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Outline
Technical analysis is the financial markets methodology that asserts the capability to foretell the probable course of security charges by the means of past market data study, principally price and volume. In its clearest type, technical analysis suggests only the real price performance of the market or tool, on the supposition that charge reproduces all relevant components before any shareholder turns to be aware of them using the other channels. Technical analysts may apply models and trading regulations grounded, for instance, on price modifications, such as the Relative Strength Index, moving averages, regressions, inter-market and intra-market price connections, cycles or, characteristically, through recognition of chart prototypes. (Demark, 1994)
Scientists such as Eugene Fama say the substantiation for technical analysis is meager and is conflicting with the weak type of the widely-taken efficient market notions. Economist Burton Malkiel states, “Technical analysis is an anathema to the academic world.” He further states that under the weak type of the proficient market theories, “…it is impossible to predict the probable stock prices taking into account the past stock prices.” (Fama, 1995)
In the foreign exchange markets, nevertheless, its application may be more extensive than “fundamental” analysis. While some separate studies have revealed that technical trading regulations might head for the constant reductions in the period prior to 1987, most research work has concentrated on the origin of the inconsistent position of the foreign exchange market. It is considered that this irregularity is due to central bank interference. (Hirt, Stanely, 2003)
Technical analysis is often compared with the essential analysis; the research of financial factors that some analysts say can impact values in financial advertises. Clear technical analysis states that prices already reflect all such impacts before stakeholders are attentive of them, therefore the research of price impact alone. Some traders apply technical or essential analysis completely, while others apply both forms to make trading conclusions.
Technical analysis is the research of market activity chiefly by the means of the application of charts for the aim of forecasting probable price tendencies. Technical analysts use trend line ups to classify the way of the movement of the stock charges and to define if and when the modification will change. Technical analysis is grounded on the notion that the prices of stocks shift in fairly specific expected tendencies. Trend lines can be applied to make sound speculation conclusions and get essential profits in any financial market.
The essentials of technical analysis originate from the study and thorough examination of financial markets over centuries. The oldest documented instance of technical analysis was a methodology applied by Japanese merchants as early as the 18th century, which changed into the use of candlestick method, and is today a key charting tool.
Dow Theory is grounded on the gathered notions of Dow Jones co-founder and editor Charles Dow, and motivated the application and enhancement of contemporary technical study from the end of the 19th century. Current technical analysis regards Dow Theory as its cornerstone.
Many more technical tools and theories have been developed and enhanced in recent decades, with an increasing emphasis on computer-assisted techniques.
The principles of technical analysis say that a market price reflects all relevant information so that their analysis looks at “internals” than “externals” such as news events. Price action tends to repeat itself because investors collectively tend toward patterned behavior; hence they focus on identified trends and conditions.
Based on the premise that all relevant information is already reflected by the prices there is no need for a fundamental analysis. Its in fact on this principle, that others view the inability to identify the fundamental shocks that account for significant market moves that are at times hard to reconcile that such shocks account for most variations in stock returns (Cutler, Poterba,Summers,1988).
In technical analysis market technicians, analysis examine prior price and volume data, as well as other market related indicates to determine past trends in the belief they will help forecast future ones. Much more emphasis is placed on charts and graphs of internal market data than on such fundamental factors as earning reports, management capabilities or new product development. The technical analysts believe that fundamental information may not lead to profitable trading because of turning consideration and market imperfections. These are also related to the concept of market efficiency i.e. the ability of the market to adjust very rapidly to the ability of the market to adjust very rapidly to the supply of new information in valuing a security.
Active money management requires technicians ability to draw references from observation of money management activities especially in the stock market such activities are continuously done by these experts who include brokers and financial analysts. This approach is base on some basic assumptions viz;
- That market value is determined solely by the interaction of demand and supply
- That though there are minor fluctuations in the market stock prices tend to move intends that persist for long periods.
- Reversals of trends are caused by shift in demand and supply.
- That shifts in demand and supply can be detected sooner or later in charts.
- That many charts patterns tend to repeal themselves.
The basic premise, Hirt and Stanley (2003), is that past trends in market movements can be used to forecast or understand the future. The many market is a float with investors who have little or no knowledge on market timings or piece movements. However, to gain in the stock securities market an active approach to intervention by chartists or technicians to easen the understanding of stock prices is important; these experts help in creating an understanding on the relationship between pas and future stock prices.
Technical analysis(Murphy,1986), has been used for a long time before the availability of more sophisticated instruments for financial analysis and suggests decisions of the occurrence of patterns through data. To get the best trading decision is an art, independently from the model, interpretation of charts heavily relies on the skills of analysts.
Technical analysis signals the reaction of financial agents to the market conditions than can be detected through the study of charts. The analyses use particular signals in order to trigger either buy or sell orders.
Dow Theory classifies major trends for the periods longer than one year. Trends have a time length that can range from a minimum of three weeks to a maximum of several months. Intermediate trends can be useful for future markets. Short trends can be identified in periods shorter than two or three weeks. Therefore it’s important to fix the period before to try to define the trend. Shorter trends can be used for the detection of starting points of major trends. Buy and sell signals rely on the identification of particular configurations and several rules can be found for such identification.
There are traders that are skeptical to technical analysis and it should thus be pointed out that the Efficient Market Hypothesis implies that if the market is efficient , there is no way of making any forecast of future prices with the help of technical analysis.
The stock market is not an efficient market; herding behavior is common among investors. All investors can not get all information at the same time it takes to evaluate information before they act differs between investors. Many investors do not show rational behavior, greed and fear and strong feelings and may result in panic sales and stock market buddies. (Lo Andrews, 2000)
The complex issue is that the charts and graphs may not be every bodied reading material as they require expert interpretations and an ongoing basis. The technical factors are total numbers of shares traded, number of buy orders over a period of time and the number of sell orders.
The chartists construct charts that plot past price movements and other averages; these allow them to observe trends, patterns for the market that enable them to predict whether a specific stocks market value will increase / decrease.
Empirical studies and theoretical problems question whether technical analysis is really useful. Academic studies have shown that when most people, professionals and a amateurs alike, try to move money in and out of stocks to beat market fluctuations, they tend to wing up with losses (Browning 2007). The same article further shows how several technical analyses can simultaneously contradictory predictions when exposed to the same data.
Review of Literature
Like dieting and working out, money management is something that most traders pay lip service to, but few practice in real life. The reason is simple: just like eating healthy and staying fit, money management can seem like a burdensome, unpleasant activity. It forces traders to constantly monitor their positions and to take necessary losses, and few people like to do that. However, as Figure 1 proves, loss-taking is crucial to long-term trading success.
On the whole, there are two methods to perform successful money management. A company can take lots frequent small impedes and try to produce incomes from the few large beneficial deals, or a company can select to go for lots of small saver-like increases and take uncommon but large stops expecting the many small incomes will overshadow the few large failures. The first way produces lots of minor examples of psychological ache, but it creates a few key moments of joy. On the other hand, the second strategy provides lots of lesser instances of delight, but at the cost of experiencing some very spiteful emotional strikes. With this wide-stop strategy, it is not strange to lose a week or even a month’s worth of incomes in one or two deals. (Bernstein 1988)
To a great deal, the method one selects depends exclusively on one’s personality; it is the component of the procedure of detection for each trader. One of the great advantages of the financial market is that it can put up both styles uniformly, without any extra expenditure to the vend trader.
When stating the tasks of money management, it is necessary to mind, that trader usually needs to perform the following significant money management errands to do the job correctly:
- Define how much it would be necessary to risk on each trade.
- Realize the risk of the trade which is going to be taken and measure the trade correctly.
- Trail the trade going forward.
- Pay essential attention to the risk levels; take small losses before they become big.
- Review the performance.
It’s easy to define how much hazard there is in a finicky trade. The first stair is to consider – before the trade had been started – at what charge the trade would be finished, if the process goes the unwished way. There are two methods to define this charge extent. The first is to apply a trading way grounded on technical analysis that will offer a reversal indication or a stop-loss the price. The second is to let money management define the termination when a technical or fundamental estimation about where the “I was wrong” is absent. This is where one makes a line in the sand and tells the market that it is not able to take any more finances out of the trader’s funds. The point is that no matter what the approach – whether technical, original, astrological or even a random dartboard selection – one should not trade or invest in anything without realizing, at all times, what the exit price would be. One needs to realize this price in front of time so that there will not be a necessity to worry about the conclusion when that price is achieved – the action at that point should be mechanical. There will not be enough time to disorder it out when the market is blaring in the opposite direction that was regarded to go. (Alexander, 2001)
Charts
The using charts if often linked to the development of the Dow Theory of the late 1890s by Charles Dow the founder of the Dow Jones company. His works have been refined by other market technicians and it is widely believed he successfully signaled the market crash of 1929 (Geoffrey and Stanley 2003)
The Dow Theory maintains that there are three major movements in the market daily fluctuations; secondary fluctuations movements that often (cover between two weeks to a month).
The Dow Theory includes the three movements: as markets oscillate in more than one time frame at the same time, nothing is more positive than that the market has three well classified associations which fit into each other.
- The first is the daily variation due to local causes and the balance of buying and selling at that particular time (Ripple).
- The secondary movement covers a period ranging from days to weeks, averaging probably between six to eight weeks (Wave).
- The third move is the great swing covering anything from months to years, averaging between 6 to 48 months (Tide). (Dorsey, 2001)
- Bull markets are broad upward movements of the market that may last several years, interrupted by secondary reactions. Bear markets are long declines interrupted by secondary rallies. These movements are referred to as the primary trend.
- Secondary movements normally retrace from one third to two thirds of the primary trend since the previous secondary movement.
- Daily fluctuations are important for short-term trading, but are unimportant in analysis of broad market movements.
There is no much research and scientific support for the reliability of the Dow Theory. Alfred Cowles in a study in Econometrica in 1934 depicted that trading grounded upon the leader recommendation would have effected in earning less than a buy-and-hold tactics applying a well expanded selection. Cowles terminated that a buy-and-hold strategy created 15.5% annualized returns from 1902-1929 while the Dow Theory tactics created annualized returns of 12%. After plenty of the studies maintained Cowles over the following period, lots of researchers stopped examining Dow Theory suggesting that Cowles’s results were final. (Palos, 2003)
In recent years nevertheless, Cowles’ terminations have been resumed. William Goetzmann, Stephen Brown, and Priyank Kumar believe that Cowles’ study was incomplete and that Dow Theory produces excess risk-adjusted returns. Specifically, the return of a buy-and-hold strategy was higher than that of a Dow Theory portfolio by 2%, but the riskiness and volatility of the Dow Theory portfolio was lower, so that the Dow Theory portfolio produced higher risk-adjusted returns according to their study. Nevertheless, adjusting returns for risk is controversial in the context of the Dow Theory. One key problem with any analysis of Dow Theory is that the editorials of Charles Dow did not contain explicitly defined investing “rules” so some assumptions and interpretations are necessary. (Radcliffe, 1996)
Many technical analysts consider Dow Theory’s definition of a trend and its insistence on studying price action as the main premises of modern technical analysis.
The primary movements in the movements is usually positive despite the market down turns the important facts in the secondary movement is that in this case each law is higher than the previous law and each high is higher than the previous high confirming a bullish trend under Down theory, it is assumed that his pattern will continue for along period and the analysists must be confused by secondary movements. The upward pattern must ultimately end. This could be indicated by a new pattern where a recovery fails to exceed the previous high abortive recovery and new low penetrates a previous law (Benning 1997)
When any trader makes a decision to buy or sell (short), they must also decide at that time how many shares or contracts to buy or sell — the order form on every brokerage page has a blank spot where the size of the order is specified. The essence of risk management is making a logical decision about how much to buy or sell when you fill in this blank. This decision determines the risk of the trade. Accept too much risk and you increase the odds that you will go bust; take too little risk and you will not be rewarded in sufficient quantity to beat the transaction costs and the overhead of your efforts. Good money management practice is about finding the sweet spot between these undesirable extremes.
A change form a bear to a bull market would require similar patterns of confirmation. The biggest setback of this theory is that there always is a problem of false signals. E.g. note every abortive recovery is certain to signal a bull market. An investor may have to wait a long time to get full confirmation of a change in primary trend.
Chartists attempt to define trading levels for individual securities (or the market) where there is a like hood that price movements will be challenged in the financial daily or an television, the statements made that “the next barrier to the correct market move is at 12000” (or some other level) assumes the existence of support and resistance levels (Hirt and Stanley, 2003). A support level is associated with the lower and of a trading range and resistance level with the upper end.
Support develops each time a stock goes down to a lower level of trading because investors who previously passed up a purchases opportunity may now choose to act. This is a signal that new demand is coming into the market, when a stock reaches the high side of the normal trading range resistance may develop because some investors who may have bought in the previous wave of the enthusiasm may now view this as a chance to get even while others may see this as an opportunity to take a profit.
Market reversal and Confirmatio
Support and resistance
The amount of volume supporting a given market movement is also considered significant if a stock (market) makes a new high on heavy trading volume this is considered to be bullish and the reverse could as well be considered bearish.
The difference in volume of trade may either create very strong interest or erode the same in the trading pattern of the market. (Wodley, 1998)
Types of charts
Besides typical line charts to indicate market patterns, technicians also use bar charts and point and figure charts (Blume, Easley and Maureen, 1994).
- Bar charts: show the high and low price for a stock with a horizontal dash along the line to indicate the closing price trend line published through a division of standards and poors; provides excellent charting information on a variety of securities traded on the major stock exchanges and available at many libraries and brokerage houses. Market technicians carefully evaluate the charts, looking for what they perceive to be significant patterns of movement. A series of price movement patterns presumably indicate market bottoms and tops. (Dorsey, 2001)
- Point and figure charts ( PFC) emphases significant price changes and the reversal for significant price changes chartists carefully read point and figure charts to observe market patterns (Colby and Meyers, the encyclopedia of technical market indicates) (Dorsey, 2001)
- Median charts: A median chart is a particular aim difference of the X-bar chart. This chart uses the median in preference to the subgroup standard to reveal the data key location. The median is the central point when information points are assembled from high to low. The diagram reveals all the particular considerations on the price forecasts. This chart is generally used to define if the system is steady and expected or to monitor the impacts of procedure development hypotheses. (Dorsey, 2001)
A contrary opinions rule is another approach for active money management. The essence of a contrary opinion rule is that it is easier to fire out who is wrong then who is right. Small investors tend to engage in odd lot transactions, the odd lot theory suggests that one watch very closely what small investors are doing and their do the opposite. The suggests that the small traders does all right most of the time but badly misses on key market turns. These add-lot traders are assumed to be strong seller right before the bottom of a bear market. (Demark, 1994)
Another contrary opinion rule is base on the volume of short sales in the market. A short sale represent the selling of a security you do not won with the anticipation of purchasing the security in the future to cover your short position investors engage in short sale transaction if they believe the security would infact be going down in price in the near future so they could buy back the security at a lower price to cover the short sale.
Overall market rules
The overall market indicators the breadth of market indicators series and the cash position of mutual fund. Breadths of the market indicators attempts to measure what a broad range of securities is doing as apposed to merely examining a market average. To get a broader perspective of the market an analyst may examine all stocks on an exchange.
Technicians often compare the advance declines with the movement of a popular market average if there is a divergence between the two breadths markets data can also be use to analyses upturns in the market. (Blume, Easley, 1998)
Mutual fund cash position indicates the cash position of mutual funds. This average indicates the buying potential of mutual funds and is generally representative of the purchasing potential of other large institutional investors (Bernstein, Peter 1988).
Implication of technical analysis
Security prices appear to be independent over time or more. Specifically move in the pattern of a random walk. Others challenge the research on the bars that academic research in this area does not capture the personal judgment an experienced technician brings forward in reading charts. There is also an infinite number of trading rules and not all of them can or have been tested.
Technical is a technique that supposedly predicts the direction of financial markets, using patterns in the movement of price using charts (Murphy, 1986). Technical analysis considers only the actual price behavior of markets or instrument, on the assumption that price reflects all the relevant factors before an investor becomes aware of them through other channels.
Academicians like Eugene Fama say the evidence for technical analysis is sparse and is inconsistent with the weak form of generally accepted efficient market hypothesis(Fama, 1995), Burlen Malkiel argues that under the weak form of efficient Market hypothesis and that one cannot predict future stock prices from past stock prices(Browning, 2007)
Technical analysis (or technicians) seeks to identify price patterns and trends in financial markets and attempts to exploit those patterns (Murphy, 1990) while technicians use various methods and tools the study of price charts is primary. Many technical analysts also follow indicators of investor’s psychology (Market sentiments).
Essentially technical analysis examines two areas of investing: the analysis of market”psych” or sentiment), the analysis of supply/demand (whether investors have the funds to support their hopes and years). A bullish investor without funds cannot take the market higher.
Technicians seek to forecast price movements such that large gains from successful trades exceed more numerous but smaller losing trades, producing positive returns in the long run through proper risk control and money management.
There are several schools of technical analysis- Adherents of different schools, candlestick, Dow theory, and Elliot wave theory, may ignore the other approach is yet many traders combine elements from more than one school. The analysts use judgment gained from experience to decide which pattern a particular instrument reflects at a given time and what the interpretation of the pattern should be.
Indicators and Oscillators
Indicators are calculations based on the price and the volume of a security that measure such things as money flow, trends, volatility and momentum. They are used as a secondary measure to the actual price movements and add additional information to the analysis of securities. They are used for two main reasons viz. to confirm price movement and the quantity of chart patterns and to form bury and sell signals. (Radcliffe 2008)
The two main indicators are leading and lagging where a leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price moment. A leading indicator is thought to be the strongest during periods of sideways or non-trending trading ranges, while the lagging indicators are still useful during trending periods.
There are also two types of indicator constructions; those falling in a bounded range and those that do not. Those that are bound within a range are called oscillators-(most common type of individuals). The two main ways that indicators are used to form buy and sell signals in technical analysis is through crossovers and divergence. Crossovers are the most popular and are reflected when either the price moves through the moving average, which happens when the direction of the price trend and the direction of the indicator trend are moving in the opposite direction.
Indicators that are used in technical analysis provide an extremely useful source of additional information. These indicators help identify momentum, trends, volatility and various other aspects in security to aid in the technical analysis of trends. It is important to note that while some traders use a single indicator solely to buy and sell signals, they are best used in conjunction with price movements, chart patterns and other indicators. (Wodley, 1998)
Use of trend
Trend is one of the most important concepts in technical analysis. 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. Trend is not always easy to see. Defining a trend goes way beyond the obvious. In a 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 constitute a trend.
This is an example of an uptrend; a series of highs and lows, while a downtrend is one of lows and lower highs. The trend includes uptrend, downtrends, sideways and horizontal trends. As the names imply, when each successive peak and trough is higher, it is referred to as an upward trend. If the peaks and troughs are getting lower, it is downtrend. When there is a little movement up or down in the peaks and troughs, it is a sideways or horizontal trend.
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 a one-month trend is not as significant as a five-year 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”, illustrate how important analysis is for technical traders. (Konosh, 1996)
Summary
- Technical analysis is a method of evaluating securities by analyzing the statistics generated by market activity. It is based on three assumptions (1) the market discounts everything. (2) Price move in trends (3) History tends to repeat itself.
- Technicians believe that all the information they need about a stock can be found in the charts.
- Technical traders take a short term approach to analyzing the markets
- Criticism of technical analysis stems from the efficient market hypothesis which states that the market price is always the correct one, making any historical analysis useless.
- One of the most important concepts in technical analysis is that of a trend which the general direction that a security is headed is.
- Support is the price level through which a stock or market seldom falls. Resistance is the price level that a stock or market seldom surpasses.
- A moving average is the average price of a security over a set amount of time. They help technical traders smooth out some of the noise that is found in day to day price trend.
- Indicators are calculators based on the price and the volume of a security that measure such things as money flow trends, volatility and momentum. The types are both leading and lagging.
Convertible arbitrage involves purchasing portfolio of convertible generally convertible bonds & hedging a portion of the equity risk by selling short the underlying common stock. Certain mergers may also seek to hedge interest rate exposure under some circumstances. Most mergers employ some degree of leverage, ranging from zero to 6:1. the equity hedge ratio may from 30-100 per cent.
Distressed securities strategies invest in and may sell short the securities of companies where the security‘s price has been or is expected to be affected by a distressed situation. This may involve reorganization’s bankruptcies; stressed sales and other corporate restructuring. Depending on the manager’s style, investments may be made in bank corporate debts trade drums common stock, proffered stock & warrants.
Equity market neutral investing seeks to profit by exploiting pricing inefficiencies between related equity securities, neutralizing exposure to market risk by combining long & short position. One example of this strategy is to build portfolios made up of long positions in the strongest companies in several industries & taking corresponding shod positions in those showing signs of weaknesses.
Event driven is known as corporate life cycle investing. This involves investing in investing in opportunities created by significant transactional events such as spin-offs mergers; mergers and acquisitions; bankruptcy reorganizations, recapitalizations & share buy banks. The portfolio of some Event driven managers may shift in majority weighting between Risk Arbitrage and Distressed Securities while other may take a broader scope. Market timing involves allocating assets among investments that appear to be beginning an uptrend and switching out of investments that appear to be starting a downtrend. This primarily consists of switching between mutual funds & money markets. Typically technical trend following indicators are used to determine the direction of a fund and identify buy and signals. In an up move buy signal money is transferred a money market fund into a mutual fund in an attempt to capture a capital gain. In a down move “sell signal” the assets in the mutual funds are sold and moved back into the money market for safe keeping until the next up move. The goal is to avoid being invested in mutual funds during a market decline. (Alexander, 2001)
Mergers Arbitrate sometimes called Risk Arbitrate involves investment in event driven situation such as leveraged buyouts, mergers and hostile takeovers. Normally the stock of an acquisition target appreciates while the acquiring company’s stock decreases in value. These strategies generate returns by purchasing stock of the company being acquired and in some instances, selling short the stocks of the acquiring company. Managers may employ the use of equity options as a low risk alternative to the outright purchase or sale of the common stock. Most merger Arbitrage funds hedge against market risk by purchasing S&P put options or put options spreads.
Short selling involves the sale of a security not owned by the seller, a technique to take advantage of an anticipated price decline. To affect a short sale the seller borrows securities from a third party in order to make a delivery to the purchaser. The seller returns the borrowed securities to the lender by purchasing the securities in the open market. If the seller can buy that stock back at a lower price, a profit results. If the price rises, however a loss results. A short seller must generally pledge other securities or cash with the lender in an amount equal to the market price of the borrowed securities (www.hedgefundresearch.com.)
According to (www.DailyWealth.com/income report), technical analysis examines stock prices in the attempt to predict future prices. Technical analysts believe that all the relevant information about economic fundamentals of an industry and of stock are reflected in the direction and volume of prices. Technical analyses look to the past for they believe that markets are cyclical forming specific patterns and these patterns repeat themselves over time. They further believe that it is only necessary to compare short term and intermediate price movements to long term trends in order to predict market direction.
Two major techniques forming the basis of technical analysis are; the studying of key indicators and the charting of marketing activity. The key indicators commonly utilized by technical analysts include (Baner and Julie 1998)
- Trading volume based on supply and demand relationships and indicates market strength or weakness. Rising prices with increased buying generally signals up trends. Decreasing prices with increasing demand and increasing prices with decreasing volume signals downtrends. Trading volume applies best to the short term (3-9 months)
- Market breadth examines the activity of a broader range of securities than do highly polished indices such as the Dow Jones Industrial Average. The breadth index is the net daily advances or declines divided by the amount of securities traded. It is calculated by the volume of securities, the dollar volume or nominal volume. Breadth analysis concentrates on change rather than on level in order to evaluate the dispersion of a general movement in prices. This indicators point to the prime turning points in pull and bear markets.
- Confidence indices evaluate the trading patterns of bond investors who are regarded as more sophisticated and more well informed that stock traders and thus spot trends more quickly. Other confidence theories measure the sentiment among analysts themselves in options and future trading and consumer confidence. Analysts consider these to have in the near and intermediate term.
- The put-call ratio divides the volume of puts outstanding by the volume of calls outstanding. Investors generally purchase the greatest number of puts around market bottoms when their pessimism peaks, thus indicating turnaround. Call volume is greatest around market peaks and the heights of investor enthusiasm also indicating a market turn
- The cash position of funds gives an indication of potential demand. Analysts examine the volume and composition of cash held by institutional investors, pension funds, mutual funds and the like. Because fund managers and performance driven analysts expect them to search out higher returns on large cash balance and therefore will invest more heavily in securities, driving prices higher.
- Short selling represents a bearish sentiment. Analysts in an agreement with short sellers expect a downturn in the market in a specific stock. In addition, analysts look at odd-lot short sellers who indicate pessimism with increased activity. However many technical analysts express a “Contrarian” view regarding short sales. These analyst believe short sellers overreact and speculate because of the potential profits involved. Short sellers will purchase the securities in the future, thus putting upward pressure on prices. Short selling analysis is based on month to month trends.
- Odd-lot theory follows the trends of transactions involving less than round lots( less than 100 shares). This theory rests on a contrarian opinion about small investors. This theory believes the small trader is right most of the time and begins to sell into an upward trend. As the market continues to rise, the small investors re-enters the market as the sophisticated traders are bailing out in anticipation of a top and a pull back. Therefore an increase in odd-lot trading signals a downturn in the market.
Charting
Charting is useful in analyzing market condition and price behavior of individual’s securities. Standard and poor trend line is a well known charting service which provides data on companies. This data shows the trend of prices, insider sales, short sales and trading volume over the intermediate and long term. Analysts have plotted this data on graphs to form line, bar and point and figure charts (Bauer and Julie, 1998)
Charts interpretation requires the ability to evaluate the meaning of the resulting formations in order to identify ranges in which to buy or sell. Charting assists in ascertaining major market down turns, upturns and trend reversals.
Analysts use moving averages to analyze intermediate and long-term moving averages. A moving average depicts the underlying direction and degree of change.
The relative strength of an individual stock price is a ratio of the average monthly stock price compared to the monthly average index of the total market or the stock industry group. It informs the analysts of the relationships of specific prices movement to an industry or the market in general. When investors favor specific stocks or industries, this will relatively be strong. Stocks that outperform in a declining market usually attract other investors and remain strong.
An analyst construct charts, certain trends appear. These trends are characterized by a range of prices in which the stock trades. The lower end of the range forms a support base for the price. At the end, if a stock is a “good” buy and attracts additional investors and thus forms a support level. As the price increases a stock may become “unattractive” when compared to other stocks. Investors sell causing the upper limit to form a resistance level. Movements beyond the support and resistance levels require a fundamental change in the market and/or the stock (Portfolio management theory valuation), (Woolley, 1998)
Statistical test
The increase of index funds has been one of the most remarkable phenomena in the funding sphere over the previous 25 years. The customary justification for the achievement of index funds is grounded on market competence, net of deals costs.
For most companies, the prognostic power of support and confrontation extents lasted at least five business days beyond the levels’ issuing date. Despite their general achievement at classifying points of trend disruptions, none of the companies appropriately charged the comparative probability of trend disruptions at the various extents. These conclusions are dependable across firms and are maintained over a number of compassion examinations. The statistical tests are grounded on the bootstrap technique, a nonparametric way regularly applied to estimate technical trading tactics. To employ the tests, it is necessary to compare the behavior of exchange rates upon attaining issued maintenance and confrontation extents with the behavior upon achieving 10,000 sets of randomly selected support and resistance levels. If the result connected with the actual levels surpasses the average result for the subjective extents in a high section of months, it is concluded that the issued levels have essential prognostic authority.
For every day, the artificial support and confrontation extents are chosen at random from exchange rates within a definite range of the day’s opening rate. The range for each month is grounded on the exchange rate’s actual performance, as follows: for a given month, the gap between the opening rate and intraday highs and lows for each day is calculated. The complete charge of the hugest of these gaps is applied as the range for calculating reproduction support and confrontation extents for that month. For every day, twenty artificial support and twenty artificial resistance levels are calculated using the following algorithm:
Rti = Ot + btirange
Sti = Ot – atirange
Here, t represents time, Sti(Rti) is the ith artificial support (resistance) level, Ot is the day’s opening rate, ati and bti are random numbers generated from a uniform distribution over [0,1], and range is the range for that month. These levels are then rounded off so that they have the same number of significant digits to the right of the decimal point as actual quoted exchange rates. (Benning, 1997)
While these results are interesting they should still be viewed with some caution. There are still several interest rate and timing issues that are not exactly worked out. Also, the use of other risk factors than CAPM beta may be important. As in any trading rules test there are further questions about the parameters used and whether the prices used were actually tradable. Given these issues and the lack of a statistical test on the distribution comparisons the results can not be taken as clear evidence that every economic agent is missing a big opportunity. However, for one group of agents the results are pretty strong. For people who are involved in foreign exchange markets, either in trading goods or securities, and who maintain positions in foreign currencies there appear to be major gains over buy and hold strategies. This is easily seen in table 15 by comparing the buy and hold strategies with those for the rules. This may explain the large number of technical trading services available in the foreign exchange market.
Conclusions and further work
Any automatic trading buy and sell orders when either upper or lower barrier is crossed and this rule ,even so simple can cause crashes in markets. Technical analysis signals provide a more complex structure and often rely on the sensitivity of the analysts. The possibility to relate the probability of the model provides on one side the reliability of the signals allowing for a more coherent usage of the rules, and the other side furnishes an explanation about the market structure (Alexander, 2001)
- Evaluating data mining bias that generates statistically significant out performance. More complex rules or other financial data sets which might indicate abnormal returns.
- More experiment on subjective prediction to even simple statistical methods on the basis of intrusions of emotion, evolution driven cognitive biases and lack of biological data processing power.
- The need to modernize technical analysis while exploring human inventiveness while avoiding human gullibility.
How rationalization of financial analysis can be done in the future that looks more volatile.
Such methods, surely, can only be efficient in trading if the price of economic gadgets is non-random; this has yet to be stated.
Moreover, as ANNs are fundamentally non-linear statistical representations, their correctness and forecast abilities can be both scientifically and practically examined. In various researches, authors have stated that neural networks applied for creating trading indications given different technical and essential inputs have considerably outperformed buy-hold tactics as well as customary linear technological analysis techniques when joined with rule-grounded expert schemes.
While the proceeded arithmetical nature of such adaptive schemes have kept neural schemes for economic study mostly within scientific research cycles, in recent years more user friendly neural network software has made the technology more available to dealers. Nevertheless, large-scale request is difficult due to the matter of matching the correct neural topology to the market being investigated.
Regulation-grounded trading is an approach to make one’s trading charts by strict and clear-cut rules. Not like some other technological ways or most significant analysis, it describes a set of regulations that defines all trades, leaving minimal discretion.
For instance, a trader might make a set of rules stating that he will take a long position whenever the price of a particular instrument closes above its 50-day moving average, and shorting it whenever it drops below.
References
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Banner, Richard j and Julie R. Dahequist (1998), Technical Market Indicators: Analysis and Performance New York John Wiley& Sons.
Benning; Carl J. (1997) Prediction Skills of Real World Market Timers, Journal of Portfolio Management.
Bernstein, Barbara and Peter L. Berustein (1998) where the post crash studies went wrong. Institutional investor.
Blume Lawrence; David Easley and Mareen O’ttava (1994) Market Statistics & Technical Analysis. The Role of Volume.
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Cutler , David M., James m Poterba, Lawrence.h summers(1988 what makes stocks prices). Demark, Thomas R. (1994) he Science of Technical Analysis, New York, John Wiley & Sons.
Dorsey, Thomas J. (2001) Point and Figure Charting: The Essential Application for Forecasting and Tracking Market Prices, Wiley publisher 2nd Edition.
Fama Eugene F. (1995) “Random walks in stock prices” Financial analyst’s journal.
Hirt, Geoffrey & Stanely B. Block (2003). Fundamentals of Investment Management.
Jansen, Cory, Chad Langager and Casey Murphy (2008).
Konosh, Atsuo and Ravi E. Dattatreya eds (1996). The Handbook of Denvative Instruments. Chicago Irwin Professional Publishing.
Lo Andrews W., Harry Mamaysky and Jiang Wang (2000) Fundamentals of technical analysis.
Murphy, John J., 1986, Technical analysis of the Future Markets (New york Institute of Finance.
Palos, J. A. (2003) A Mathematician plays the stock market basic books. Griffion Technical analysis in Financial Markets.
Radcliffe, Robert C. Investments (2008) Concepts Analysis Strategy. Reading M. A. Addison- Wesley Publishing Co.
Wodley, Suzanne (1998) “Technicians Take Centre Stage” Business Week.
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