Tutorials
Technical Analysis
Q) What is meant by Technical Analysis?
Technical analysis refers to the study of the market itself as opposed to the study of shares in which the market deals. It is the science of recording, usually in graphic or, the actual history of trading in stocks and deducing future trends from it. Technical analysts believe that all information relevant to stock is already factored into its price and thus price is the only parameter of importance. They believe that trends in stock prices persist and the identification of these is their main task. Technical Analysis origin lies in the Dow Theory given by Charles Dow (founder of the Dow – Jones financial news service), this theory explains the different kinds of trends which an investor should learn to decipher.
1. Primary Trends - These are broad overall up and down movements which usually last for more than a year and may run for several years. So long as each successive price advance reaches a higher level than the one before it and each price trend reversal from down to up stops at level higher than two previous one, the primary trend is up i.e. a Bull market and vice versa for a Bear Market. The primary trend is the only trend with which the true long term investor is concerned, with the aim being to buy early in the Bull Market and hold it until its end.
2. Secondary Trends - These are intermediate declines /corrections occurring during Bull Markets and the intermediate rallies /recoveries during Bear Markets. They usually last from 3 weeks to 3 months.
3. Minor Trends – These are brief fluctuations which are meaningless in themselves, but when combined they make up secondary trends. They usually last for less than 6 days and rarely for as long as 3 weeks. Minor trends are the only kind of trends which are subject to manipulation and are hence best ignored. A basic tenet of Technical Analysis says ‘Volume Goes with the Trend i.e.. It so happens that trading activity (Volume) tends to increase as prices move in the direction of the current primary trend. Hence, in a Bull Market volume increases
when prices rise & vice versa and in a Bear Market volume increases when prices drop and vice versa. Any digression from this is a cause of concern .
Technical analysts not only try to identify patterns in stock charts but also employ mathematical tools on this data to arrive at conclusions. Some of the most popular mathematical tools are discussed below, you may even apply these tools to all charts available on our site automatically
Q) What is meant by Simple Moving Average (SMA)?
SMA is nothing but the average price of an equity over a time period (30 days at Aisapaisa.com).
Q) What is meant by Exponential Moving Average (EMA)?
The EMA is another way of averaging the price over a period of time (100 days at Aisapaisa.com) giving greater weight to more recent price figures, thus enabling investors to react quickly as compared to Simple Moving Averages as trends would take longer to appear on them.
Q) What is MACD (Moving Average Convergence Divergence), what are the various ways of interpreting it?
MACD is an indicator commonly employed by Technical Analysts, it is a trend following momentum indicator that shows the relationship between two moving averages of prices, it has been in use since its creation in the 1960s.
It makes use of Moving Averages (these are used to smooth out short-term fluctuations, thus highlighting longer-term trends or cycles) which are lagging indicators, to include trend-following characteristics. Exponential Moving Average is employed as it gives greater importance to recent changes in the variable as compared to older ones.
In common usage the MACD is the difference between a 26 day and 12 day exponential moving average.
It is seen that when the MACD rises drastically the equity is believed to be overbought and a correction is to be expected in the near future. Also, when the equity is found to diverge from the MACD it is expected that the current trend being followed by it is about to end (since the underlying assumption is that the derived moving average trend is to be sustained in the long run).
Another similar indicator used in conjunction with the previously described MACD is known as the trigger (signal); this is the nine day exponential moving average of difference between the 26 and 12 day EMA and is plotted on top of the MACD to indicate the following:
MACD falls above the trigger line - Buy
MACD falls below the trigger line - Sell
MACD = EMA (12) of price - EMA (26) of price
Trigger = EMA (9) {EMA (12) of price - EMA (26) of price}
Q) William’s % R indicator.
The William’s % R indicator is another popular Technical Analysis indicator which attempts to measure overbought and oversold market conditions. The %R always falls between a value of -100(lowest) and 0(highest) - a negative scale. There are two horizontal lines in the study that represent the 20% and 80% overbought and oversold levels. It is designed to show the difference between the period high and today’s closing price with the trading range of the specified period (10 days). The indicator therefore shows the relative situation of the closing price within the observation period.
Though values below -80 are considered as oversold and above -20 as overbought, the suggested rules of trade are not as straightforward, they may be stated as:
Buy an oversold if:
1. %R reaches -100%.
2. Five trading days pass since -100% was last reached
3. %R rises above -95% or -85%
Sell an overbought if:
1. %R reaches 0%
2. Five trading days pass since -100% was last reached
3. %R rises above -5% or -15%
Formula -
% R =100* (Today’s closing price - highest price in last 10 days)/ (highest price in last 10 days- lowest price in last 10 days)
Q) What is meant by resistance & support?
Resistance and support are price bands at which there is concentrated demand and supply intersection.
Support is the price at which demand is large enough to prevent the Scrip price from slipping further. A lot of traders are willing to buy the Scrip at the support price, which prevents the price from slipping further. Not too many traders are willing to sell the scrip at this price.
Resistance is the price at which supply is large enough to prevent the Scrip price from rising further. A lot of traders are willing to sell the Scrip at the Resistance price,
Which prevents the price from rising further. Not too many traders are willing to buy the scrip at this price.
The resistance level (Price) is obviously greater than the support level (Price).
These price bands can be derived from the previous trading day’s high, low and close, the Pivot point which is simply the average of these three in indicative of future movement in the prices with the idea being to go long above the pivot and short below the pivot.
Pivot (P) = (H + L + C)/3
Resistance level 1 (R1) = (2*P) - L
Support level 1 (S1) = (2*P) - H
Resistance level 2 (R2) = (P - S1) + R1
Support level 2 (S2) = P - (R1 - S1)
Q) What are candlestick charts? How can I read them?
A candlestick chart is a combination of a line and a bar chart, originally developed in 18th century Japan it finds extensive use amongst followers of technical analysis today for evaluating price movements in securities, foreign exchange etc.
Candlesticks are composed of a body with upper and lower ends and a wick, which unlike real life candles extends on both sides.
Each candle represents a day’s trade for a security; the wicks on either side represent the day’s highest and lowest prices and the ends of the candle signify the opening and closing prices with the length of the candle depicting the difference between the two.
On our site the candles have been colour coded – a red candle represents overall decline in prices at the end of the day’s trading and green represents vice versa.
Once understood, this form of charting makes it easier for a user to assimilate more information in one glance since each data point (a candle) represents five parameters (day’s high, low, opening, closing and change in price).
Furthermore these charts are used to identify complex patterns for predicting future market movements.
Fixed Income Securities
Q) What are fixed income instruments or debt based securities?
Bonds and other “fixed income securities” are investments that are based on debt. Bonds can be issued by companies and governments and when you buy a bond, you are lending your money to a government or company for a certain time period. In return, they promise to pay you interest on your money and to repay the face value at the end of the bond’s term. The face value is the value of the bond when it was issued.
Most fixed income securities come with a guarantee and are relatively safe. They tend to offer better rates of return than cash equivalent investments because you’re taking on more risk by lending out your money for a longer period. Other bonds, like “junk” bonds, offer much higher rates of return, but they can be very risky and have no guarantees.
Q) What are the prime characteristics of bonds?
The basic characteristics of a bond are:
• A maturity date
• A fixed rate of interest payment or coupon
• A fixed face or par value (principal sum) redeemable upon maturity
Q) Can retail investors participate in the bond market?
Yes, in principle retail investors can participate in the bond market, but since most of them are traded in over the counter markets, require understanding of sophisticated concepts such as yield curves and have high maturity periods it is institutional investors (unit trusts, banks etc.) who trade in the same.
Q) How are bonds traded?
When the issuer (government or corporations or institutions) first offers new issues, that first trading is done at the primary market. What this means is that the issuer is able to raise funds for its use and the money raised from the sale of the bonds come directly to the issuer.
Subsequently, the bonds bought from the issuer can be bought and sold among other investors, and this is referred to as the secondary market. The secondary market provides liquidity to the individuals or institutions that have acquired the bonds, which are now able to sell off the bonds before the maturity date, should they wish to do so. The trading of bonds in the secondary market creates a market pricing of the bonds that depends on the supply and demand of the bonds, and prevailing interest rates, among other factors.
When the market price of the bond is less that its par value, the bond is considered as
Being sold at a discount. When the market price of the bond is more than its par value, then the bond is being sold at a premium.
The secondary market plays an important role because:
• Investors purchasing bonds at the primary market know there is an avenue to sell-off their bonds.
• The secondary markets provide a gauge for issuers to price their primary issues.
Q) What is implied by the nominal value of a bond?
The nominal value of a bond is the par or face value and sometimes, also referred to as the principal value of the bond. This is the amount the issuer of the bond has agreed to pay the bondholder at the maturity date. In view of this, the principal is also called the redemption or maturity value.
Q) What is meant by coupon rate?
The coupon rate is the amount of interest the bondholder will receive periodically. For example if the nominal value of the bond is Rs.10, 000 and the coupon rate is 6%, then the bondholder will receive an annual interest of Rs. 600. If the agreed periodic payment is every six months, then the bondholder will receive Rs.300 every six months.
Q) What is meant by the yield of a bond?
Firstly, the yield of a bond must not be confused with its coupon rate. While the coupon rate is fixed at issue, and does not change till maturity, the yield is the discount rate or interest rate that an investor wants from investing in a bond. Price of bonds are quoted in relation to their yields. As the required yield increases, the price of the bond decreases. The reverse in also true.