Investment and Securities Management_2nd Assignment

8/2/2019 Investment and Securities Management_2nd Assignment

1/23

Investment and Securities Management Table of Contents

Allama Iqbal Open University Islamabad i

Contents

Chapter 1 INTRODUCTION .......................................................................................................... 21.1 What is technical analysis? ................................................................................................... 2

1.2 Technical analysis pre-empts fundamental data ................................................................... 31.3 Optimism, pessimism, greed and fear ................................................................................... 41.4 Types of charts ...................................................................................................................... 5

1.4.1 Line Charts ..................................................................................................................... 51.4.2 Bar Charts ...................................................................................................................... 61.4.3 Candlestick Charts ......................................................................................................... 71.4.4 Point & Figure Charts .................................................................................................... 8

1.5 Support and Resistance ......................................................................................................... 91.6 The Concept of Trend ......................................................................................................... 101.7 Investment horizons ............................................................................................................ 121.8 Moving averages ................................................................................................................. 131.9 Momentum studies .............................................................................................................. 141.10 Indicators........................................................................................................................... 14

Chapter 2 CASE STUDIES .......................................................................................................... 152.1 Case Study 1 ....................................................................................................................... 152.2 Case Study 2 ....................................................................................................................... 17

Chapter 3 DATA COLLECTION and SWOT ANALYSIS ......................................................... 193.1 Data collection .................................................................................................................... 193.2 SWOT ANALYSIS ............................................................................................................ 19

Chapter 4 CONCLUSION ............................................................................................................ 22Chapter 5 REFERENCES ............................................................................................................. 23


2/23


Allama Iqbal Open University Islamabad 2

Chapter 1 INTRODUCTION

1.1What is technical analysis?

Technical analysis is the study of financial market action. The technician looks at price changes

that occur on a day-to-day or week-to-week basis or over any other constant time period

displayed in graphic form, called charts. Hence the name chart analysis.

A chartist analyzes price charts only, while the technical analyst studies technical indicators

derived from price changes in addition to the price charts.

Technical analysts examine the price action of the financial markets instead of the fundamental

factors that (seem to) effect market prices. Technicians believe that even if all relevant

information of a particular market or stock was available, you still could not predict a precise

market "response" to that information. There are so many factors interacting at any one time that

it is easy for important ones to be ignored in favor of those that are considered as the "flavor of

the day."

The technical analyst believes that all the relevant market information is reflected (or discounted)

in the price with the exception of shocking news such as natural disasters or acts of God. These

factors, however, are discounted very quickly.

Watching financial markets, it becomes obvious that there are trends, momentum and patterns

that repeat over time, not exactly the same way but similar. Charts are self-similar as they show

the same fractal structure (a fractal is a tiny pattern; self-similar means the overall pattern is

made up of smaller versions of the same pattern) whether in stocks, commodities, currencies,

bonds. A chart is a mirror of the mood of the crowd and not of the fundamental factors.

Thus, technical analysis is theanalysis of human mass psychology. Therefore, it is

also called behavioral finance.


3/23



1.2Technical analysis pre-empts fundamental data

Fundamentalists believe there is a cause and effect between fundamental factors and price

changes. This means, if the fundamental news is positive the price should rise, and if the news is

negative the price should fall. However, long-term analyses of price changes in financial markets

around the world show that such a correlation is present only in the short-term horizon and only

to a limited extent. It is non-existent on a medium- and long-term basis.

In fact, the contrary is true. The stock market itself is the best predictor of the future fundamental

trend. Most often, prices start rising in a new bull trend while the economy is still in recession

(position B on chart shown below), i.e. while there is no cause for such an uptrend. Vice versa,

prices start falling in a new bear trend while the economy is still growing (position A), and not

providing fundamental reasons to sell. There is a time-lag of several months by which the

fundamental trend follows the stock market trend. Moreover, this is not only true for the stock

market and the economy, but also for the price trends of individual equities and company

earnings. Stock prices peak ahead of peak earnings while bottoming ahead of peak losses.


4/23



The purpose of technical analysis is to identify trend changes that precede the

fundamental trend and do not (yet) make sense if compared to the concurrent

fundamental trend.

1.3Optimism, pessimism, greed and fear

Why arent more people making more money in the financial markets? Because, as we have

seen, people are motivated by greed (optimism) when buying and by fear (pessimism) when

selling. People are motivated to buy and sell by changes in emotion from optimism to pessimism

and vice versa. They formulate fundamental scenarios based on their emotional state (a

rationalization of the emotions), which prevents them from realizing that the main drive is

emotion.

The chart below shows that if investors buy based on confidence or conviction (optimism) theyBUY near or at the TOP. Likewise, if investors act on concern or capitulation (pessimism) they

SELL near or at the BOTTOM. Investors remain under the bullish impression of the recent

uptrend beyond the forming price top and during a large part of the bear trend. Vice versa, they

remain pessimistic under the bearish impression from the past downtrend through the market

bottom and during a large part of the next bull trend. They adjust their bullish fundamental


5/23



scenarios to bearish AFTER having become pessimistic under the pressure of the downtrend or

AFTER having become optimistic under the pressure of the uptrend. Once having turned bearish,

investors formulate bearish scenarios, looking for more weakness just when it is about time to

buy again. The same occurs in an uptrend when mood shifts from pessimism to optimism.

Investors formulate bullish scenarios AFTER having turned bullish, which is after a large part of

the bull trend is already over. Emotions are the drawback of fundamental analysis. Investors

must learn to buy when they are fearful (pessimistic) and sell when they feel euphoric

(optimstic). This may sound easy (simple contrary opinion), but without Technical Analysis it is

hard to achieve.

The main purpose of technical analysis is to help investors identify turning points

which they cannot see because of individual and group psychological factors.

1.4Types of charts

1.4.1Line Charts

This is the simplest chart format and is generated by using a line to join the data points.


6/23



The most common use for line charts is for indicators that only have a single daily value

(rather than high/low) such as momentum or moving averages.

The daily line chart is perhaps the simplest of charts available, showing only the closing price of eachday.

1.4.2Bar Charts

As their name suggests, bar charts use vertical bars to represent price action for that day, drawn from the

lowest price to the highest price.

The left hand .notch. represents the opening price and

the right hand .notch. represents the closing price.

One of the advantages of bar charts is that a longer time period can be

viewed by changing the scale from daily to weekly or monthly bars.


7/23



This is a daily .HLC. bar chart: each bar showing the day.s .high., .low. and .close. prices. The

period viewed is 6 months from November 2003 to April, 2004.

This is a weekly bar chart: each bar showing the weekly high, low and close. The period covered

is two years, from April, 2002 to April, 2004, and shows the movement in the daily chart

(bottom right area) in its longer term context.

1.4.3Candlestick Charts

Candlestick charts are generally plotted over a one-day period but technical analysts also use

weekly and monthly candlestick charts to provide a valuable picture of the longer-term price

action.


8/23



1.4.4Point & Figure Charts

Point & figure charts have a devoted following, particularly amongst Wall Street operators. They

are unique in several ways: a) They have no time scale, only registering changes when

significant price action occurs. b) P&F charts box scale serves as a "noise reduction" system

thereby eliminating minor movements so that the primary trend characteristics are revealed to the

user. c) They quickly filter out the most consistently trending stocks or financial instruments

from erratic and trend-less ones.

Areas of congestion on the charts define the key areas of supply and demand for a security

(commonly known as support and resistance).


9/23



1.5Support and Resistance

Understanding the concepts of support and resistance is vital in developing a disciplined trading

strategy. Prices are dynamic, reflecting the continuing change in the balance between supply and

demand. By identifying the price levels at which these balances change we can plan not only the

price level at which to purchase but also the level at which we can subsequently sell (and vice

versa for a short trade). Whilst these levels may be created by the markets subconsciously they

represent the collective opinions of the participants in the markets.

Support represents the level at which buying pressure is strong enough to absorb and overcome

the selling pressure. At price support levels buyers step into the market mopping up the

imbalance between supply (sellers) and demand (buyers) and when this happens the price will

halt its decline and will potentially rise.

Resistance is the opposite of support and is the level at which the volume of selling (supply)

outweighs the volume of buying (demand). These mini-levels can change frequently but over

time a clear pattern emerges and firm levels become established.


10/23



The above chart clearly shows the sideways trading range in Smith & Nephew during 2003.

1.6The Concept of Trend

Charles Dow is probably best known as the founder of the Dow Jones Industrial Average.

However, it was during his time as editor of the Wall Street Journal that he produced a series of

articles examining stock market behaviour, and it was from these editorials that Dow Theory

evolved.

Dow theory provides us with a clear definition of trend. Dow described how prices did not rise or

fall in a straight line but moved in a series of zigzags which resembled waves and it was the

relative positioning of the peaks and troughs in these waves that defined the trend.

For a stock to be in an uptrend, it must make successive higher peaks (highs) and higher troughs

(lows). For a stock to be in a downtrend, it must make lower peaks (highs) and lower troughs

(lows).


11/23



By identifying these peaks and troughs, we can not only describe the current trend and put it in

its historic context but, just as importantly, determine when it is changing. We do this by

looking at the patterns formed by the peaks and troughs and this is covered in the next section

(Major Reversal Patterns).


12/23



1.7Investment horizons

The charts on the previous pages show that investors require perspective. It is imperative to

differentiate between a short-term, a medium-term and a long-term trend. If somebody tells you

to buy the US dollar because it is likely to rise, make sure you understand whether the dollar is

expected to rise over a few days or a few months and if you should buy the dollar with the

intention to hold it for several days, several weeks or several months.

For a technician on the trading floor, the long-term horizon is entirely different from that of an

institutional investor. For a trader, long-term can mean several days, while for the investor, it can

mean 12 to 18 months. We can compare the charts and indicators to a clock (shown above).

Short-term trends (the seconds) are best analyzed on daily bar charts. Medium-term trends (theminutes) are best seen on weekly bar charts and long-term trends (the hours) are best seen on

monthly bar charts. Some investors onlywant to know the hour, some want to know the seconds

and some want to know the exact time.

The best investment results are achieved when all three trends on the daily,

weekly andmonthly charts point in the same direction.


13/23



1.8Moving averages

The moving average (often shortened to "ma" in our research) is one of the most popular

indicators and is used by technical analysts for a variety of tasks:

To identify areas of short term support/resistance

To determine the current trend

As a component in many other indicators such as the MACD, or Bollinger bands.

The main advantages of moving averages is firstly that they smooth the data and thus provide a

clearer visual picture of the current trend and secondly, that m.a. signals can give a precise

answer as to what the trend is. The main disadvantage is that they are lagging rather than leading

indicators but this should not be a problem to longer term investors.

There are two main forms of moving average:

The simple moving average (as the name suggests) calculates the average price over a specified

moving time period. For example, a 20 day simple moving average will calculate the average

mean price from the last twenty days closing prices and so on.


14/23



The exponential moving average ("ema") also averages the last x days closes but assigns a

greater weight to the more recent prices making it more sensitive to current price action and thus

reducing the lag effect.

1.9Momentum studies

Momentum indicators are used to monitor the underlying "health" of a particular trend. They do

this through a variety measurements and most commonly by assessing the rate at which a stock

or financial instrument is advancing or declining.

Changes in the rate of advance/decline are useful in determining the level of investor enthusiasm:

for example, an uptrend .losing momentum. suggests investors are no longer prepared to buy as

much stock at current prices demand pull had run out of steam and we could reasonably expect a

period of consolidation before enthusiasm returns.

1.10Indicators

An indicator is a mathematical calculation that can be applied to a security's price and/or volume

fields. The result is a value that is used to anticipate future changes in prices.

A moving average fits this definition of an indicator: it is a calculation that can be performed on

a security's price to yield a value that can be used to anticipate future changes in prices.


15/23



Chapter 2 CASE STUDIES

2.1Case Study 1

The chart below shows three US dollar/Swiss franc trends.

1) The uptrend from 1995 to 1997 is long term. It is also called the PRIMARY trend (the

Hours). It was broken by the 1998 decline. The long-term uptrend is not a straight line, but is

interrupted by corrections of a smaller degree.

2) These corrections are the medium-term or intermediate-term trends (the Minutes). They are

also called SECONDARY trends. The mediumterm correction is also not a straight line, but is

made up of smaller corrections.

3) These smaller trends are the short-term trends. They are also called MINOR trends (the

Seconds). A minor downtrend can be part of an intermediate- term uptrend, which itself can be

part of a longer-term primary downtrend.


16/23



Sometimes it is difficult to differentiate between a short- and a medium-term or a long-term

trend.

Technical analysis helps you to differentiate between the various trends in all

financial markets and instruments.

We incorporate two basic moving averages to track the three investment horizons. They are

shown on the three charts on this page. On the monthly chart below, the 13-month and 21-month

moving averages track the long-term trend. On the weekly chart below, the 13-week and 21-

week moving averages track the medium-term trend.

On the daily chart below, the 13-day and 21-day moving averages track the short-term trend.

The direction of the moving averages indicates the direction of the three basic trends in force.

Instead of showing the moving averages on three separate charts to illustrate the three basictrends, we more often display all moving averages on a single daily chart. This is shown on the

next page. The long-term moving average is not shown on the monthly chart, but on the daily

chart. The medium-term moving average is also shown on the daily chart instead of the weekly

chart.


17/23



2.2Case Study 2


18/23



IBM is shown above together with the medium-term momentum indicator on the weekly chart.

Signals are given when the trend reverses an extreme levels. The stock is said to be

OVERBOUGHT when the momentum oscillator reaches an extreme upper level above the zero

line and OVERSOLD when it reaches an extreme lower level below the zero line. The oscillator

acts like a rubber band: the further it stretches, the more the prices need energy to sustain the

trend, i.e. a trend reversal should be expected the more stretched the momentum indicator

becomes.

Sometimes signals leave room for interpretation (technical analyis is an art not a science). The

indicator does not always cross the zero line before giving a new buyor sell signal. These signals

are called redistribution examples (see scheme below and chart above) or re-accumulation.


19/23



Chapter 3 DATA COLLECTION and SWOT ANALYSIS

3.1Data collection

Most of the information is collected from secondary sources. Information required in writing this

report is already available on internet and I have extracted it from different websites. I have also

collected data from sources such as articles, journals, magazines, books and periodicals to obtain

historical and other types of information. Some information is also collected from the primary

source. I have taken lot of information about the company from its website.

3.2SWOT ANALYSIS

AlThOUGh TEChnICAl AnAlySIS can appear to be incredibly complicated and not for the

fundamental investment purist, it does have some advantages over fundamental investment

analysis. Yonatan Rom, CEO of The Winning Edge, says that technical analysis has three key

advantages over fundamental analysis.

Advantages of Technical Analysis for Investors

The first key advantage of technical analysis, according to Rom, is that it can be adaptedto any trading medium or time horizon. Technical analysis can be used on any financial

security with a trading history, including shares, unit trusts, commodities, foreign

exchange, fixed income securities or futures.

In addition, technical traders can change their investment horizon to whatever they want

as you get daily, weekly, monthly or intraday charts that can go from minute-to-minute or

30-minute charts.

The key advantage of technical analysis over fundamental analysis is that investors can

look at any market instead of just focusing on a narrow range of investment instruments

as fundamental analysts do, which can be very time-consuming.

Technical analysis is an important tool in the investors arsenal and is increasingly used

by both professional and personal investors to aid in making and timing investment

decisions.


20/23




21/23



Disadvantages of Technical Analysis for Investors

It can be dangerous to depend totally on the assumption that today's prices predict future

prices. They often do, but not necessarily.

Relying on charts completely will not help you to pick up the signals about the changing

of a trend until the change has actually taken place. This means you could miss up to one-

third of the fluctuations in currency trading.

It is also possible in currency trading to act on a pattern prematurely or in a bit of a panic.

If a large number of currency traders do this, it can create a self-fulfilling prophecy.


22/23



Chapter 4 CONCLUSION

A fitting conclusion to an introduction on technical analysis is a list of lessons I have learned,

both from others and the hard way.

Don't compound your losses by averaging down (i.e., don't keep buying additional shares

at lower prices). It is tempting to think that a loss "doesn't count" until the position is

closed--but it does!

Anytime you own a security, ask yourself if you would buy it today. If you wouldn't buy

it, you should consider selling it.

Don't get distracted by others' investment prowess. Most investors only discuss their

successes, threatening your focus and confidence.

Wise investments aren't made with Ouija boards, they are made using logical approaches

that minimize risks and maximize opportunities.

Master the basics. Most investors spend their time looking for easy money (which is not

an easy search) instead of learning the key factors to security prices--supply and demand.


23/23



Chapter 5 REFERENCES

(1)Charts in this report are from MetaStock from Equis International and from Datastream.

Indicators are by Credit Suisse Private Banking.Data is from Reuters, Bloomberg and

Datastream.

(2)Technical Analysis from A to Z by Steven B. Achelis.

(3)Investors Intelligence Introduction to Technical Analysis by Dominic Hawker, July 2004.

(4)Technical Analysis Explained, Zurich/Switzerland, Global Technical Research

andBehavioral Finance.

(5)TEChnICAl AnAlySIS by Standard Financial Markets (Pty) Ltd.

(6)The Use of Technical Analysis by Fund Managers by Lukas Menkhoff.

(7)http://www.chartfilter.com/Technical-Analysis/technical-analysis-provides-an-important-

tool.html

(8)http://www.beyondtechnicalanalysis.com/pros-and-cons-of-technical.html

(9)http://www.investorsintelligence.com/x/default.html
http://www.chartfilter.com/Technical-Analysis/technical-analysis-provides-an-important-tool.htmlhttp://www.chartfilter.com/Technical-Analysis/technical-analysis-provides-an-important-tool.htmlhttp://www.chartfilter.com/Technical-Analysis/technical-analysis-provides-an-important-tool.htmlhttp://www.chartfilter.com/Technical-Analysis/technical-analysis-provides-an-important-tool.htmlhttp://www.beyondtechnicalanalysis.com/pros-and-cons-of-technical.htmlhttp://www.beyondtechnicalanalysis.com/pros-and-cons-of-technical.htmlhttp://www.investorsintelligence.com/x/default.htmlhttp://www.investorsintelligence.com/x/default.htmlhttp://www.investorsintelligence.com/x/default.htmlhttp://www.beyondtechnicalanalysis.com/pros-and-cons-of-technical.htmlhttp://www.chartfilter.com/Technical-Analysis/technical-analysis-provides-an-important-tool.htmlhttp://www.chartfilter.com/Technical-Analysis/technical-analysis-provides-an-important-tool.html

Investment and Securities Management_2nd Assignment

Documents

Transcript of Investment and Securities Management_2nd Assignment