ABOUT TECHNICAL ANALYSIS
 
 
There is this feeling – which is so widely accepted that it has almost become a truth – that technical analysis is applicable only for trading. This wrong notion is prevalent to such an extent that larger and longer-term players feel that they should NOT be using technical analysis!! Technical analysis (TA) is useful to everyone - not just the short-term trader or intermediate-term speculator, but to the long-term investor as well. The purpose of this entire tutorial exercise is to introduce you to the basics of technical analysis as a subject and inter alias, give you some tools, which you could put to use to improve your bottom line.
 
While some technicians, like their fundamental analysis (FA) counterparts, will contend that theirs is the only discipline that is useful, it is always much better to use the inputs of both the forms of analysis. Ultimately, the idea is to get a make on the trend and the possible future direction of stock prices. Being purist, shows you only half the side of the equation.
 
Neither FA or TA can claim absolute precision, because they are only barometers to help forecast the future price of a security, which always has two values -actual value, which is estimated, and market price, which is known.
 
The actual value of a company could be said to be the price at which it would theoretically sell if someone were to actually buy it. FA tries to determine the actual value of the company, which is useful because this price acts like a magnet to the market price, pulling it back from extremes of overvalue and undervalue. But actual value is not an absolute because it too is subject to market pressures of supply and demand even if its fundamental characteristics remain stable.
 
We discussed as a part of the last article how prices are formed and what exactly is the role of prices. The problem is that we don't buy the company, we buy the stock at the market price, which, in the auction market, is affected by crowd psychology and the alternating emotions of confidence and fear, and, in the extreme, greed and panic. The overall trend of money flowing in or out of the market and your stock is what affects the price you can get today for your stock, and charts can reveal at a glance the effect that market psychology is having on the flow of money into or out of the issue. Actual value is only an estimate and market price moves above and below actual value (whatever it is) -- pushed by market psychology and pulled by actual value. It is therefore psychology which really drives the prices and ultimately we are all following the collective expression of this mass psychology.
 
As a practical matter how do we use this knowledge? If we estimate actual value of a company to be Rs.500 per share, and the market price is Rs.200 per share, we can assume that the market price will eventually move back toward Rs.500. However, if the chart reveals that the price is still trending down, it is prudent to wait until that trend has clearly reversed before committing funds to the issue.
 
Conversely, if we owned the stock of the same Rs500 per share (estimated actual value) and it was selling on the market for Rs.100/share, we should be aware that the price will someday be pulled back toward Rs.500, but we can hold it as long as a steady up trend is maintained. It could literally be years before the trend changes.
 
There are plenty of sources available to evaluate what the actual value of a company might be. In fact, most of what is available these days is in the fundamental arena and goes to solve some or most of the problems that people have in relation with estimating what is the worth of the stock. However, many a times, this solution itself becomes a problem!! There are so many estimated valuations that it becomes difficult for the small investor to decide as to which is the valuation which is likely to be the correct one. This is where a good grasp of technical analysis can probably come to the aid of the investor – whatever his time frame may be. He can assess as to which is the valuation – among the plethora that are available – that the market is approximating to. By doing it this way, one’s personal bias gets removed to some degree and the market’s valuation is taken as the best one.
 
The purpose of the series of articles on technical analysis to be carried in here is to give you, the reader, the means to determine the net direction in which market psychology and real value are moving the market price.
 
In this series we plan to take the reader through the basics of the subject. It is not possible to have an exhaustive write up and readers are also advised to take some additional reading of relevant books. Once there is a grasp of the basics, then applying the tools in real-time analysis would be much easier.
 
At the beginning we stated that TA could be especially useful to all kinds of players. One can take advantage of the long term trends - i.e. an investor - in the market by using only the long term monthly or quarterly charts. A positional trader (someone who trades on budla) or a medium term investor could use technical analysis by looking at the weekly and monthly charts. A settlement trader or a short-term investor can look at the daily and weekly charts and take his clues and signals from there. A day trader can look at the signals as they emerge from the intra day and daily charts.
 
Whatever-term perspective, we want to emphasize that, as you zoom-in on shorter and shorter time frames, the same principles apply. Just remember that the amplitude and duration implied by a given chart pattern will only apply to the time frame in which you are working.
 
How does one speed up the process? The only way is to practice. Draw some charts using a standard chart paper or buy software if you can. Of course, the learning curve is much more solid if one draws charts rather than have the software draw them. Study these charts, try to identify the patterns discussed here, draw the lines, and identify the action points. As you go through the process, try to determine what actions you should have taken to avoid the obvious (in hindsight) traps set and sprung by the market. These exercises will prepare you to use these principles in real time.
 
One recommended investment strategy would be to identify promising chart patterns, then verify that the fundamentals are appropriate to the action you are contemplating. We like this approach because hundreds of charts can be reviewed in a very short period of time, narrowing down the list of candidates for the more time consuming and tedious fundamental research. Another method would be to run computer screens on fundamental statistics and then check the charts on the stocks meeting your fundamental criteria.
 
The articles here would certainly not be the last word on this subject nor do we claim them to be so. Our interpretations of certain charts (featured as advise on other columns) might also differ from what you may conclude after your own study. Chart analysis is as much art as it is science, and you should learn to rely on your own judgment. Analysis of historical price movement is always 100% accurate, but it is much more difficult when we are dangling from the end of the price line, trying to see into the future.
 
Rather than prediction, it is more an estimation of probabilities of certain events happening that is really studied in technical analysis. In the end, your objective should be to acquire tools and develop consistent strategies that allow you to make your own investment decisions. Keep it simple, and remember that nothing works all the time. You cannot know all things about all things, so limit your scope to the time available to you. Your methods should provide for the protection of your principal, allow you to let your profits run, to take profits when it is time, and to limit losses.
 
Also remember the market can ignore fundamentals and Technicals any time it feels like it. Don't get trapped in an excruciating down trend just because the fundamentals say the price should be going up, and don't think of a trend line as an iron curtain through which price will never pass. Investment strategy is not religion or a test of faith, it is procedure, which should help you adapt to market change.