What is Technical Analysis? What are the tools or techniques of technical analysis?

Ans. Meaning of Technical Analysis : Technical analysis is a method of evaluating securities b analyzing the statistics generated b market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.

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Unlike fundamental analysts, technical analysts don’t care whether a stock is undervalued-the only thing that matters is a security’s past trading data and what information this data can provide about where the security might move in the future.

Basic Technical Assumptions : The basic technical assumptions are:

(i) The market Discounts Everything : A major criticism of technical analysis s that it only considers price movement, ignoring the fundamental factors of the company.

However, technical analysis assumes that, at an given time, a stock’s price reflects everything that has or could affect the company-including fundamental factors.

(ii) Price Moves in Rrends : In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement s more likely to be in the same direction as the trend than to be against it.

Most technical strategies are based on this assumption.

(iii) History Tends to Repeat Itself : Another important postulate in technical analysis s that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time.

Technical analysis uses chart patterns to analyze market movements and understand trends.

Tools of Technical Analysis : The tools of technical analysis are:

(1) Dow Theory : The Dow Theory is one of the oldest and most famous technical tools. T was originated by Charles Dow, who founded the Dow Jones company and was the editor of The Wall Street.

According to Dow

“The market is always considered as having three movements, all going at the same time. The first is the narrow movement from day-to-day. The second is the short swing running from two weeks to a month or more, the third is the main movement covering at least four years in duration”.

These movements are called :

(a) Daily Fluctuations (Minor Trends) :The minor trends have little analytical value, because of their short duration and variations in amplitude.

(b) Secondary Movements (trends) : The secondary trend acts as a restraining force on the primary trend. It ends to correct deviations from its general boundaries.

(c) Primary Trends : The primary trends are the long range cycle that carries the entire market up or down (bull or bear markets).

Types of Averages : The Dow Theory is build upon the assertion that measured of stock prices tend to move together. It employs two of the Dow Jones Averages.

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(a) Dow-jones Industrial Average (b) Dow-jones Transportation Average Types of Market : There are three types of market:

(a) Bull Market: If both the averages are rising.

(b) Bear Market: If both the averages are falling (c) Uncertain: If one rising and other is falling

Criticism of Dow Theory : Several criticisms are leveled against the Dow Theory:

(a) It is not a theory but an interpretation of known data. A theory should be able to explain why a phenomenon occurs. No attempt was made by Dow or his followers to explain why the two averages should be able to forecast future stock prices.

(b) It has poor predictive power.

(2) Trend Analysis : There are three types of trend:

(a) Upward Trend : As the name imply, when each successive peak and trough s higher, it’s referred to as an upward trend.

(b) Downward Trend : If the peaks and troughs are getting lower, it’s a downtrend.

(c) Horizontal Trend : When there is little movement up or down in the peaks and troughs, it’s a sideways or horizontal trend.

(3) Charts Types : Technical analysts use three basic types of charts:

(a) Line Charts : The most basic chart is the line chart because it represents only the closing prices over a set period of time. The line of formed by connecting the closing prices over the time frame. Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices. However, the closing price is often considered to be the most important price in stock data compared to the high and low for the day and this is why t is the only value used in line charts.

(b) Bar Charts : Most investors interested in charting use bar charts-primarily because the have meanings familiar to a technical analysts, but also because these charts are east to draw. The procedure for preparing a vertical line or bar chart is simple. The vertical dimensions of the line represent price, the horizontal dimension indicates the time involved by the chart as a whole.

(4) Chart Pattern : A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future price movements. Chartists use these patterns to identify current trends and trend reversals and to trigger buy and sell signals. There are various types of chart patterns:

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(a) Head and Shoulders : This is one of the most popular and reliable chart patterns n technical analysis. Head and shoulders are a reversal chart pattern that when formed, signals that the security likely to more against the previous trend. There are two types of Head and Shoulders Chart patterns:

ØHead and Shoulders Top :

ØHead and Shoulders Bottom :

(e) Double Top : It represents a bearish development, signaling that the price is expected to fall.

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(f) Double Bottom : It reflects a bullish development signaling that the price is expected to rise.

(g) Triangles : Triangles are some of the most well-known chart patterns used in technical analysis.

(5) Moving Averages : Most chart patterns show a lot of variation in price movement.

This can make it difficult for traders to get an idea of a security’s overall trend. One simple method traders use to combat this is to apply moving averages.

A moving average is the average price of a security over a set amount of time. It simple takes the sum of all of the past closing prices over the time period and divides the results by the number of prices used in the calculation. For instance, in a 10-day moving average, the last 10 closing prices are added together and then divided by 10.

Criticism of Technical Analysis : The various limitations of technical analysis were pointed out by its critics are as given under:

(i) Difficult in interpretation : Technical analysis is not as simple as it appears to be.

While the charts are fascinating to look at, interpreting them correctly is very difficult.

(ii) Frequent Changes : With changes in market, chart patterns keep on changing.

Accordingly, technical analysts change their opinions about a particular investment frequently. One day they put signal. A couple of weeks later, the see a change pattern and put up a sell signal.

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(iii) Unreliable Changes : hanges in market behaviour observed and studied by technical analysts man not always be reliable owing to ignorance or intelligence or manipulative tendencies of some participants.

(iv) History does not repeat itself : One of the major limitations of technical analysis is that the entire data s based on the past. It is presumed that future resembles the past.

There s no guarantee that history repeats itself.

(v) False signals can occur : Technical analysis is a signaling device. Like a thermometer, it may give a false indication when there is no alarm.