, the upper line of the
or
line, as the price does not
support line as the price does not go below it.go beyond and the lower line
is known as the it
(three upper and three lower) to Usually, there are six points
form a triangle. There is a time limit
triangle pattern and that is at a point when the two lines for the end of the
meet. Before the end of the triangle
or
immediately after the end, the
earlier trend. The breakout from price should break out of the triangle in the direction
of the
a
triangle is usually
accompanied by inereasing volumes.
Flags. A flag formation appears when a bull
pattern appearing as a rectangle or a rally or bear phase is interrupted by a consolidation
for a short parallelogram. The consolidation process appears only
period during which volume may diminish
a
pause before the continuation of trend drastically. As the formation
flag indicates
the flag as before. earlier, the prices move in the same direction after
EQUITY SHARES
FUNDAMENTAL AND TECHNICAL ANALYSIS
At the start 179
or just prior to the
formation of a flag pattern, the
However, volumes taper off as the formation is complete. So, the
volume is very high.
may be taken as suficient decrease in volume
indicator of flag completion.
Various price patterns bave been
shown in Figure 6.10:
Price
Increasing Price
Decreasing
-----

NNNMYA
Trend

ime
Time
Price
Prce Inverted

Head and
Shoulders

Time
AN HS

Time
Price Price
Double Tops Double Bottoms
Double
Tops
Bottoms
nd ww
M

Time Time

Price Price
Ascending Descendingg

Triangles w w w w w ANN wn
Time Time

Price Price

Flags
ww w
TIme Tme

Figure. 6-10: Some Selected Price Patterns.

180 INVESTMENT MANAGEMENT EQ
Supportand ResistanceLevels. The support and resistance levels are those price levels'at
which the declining trend and rising trend are expected to take a turn and move in a reverse Co
direction. These levels are determined on the basis of past data and help determine the level ex
below which or above which the price may not fall or
rise
fu
is unlikely to fall. On the other hand, the resistance level is4 support level is the price pa
one above which the price level is unlikely to rise. These two level below which the market
levels are determined with reference to recent history of prices is unlikely to fall. On the |
and keep on changing from one value to other hand, the resistance
another. In case the
price increases beyond the resistance level, it is considered level is one above which the
as a bull signal. When the price penetrates from below the Price level is unlikely to rise.
support level, it is considered as a bear signal. For example, market price of Reliance share is
movingbetween, say ~ 1,230 and 1,255. Whenever pricereaches 1,230, it begins to rise and
whenever it reaches 71,255, it begins to fall. These two may be considered as support level
and resistance level, respectively. Whenever price level reaches 7 1,255, investors in market
think that the prices do not go beyond that level and want to sell off their holding at the level
of 1,255 bringing down the level. Similarly, whenever price level reaches 1,230, investors
feel that this is the lowest level and start buying and thereby upbringing the
price. Breaching
the support level and resistance level gives rise to bear trend or bull trend. Figure 6 11 shows
the support level and resistance level.

Share
Price - - - - Resistance Level

Support Level

Time

Figure. 6-11: Support Level and Resistance Level.

The support and resistance levels chart helps
identifying the occurrence of support zone
and resistance zone. A support zone occurs when the
supply-demand balance is tilted in favour
of demand and the price is expected to increase. However, if the share
price breaks the support
level and moves downward, it signals the bearish trend in the market and the
price may fall
further. On the other hand, if the supply-demand balance is tilted in favour of
the prices are expected to fall. However, if the share
supply, then
price breaks the resistance level, the
prices may further increase indicating an uptrend in prices.
The support and resistance levels can be used to confirm reversal in
points are worth noting in respect of support and resistance levels:
prices. Following
(i) These levels are only indicative levels that the prices are expected to move within.
However, the limits may change any time.
(ü) Ifthe prices penetrate the resistance or support level, it is indicative of a strong move in
the same direction.
(ii) Prices tend to move within very narrow range in the congestion
zone. The break-up
point cannot easily be forecasted.
EQUITY SHARES: FUNDAMENTAL AND
TECHNICAL ANALYSIS 181
Pricepatterns discussed above can also be classified as Reversal Paiterns and
Continuation Patterns. The reversal patterns are those which indicate a reversal of
the
existing trend, whereas the continuation patterns suggest that there is only a pause in the
market and the old trend will continue
again after the pause. The
further classified as Bullish Patterns and Bearish Patterns. TableReversal
Patterns can be
6.1 lists these different
patterns.
Table 6.1: Classification of Price Patterns

Reversal Patterns Continuation Patterns

Bullish Bearish
1. Up Trend 1. Down Trend 1. Triangles
2. Inverted Head and Shoulders 2. Head and Shoulders 2. Flag
3. Double Bottoms 3. Double Tops
4. Triple Bottoms 4. Triple Tops
5. Support Level 5. Resistance Level

Principles of Analysis of Price Patterns: Identification and analysis of various price patterns
in the share prices is not merely a matter of visual look. It
requires a lot of insight and depth
of knowledge to identify a pattern. Here comes the relevance of the
experience of the technical
analyst. Following principles and guidelines may be noted:
1. A price pattern is a function of size (volume) and
depth. Movement of volume must be
looked into before identifying the price pattern. The length of the
pattern is equally
important. Longer the duration of the pattern, greater would be the fluctuations within
the pattern. What is required is to concentrate on basic pattern rather than being lost in
the intermediate fluctuations.
2. The strength of the new trend depends on the time taken to come out of the earlier trend.
Longer the time taken for coming out of existing trend, stronger would be the new trend.
So, both the height of the pattern (volatility in prices) and the lengih of the pattern (length
of the period) be considered.
3. Bearish phase is generally shorter in duration than a bullish phase.
4 Volume in the market generally has a positive correlation with the trend. During uptrend,
the volume increases while during downtrend, volumes decrease. Volume pattern can be
used to identify a trend reversal.
5. Breaking of a major trendline may be considered as indicator of an impending trend
reversal. However, cautions must be taken to find out whether it is really a reversal or
just sideways.

INDICATOR ANALYSISS
Indicator analysis is a newer form of interpretation of price-volume charts. It is a math-
oriented examination of price and volume information over a given period through a series ot
calculations. The objective of this mathematical examination is to predict where and in which
direction the price
may move in near future. The indicator analysis attempts to establish a
mathematical relationship of current price to past prices. Various indicators have been used
182
INVESTMENT MANAGEMENT
by technical analysts. These indicators can be classified as
Trend Following (eg., Moving
Averages) or Oscillators (e.g., Relative Strength Index). Out of
than the latters. Whereas Trend these, former react slowly
the
Following
future, the Oscillators reacts rather
indicators look deeply into the past to forecast
quickly to the short-term changes in prices. Some
indicators have been discussed
hereunder of the
1. Moving Averages. Moving averages have been the
studying the price charts. Moving average of most popular technical indicators for
share prices refers to the average level of closing
prices, caleulated on a regular basis. In order to find out the average, the sum of a
number of previous closing specifie
prices is divided by the number of observations. A sequence of
averages is caleulated by calculating the average on
daily basis. The sequence gives rise to the
moving averages.
In order to find out the
moving averages, first of all, the moving average period is selected,
say a period of 5 weeks, 10 weeks, 50 days, 100 days or 200 days, or a
of 5 weeks is selected for year. Suppose, a period
calculation of weekly averages. Each week the moving average is
calculated by dropping the oldest
of 5 weeks is calculated.
week and adding a new week (latest). Every time, the average
Example 6.2 explains the moving method.
average
Example 6.2
Following are weekly Sensex level for 20 weeks. Find out and depict the
on the graph on the basis of 5-week moving average basis. moving averages
Week Sensex 5-WeekMoving 5-Week Moving
Average Week Sensex
35,300 Average
11 35,500
2 35,350 35,464
12 35,570
3 35,320 35,478
13 35,600
4 35,400 35,510
14 35,650
5 35,410 35,356 35,560
15 35,590
6
35,460 35,388 35,582
16 35,540
35,500 35,418 35,590
17 35,510
8
35,440 35,442 35,578
18
9
35,400 35,470 35,552
35,442 19
10
35,480 35,420 35,506
35,456 20
35,410 35,470
The values of Sensex
and 5-week
moving averages have been shown in
Figure 6-12 shows that Figure 6-12.
moving
comparison of Sensex line and average line represents the basic trend of Sensex. A
Moving average line
behaviour.
the moving
When the prices are
rising, moving line willthrough
the
can
light on expected price
average line breaks be below the Sensex line. When
it 1s a
'sell' signal for the through the Sensex line from
above, it is taken as a investors. If the moving below, the prices are falling and
'buy' signal as the prices are average breaks through the Sensex from
prepared for specific shares
also on the same inereasing. Moving Average graphs can be
lines as given in
Figure 612. It may be noted
EQUITY SHARES. FUNDAMENTAL AND
TECHNICALANALYSIS 183
that the moving averages show what the price behaviour
already had been, and not what
they would be.
Sensex
35,650
35,600

35,550
35,500

35,450 5-Week Moving

Average
35,400 Sensex

35,350

35.300

35,250
Weeks

Figure. 6-12:5-Week Moving Average and SensexValues.

Moving average line gives a visual presentation of
the price behaviour. What is attempted is the smooth MOving average line gives a visual
and simple curve for the prices so that the random presentation of the price behaviour.
variations and irratic price changes are cancelled out and a general underlying trend is
identified.
Some ofthe other techniques used by technical analysts are:
) Breadth (Advance-Decline Line),
(ii) Relative Strength,
(i) New Highs and Lows, and
(vi') Moving Average Convergence Divergence.

WEAKNESSES AND SHORTCOMINGS OF TECHNICAL ANALYSIS

Diferent tools and techniques of technical analysis can be used to forecast the price
behaviour. Various price patterns can be used to prediet future prices. Still, however, these
tools must be used with care. There are several weaknesses of the technical analysis as
follows
(i) Careful Interpretation. Identification and interpretation of a price pattern require a lot ot
experiene. More fluctuations in prices over a few days need not be taken as forming apattern
A technical analyst has to look for the occurrence of a real pattern. He should also be able to
identify the short-term and long-term patterns.
7) Biasness. The interpretation of a price pattern need not be affected by the personal biases
of the analyst. If the analysis is bullish and optimistic, then such feeling will overshow the