Page 193 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes  Elaborate the old puzzles and new developments
 Discuss the neutral networks
 Describe the tools of technical analysis
 Explain the Dow Theory
 Discuss the criticisms of technical analysis
Introduction

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. 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.

The term technical analysis is used to mean fairly wide range of techniques, all based on the
concept that past information on prices and trading volume of stocks give the enlightened
investor a picture of what lies ahead. It attempts to explain and forecast changes in security
prices by studying only the market data rather than information about a company or its prospects
as is done by fundamental analyst. John Magee, whose book Technical Analysis of Stock Trends
is considered a classic for technical analysts, says:
“The technician has elected to study, not the mass of fundamentals, but certain abstractions,
namely the market data alone. But this technical view provides a simplified and more
comprehensible picture of what is happening to the price of a stock. It is like a shadow or
reflection in which can be seen the broad outline of the whole situation. Furthermore, it works.”
The technical analysts believe that the price of a stock depends on supply and demand in the
marketplace and has little relationship to value, if any such concept even exits. Price is governed
by basic economic and psychological inputs so numerous and complex that no individual can
hope to understand and measure them correctly. The technician thinks that the only important
information to work from is the picture given by price and volume statistics.
The technician sees the market, disregarding minor changes, moving in discernible trends,
which continue for significant periods. A trend is believed to continue until there is definite
information of a change. The past performance of a stock can then be harnessed to predict the
future. The direction of price change is as important as the relative size of the change. With his
various tools, the technician attempts to correctly catch changes in trend and take advantage of
them.

10.1 Concept of 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.

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