Technica and Fundamental Analysis

8/8/2019 Technica and Fundamental Analysis

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Technical Analysis

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BySHRAVAN



Business cycle

NASCENT

GROWTH

PEAK

DEMAND < SUPPLY

DECLINE

DEMAND > SUPPLY



TA Assumptions

Price discounts everything

History repeats itself

Prices move in trends Volume leads price action

Price leads fundamentals or future

Price depends on supply and demand

Timing the entry and exit is possible

Keeps emotions and ego out of trading



Dow Theory ± Basic Tenets

(it worked 45 out of 52 times!!!) Averages discount everything

Market has 3 movements±Prim/Sec/Minor

Lines indicate accumulation/distribution(5% price variation for 4 weeks or more)

Price/Vol relationships provide background

Price action determines trend

Averages must confirm.

Success rate 45/52 from 1897 to 1998



Basic Bar

High

Low

Close

Open

Up Day

High

Low

Open

Close

Down Day



Trend is your friend

Up

Down



Bull Trends

A bull trend starts when price rallies abovethe previous high,

A bull trend ends when price declinesbelow the previous low,

A bear trend starts at the end of a bulltrend (and vice versa).



Begin and End of Bull trends

BUY

SELL

Trend line acts as support

Price

Return line acts as resistance



Time frames

Long-term (or primary) trends that are

measured in years;

Intermediate (or secondary) trends of 3weeks up to 6 months;

Short-term cycles of less than 3 weeks;

and

Intra-day cycles.



Investor¶s choice

Which stocks to buy?

How much trading capital?

Time frame Risk appetite and risk control

Reward is proportional to risk

Learn from your Track Record Position management



Market decides

Market will move up or down

How much will it move?

When to buy/sell?



Steps to Trading success

The key is to buy when the market signals thestart of a bull trend.

Select leading stocks that are outperformingthe market.

Sell when the bull trend has ended.

There are exceptions to this rule: Sellindividual stocks if they move against thetrend.



Successfully trading trends

Select Security

Market Direction

Scrip direction

Entry signal

Stop Loss trailing

Exit signal

Market Leaders

Indicator

Same indicator

Oscillator, price action

Affordable, Technical

Stop loss, Supports,

Patterns



Stop Loss

Support/ resistance levels,

Above/below the most recent peak/trough,

Above or below reversal signals; or At the crossing of moving averages.

Affordable levels based on 5 to 7%.



Supports & Resistances

the number of times that the level has been respected;

the amount of volume that has been traded near thelevel;

whether the level is old or new - recent levels havegreater significance;

whether the level is a new High or new Low - moreextreme levels have greater impact; or

a level formed at a round number (e.g. Rs. 50.00 or Rs.100.00) leaves a lasting imprint.



Fibonacci Retracement

If rise is 100 points then supports are at

the following levels from top (0%)

23.6 % 38.2%

50%

61.8%



Pivot points

Resistance 3 = High + 2*(Pivot - Low)Resistance 2 = Pivot + (R1 - S1)Resistance 1 = 2 * Pivot - LowPivot Point = ( High + Close + Low )/3Support 1 = 2 * Pivot - HighSupport 2 = Pivot - (R1 - S1)Support 3 = Low - 2*(High - Pivot)

As you can see from the above formula, just by havingthe previous days high, low and close you eventuallyfinish up with 7 points, 3 resistance levels, 3 support

levels and the actual pivot point. If the market opens above the pivot point then the bias

for the day is long trades. If the market opens below thepivot point then the bias for the day is for short trades.



Trading with Pivots

If the market opens above the pivot point thenthe bias for the day is long trades. If the marketopens below the pivot point then the bias for theday is for short trades.

The three most important pivot points are R1, S1and the actual pivot point.

The general idea behind trading pivot points areto look for a reversal or break of R1 or S1. By

the time the market reaches R2,R3 or S2,S3 themarket will already be overbought or oversoldand these levels should be used for exits rather than entries.



CHART PATTERNS

Recognize successfully



Trading Range

Support

Resistance

Target = Distance between resistance & support ( or higher )

Once a resistance is broken it becomes a support andvice versa.



Head and Shoulders - Reversal

High volume at S1

Moderate at Head

Low volume at S2

High volume at break

below neckline

S 1

H

S 2 Sell

Target = Distance between H and neckline



Double Top - Reversal

T 1 T 2

High volume at T1 & lower

volume at T2. Increased volume

on break below previous trough.

Target = Distance from top

to trough from break down

level

TRIPLE TOP IS SIMILAR TO DOUBLE TOP.



Inside Bar

If there are three or more bars whose

entire range is within a big bar then you

look for a break out and trade in that

direction.



Flags & Pennants - continuationThese are pauses in the primary trend & indicate consolidation

FLAG

PENNANT

Volume increases at the

beginning of pattern and

reduces towards the end.

Targets: These patterns occur in

the middle of a trend. So

projected price is equal to

preceding trend¶s price range.



Wedges

A falling wedge forms with lower highs and lower

lows. A bullish signal, a falling wedge is a

continuation signal in an up-trend and a reversal

signal when observed in a down-trend. A rising wedge is formed by higher highs and

higher lows. A bearish signal, the pattern is

normally a continuation signal in a down-trend

but acts as a reversal signal when encounteredin an up-trend. Targets are similar to flags.



Falling Wedge

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Symmetrical Triangles

Symmetrical triangles form with lower highs and

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pattern. This will be signalled by the breakout. An upward breakout is a bullish signal, while a

downward breakout is bearish.

Target = Height of triangle from breakout.



Symmetrical triangle

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Ascending triangle

An ascending triangle is formed by equal highs

and higher lows. It is a bullish signal, whether

encountered in an up- or down-trend. It is most

often observed as a continuation pattern in anup-trend but is a strong reversal signal when

witnessed in a down-trend



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Cup & handle

This pattern was identified by William O'Neil.

The cup commences with a new peak [1], formed after astrong up-trend.

A secondary correction occurs, with price falling +/- 50%from the peak at [2]. This is high - cup and handlecorrections normally vary between 10% and 30%.

The stock then forms a second peak at [3], slightly lower than the first.

The handle is completed [4] when price breaks abovethe intervening peak [3]. The handle should form in thetop half of the cup pattern, with volume contracting asthe handle forms and then expanding on the breakout.



Cup & Handle

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GAPS

Common

Breakaway

Runaway

Exhaustion

No action

From a congestion

Midway in a trend

End of trend

An island reversal marks Trendreversal



VOLUME

PRICE VOLUME IMPLICATION

Rising Up Bullish

Rising Down Bearish

Declining Up Bearish

Declining Down Bullish



INDICATORS

Moving averages ± Simple, Weighted and

Exponential

Volume Oscillators ± MACD, RSI, Stochastics

TREND is Primary and Indicators are

Secondary. Use indicators for spottingCONFIRMATION or DIVERGENCE. Trade

on price signal only.



Moving Average ( Dow Jones)

Use closing prices to calculate MA.

MA is a trend following indicator and

should be followed in a trending market. When the short term MA crosses the

longer term MA from below, a BUY signal

is generated and vice versa for a SELL

signal.



Using Moving Averages(5/20 day)

Bullish above zero

Bearish below zero



MACD ( Gerald Appel)

MACD measures the distance between two expsmoothed averages and is used as a histogramor crossover for signals

When the MACD line crosses the signal line aBUY/SELL signal is generated.

Above zero line is bullish and below zero line isbearish.

A negative, or bearish, divergence exists whenMACD lines are well above the zero line & startto weaken while price continues to trend higher.



RSI ( Welles Wilder, Jr.)

RSI is plotted on a scale of 0 to 100. Overbought >70/80; Oversold < 30/20.

A ³Top Failure Swing´ ± when a peak of RSI(>70) fails to

exceed its previous peak in an uptrend followed by adownward break of its previous trough or 70 level. Viceversa for ³ Bottom failure Swing´.

Divergences above 70 & below 30 are Serious warningsignals, at the end of a trend.

RSI = 100 ± 100/(1+RS); RS = Avg. of up/Avg. of down. A 14 period RSI is most popular.



RSI with Moving Averages

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Stochastic ( George Lane)

%K = 100[(C-L14)/(H14-L14)] - Fast

%D is 3 period MA of %K - Slow

Range 0 to 100 ; OB > 80 OS < 20; Divergence similar to RSI.

Buy signal occurs when %K crosses

above %D in OS zone and Sell signalwhen %K crosses below %D in OB zone.



Stochastics with Moving Avgs.

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Bull vs Trading market

MA ± Buy upside

crossovers

RSI, %R,, Oscillators

± Buy oversold,Ignore overbought

Stochastics ± Buy

upside crossovers,

Ignore downside

crossovers

MA ± not useful

RSI, %R, Oscillators-

Sell overbought, Buy

oversold. Stochastics ± Buy

upside crossovers,

Sell downside

crossovers



OPEN INTEREST

Price Open Interest Interpretation

Rising Up Bullish

Rising Down Bearish

Declining Up Bearish

Declining Down Bullish



Risk Management

Place Stop loss orders with the trade.

Amount of money per trade

Limit the total amount of trading capital Determine your success percentage - 70%

Keep a record of your trades and analyze

Limit your amount per trade based on your failure rate. Keep ruin chances below 1%



Chance of ruin @ 30% fail rate

0.3*0.3 = 0.09 ie 9%

0.3*0.3*0.3*0.3 = 0.0081 ie 0.8 %

0.3*0.3*0.3*0.3*0.3 = 0.00243 ie 0.2 %

So limit your money per trade to 1/5 of your balance trading capital.



Steps suggested

Select the trading system you are

comfortable with

Decide on acceptable risk and Rs./trade.

Continuously reduce risk/ cost of purchase

Have a profit/loss taking strategy. Eg Sell

at 30% rise or sell when trend has

reversed etc.

Profit/loss ratio = 3 or higher



P/L 3 or higher

30 trades/year; Success rate 70%, P =

Rs.300 L= Rs.100 ; Investment Rs

1000/trade; 5 trades per week; 6 times in a

year

Profit 21*300 = 6300

Loss 9*100 = 900 Net 5210 (100%)

In 25 years 12 times dbl = 4096 times

5000*4000 = 20,000,000 ( 2 cr. )



USEFUL TIPS

Wait for the right time

Select stocks with sustainable advantage

Returns must be clearly achievable

Remove weeds and water flowers

Sell only when you find a better return

Avoid glitter stocks

Calculate ROCE/ ROE/ PEG

Think value NOT Price



Themes

Value > price

Demand > supply

Sales and profits increasing steadily Strong clients whose business is growing

Turnaround stories

New products in pipeline Upturn in business cycle



Market features

Is either over valued or under valued

Fat gains are followed by fat losses

Bubbles develop frequently (M Cap>NP) Tips ± bad advice is free

Volatility- News, ECN, Day traders, Needs

Researchers, Speculators, free riders exist



Fundamentals

Strong financials, earnings stability and

growth, Strong sales & profit margins,

Internal cash funds growth

Quality & Integrity of management which

rewards shareholders

Good labor relations

Some knowledge about the business



Positives

It is not a waste of time to study individualinvestment opportunities in stocks.

You are likely to do better by thinking aboutwhether individual investment opportunities

make sense than by randomly selecting a groupof stocks for a portfolio by throwing darts at thestock tables

Nor will you do better by using modern portfoliotheory¶s strategy of putting your eggs in lots of different baskets based on what tells you therisk of each basket is.



Lessons to learn

Methods are useful as tools but good

judgment comes not from methods alone

Good judgment comes from experience

Experience comes from bad judgment

Concentrate on assumptions ± interest

rates, taxes, inflation & compounding

Start early and save regularly. Invest only

when the price is right.



Joy of compounding

Rule of 72 : Doubling period * Rate = 72

2^5 = 32; 2^10 = 1024; 2^ 12 = 4096



Worries and remedies

Over confidence

Confirmation &

resistance

Giving too muchimportance to news or

information flow

Recognize your

limitations

Articulate the

justification for your decisions

Have clear guidance

in decision making



MOST ATTRACTIVE CO.

Customers keep coming back ± Coca Cola

Branded products ± Sony, Honda, Infosys,

Microsoft, Disney

Minimum inventory - Dell

Enduring demand pattern ± Oil cos.

Diversified markets ± Grasim, Microsoft Killer instinct ± Wal Mart, Reliance



TISCO EPS

TISCO

EPS

P E



TISCO Price

TISCO

Price



TISCO Value

Average EPS last 10 years = 19.45

Assume it will be same for next 10 years

NPV of 19.45 for 10 years = 91.83 (16%)

Assume different risk profiles: (Rs.350)

91.83/0.12 = 765 118%

91.83/0.16 = 573 63%

91.83/0.20 = 459 31%

91.83/0.24 = 382 9%



High Growth

Research on your own

Self belief

Multi-bagger in the making Favorable market conditions

Should hold for long term

NP growing faster than peers Company should enter growth phase.



Make up methods

Modifying revenue recognition policies

Adjusting reserves and treatment of returns

Recording the value of market share as an asset

Recording the amount of cash we ³burn´ as anasset

Reporting in a different currency

Refining the concept of materiality

Earnings are inflated



Managerial Quality

Integrity - Warren Buffet, Narayana Murthy

Achievement ± Jack Welch, GE; Mike Goizueta,Coca Cola, Dr. Kurien, Amul

Energy ± Wasim Akram, Lance Armstrong Intelligence ± George Soros

Knowledge ± John Maynard Keynes

Leadership ± Jack Welch, GE, 6 sigma

Creativity ± Edward De Bono, Mike Eisner,Disney Corp, Akio Morita, Thomas Edison, DanGlover, Intel

Technica and Fundamental Analysis

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