TECHNICAL ANALYSIS

Technical analysis defined It is an art of identifying a trend reversal at a relatively early stage and ride on that trend until the weight of the evidence shows or proves that the trend has reversed. The evidence in this case is represented by a number of indicators like peak and trough analysis, price patterns and moving averages.

Technical approach is based on the theory that the price is a reflection of mass psychology that moves between panic, fear and pessimism on one hand and confidence, excessive optimism and greed on the other. The price level is never what the stocks are worth, but what people think they are worth.

Technical vs. Fundamental analysis Technical analysis predicts short term price movements whereas fundamental analysis establishes long term values. Technical analysis focuses on internal market data i.e. price and volumes whereas fundamental analysis focuses on E-I-C analysis.

Dow Theory It is the oldest and by far the most publicized method of identifying major trends in the stock market. It is concerned with the direction of a trend and has no forecasting value as to its ultimate duration. This theory is only one piece of evidence in technical analysis.

Dow theory cont… The theory assumes that majority of stocks follow the underlying trend of the market most of the time. In order to measure the market, Dow constructed two indexes which are now called Dow Jones Industrial Average and the Dow Jones Transportation Average.

Dow theory cont… The market has three movements: primary movement, secondary reactions and minor movements. Primary or major trend is also known as bull or bear market. Such movements last from less than a year to several years.

Dow theory cont… Secondary or intermediate reaction is defined as an important decline in a bull market or advance in a bear market. They last for three weeks to few months. During this interval, the movement generally retraces from 33% to 66%of the primary price change since the termination of the last preceding secondary reaction.

Dow theory cont… Minor movements last from a week or two up to as long as 6 weeks. It has no forecasting value for longer term investors since short term movements can be manipulated to some extent unlike secondary and primary trends.

Price action determines the trend

Can point x be considered as an indication of a bear market? At point x, the series of rising troughs has been broken but not the series of rising peaks. So, only half a signal has been generated at point x. The complete signal of a reversal arises at point y. But waiting for point y would mean giving up a substantial amount of the profits earned during the bull market.

Therefore, at point x, the weight of the evidence from other technical indicators such as moving averages, volume and breadth should be considered before forming an opinion.

The averages must confirm One of the most important principles of Dow theory is that the movement of the Industrial Average and the Transportation Average should always be considered together.

The averages must confirm