INTRODUCTION TO PORTFOLIO MANAGEMENT

Notes Compiled by Prof.V.S.Gopal

Chapter I

INTRODUCTION TO PORTFOLIO MANAGEMENT

We all dream of beating the market and being super investors and spend an inordinate amount of time and resources in this endeavor. Consequently, we are easy prey for the magic bullets and the secret formulae offered by eager salespeople pushing their stuff. In spite of our best efforts, most of us fail in our attempts to be more than average investors. Nonetheless, we keep trying, hoping that we can be more like the investing legends another Warren Buffett or Peter Lynch. We read the words written by and about successful investors, hoping to find in them the key to their stock-picking abilities, so that we can replicate them and become wealthy quickly.

Investing in shares and debentures is profitable as well as exiting. It is indeed rewarding, but involves a great deal of risk and calls for scientific knowledge and forecasting skill. In such investments, both rational as well as emotional responses are involved. Investing in securities is considered as one of the best avenues to invest ones savings while it is acknowledged to be one of the most risky avenues of investment.

It is unusual to find investors investing their entire money in one single security. Instead, they tend to invest in a group of securities. Such a group of securities is called a portfolio. Creation of a portfolio helps to reduce risks without sacrificing returns. Portfolio management deals with the analysis of individual securities as well as with the theory and practice of optimally combining securities into portfolios. An investor who understands the fundamental principals and analytical aspects of portfolio management has a better chance of success.

WHAT IS PORTFOLIO MANAGEMENT?

An investor considering investment in securities is faced with the problem of choosing from among a large number of securities. His choice depends on the risk-return characteristics of individual securities. He would attempt to choose the most desirable securities and like to allocate his funds over this group of securities. Again he is faced with the problem of deciding which security to hold and how much to invest in each. The investor faces an innumerable number of possible portfolios or group of securities. The risk and return characteristics of portfolios differ from those of individual securities combining to form a portfolio. The investor tries to choose the optimal portfolio taking into consideration the risk return characteristics of all possible portfolios. As the economic and financial environment keeps changing the risk and return characteristics of individual securities as well as portfolios also change. This calls for periodic review of and revision of investment portfolios of investors. An investor invests his funds in a portfolio expecting to get good return consistent with the risks that he has to bear. The return realized from the portfolio has to be measured and the performance of the portfolio has to be evaluated.

It is evident that rational investment activity involves creation of an investment portfolio. Portfolio management comprises all the processes involved in the creation and maintenance of an investment portfolio. It deals specifically with security analysis, portfolio analysis, portfolio selection, portfolio revision and portfolio evaluation. Portfolio management makes use of analytical techniques of analysis and conceptual theories regarding rational allocation of funds. Portfolio management is a complex process, which tries to make investment activity more rewarding and less risky.

OBJECTIVES OF PORTFOLIO MANAGEMENT

Security/Safety of Principal: Security not only involves keeping the principal sum intact but also keeping intact its purchasing power.

Stability of Income: Stability of income so as to facilitate planning more accurately and systematically the reinvestment or consumption of income.

Capital Growth: Capital growth which can be attained by reinvesting in growth securities or through purchase of growth securities.

Marketability: The case with which a security can be bought or sold. This is essential for providing flexibility to investment portfolio.

Liquidity: Liquidity i.e. nearness to money. It is desirable for the investor so as to take advantage of attractive opportunities upcoming in the market.

Diversification: The basic objective of building a portfolio is to reduce the risk of loss of capital and income by investing in various types of securities and over a wide range of industries.

Favourable Tax Status: The effective yield an investor gets from his investment depends on tax to which it is subject. By minimizing the tax burden, yield can be effectively improved. BASIC PRINCIPLES OF PORTFOLIO MANAGEMENT

There are two basic principles for effective Portfolio Management:

1) Effective investment planning for the investment in securities by considering the following factors:

a) Fiscal, financial and monetary policies of the Government of India and the Reserve Bank of India.

b) Industrial and Economic environment and its impact on industry prospects in terms of prospective technological changes, competition in the market, capacity utilization with industry and demand prospects etc.

2) Constant review of investment: Portfolio managers are required to review their investment in securities and continue selling and purchasing their investment in more profitable avenues. For this purpose they will have to carry the following analysis:

a) Assessment of quality of management of the companies in which investment has already been made or is proposed to be made.

b) Financial and Trend analysis of companies, Balance Sheet/Profit and Loss accounts to identify sound companies with optimum capital structure and better performance and to disinvest the holding of those companies whose performance is found to be slackening.

c) The analysis of securities market and its trend is to be done on a continuous basis.

The above analysis will help to arrive at a conclusion as to whether the securities already in possession should be disinvested and new securities be purchased. If so, the timing for investment or dis-investment is also revealed.

ACTIVITIES IN PORTFOLIO MANAGEMENT

The following three major activities are involved in an efficient portfolio management:

a) Identification of assets or securities, Allocation of investments and identifying asset classes.

b) Deciding about major weights/proportion of different assets/securities in the portfolio.

c) Security selection within the asset classes as identified earlier.

The above activities are directed to achieve the sole purpose to maximize return and minimize risk in the investments. This will however be depending upon the class of assets chosen for investment.

The class of assets/securities varies according to the degree of risk. It is well interpreted that higher the risk, higher will be the returns and vice versa. The portfolio manager foresees the balancing of risk and return in a portfolio investment. The composite risks involving the different risks are as indicated:

1) Interest Rate Risk: This arises due to variability in the interest rates from time to time. A change in the interest rates establishes an inverse relationship in the price of security i.e. price of securities tend to move inversely with change in rate of interest, long term securities show greater variability in the price with respect to interest rate changes than short term securities. Interest rate risk vulnerability for different securities is as under:

TYPESRISK EXTENT

Cash equivalentLess vulnerable to interest rate risk.

Long term bondsMore vulnerable to interest rate risk.

2) Purchasing Power Risk: It is also known as inflation risk also emanates from the very fact that inflation affects the purchasing power adversely. Nominal return contains both the real return component and an inflation premium in a transaction involving risk to compensate for inflation over an investment holding period. Inflation rates vary over time and investors are caught unaware when rate of inflation changes unexpectedly causing erosion in the value of realized rate of return and expected return. Purchasing power risk is more in inflationary conditions especially in respect of bonds and fixed income securities. It is not desirable to invest in such securities during inflationary periods. Purchasing power risk is however, less in flexible income securities like equity share or common stock where rise in dividend income off-sets increase in the rate of inflation and provides advantage of capital gains.

3) Business Risk: Business risk emanates from sale and purchase of securities affected by business cycles, technological changes, etc. Business cycle affect all types of securities viz. there is cheerful movement in boom due to bullish trend in stock prices whereas bearish trend in depression brings down fall in the prices of all types of securities. Flexible income securities are more affected than fixed rate securities during depression due to decline in their market price.

4) Financial Risk: It arises due to changes in the capital structure of the company. It is also known as leveraged risk and expressed in terms of debt-equity ratio. Excess of debt equity in the capital structure indicates that the company is highly geared. Although a leveraged companys earnings per share are more but dependence on borrowings exposes it to the risk of winding-up for its inability to honor its commitments towards lenders/creditors. This risk is known as leveraged or financial risk of which investors should be aware and portfolio managers should be vary careful.

Chapter II

INTRODUCTION TO PORTFOLIO MANAGER

In view of peculiar nature of stock exchange operations most of the investors feel insecure in managing their investment on the stock market because it is difficult for an individual to identify companies which have growth prospects conducive for investment. This is further complicated by the volatile nature of the markets, which demands constant reshuffling of portfolios to capitalize on the growth opportunities.

Even if the investor is able to identify growth oriented companies and their securities, the trading practices are complicated, making it a difficult task for investors to trade in all the exchanges and follow-up on post trading formalities. That is why professional investment advice through Portfolio Management Services (PMS) can help the investor to make an intelligent and informed choice between alternative investment opportunities without the worry of post trading hassles.

DEFINITION OF PORTFOLIO / PORTFOLIO MANAGER:

Portfolio means the total holdings of securities belonging to any person. Portfolio manager means any person who enters into a contract or agreement with a client. Pursuant to such agreements he advices the clients or undertakes on behalf of such client management or administration of a portfolio of securities or invests and manages the clients funds.

Two Types of Portfolio Managers

Discretionary Non- Discretionary

Portfolio Manager Portfolio Manager

1. Discretionary Portfolio Manager:

A discretionary portfolio manager means a portfolio manager who exercises or may, under a contract relating to portfolio management, exercises any degree of discretion in respect of the investments or management of the portfolio of securities or the funds of the clients, as the case may be. He shall individually and independently manage the funds of each client in accordance with the needs of the client in a manner which does not resemble a mutual fund.2. Non-Discretionary Portfolio Manager:

A Non-Discretionary Portfolio Manager shall manage the funds of each client in accordance with the directions of the client.

A portfolio manager, by the virtue of his knowledge, background and experience is expected to study the various avenues available for profitable investment and advise his client to enable the latter to maximize the return on his investment and at the same time safeguard the funds invested.

NEED FOR AND ROLE OF PORTFOLIO MANAGER:

With the development of the Indian securities market and with the appreciation in the market price of equity shares of profit-making companies, investment in securities of such companies has become quite attractive. At same time, the stock market becoming volatile n account of various factors, a layman is puzzled as to how to make his investments without losing the same. He has felt the need of experts guidance n this respect. Similarly Non-resident are eager to make their investments in Indian companies. They have also to comply with the conditions specified by the Reserve Bank of India under various schemes for investment by the non-resident. The Portfolio Manager, with his background and expertise, meets the needs of such investors by rendering service in helping them to invest their funds profitably.

FUNCTIONS OF PORTFOLIO MANGERS:

Portfolio mangers rendering the services of portfolio management to their clients in different categories, viz. individuals, resident Indians and non-resident Indians, firms, association of persons like Joint Hindu Family, Trust, Society, Corporate Enterprises Provident Fund Trustees etc. have to enquire of their individual objectives, need pattern for funds, perspective towards growth and attitude towards risk before counseling them on the subject and acceptance of the assignment. Nevertheless, portfolio managers in the wake of rendering their services perform following set of functions:

They study economic environment affecting the capital market and clients investment.

They study securities market and evaluate price trend of shares and securities in which investment is to be made.

They maintain complete and updated financial performance data of Blue-Chip and other companies.

They keep a track on latest policies and guidelines of Government of India, RBI and Stock Exchanges.

They study problems of industry affecting securities market and the attitude of investors.

They study the financial behaviour of development financial institutions and other players in the capital market to find out sentiments in the capital market.

They counsel the prospective investors on share market and suggest investments in certain assured securities.

They carry out investments in securities or sale or purchase of securities on behalf of the clients to attain maximum return at lesser risk.

CODE OF CONDUCT - PORTFOLIO MANAGERS:

A portfolio manager shall, in the conduct of his business, observe high standards of integrity and fairness in all his dealings with his clients and other portfolio managers.

The money received by a portfolio manager from a client for an investment purpose should be deployed by the portfolio manager as soon as possible for that purpose and money due and payable to a client should be paid forthwith.

A portfolio manager shall render at all time high standards of services exercise due diligence, ensure proper care and exercise independent professional judgment. The portfolio manager shall either avoid any conflict of interest in his investment or disinvestments decision, or where any conflict of interest arises; ensure fair treatment to all his customers. He shall disclose to the clients, possible sources of conflict of duties and interest, while providing unbiased services. A portfolio manager shall not place his interest above those of his clients.

A portfolio manager shall not make any statement or become privy to any act, practice or unfair competition, which is likely to be harmful to the interests of other portfolio managers or it likely to place such other portfolio managers in a disadvantageous position in relation to the portfolio manager himself, while competing for or executing any assignment.

A portfolio manager shall not make any exaggerated statement, whether oral or written, to the client either about the qualification or the capability to render certain services or his achievements in regard to services rendered to other clients.

At the time of entering into a contract, the portfolio manager shall obtain in writing from the client, his interest in various corporate bodies, which enables him to obtain unpublished price-sensitive information of the body corporate.

A portfolio manager shall not disclose to any clients or press any confidential information about his clients, which has come to his knowledge.

The portfolio manager shall where necessary and in the interest of the client take adequate steps for registration of the transfer of the clients securities and for claiming and receiving dividend, interest payment and other rights accruing to the client. He shall also take necessary action for conversion of securities and subscription of/or rights in accordance with the clients instruction.

Portfolio manager shall ensure that the investors are provided with true and adequate information without making any misguiding or exaggerated claims and are made aware of attendant risks before they take any investment decision.

He should render the best possible advice to the client having regard to the clients needs and the environment, and his own professional skills.

Ensure that all professional dealings are affected in a prompt, efficient and cost effective manner.

Chapter III

INVESTMENT AND THEIR ALTERNATIVES

WHAT IS INVESTMENT???

The income that a person receives may be used for purchasing goods and services that he currently requires or it may be saves for purchasing goods and services that he may require in the future. In other words, income can be what is spent for current consumption or saved for the future consumption. Savings are generated when a person or an organization abstains from present consumption for future use. The person saving a part of his income tries to find a temporary repository for his savings until they are required to finance his future expenditure this results in investments.

MEANING OF INVESTMENT

Investment is an activity that is engaged in by people who have savings, i.e. investments are made from savings, or in other words, people invest their savings. But all savers are not investors. Investment is an activity, which is different from saving.

It may mean many things to many persons. If one person has advanced some money to another, he may consider his loan as an investment. He expects to get back the money along with interest at a future date. Another person may have purchased one kg of gold for the purpose of price appreciation and may consider it as an investment. Yet another person may purchase an insurance plan for the various benefits it promises in the future. That is his investment.

In all these cases it can be seen that investment involves employment of funds with the aim of achieving additional income or growth in values. The essential quality of investment is that it involves waiting for a reward. Investment involves the commitment of resources, which have been saved in the hope that some benefits will accrue in the future.

Thus investment may be defined as a commitment of funds made in the expectation of some positive rate of return. Expectation of return is an essential element of investment. Since the return is expected to be realized in future, there is a possibility that the return actually realized is lower than the return expected to be realized. This possibility of variation in the actual return is known as investment risk. Thus every investment involves return and risk.

CHARECTERISTICS OF INVESTMENT

Certain features characterize all investments. Let us analyze these characteristic features of investments.

RETURN:

All investments are characterized by the expectation of return. In fact, investments are made with the primary objective of deriving a return. The return may be received in the form of yield plus capital appreciation. The difference between the sale price and the purchase price is capital appreciation. The dividend or the interest received from the investment is the yield. Different types of investments promise different rates of return. The return from an investment depends upon the nature of the nature of the investment, the maturity period and a host of other factors.

RISK:

Risk is inherent in any investment. This risk may relate to loss of capital, delay in repayment of capital, nonpayment of interest, or variability of returns. While some investments like government securities and bank deposits are almost risk less others are more risky. The risk involved in an investment depends on the following factors: -

1) The longer the maturity period, the larger the risk.

2) The lower the credit worthiness of the borrower, the higher is the risk.

3) The risk varies with the nature of investment. Investments in ownership securities like equity shares carry higher risk as compared to investments in debt instruments like debentures and bonds.

Risk and return of an investment are related. Normally, the higher the risk, the higher is the return.

SAFETY:

The safety of an investment implies the certainty of return on capital without the loss of money or time. Safety is another feature, which an investor desires for his investment. Every investor expects to get back his capital on maturity without loss and delay.

LIQUIDITY:

An investment, which is easily saleable or marketable without the loss of money and time, is said to possess liquidity. Some investments like company deposits, bank deposits, P.O. Deposits, NSC are not marketable. Some investment instruments like preference shares and debentures are marketable. but there are no buyers in many cases and hence their liquidity is negligible. Equity shares of companies listed on the stock exchange are easily marketable through the stock exchanges.

An investor generally prefers liquidity for his investments; safety for is funds, a good return for a minimum risk and also maximization of his returns.

OBJECTIVE OF INVESTMENT:

An investor has various alternative avenues of investment for his savings to flow to. Savings kept, as cash are barren and earn nothing. Hence savings are invested in assets depending on their risk and return characteristics. The objective of the investor is to minimize the risk and maximize the return on his investment.

Our savings kept in cash are not only barren because they do not earn anything, but also loses its value to the extent of rise in prices. Thus rise in prices or inflation erodes the value of money. Savings are invested to provide a hedge or protection against inflation. If the investments cannot earn as much as the rise in prices, the real rate of return would be negative. Thus, if inflation is at an average rate of 10%, then the return from the investments made should be more than 10% to induce savings to flow into investments. Thus the objectives of an investor can be stated as follows: -

a. Maximization of return.

b. Minimization of risk.

c. Hedge against inflation.

Investors, in general, desire to earn as large returns as possible with the minimum of risk. Risk here may be understood as the probability that actual returns realized from an investment would be different from the expected returns. The financial assets available for investment can be classified into the following categories: -

a. Government securities risk free.

b. Debentures and preference shares medium risk assets.

c. Equity shares high-risk assets.

An investor would be prepared to assume higher risk only if he expects to get proportionately higher returns. There is a trade-off between the risk and return. The expected return of an investment is directly proportional to its risk. Thus in the financial markets, there are various assets with varying risk-return characteristics.

INVESTMENT VS SPECULATION

Investment and speculation are two terms that are closely related. Both involve the purchase of assets like shares and securities. Traditionally investment is distinguished from speculation with respect to three factors, viz.

i. Risk.

ii. Capital gain

iii. Time period.

Risk:

It refers to the possibility of incurring a loss in a financial transaction. It arises from the possibility of variation in returns from an investment. Risk is invariably related to return. Higher return is associated with higher risk.

No investment is completely risk free. An investor generally commits his funds to low risk investment, whereas a speculator commits his fund to higher risk investments. A speculator is prepared to take higher risk in order to receive higher returns.

Capital Gains:

The speculators motive is to achieve profits through price changes, i.e. he is interested in capital gains rather than the income from the investment. if purchase of securities is preceded with proper investigation and analysis to receive stable returns and capital appreciation over a period of time, it is investment. Thus speculation is related with buying low and selling high with the hope of making high capital gains. A speculator consequently engages in frequent buying and selling transactions.

Time Period:

Investment is long term in nature, whereas speculation is only short-term. An investor commits his funds for a longer period and waits for his return. But a speculator is interested in short-term gains through buying and selling of investment instruments.

Analysis of these distinctions helps us to identify the role of the investor and the speculator. The investor is interested in a good rate of return earned on a rather consistent basis for a relatively longer period of time. He evaluates the worth of the security before investing in it. The speculator seeks opportunities promising very large returns achieved very quickly. He is interested in market action and price movements. Consequently speculation is more risky than investment.

Basically both investment and speculation aim at good returns. The difference is in motives and methods. As a result, the distinction between investment and speculation is not very wide. Investment is sometimes described as a well grounded and carefully planned speculation

EVALUATION OF RISK AND RETURN

A Portfolio is a combination of securities. It is essential that every security should be evaluated in portfolio content. Portfolio analysis considers the determination of future risk and return in holding various combinations of individual securities. Expected return on the portfolio is a weighted average of the expected return of individual securities. However, portfolio variance can be less than a weighted average of securities variances. Thus, an investor can reduce portfolio risk by adding more securities with greater individual risk than any other security in the portfolio. An investor can estimate the expected return and expected risk level of a given portfolio of securities. In order to estimate the total risk of a portfolio, several estimates are needed. This requires the variance of each individual security and the co-variance or correlation co-efficient of each security.

INVESTMENT ALTERNATIVES

Investment alternatives are the outlets of funds. There are varieties of investment alternatives available. Investors are free to select any one or more alternatives depending upon their needs. All categories of investors are equally interested in safety, liquidity and reasonable return on the funds invested by them. In India, investment alternatives are continuously increasing along with new developments in the financial market. Investment is now possible in corporate securities, public provident fund, mutual fund etc. Thus, wide varieties of investment alternatives are now available to the investors. However, the investors should be very careful about their hard earned money. An investor can select the best one after studying the merits and demerits of the available alternatives.

Non Marketable Financial Assets: A good portion of financial assets is represented by non- marketable financial assts. These can be classified into the following broad categories:

Bank Deposits

Post office Deposits

Company Deposits

Provident Fund Deposits

Equity Shares: Equity shares represent ownership capital. As an equity shareholder, you have an ownership stake in the company. This essentially means that you have a residual interest in income and wealth. Perhaps the most romantic among various investment alternatives, equity shares are classified into the following broad categories by stock market analysts:

Blue Chip Shares Growth Shares

Income Shares

Cyclical Shares

Speculative Shares

Bonds: Bonds or debentures represent long-term debt instruments. The issuer of a bond promises to pay a stipulated stream of cash flow. Bonds may be classified into the following categories:

Government Securities

Savings Bonds

Government Agency Securities

PSU Bonds

Debentures of Private Sector Companies

Preference Shares

Money market Instruments: Debt instruments which have a maturity of less than one year at the time of issue are called money market instruments. The important money market instruments are:

Treasury Bills Commercial Paper

Certificate of Deposit

Mutual Funds: Instead of directly buying equity shares and/or fixed income instruments, you can participate in various schemes floated by mutual funds which, in turn, invest in equity shares and fixed income securities. There are three broad types of mutual fund schemes:

Equity Schemes

Debt Schemes

Balanced Schemes

Life Insurance: In a broad sense, life insurance may be viewed as an investment.

Insurance premiums represent the sacrifice, and the assured sum, the benefit. The important types of insurance policies in India are:

Endowment Assurance Policy

Money Back Policy

Whole Life Policy

Term Assurance Policy

Real Estate: For the bulk of the investors the most important asset in their portfolio is a residential house. In addition to a residential house, the more affluent investors are likely to be interested in the following types of real estates:

Agriculture Land

Semi-Urban Land

Commercial Property

Precious Objects: Precious objects are items that are generally small in size but highly valuable in monetary terms. Some important precious objects are:

Gold and Silver Precious Stones Art Objects Financial Derivatives: A financial derivative is an instrument whose value is derived from the value of an underlying asset. The most important financial derivatives from the point of view of investors are:

Options

Futures

CHAPTER IV

TECHNICAL ANALYSIS

Prices of securities in the stock market fluctuate daily on account of continuous buying and selling. Stock prices move in trends and cycles and are never stable. An investor in the stock market is interested in buying securities at a low price and selling them at a high price so as to get a good return on his investment. He, therefore, tries to analyze the movement of share prices in the market. Two approaches are commonly used for this purpose. One of these is the fundamental analysis wherein the analyst tries to determine the true worth or intrinsic value of a share based on the current and future earning capacity of the company. He would buy the share when its market price is below its intrinsic value. The second approach to security analysis is called technical analysis. It is an alternative approach to the study of stock price behavior.

MEANING OF TECHNICAL ANALYSISThe technical analyst believes that share prices are determined by the demand and supply forces operating in the market. These demand and supply forces in turn are influenced by a number of fundamental factors as well as certain psychological or emotional factors. Many of these factors cannot be quantified. The combined impact of all these factors is reflected in the share price movement. The technical analyst therefore concentrates on the movement of share prices. He claims that by examining past share price movements future share prices can be accurately predicted. Technical analysis is the name given to forecasting techniques that utilize historical share price data.

The rationale behind technical analysis is that share price behavior repeats itself over time and the analyst attempts to derive methods to predict this repetition. The technical analyst looks at the past share price data to see if he can establish any patterns. He then looks at current price data to see if any of the established patterns are applicable and, if so, extrapolations can be made to predict the future price movements. Although past share prices are the major data used by technical analysts, other statistics such as volume of trading and stock market indices are also utilized to some extent.

The basic premise of technical analysis is that prices move in trends or waves, which may be upward or downward. It is believed that the present trends are influenced by the past trends and that the projection of future trends is possible by an analysis of past price trends. The technical analyst, therefore, analyses the price and volume movements of individual securities as well as the market index. Thus, technical analysis is really a study of past or historical price and volume movements so as to predict the future stock price behavior.

Dow TheoryWhatever is generally being accepted today as technical analysis has its roots in the Dow theory. The theory is so called because Charles H. Dow who was the editor of the Wall Street Journal in U.S.A formulated it. In fact, the theory was presented in a series of editorials in the Wall Street Journal during 1900-1902.

Charles Dow formulated a hypothesis that the stock market does not move on a random basis but is influenced by three distinct cyclical trends that guide its direction. According to Dow Theory, the market has three movements and these movements are simultaneous in nature. These movements are the primary movements, secondary reactions and minor movements.

The primary movement is the long-range cycle that carries the entire market up or down. This is the long-term trend in the market. The secondary reactions act as a restraining force on the primary movement. These are in the opposite direction to the primary movement and last only for a short while. These are also known as corrections. For example, when the market is moving upwards continuously, this upward movement will be interrupted by downward movements of short durations. These are the secondary reactions. The third movement in the market is the minor movements, which

are the day-to-day fluctuations in the market. The minor movements are not significant and have no analytical value as they are of very short duration. The three movements of the market have been compared to the tides, the waves and the ripples in the ocean.

According to Dow Theory, the price movements in the market can be identified by means of a line chart. In this chart, the closing prices of shares or the closing values of the market index may be plotted against the corresponding trading days. The chart would help in identifying the primary and secondary movements.

The primary trend of the market is upwards but there are secondary reactions in the opposite direction.

Among the three movements in the market, the primary movement is considered to be the most important. The primary trend is said to have three phases in it, each of which would be interrupted by a counter move or secondary reaction, which would retrace about 33-b6 per cent of the earlier rise or fall.

BULLISH TRENDDuring a bull market (upward moving market), in the first phase the prices would advance with the revival of confidence in the future of business. The future prospects of business in general would be perceived to be promising. This will prompt investors to buy shares of companies. During the second phase, prices would advance due to the improvements in corporate earnings. In the third phase, prices advance due to inflation and speculation. Thus, during the bull market, the line chart would exhibit the formation of three peaks. Each peak would be followed by a bottom formed by the secondary reaction. Each peak would be higher than the previous peak, each successive bottom would be higher than the previous bottom. According to Dow theory, the formation of higher bottoms and higher tops indicates a bullish trend.

BEARISH TRENDThe bear market is also characterized by three phases. In the first phase, prices begin to fall due to abandonment of hopes. Investors begin to sell their shares. In the second phase, companies start reporting lower profits and lower dividends. This causes further fall in prices due to increased selling pressure. In the final phase, prices fall still further due to distress selling. A bearish market would be indicated by the formation of lower tops and lower bottoms.

The Dow theory laid emphasis on volume of transactions also. According to the theory, volume should expand along the main trend. This means that if the main trend is bullish, the volume should increase with the rise in pr. ices and fall during the intermediate reactions. In a bearish market when prices are falling, the volume should increase with the fall in prices and be smaller during the intermediate reactions.

The theory also makes certain assumptions which have been referred to as the hypotheses of the theory.

The first hypothesis states that the primary trend cannot be manipulated. It means that no single individual or institution or group of individuals and institutions can exert influence on the major trend of the market. However, manipulation is possible in the day-to-day or short-term movements in the market.

The second hypothesis states that the averages discount everything. What it means is that the daily prices reflect the aggregate judgement and emotions of all stock market participants. In arriving at the price of a stock the market discounts (that is, takes into account) everything known and predictable about the stock that is likely to affect the demand and supply position of the stock.

The third hypothesis states that the theory is not infallible. The theory is concerned with the trend of the market and has no forecasting value as regards the duration or the likely price targets for the peak or bottom of the bull and bear markets.

BASIC PRINCIPLES OF TECHNICAL ANALYSISThe basic principles on which technical analysis is based may be summarized as follows:

1. The market value of a security is related to demand and supply factors operating in the market.

2. There are both rational and irrational factors, which surround the supply and demand factors of a security.

3. Security prices behave in a manner that their movement is continuous in a particular direction for some length of time.

4. Trends in stock prices have been seen to change when there is a shift in the demand and supply factors.

5. The shifts in demand and supply can be detected through charts prepared specially

to show market action.

6. Patterns that are projected by charts record price movements and analysts to make forecasts about the movement of prices in future use these recorded patterns.

FUNDAMENTAL ANALYSIS V/S TECHNICAL ANALYSIS

Fundamental AnalysisTechnical Analysis

Fundamentalists study the causeTechnicians study the effect.

No one should buy without knowing as much as possible about the company that issues it.Security prices already reflect everything that is currently known about the security.

Fundamentals reflect the past.Price even discounts the future, unknown news

Informed investing is the philosophy of fundamental analysis. Investment in shares is a serious business and all aspects and factors must be analyzed and considered. There is no substitute for information. The market is not a roulette wheel. Good research and good ideas are the one absolute necessity in the market place.The market is a roulette wheel. A casino makes money on a roulette wheel, not by knowing what number will come up next, but by slightly improving their odds with the addition of a "0" and "00."Similarly, if an investor buys a stock when it is in a rising trend, after a minor sell off, and when interest rates are falling, he will have improved his odds of making a profit.

One should buy a share when it is below its intrinsic value and sell it when it rises above its intrinsic value. Price of a stock is the outcome of demand and supply of that stock in the market and is nowhere related to the intrinsic value.

Historical facts cannot be used to forecast the market development. Any success with a charting technique is just a consequence of the laws of probability.Past price behavior can be used to forecast future price behavior. History repeats itself. Price movements are not a random walk but unfold in trends.

Investment

Alternatives

Mutual Fund

Schemes

Money Market Instruments

Bonds

Equity

Shares

Non Marketable

Financial Assets

Real

Estate

Life Insurance

Policies

Precious

Objects

Financial Derivatives