tpp - technical analysis

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TRAINING REPORT ON

FUNCTIONING AND TECHNICAL

ANALYSIS

IN STOCK EXCHANGES IN INDIA

For the training under gone at

KARNAL BRANCH

In the partial fulfillment of MBA - 5 - Year Degree

SUBMITTED TO: PRESENTED BY:

Dr. B. S. Bodla Harshul Nagpal

Director 6th Semester

IMS, KUK Roll No: 50

Reg. No. 08 UD 1136

Batch 2008-13

Institute of Management Studies,

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Kurukshetra University, Kurukshetra.

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DECLARATION

I, Harshul Nagpal hereby declare that I have completed the project, entitled Functioning

and Technical Analysis in Stock Exchanges in India provided by the Branch Manager of

SPA Securities at the training. This report is to be submitted in the partial fulfillment of

MBA-5-Year Degree from Kurukshetra University. Further I declare that this is original

work done by me and the information provided in the study is authentic to the best of my

knowledge and belief. My training period was from 04-01-2011 to 28-01-2011.

This study has not been submitted to any other institution or University for the award ofany other degree or for any purpose.

Dated: 11-03-2011

HARSHUL NAGPAL

6th Semester

Roll No.-50

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ACKNOWLEDGEMENT

First of all, Id like to thank the department, Institute of Management Studies, for giving

us such a creative idea, of going through a training program and preparing a report on its

basis, which will help us in developing our skill in corporate sector, beforehand.

Further Id also like to mention the name of the Departments Library from where I got

the books for having the matter for my Training Report. I am also thankful to all the

authors and publishers whose works have been quoted in the present study.

I would also like to mention the name ofDr. S. P. Sinha, retired professor in Geography,

Kurukshetra University, Kurukshetra; under whose guidance and consultation I was able todo the needful for the creation of this Training Report.

I am also thankful to my Training Executive, Mr. Vikas Nagpal, Branch Manager, SPA

Securities, Karnal, who also guided me for the preparation of the training report and

provided me the useful matter for the report.

My sincere thanks are also due to my family who always motivated me throughout this

project and especially my father, Dr. I. J. Nagpal, without whose guidance this work

would not been possible. I am thankful to him for his valuable suggestions, ideas, ways and

guidance. My heartiest gratitude is also due to my mother, Mrs. Neeta Nagpal and sister,

Arunima Nagpal because without their support and motivation, any work of mine could

not be a success.

At last, and most importantly, Id like to thank my Seniors, because without their guidance

about the preparation and presentation of report, I would not have been able to handle this

project.

HARSHUL NAGPAL

6th Semester

Roll No.-50

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CONTENTS

Acknowledgement

4

1. Company Profile

7

Introduction

Milestones

Services

Other Services

2. Overview of Stock Exchange

12

Introduction to Stock Exchange

Stock Market

Meaning of Stock Exchange

Definitions of Stock Exchange

Primary Markets

Functions of Stock Exchange

Services of Stock Exchange

Evaluation of Stock Exchange

Management of Stock Exchange

Regulation of Stock Exchanges

History of Stock Exchanges in India

Trading Procedure in a Stock Exchange

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How Business is Transacted in a Stock Exchange

Speculation and Stock Exchange

Major Defects in Trading in Indian Stock Exchanges

Suggestions for Stock Exchange Reform

Introduction to Technical Analysis 29

Introduction

Technical Analysis: The Basic Assumptions

Difference between Fundamental Analysis and Technical Analysis

The Use of Trend

Support and Resistance

The Importance of Volume

What is a Chart?

Chart Types

Chart Patterns

Technical Indicators

Five Ways That Technical Analysis Can Fail

Conclusion

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Bibliography

70

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Chapter - 1

COMPANY

PROFILE

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Introduction

SPA Group was promoted by a team of finance professionals in 1995 with an objective to

provide value added financial services. Initially, the Group focused as a niche financial

solutions provider in corporate finance and wealth management to Indian companies and

high net worth individuals. In January 2000, the Group expanded its operations and the

range of services. Today, SPA provides services for securities broking, merchant banking,

wealth management, financial advisory, corporate finance, risk management and insurance

broking.

SPA is being managed by its promoters along with a young and dynamic team of over

1000+ professionals with rich experience, in their respective fields. The Group has

established itself as one of Indias leading financial advisory house, offering various

financial solutions to its Institutional, corporate and individual clients.

Customer centric approach of SPAs dedicated professional team has helped carve a niche

for itself in financial services arena and won confidence of its clients. Clients of SPA are

from a wide spectrum and comprise of Banks and other financial institutions, Mutual funds,

Insurance companies, foreign institutional investors, public sector undertakings and

government departments, private corporate, trusts and individuals.

Milestones / Achievements

Since 1994, with the coming into existence of the SPA Group, we have diversified into a

complete financial solution providing house, catering varied needs of our clients ranging

from investment advisory services to investment banking, corporate re-structuring,

distribution and broking services, risk management and insurance advisory. Within a short

span of time, the Group has made a place for itself in the midst of the top financial

solutions provider in the country.

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Securities Broking

SPA Securities Ltd. is registered member of NSE-WDM segment, Capital Market segment

and Futures and Options segment. The company is also a member of The Stock Exchange,

Mumbai. SPA Comtrade Pvt. Ltd. is the commodities broking company of the group and is

a member of NCDEX and MCX. The Company has dedicated teams operating from a state

of the art dealing room in Mumbai for equity, debt and derivatives broking supported by a

strong in-house research team.

Debt Broking

The division is engaged in providing debt advisory and broking services to institutional,

semi-institutional and retail customers. The company caters to a wide range of investors

across the country ranging from Provident Funds, Banks, Corporate Treasuries, Financial

Institutions, Mutual Funds, Educational, Religious and Charitable Trusts, Insurance

Companies, HNI's etc. The company deals in Government Securities, Treasury Bills,

Commercial Papers, Certificate of Deposits, PSU, SLU and Corporate Bonds and other

debt instruments. With its nationwide network providing institutional broking services the

company has executed business of over Rs. 300 Billion in last 3 years.

Equity Broking

The Company is engaged in equity research and broking for its institutional clients. On

strength of its research and impeccable servicing the Company in its first year of operation

in equity broking is empanelled with all the major domestic institutional players and has

achieved a turnover of over Rs. 1,600 crores.

Commodities Broking

SPA Comtrade Pvt. Ltd., the commodities broking arm of the group has recently

commenced operations. The company is catering to existing customers of the group by

providing research based commodity broking services.

Insurance

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SPA Insurance Broking Services Ltd is the insurance broking company of the group

providing life and general insurance advisory services.

Life Insurance advisory services are process oriented, which include identification of the

needs of the clients, offering the best product available, resolution of their queries and post

sales service. The company has covered over 2000 lives in 18 months of business with sum

assured of over Rs. 20 billion and premium collection of over Rs.3.5 billion.

Mutual Funds

The SPA Group, on strength of its research based customer centric approach and

impeccable servicing, is recognized as one of the leading financial advisory service

providers in the country.

SPA Capital Services Ltd., the flagship company of the group provides investment

advisory services. The company is engaged in advisory and distribution services of mutual

funds and is ranked amongst top 10 intermediaries in the country. The Company provides

customized solutions to the requirements of High Net worth Individuals and Corporate

clients. Our strength lies in our ability to advice on investment strategies and structures,

developing innovative products and distribute amongst a wide network of investors across

the country. We have constantly endeavored to develop new instruments, tailor made to the

requirements of our clients, enabling them to earn efficient post tax returns in accordance

with their specific risk, return and maturity profiles. The company also has a distribution

network of 200 sub-brokers across India being serviced by its eight branches. The

company has mobilized more than Rs.7 trillion for various Mutual Funds during the last 7

years and is currently having Asset under Management of over Rs.50 billion with satisfied

customers.

OTHER ADVISORY SERVICES OF SPA

Investments

Mutual Funds

Fixed Deposits

Capital Gains & Other Bonds

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Broking Services

Equity Broking (NSE & BSE)

Depository Services (CDSL)

Currency Derivative (BSE, NSE & MCX-SX)

IPO

Insurance

Life

o Unit Linked Insurance Plan

o Retirement Plan

o Endowment Plan

o Single Premium Plan

o Children Plan

General

o Vehicle Insurance

o Mediclaim/Overseas Mediclaim Insurance

o Personal Accident Insurance

o

Householder Policyo All Other Risk Covers

Loan & Mortgages

Housing Loan

Personal Loan

Loan Against Securities

Taxation

Income Tax Planning & Advisory

Income Tax Filing & Assessment

Services for Permanent Account Number (PAN)

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Chapter - 2

STOCK

EXCHANGE

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INTRODUCTION TO STOCK EXCHANGE

The stock exchanges provide an organized market-place for the investors to buy and sell

securities freely. The market for these securities is an almost perfectly competitive one

because a large number of sellers and buyers participate. The shares listed, however, are

not really homogeneous like a commodity in a perfectly competitive market. They vary

broadly in terms of credit rating and often involve carrying costs.

In the stock exchange, there is active bidding and a two-way auction trading takes place.

The bargains that are struck are the fairest price determined by the basic laws of supply and

demand. The stock exchanges provide an auction market in which members of the stock

exchange participate to ensure continuity of price and liquidity to investors.

The financial system consists of the money market and the capital market. The capital

market discharges the important function of transfer of savings, especially of the household

sectors to the companies, governments and public sector bodies.

PRIMARY MARKETS

Households which are in financial surplus, exchange their savings for shares, debentures

and securities of the financial deficit sectors such as the companies and governments. It is

the primary market. The market consists of investors or buyers, sellers, dealers and brokers

and does not reflect a physical location. The participants are regulated by formal rules for

originating financial securities. The primary market in which public issue of securities is

made through prospectus is a retail market and is reached through direct mailing. In the

primary market, new issues of equity and debt are arranged in the form of a new flotation,

either publicly or privately or in the form of a rights offer, to existing shareholders.

Companies raise new cash in exchange of financial claims. The financial claims may take

the form of shares or debentures. Public sector companies too issue securities. The

transactions in the primary market result in capital formation.

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STOCK MARKET

Capital market apart from the primary market also includes markets where securities which

have been issued in the past are traded. These secondary markets are called stock markets

or stock exchanges. The stock markets predominantly deal in stock or equity shares. They

enable owners of shares to sell their holdings readily ensuring liquidity. The secondary

market enables investors to continuously rearrange their assets if they so desire by

divesting themselves of such assets while others can use their surplus funds to acquire

them. Any trade of share subsequent to its primary offering is called a secondary

transaction. The initial buyer in the primary market may re-offer the securities to any

interested buyer at whatever price I mutually satisfactory prices may be determined. They

offer opportunities primarily for trading risk and boost liquidity.

The presence of an active secondary market actually promotes the growth of the primary

market and capital formation because investors in the primary market are assured that a

continuous market exits and should occasion arise they can liquidate their investment in the

stock exchange. The participants in the secondary market are linked by formal trading rules

and communication networks for trading in securities.

MEANING OF STOCK EXCHANGE

The stock exchange is a market where stocks, shares and other securities are bought and

sold. It is the market where the owners may dispose of their securities as and when they

like. In a modern capitalist economy, almost all commodities even the smallest, are

produced on a large scale; and a large scale production implies large amount of capital.

The joint stock company or the corporate form of organization is ideally suited to secure

large amount of capital from all those who have surplus funds and who are willing to take

risks in investing in companies. An investor who puts his savings in a company by buying

its securities cannot get the amount back from the company directly. The only way the

capital invested in stocks and shares of a joint stock company may be realized by its

owners is through the sale of those stocks and shares to others. The stock market or

exchange is a place where stocks and shares and other long-term commitments or

investments are bought and sold.

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DEFINITIONS OF STOCK EXCHANGE

Security Exchanges are marketing places where securities that have been listed there on

may be bought and sold for either investment or speculation.

-Pyle

Securities or stock exchanges are privately organized markets which are used to facilitate

trading in securities.

-Husband and Dockeray

It is an association or organization or body of individuals, whether incorporated or not,

established for the purpose of assisting, regulating and controlling business in buying,

selling and dealing in securities.

-The Securities Contracts Regulation Act, 1956 U/S 2(3)

From the definitions cited above it will be seen that the stock exchanges are the institutions

organized for providing the necessary facilities to carry on trading o dealings in securities

representing claims on capital. The securities dealt on the stock exchanges include shares,

debentures or bonds issued by the companies, the govt. securities, etc.

Important ingredients of a stock exchange are the following:

1. Provision of the place for the buyers and sellers of securities for transacting their

dealings;

2. Existence of brokers and other intermediaries to assist their client investors in

finalizing their deals;

3. Scope of legitimate speculation so as to make the market continuously responsive to

the basic forces of demand and supply; and

4. Framing of regulations as to avoid undue fluctuations and unfair dealings.

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FUNCTIONS OF STOCK EXCHANGE

1. Helpful in Distribution of New Securities:

Stockexchanges aid in distribution of new security issues. Shares listed on the stock

exchanges are more acceptable and may fetch higher market value. Costs of

underwriting such issues are relatively less. Public response to new issues is easily

secured if they are routed through stock exchanges.

2. Ensure Safety of Funds:

Stock exchanges ensure safety of investible funds because they have to operate under

set rules which seek to check over-trading, illegitimate speculation and manipulation

etc. This would strengthen the investors confidence and stimulate larger investment in

business securities.

3. Continuous Marketability to Securities:

Stock exchanges provide continuous marketability and price continuity to the investors

in respect of the securities they hold or intend to hold. Buying and selling of securities

would tend to concentrate on exchanges where it listed.

4. Proper Direction to the Flow of Capital:

Stock exchanges are regarded as a very sensitive barometer of business activity. The

prices quoted for different securities on the stock exchange indicate their relative

profitability or popularity. Funds tend to be attracted towards securities of greater

market standing and securities having no status in the market have poor response from

the investors and dealers.

5. Mirror of Business Cycle:

Stock exchanges mirror the phases of business cycle, which are the changing conditions

of economic health of a country. Booms and depressions find their echoes in the

dealings of the stock exchanges.

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6. Mobilization of Savings:

Stock exchanges help in mobilization of savings, facilitate capital formation and assist

the process of economic growth. The surplus funds available with individuals and

institutions would not have found remunerative channels had there been no stock

exchanges.

7. Providing Liquidity:

An investment in equity share capital is a perpetual or permanent commitment in

contributing fixed capital of a company, thus blocking liquidity. It is the stock exchange

which provides liquidity when needed.

8. Rotating Contribution:

Investment in equity share is fixed for the life of the company, the ability to shift the

ownership to others during this course of period permits more individuals to participate

in the long-term financing of the company.

9. Reducing of Personal Risk:

Through marketability, personal risk of investor is reduced by broadening the supply of

equity and long-term debts capital for financing business enterprises.

10. Transferring Ownership:

Transaction in securities at a stock-exchange represents shifts in ownership from one to

other of a long-term security, thus, widening ownership base.

SERVICES OF STOCK EXCHANGE

Stock exchanges thus serve as effective agency whose operations, because of their growth

orientation, would be beneficial to the community at large, apart from serving the interests

of the investors and the company.

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Benefits to the Community

1. Financing economic growth through capital mobilization.

2. Portraying the prevailing economic situation.

3. Inculcation of saving habits and facilities for capital formation.

4. Providing medium of evaluation regarding the worth of different securities.

5. Diversification of investment on the criteria of stable and increasing yields.

Services to Investors

Stock exchanges are in fact a boon to the investors. They sustain their confidence by

providing continuous marketing facilities:

1. Liquidity of securities is ensured by enabling the holders to sell them whenever they

need liquid funds.

2. Information about the value of securities is imparted to the investors through daily

quotations of listed securities.

3. Better price for securities dealt on the stock exchange can be ensured through the

sensitive and continuous operations transacted by different dealers.

4. Undue fluctuations in security prices are avoided by the balancing operations of

speculators (bulls and bears) and hedgers.

5. Guidance to the investors regarding the choice of securities to be bought is provided

by the trends of dealings on the stock exchange.

6. Purchases of listed securities are less risky since listing presupposes their evaluation

by stock exchange authorities.

Services to Companies

Companies raising their capital through stock exchanges will find better response to their

security-issues.

1. Listed securities command quicker and better response from the investors.

2. Market for securities is enlarged if they are channeled through stock exchanges.

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3. The credit-standing and goodwill of the company would be higher if its securities

are listed on the stock exchange.

4. Market value of listed securities tends to be higher subject to asset-values of the

company, its earnings, reserves and dividends. This would enhance the financial status

and increase its bargaining power in any collective ventures, mergers etc. with other

companies.

EVALUATION OF STOCK EXCHANGE

Merits of Stock Exchange

1. Mobilization of Savings:

Small savings of the people are mobilized in the productive channel of the country.

2. Industrial Growth of the country:

Subscribing for securities helps in theindustrial growth of the country.

3. Investment at Will:

Purchase and sale of securities is always at will of the investors. It provides free

markets to the securities.

4. Protection to Foreign Investors:

Investment through stock exchange is safe hence foreign investors can invest in

securities of the country.

5. Protection from False Securities:

Stock exchange protects investors from false securities.

Demerits of Stock Exchange

1. Economic Instability:

Fluctuations in the price of securities adversely affect the economic world.

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2. Encouragement to speculation:

Many investors become the victims of speculation, because of the rise and fall of the

prices of the securities.

3. Loss of innocent investors:

Normally small investors are ignorant about the functioning of the stock exchanges.

They invest on the advice of other investors. Generally, such persons are the losers.

4. Insider-Trading:

Insider-Trading means operating on information which is price sensitive and hence, not

available to the public. Insider-Trading violates level-playing field (i.e., a state where

equal opportunity is not provided to all)

5. Limited Forward Trading:

Trading in shares for clearing or forward trading is confirmed to selected slips under

rolling settlement on the same day.

6. Oligopolistic Character:

Indian stock market cannot be called truly comparative. It I largely dominated by large

financial institutions, big brokers and operators.

MANAGEMENT OF STOCK EXCHANGE

The stock exchange is managed by a Governing Body which consists of a President, a

Vice-President, Executive Director, elected Directors, public representatives and nominees

of the Government. The governing body is responsible for policy formulation and for

ensuring smooth functioning of the exchange. The executive functions are discharged by

the Executive Director or Secretary.

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REGULATION OF STOCK EXCHANGES

The legislative jurisdiction over stock exchanges is vested in the Union Governmentby the

Constitution of India. The Union Government enacted the Securities Contracts

(Regulations) Act in 1956 (SCR Act) for the regulation of stock exchanges and contracts in

securities traded on the stock exchanges. The SCR ct and the Securities Contracts

(Regulation) Rules (1957) constitute the legal framework for the regulation of stock

exchanges and protection of the interests of investors.

The Securities Contracts Regulation Act, 1956 provides inter alia for recognition of stock

exchanges and regulation of their functioning, licensing dealers, recognition of contracts,

controlling speculation, restricting rights of equitable holders of shares and empowering

government to compel any public limited company to get its shares listed.

Under the Securities Contracts Regulation Act, Government has promulgated the Securities

Contracts (Rules, 1957) for carrying into effect the objects of legislation. The rules are

statutory and constitute a code of standardized regulations applicable to all recognized

exchanges.

The Securities and Exchange Board of India Act, 1992 provides for the establishment of

the Securities and Exchange Board of India (SEBI) to protect the interest of investors in

securities and to promote the development of and to regulate the securities market.

Each exchange has bye-laws and regulations, which are more or less uniform in all

exchanges, for regulation and control of transactions in the exchange.

HISTORY OF STOCK EXCHANGES IN INDIA

The first organized stock exchange in India was started in Mumbai when the Native Share

Stock Brokers Associationknown as the Mumbai Stock Exchange was formed by the

brokers in Mumbai. In 1894, the Ahmedabad Stock Exchange was started to facilitate

dealings in the shares of textile mills there. The Kolkata Stock Exchange was started in

1908 to provide a market for shares of plantations and jute mills. The Second World War

saw great speculative activity in the country and the number of stock exchanges rose from

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7 in 1939 to 21 in 1945. Besides these organized exchanges, there were a number of

unorganized and unrecognized exchanges known as kerb markets which functioned under a

set of usages and conventions and did not have any set of rules which could be enforces in

courts of law. Under the Securities Contracts (Regulation) Act of 1956, the Government of

India has so far recognized 24 stock exchanges.

In addition, there are National Stock Exchange (NSE, Mumbai) and the Over the

Counter Exchange of India (OTCEI). TheMumbai Stock Exchange is known asDalal

Street and the Kolkata Stock Exchange asLyons Range. The Mumbai and the Kolkata

Stock Exchange dominate the business from Indian investors. Kolkata Stock Exchange is

more of an investment market while Mumbai Stock exchange is more of a speculative

market. Mumbai is the premier stock exchange in the country and nearly 70 percent of all

transactions in the country are done in that exchange.

TRADING PROCEDURE IN A STOCK EXCHANGE

Unlike other markets wherein anybody can simply go and pick up what one want, pay for it

and leave with their purchases; the stock markets are fortresses that allow entry only to

their members, and therefore, if we wish to buy or sell securities, we need to contact a

member. Transactions inside the stock exchanges take the form auction bids. The

procedure of trading a business is as follows

1. Find the Broker:

Brokers are members of stock exchanges and they have the right to transact business on

behalf of other people in a stock exchange. These people need to be contacted for

purchase and sale of securities of the concerned stock exchange.

2. Find the Terms:

The securities (Shares, Debentures, Bonds, etc.) that one wishes to buy and sell needs

to be decided before hand, as also the price at which the transaction would be

acceptable. Such information should be given to the broker selected for the purpose.

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3. Place the Order:

At this stage the buyer and the seller of securities goes ahead and informs the chosen

broker about his/her decision to buy/sell the desired securities and the terms that are

acceptable to the buyer/seller.

4. Execute the order:

The broker then carries out the instructions of the buyer/seller in the course of purchase

and sale of the desired security.

5. Contract Note:

Contract Note is prepared by the broker for the benefit of buyer/seller of the security

and it serves as a proof of the transaction. Such a document contains information

relating to the security transacted, the price involved, the amount of brokerage due to

the broker and any other detail.

6. Payment:

This is the final stage of transaction, since once the payment is received or made, the

contract is completed.

HOW BUSINESS IS TRANSACTED IN A STOCK EXCHANGE

A typical investment transaction will consist of four stages:

1. Placing an order with a broker:

In a stock exchange, only members are entitled to transact business and outsiders

must get the transactions carried out through a member-broker. The intending client

should furnish bank or other references regarding hi financial position.

2. Execution of the order:

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As soon as an order is received from a client, the broker or his authorized clerk

approaches that part of the stock exchange in which the particular share is traded. He

asks for a quotation or may quote his own price. The bargain is struck by word of

mouth and short notes are made in pencil in a small note-book as regards the number,

description of shares and the name of the party from whom the shares are bought or to

whom the shares are sold.

3. Reporting the deal to the client:

As soon as the deal is transacted, the details of the transaction are recorded in the

books of the brokers, after which a contract note is prepared and sent to the client.

The contract note gives details of the security bought or sold, the price, the brokers

commission, the cost of the revenue stamp and the detail of settlement (unless the

bargain is for cash).

4. Settlement of transactions:

There are two methods of settlement of transaction depending upon on the nature of

the transaction. In the case of ready delivery (or cash) transactions, payment has to be

made immediately on the transfer of the securities or within a period of one to seven

days. The settlement may be made either through the clearing house or by hand

delivery between the members without the intervention of the clearing house.

SPECULATION AND STOCK EXCHANGE

The essential idea of speculation is the purchase or sale of a commodity or security at one

time, with the object of making a profit by its sale or purchase at another time. A high

degree of speculation is associated with stock exchanges in India.

There are two types of transactions in a stock exchange, viz., investment transactions and

speculative transactions. Investment transactions refer to purchase or sale of securities

undertaken with the long-term prospect relating to their yield and price. An investment

transaction normally involves the actual delivery of the security and the payment of its

full price. Actually, no stock exchange can operate purely on the basis of investment

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buying and selling alone, since pure investors cannot provide the requisite volume of

business or continuity of business which alone will ensure correct valuation of the shares

according to their real worth. Investment transactions are, therefore, supplemented by

speculative transactions.

In a speculative transactionbuying or sellingthe delivery of securities or the payment of

full price are rare: instead, only the differences in prices are paid. The predominance of

speculative transactions over investment transactions in a stock exchange is due to the

fact that the latter involve a larger volume of money (as securities bought have to be paid

in full) while speculative transactions are possible with smaller amounts of money (as

delivery of securities and payment of full price are rare).

MAJOR DEFECTS IN TRADING IN INDIAN STOCK EXCHANGES

There are certain serious defects in working of our stock exchanges, particularly the

major stock exchanges such as Mumbai Stock Exchange (MSE):

1. Specified and non-specified shares: Major stock exchanges follow the

peculiar practice of classifying listed shares into specified group and unspecified

group. The shares in the specified group are provided certain special facilities like

settlement period, carry forward and clearing to promote speculation.

2. Investors Interests: The trading activity in our exchanges has been

designed and evolved to benefit only the brokers and the interests of the genuine

investors are generally ignored. The investors confidence in market machinery is

weak, as most of them have a suspicion that they are always cheated on price by the

brokers.

3. Margins: The margins levied by Indian stock exchanges on speculative

transactions are wholly of discretionary character, varying from share to share and

from day to day, ranging from zero to 40 percent. Higher margins ingeniously

avoided.

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4. Lack of Integration: There are a large number of stock exchanges in the

country, though MSE dominates them with over 70 percent of all transactions in the

country. There is nothing wrong in this, because in other countries too there are many

small exchanges, with one dominating (New York SE in USA and London SE in

England). But the real problem in India is that there is no proper integration between

all the stock exchangeswith too much variation in prices of shares in the different

markets.

5. Weakness of SE management: The management organization and structure

of Indian stock exchanges, in general, is weak and deficient. The stock exchange is

still regarded as a private club, exclusively managed by and for the benefit of the

member-brokers. The Governing Body (GB) of a stock exchange has not the concern

or the will to introduce necessary reforms in trading. It does not call for detailed

reports about investors complaints.

6. The system of settlement and carry forward (badla): The settlement

system varies from one stock exchange to another but MSE has a fortnightly system.

This is responsible for high price fluctuations and high risk exposure to market

participants. It is often responsible for excessive speculation.

The Indian system of carry forward has been evolved with the sole objective of

promoting speculation in a handful of shares in the specified group. It promotes a

wholly spurious kind of share trading in which neither the buyer has the money to pay

for the shares at the time of settlement nor the seller has the shares to deliver. Both of

them or at least one of them is spurious.

SUGGESTIONS FOR STOCK EXCHANGE REFORM

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In hisExpert Study of Trading in Shares in Stock ExchangesDr. L.C. Gupta has made

very useful and practical suggestions for changing the current trade practices in our stock

exchanges. These relate to the weaknesses we have already explained.

1. Marking to the market system: The system of margin trading is defective and

has failed to prevent over-speculation and default. Dr. L.C. Gupta has suggested two

alternatives. The first is to adopt the margin trading system of U.S.A. under which

commercial banks finance stock market trading. In this system, the buyer has to put

up at least 50 percent of the value of the shares purchased and also pledge the share

with a bank in actuality (for, the bank will pay the balance, and the seller will get the

full payment). Under this system, there would be a better control over speculation if

we can change to margin trading supported by bank financing.

2. Market making: In all leading stock exchanges, like London and New York,

there are market makers who are given market making responsibilities for specific

shares. The market maker assumes the responsibility for both buying and selling a

share at given prices. He is an integral part of the trading mechanism and

arrangements. He protects the investors from being exploited by stock brokers and he

ensures that the transactions are carried out at the best market rate. Besides. He

ensures prompt execution of transactions and thus ensures liquidity. If this suggestion

is accepted and implemented, the investors will be fully protected and all the listed

shares get liquidity.

3. Management Information System: It is essential that the information should be

available for each stock exchange about trading volume and prices, about trading

concentration in individual securities, trading concentration by stock exchange

members.

4. Introduction of uniform one week settlement: All stock exchanges in the

country should switch over to a uniform system of one week settlement. This will

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unify all the SEs on a national basis. It will reduce risk exposure of market

participants due to price movements in shares. Finally, it will check the strong

tendency towards the excessive speculation and excessive concentration of trading

activity in a few shares only. Uniformity will make inter-market transactions easier

and reduce cost and delay. It will ensure markets financial integrity at all times and

this will promote investor confidence. It will remove investors complaint of long

delayin certain cases up to 3 monthsand exposure to greater risk of default in

payment/delivery.

5. Abolish the system of carry forward: The system of carry forward has been

the most important factor for over-speculation in India and it has to be done away

with. In fact, with one week settlement and with the adoption of the system of

marking of the market, the rationale of the carry forward system disappears

automatically. If the stock exchanges were to accept only the to suggestions of one

week settlement and the abolition of the carry forward system, many of the problems

of the stock exchanges would be over.

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Chapter - 3

TECHNICAL

ANALYSIS

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Introduction To Technical Analysis

Technical analysis is a method of forecasting price movements by looking at purely

market-generated data. Price data from a particular market is most commonly the type of

information analyzed by a technician, though most will also keep a close watch on

volume and open interest in futures contracts. The bottom line when utilizing any type of

analytical method, technical or otherwise, is to stick to the basics, which are

methodologies with a proven track record over a long period. After finding a trading

system that works for you, the more esoteric fields of study can then be incorporated into

your trading toolbox.

Almost every trader uses some form of technical analysis. Even the most reverent

follower of market fundamentals is likely to glance at price charts before executing a

trade. At their most basic level, these charts help traders determine ideal entry and exit

points for a trade. They provide a visual representation of the historical price action of

whatever is being studied. As such, traders can look at a chart and know if they are

buying at a fair price (based on the price history of a particular market), selling at a

cyclical top or perhaps throwing their capital into a choppy, sideways market. These are

just a few market conditions that charts identify for a trader. Depending on their level ofsophistication, charts can also help much more advanced studies of the markets.

On the surface, it might appear that technicians ignore the fundamentals of the market

while surrounding themselves with charts and data tables. However, a technical trader

will tell you that all of the fundamentals are already represented in the price. They are not

so much concerned that a natural disaster or an awful inflation number caused a recent

spike in prices as much as how that price action fits into a pattern or trend. And much

more to the point, how that pattern can be used to predict future prices.

The methods used to analyze securities and make investment decisions fall into two very

broad categories:fundamental analysis and technical analysis. Fundamental analysis

involves analyzing the characteristics of a company in order to estimate its value.

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Technical analysis takes a completely different approach; it doesn't care one bit about the

"value" of a company or a commodity. Technicians (sometimes called chartists) are only

interested in the price movements in the market.

Despite all the fancy and exotic tools it employs, technical analysis really just

studies supply and demand in a market in an attempt to determine what direction,

ortrend, will continue in the future. In other words, technical analysis attempts to

understand the emotions in the market by studying the market itself, as opposed to its

components. If you understand the benefits and limitations of technical analysis, it can

give you a new set of tools or skills that will enable you to be a better trader or investor.

In this tutorial, we'll introduce you to the subject of technical analysis. It's a broad topic,

so we'll just cover the basics, providing you with the foundation you'll need to understand

more advanced concepts down the road.

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Technical Analysis: The Basic Assumptions

What Is Technical Analysis?

Technical analysis is a method of evaluating securities by analyzing the statistics

generated by market activity, such as past prices and volume. Technical analysts do not

attempt to measure a security's intrinsic value, but instead use charts and other tools to

identify patterns that can suggest future activity.

Just as there are many investment styles on the fundamental side, there are also many

different types of technical traders. Some rely on chart patterns; others use

technical indicators and oscillators, and most use some combination of the two. In any

case, technical analysts' exclusive use of historical price and volume data is what

separates them from their fundamental counterparts. Unlike fundamental

analysts, technical analysts don't care whether a stock is undervalued - the only thing that

matters is a security's past trading data and what information this data can provide about

where the security might move in the future.

The field of technical analysis is based on three assumptions:

1. The market discounts everything.2. Price moves in trends.

3. History tends to repeat itself.

1. The Market Discounts Everything

A major criticism of technical analysis is that it only considers price movement,

ignoring the fundamental factors of the company. However, technical analysis

assumes that, at any given time, a stock's price reflects everything that has or could

affect the company - including fundamental factors. Technical analysts believe that

the company's fundamentals, along with broader economic factors and market

psychology, are all priced into the stock, removing the need to actually consider these

factors separately. This only leaves the analysis of price movement, which technical

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theory views as a product of the supply and demand for a particular stock in the

market.

2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that

after a trend has been established, the future price movement is more likely to be in

the same direction as the trend than to be against it. Most technical trading strategies

are based on this assumption.

3. History Tends To Repeat Itself

Another important idea in technical analysis is that history tends to repeat itself,

mainly in terms of price movement. The repetitive nature of price movements is

attributed to market psychology; in other words, market participants tend to provide a

consistent reaction to similar market stimuli over time. Technical analysis uses

chart patterns to analyze market movements and understand trends. Although many of

these charts have been used for more than 100 years, they are still believed to be

relevant because they illustrate patterns in price movements that often repeat

themselves.

Not Just for Stocks

Technical analysis can be used on any security with historical trading data. This

includes stocks, futures and commodities, fixed-income securities, forex, etc. In this

tutorial, we'll usually analyze stocks in our examples, but keep in mind that these

concepts can be applied to any type of security. In fact, technical analysis is more

frequently associated with commodities and forex, where the participants are

predominantly traders.

Now that you understand the philosophy behind technical analysis, we'll get into

explaining how it really works. One of the best ways to understand what technical

analysis is (and is not) is to compare it to fundamental analysis. We'll do this in the

next section.

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Technical Analysis: Fundamental vs. Technical Analysis

Technical analysis and fundamental analysis are the two main schools of thought in the

financial markets. As we've mentioned, technical analysis looks at the price movement of

a security and uses this data to predict its future price movements. Fundamental analysis,

on the other hand, looks at economic factors, known as fundamentals. Let's get into the

details of how these two approaches differ, the criticisms against technical analysis and

how technical and fundamental analysis can be used together to analyze securities.

Technical Analysis operates on the theory that market prices at any given point in time

reflect all known factors affecting supply and demand for a particular market.

Consequently, technical analysis focuses, not on evaluating those factors directly, but on

an analysis of market prices themselves. This approach theorize that a detailed analysis

of, among other things, actual daily, weekly and monthly price fluctuations is the most

effective means of attempting to capitalize on the future course of price movements.

Technical strategies generally utilize a series of mathematical measurements and

calculations designed to monitor market activity. Trading decisions are based on signals

generated by charts, manual calculations, computers or their combinations.

Fundamental Analysis is based on the study offactors external to the trading markets

which affect the supply and demand of a particular market. It is in stark contrast to

technical analysis since it focuses, not on price but on factors like weather, government

policies, domestic and foreign political and economic events and changing trade

prospects. Fundamental analysis theorizes that by monitoring relevant supply and

demand factors for a particular market, a state of current or potential disequilibrium of

market conditions may be identified before the state has been reflected in the price level

of that market. Fundamental analysis assumes that markets are imperfect, that

information is not instantaneously assimilated or disseminated and that econometric

models can be constructed to generate equilibrium prices, which may indicate that current

prices are inconsistent with underlying economic conditions, and will, accordingly,

change in the future.

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Another definition of Fundamental Analysis

Fundamental Analysis is an approach to analyzing market behavior that stresses the

study of underlying factors of supply and demand. It is done in the belief that such

analysis will enable one to profit by being able to anticipate price trends. A

Fundamentalist is a market observer-and/or participant who relies principally on

Supply/demand considerations in price forecasting. Components of Fundamental

Analysis:

Supply:

Weather

Acres planted to a crop

Government Programs

USDA Reports

Demand:

USDA Reports

Domestic usage - Feed & processing

Value of the Dollar

Actions of Other Countries

Exports

Transportation

The Differences

1. Charts vs. Financial Statements

At the most basic level, a technical analyst approaches a security from the charts,

while a fundamental analyst starts with the financial statements.

By looking at the balance sheet, cash flow statement and income statement, a

fundamental analyst tries to determine a company's value. In financial terms, an

analyst attempts to measure a company's intrinsic value. In this approach, investment

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decisions are fairly easy to make - if the price of a stock trades below its intrinsic

value, it's a good investment. Although this is an oversimplification (fundamental

analysis goes beyond just the financial statements) for the purposes of this tutorial,

this simple tenet holds true.

Technical traders, on the other hand, believe there is no reason to analyze a

company's fundamentals because these are all accounted for in the stock's price.

Technicians believe that all the information they need about a stock can be found in

its charts.

2. Time Horizon

Fundamental analysis takes a relatively long-term approach to analyzing the market

compared to technical analysis. While technical analysis can be used on a timeframe

of weeks, days or even minutes, fundamental analysis often looks at data over a

number of years.

The different timeframes that these two approaches use is a result of the nature of the

investing style to which they each adhere. It can take a long time for a company's

value to be reflected in the market, so when a fundamental analyst estimates intrinsic

value, a gain is not realized until the stock's market price rises to its "correct" value.

This type of investing is called value investing and assumes that the short-term

market is wrong, but that the price of a particular stock will correct itself over the

long run. This "long run" can represent a timeframe of as long as several years, in

some cases.

Furthermore, the numbers that a fundamentalist analyzes are only released over long

periods of time. Financial statements are filed quarterly and changes in earnings per

share don't emerge on a daily basis like price and volume information. Also

remember that fundamentals are the actual characteristics of a business. New

management can't implement sweeping changes overnight and it takes time to create

new products, marketing campaigns, supply chains, etc. Part of the reason that

fundamental analysts use a long-term timeframe, therefore, is because the data they

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use to analyze a stock is generated much more slowly than the price and volume data

used by technical analysts.

3. Trading Versus Investing

Not only is technical analysis more short term in nature that fundamental analysis, but

the goals of a purchase (or sale) of a stock are usually different for each approach. In

general, technical analysis is used for a trade, whereas fundamental analysis is used to

make an investment. Investors buy assets they believe can increase in value, while

traders buy assets they believe they can sell to somebody else at a greater price. The

line between a trade and an investment can be blurry, but it does characterize a

difference between the two schools.

The Critics

Some critics see technical analysis as a form of black magic. Don't be surprised to see

them question the validity of the discipline to the point where they mock its supporters. In

fact, technical analysis has only recently begun to enjoy some mainstream credibility.

While most analysts on Wall Street focus on the fundamental side, just about any major

brokerage now employs technical analysts as well.

Much of the criticism of technical analysis has its roots in academic theory - specifically

the efficient market hypothesis (EMH). This theory says that the market's price is always

the correct one - any past trading information is already reflected in the price of the stock

and, therefore, any analysis to find undervalued securities is useless.

There are three versions of EMH. In the first, called weak form efficiency, all past price

information is already included in the current price. According to weak form efficiency,

technical analysis can't predict future movements because all past information has already

been accounted for and, therefore, analyzing the stock's past price movements will

provide no insight into its future movements. In the second, semi-strong form efficiency,

fundamental analysis is also claimed to be of little use in finding investment

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opportunities. The third is strong form efficiency, which states that all information in the

market is accounted for in a stock's price and neither technical nor fundamental analysis

can provide investors with an edge. The vast majority of academics believe in at least the

weak version of EMH, therefore, from their point of view, if technical analysis

works, market efficiency will be called into question. (For more insight, read What Is

Market Efficiency? andWorking Through The Efficient Market Hypothesis.)

There is no right answer as to who is correct. There are arguments to be made on both

sides and, therefore, it's up to you to do the homework and determine your own

philosophy.

Can They Co-Exist?

Although technical analysis and fundamental analysis are seen by many as polar

opposites - the oil and water of investing - many market participants have experienced

great success by combining the two. For example, some fundamental analysts use

technical analysis techniques to figure out the best time to enter into an undervalued

security. Oftentimes, this situation occurs when the security is severely oversold. By

timing entry into a security, the gains on the investment can be greatly improved.

Alternatively, some technical traders might look at fundamentals to add strength to a

technical signal. For example, if a sell signal is given through technical patterns and

indicators, a technical trader might look to reaffirm his or her decision by looking at some

key fundamental data. Oftentimes, having both the fundamentals and technicals on your

side can provide the best-case scenario for a trade.

While mixing some of the components of technical and fundamental analysis is not well

received by the most devoted groups in each school, there are certainly benefits to at least

understanding both schools of thought.

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Technical Analysis: The Use Of Trend

One of the most important concepts in technical analysis is that of trend. The meaning in

finance isn't all that different from the general definition of the term - a trend is really

nothing more than the general direction in which a security or market is headed. Take a

look at the chart below:

It isn't hard to see that the trend in Figure 1 is up. However, it's not always this easy to

see a trend:

There are lots of ups and downs in this chart, but there isn't a clear indication of which

direction this security is headed.

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A More Formal Definition

Unfortunately, trends are not always easy to see. In other words, defining a trend goes

well beyond the obvious. In any given chart, you will probably notice that prices do not

tend to move in a straight line in any direction, but rather in a series of highs and lows. In

technical analysis, it is the movement of the highs and lows that constitutes a trend. For

example, an uptrend is classified as a series of higher highs and higher lows, while a

downtrend is one of lower lows and lower highs.

Figure 3 is an example of an uptrend. Point 2 in the chart is the first high, which is

determined after the price falls from this point. Point 3 is the low that is established as the

price falls from the high. For this to remain an uptrend each successive low must not fall

below the previous lowest point or the trend is deemed a reversal.

Types of Trends

There are three types of trend:

Uptrends

Downtrends

Sideways/Horizontal Trends As the names imply, when each

successivepeakand trough is higher, it's referred to as an upward trend. If the peaks

and troughs are getting lower, it's a downtrend. When there is little movement up or

down in the peaks and troughs, it's a sideways or horizontal trend. If you want to get

really technical, you might even say that a sideways trend is actually not a trend on

its own, but a lack of a well-defined trend in either direction. In any case, the

market can really only trend in these three ways: up, down or nowhere.

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Trend Lengths

Along with these three trend directions, there are three trend classifications. A trend of

any direction can be classified as a long-term trend, intermediate trend or a short-

term trend. In terms of the stock market, a major trend is generally categorized as one

lasting longer than a year. An intermediate trend is considered to last between one and

three months and a near-term trend is anything less than a month. A long-term trend is

composed of several intermediate trends, which often move against the direction of the

major trend. If the major trend is upward and there is a downward correction in price

movement followed by a continuation of the uptrend, the correction is considered to be

an intermediate trend. The short-term trends are components of both major and

intermediate trends. Take a look a Figure 4 to get a sense of how these three trend lengths

might look.

When analyzing trends, it is important that the chart is constructed to best reflect the type

of trend being analyzed. To help identify long-term trends, weekly charts or daily charts

spanning a five-year period are used by chartists to get a better idea of the long-term

trend. Daily data charts are best used when analyzing both intermediate and short-term

trends. It is also important to remember that the longer the trend, the more important it is;

for example, a one-month trend is not as significant as a five-year trend.

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Trendlines

A trendline is a simple charting technique that adds a line to a chart to represent the trend

in the market or a stock. Drawing a trendline is as simple as drawing a straight line that

follows a general trend. These lines are used to clearly show the trend and are also used

in the identification of trend reversals.

As you can see in Figure 5, an upward trendline is drawn at the lows of an upward trend.

This line represents the support the stock has every time it moves from a high to a low.

Notice how the price is propped up by this support. This type of trendline helps traders to

anticipate the point at which a stock's price will begin moving upwards again. Similarly,

a downward trendline is drawn at the highs of the downward trend. This line represents

the resistance level that a stock faces every time the price moves from a low to a high.

Channels

A channel, or channel lines, is the addition of two parallel trendlines that act as strong

areas of support and resistance. The upper trendline connects a series of highs, while the

lower trendline connects a series of lows. A channel can

slope upward, downward orsideways but, regardless of the direction, the interpretation

remains the same. Traders will expect a given security to trade between the two levels of

support and resistance until it breaks beyond one of the levels, in which case traders can

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expect a sharp move in the direction of the break. Along with clearly displaying the trend,

channels are mainly used to illustrate important areas of support and resistance.

Figure illustrates a descending channel on a stock chart; the upper trendline has been

placed on the highs and the lower trendline is on the lows. The price has bounced off of

these lines several times, and has remained range-bound for several months. As long as

the price does not fall below the lower line or move beyond the upper resistance, the

range-bound downtrend is expected to continue.

The Importance of Trend

It is important to be able to understand and identify trends so that you can trade with

rather than against them. Two important sayings in technical analysis are "the trend is

your friend" and "don't buck the trend," illustrating how important trend analysis is for

technical traders.

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Technical Analysis: Support and Resistance

Once you understand the concept of a trend, the next major concept is that of support and

resistance. You'll often hear technical analysts talk about the ongoing battle between

thebulls and thebears, or the struggle between buyers (demand) and sellers (supply).

This is revealed by the prices a security seldom moves above (resistance) or below

(support)

As you can see in Figure, support is the price level through which a stock or market

seldom falls (illustrated by the blue arrows). Resistance, on the other hand, is the price

level that a stock or market seldom surpasses (illustrated by the red arrows).

Why does it happen?

These support and resistance levels are seen as important in terms of market psychology

and supply and demand. Support and resistance levels are the levels at which a lot of

traders are willing to buy the stock (in the case of a support) or sell it (in the case of

resistance). When these trendlines are broken, the supply and demand and the psychology

behind the stock's movements is thought to have shifted, in which case new levels ofsupport and resistance will likely be established.

Round Numbers and Support and Resistance

One type of universal support and resistance that tends to be seen across a large number

of securities is round numbers. Round numbers like 10, 20, 35, 50, 100 and 1,000 tend be

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important in support and resistance levels because they often represent the major

psychological turning points at which many traders will make buy or sell decisions.

Buyers will often purchase large amounts of stock once the price starts to fall toward a

major round number such as $50, which makes it more difficult for shares to fall below

the level. On the other hand, sellers start to sell off a stock as it moves toward a round

number peak, making it difficult to move past this upper level as well. It is the increased

buying and selling pressure at these levels that makes them important points of support

and resistance and, in many cases, major psychological points as well.

Role Reversal

Once a resistance or support level is broken, its role is reversed. If the price falls below a

support level, that level will become resistance. If the price rises above a resistance level,

it will often become support. As the price moves past a level of support or resistance, it is

thought that supply and demand has shifted, causing the breached level to reverse its role.

For a true reversal to occur, however, it is important that the price make a strong move

through either the support or resistance.

For example, as you can see in Figure, the dotted line is shown as a level of resistance

that has prevented the price from heading higher on two previous occasions (Points 1 and

2). However, once the resistance is broken, it becomes a level of support (shown byPoints 3 and 4) by propping up the price and preventing it from heading lower

again. Many traders who begin using technical analysis find this concept hard to believe

and don't realize that this phenomenon occurs rather frequently, even with some of the

most well-known companies. For example, as you can see in Figure 3, this phenomenon

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is evident on the Wal-Mart Stores Inc. (WMT) chart between 2003 and 2006. Notice how

the role of the $51 level changes from a strong level of support to a level of resistance.

In almost every case, a stock will have both a level of support and a level of resistance

and will trade in this range as it bounces between these levels. This is most often seen

when a stock is trading in a generally sideways manner as the price moves through

successive peaks and troughs, testing resistance and support.

The Importance of Support and Resistance

Support and resistance analysis is an important part of trends because it can be used to

make trading decisions and identify when a trend is reversing. For example, if a trader

identifies an important level of resistance that has been tested several times but never

broken, he or she may decide to take profits as the security moves toward this point

because it is unlikely that it will move past this level.

Support and resistance levels both test and confirm trends and need to be monitored by

anyone who uses technical analysis. As long as the price of the share remains between

these levels of support and resistance, the trend is likely to continue. It is important to

note, however, that a break beyond a level of support or resistance does not always have

to be a reversal. For example, if prices moved above the resistance levels of an upward

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trending channel, the trend has accelerated, not reversed. This means that the price

appreciation is expected to be faster than it was in the channel.

Being aware of these important support and resistance points should affect the way that

you trade a stock. Traders should avoid placing orders at these major points, as the area

around them is usually marked by a lot ofvolatility. If you feel confident about making a

trade near a support or resistance level, it is important that you follow this simple rule: do

not place orders directly at the support or resistance level. This is because in many cases,

the price never actually reaches the whole number, but flirts with it instead. So if you're

bullish on a stock that is moving toward an important support level, do not place the trade

at the support level. Instead, place it above the support level, but within a few points. On

the other hand, if you are placing stops orshort selling, set up your trade price at or below

the level of support.

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Technical Analysis: The Importance of Volume

What is Volume?

Volume is simply the number of shares or contracts that trade over a given period of

time, usually a day. The higher the volume, the more active the security. To determine

the movement of the volume (up or down), chartists look at the volume bars that can

usually be found at the bottom of any chart. Volume bars illustrate how many shares have

traded per period and show trends in the same way that prices do.

Why Volume is Important ?

Volume is an important aspect of technical analysis because it is used to confirm trends

and chart patterns. Any price movement up or down with relatively high volume is seen

as a stronger, more relevant move than a similar move with weak volume. Therefore, if

you are looking at a large price movement, you should also examine the volume to see

whether it tells the same story.

Say, for example, that a stock jumps 5% in one trading day after being in a long

downtrend. Is this a sign of a trend reversal? This is where volume helps traders. If

volume is high during the day relative to the average daily volume, it is a sign that the

reversal is probably for real. On the other hand, if the volume is below average, there

may not be enough conviction to support a true trend reversal.

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Volume should move with the trend. If prices are moving in an upward trend, volume

should increase (and vice versa). If the previous relationship between volume and price

movements starts to deteriorate, it is usually a sign of weakness in the trend. For example,

if the stock is in an uptrend but the up trading days are marked with lower volume, it is a

sign that the trend is starting to lose its legs and may soon end.

When volume tells a different story, it is a case ofdivergence, which refers to a

contradiction between two different indicators. The simplest example of divergence is a

clear upward trend on declining volume.

Volume and Chart Patterns

The other use of volume is to confirm chart patterns. Patterns such as head and

shoulders, triangles,flags and other price patterns can be confirmed with volume, a

process which we'll describe in more detail later in this tutorial. In most chart patterns,

there are several pivotal points that are vital to what the chart is able to convey to

chartists. Basically, if the volume is not there to confirm the pivotal moments of a chart

pattern, the quality of the signal formed by the pattern is weakened.

Volume Precedes Price

Another important idea in technical analysis is that price is preceded by volume. Volume

is closely monitored by technicians and chartists to form ideas on upcoming trend

reversals. If volume is starting to decrease in an uptrend, it is usually a sign that the

upward run is about to end.

Now that we have a better understanding of some of the important factors of technical

analysis, we can move on to charts, which help to identify trading opportunities in prices

movements.

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Technical Analysis: What Is A Chart?

In technical analysis, charts are similar to the charts that you see in any business setting.

A chart is simply a graphical representation of a series of prices over a set time frame.

For example, a chart may show a stock's price movement over a one-year period, where

each point on the graph represents the closing price for each day the stock is traded:

Figure 1 provides an example of a basic chart. It is a representation of the price

movements of a stock over a 1.5 year period. The bottom of the graph, running

horizontally (x-axis), is the date or time scale. On the right hand side, running vertically

(y-axis), the price of the security is shown. By looking at the graph we see that in October

2004 (Point 1), the price of this stock was around $245, whereas in June 2005 (Point 2),

the stock's price is around $265. This tells us that the stock has risen between October

2004 and June 2005.

Chart Properties

There are several things that you should be aware of when looking at a chart, as these

factors can affect the information that is provided. They include the time scale, the price

scale and the price point properties used.

The Time Scale

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The time scale refers to the range of dates at the bottom of the chart, which can vary from

decades to seconds. The most frequently used time scales are intraday, daily, weekly,

monthly, quarterlyand annually. The shorter the time frame, the more detailed the chart.

Each data point can represent the closing price of the period or show the open, the high,

the low and the close depending on the chart used.

Intraday charts plot price movement within the period of one day. This means that the

time scale could be as short as five minutes or could cover the whole trading day from

the opening bellto the closing bell.

Daily charts are comprised of a series of price movements in which each price point on

the chart is a full days trading condensed into one point. Again, each point on the graph

can be simply the closing price or can entail the open, high, low and close for the stock

over the day. These data points are spread out over weekly, monthly and even yearly time

scales to monitor both short-term and intermediate trends in price movement.

Weekly, monthly, quarterly and yearly charts are used to analyze longer term trends in

the movement of a stock's price. Each data point in these graphs will be a condensed

version of what happened over the specified period. So for a weekly chart, each data

point will be a representation of the price movement of the week. For example, if you are

looking at a chart of weekly data spread over a five-year period and each data point is the

closing price for the week, the price that is plotted will be the closing price on the last

trading day of the week, which is usually a Friday.

The Price Scale and Price Point Properties

The price scale is on the right-hand side of the chart. It shows a stock's current price and

compares it to past data points. This may seem like a simple concept in that the price

scale goes from lower prices to higher prices as you move along the scale from the

bottom to the top. The problem, however, is in the structure of the scale itself. A scale

can either be constructed in a linear(arithmetic) orlogarithmicway, and both of these

options are available on most charting services.

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If a price scale is constructed using a linear scale, the space between each price point (10,

20, 30, 40) is separated by an equal amount. A price move from 10 to 20 on a linear scale

is the same distance on the chart as a move from 40 to 50. In other words, the price scale

measures moves in absolute terms and does not show the effects of percent change.

If a price scale is in logarithmic terms, then the distance between points will be equal in

terms of percent change. A price change from 10 to 20 is a 100% increase in the price

while a move from 40 to 50 is only a 25% change, even though they are represented by

the same distance on a linear scale. On a logarithmic scale, the distance of the 100% price

change from 10 to 20 will not be the same as the 25% change from 40 to 50. In this case,

the move from 10 to 20 is represented by a larger space one the chart, while the move

from 40 to 50, is represented by a smaller space because, percentage-wise, it indicates a

smaller move. In Figure 2, the logarithmic price scale on the right leaves the same

amount of space between 10 and 20 as it does between 20 and 40 because these both

represent 100% increases.

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Technical Analysis: Chart Types

There are four main types of charts that are used by investors and traders depending on

the information that they are seeking and their individual skill levels. The chart types are:

the line chart, the bar chart, the candlestick chart and the point and figure chart. In the

following sections, we will focus on the S&P 500 Index during the period of January

2006 through May 2006. Notice how the data used to create the charts is the same, but

the way the data is plotted and shown in the charts is different.

Line Chart

The most basic of the four charts is the line chart because it represents only the closing

prices over a set period of time. The line is formed by connecting the closing prices over

the time frame. Line charts do not provide visual information of the trading range for the

individual points such as the high, low and opening prices. However, the closing price is

often considered to be the most important price in stock data compared to the high and

low for the day and this is why it is the only value used in line charts.

Bar Charts

Thebar chartexpands on the line chart by adding several more key pieces of information

to each data point. The chart is made up of a series of vertical lines that represent each

data point. This vertical line represents the high and low for the trading period, along

with the closing price. The close and open are represented on the vertical line by a

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