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8/2/2019 Investment and Securities Management_2nd Assignment
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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
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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.
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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.
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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
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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.
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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.
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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.
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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).
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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.
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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).
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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).
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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.
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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.
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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.
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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.
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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.
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2.2Case Study 2
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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.
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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.
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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.
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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.
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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