Sundeep Sood is flummoxed each time his brokerage sends him a technical report on the likely buys and sells in the market place. He sees this as stock market mumbo jumbo and dispatches them to the trash bin.

Jignesh Rathod, on the other hand, a relationship manager with a wealth management firm believes that he has to dish out terms like ‘overbought’ or ‘weak strength’ when he is speaking with his high net worth clients. “If I don’t use jargon, sometimes the client thinks that I might not be an expert, hence the usage,” he justifies. And then we have Jude Alvares, who opens up ten charts on his desktop, ranging from the exotic Japanese candlesticks and other complex variables, seeking to make money from the signals that these charts throw up. He reluctantly agrees that this has not led him far, but he hopes that with more experience he will crack the chart code.

Technical analysis, or the reading of charts does lend itself to various reactions, from disdain, to reverence. There are some who simply idolise this technique of stock picking and others who scoff at it. “Probably it is because not many people have understood its actual utility,” says an expert not wanting to be identified.

In simple terms, technical analysis gives you a clear view about the level of the market and where it is heading. The components required for analysis are price and volume. Through price and volume, one can examine the current patterns. These charts are compared with the historical patterns to know future movement. It gives both short-term as well as medium-term calls. The basic philosophy of technical analysis is that charts and patterns indicate where the ‘trend’ is moving and how a particular sector or stock price is behaving in this trend. It captures the behaviour or the sentiment of the market through price and volume movements.

Fundamental analysis focusses on the company and industry angle. “There will be several quality companies that fundamentally should be there in your portfolio, but you would notice that the price just does not move. In such cases, the capital gains might not be attractive at all,” suggests Ajay Kohli, a Mumbai-based research analyst.

But in the equity market, if the stock price is not moving or falling down then any number crunching cannot work. Investors want capital appreciation because when the market is at an all-time high, dividend distributed would be very minuscule as a percentage of the buy price.

Every time investors make mistakes while picking stocks. When there is a decline, investors expect the market to pullback and buy stocks. But what really happens is more downside in the price action. Similar behaviour is seen in the market. Before entering into the market one should adhere to the rules and have a disciplined approach.

?Matching fundamental analysis with technical analysis to time the market or get a better deal, is an ideal option,? reckons Kohli.

Going about

While working around their trade, technically analysts usually have a top-down approach, where the sector is given importance over individual stock picks. The reason is if the overall market is falling, the overall mood of the investors would be negative.

The first thing required, a technical analyst would tell you, is being clear about the investing time frame. There are indicators for every time frame. Clearly trend is the friend in the technical analysis domain. And the trend can be a long-term, which is usually a 200-day trend, a medium term, which could range from 100 to 75 days and a short-term trend ranging from 15 to 5 days.

Charts and indicators will give you both long and short calls unlike fundamentals, which give you only buy calls. Therefore, one should try to earn money in all the phases of the market. Just because a particular stock is down by 50% it does not become a screaming ?buy?.

Till the reversal is not positive, a buy position should not be taken by investors as there may be more pain. Because when the market is falling it has an incremental effect and may fall further due to negative sentiments. No need to time the market when the prices are falling consistently. Again, being clear about the trend and your investing perspective is important.

The essence

One of the terms used in the analysis is ascending and descending tops and bottoms. It is regularly used in technical analysis. Ascending tops is used to measure the progress of the price of a stock over a given period of time. The pattern of ascending tops emerges when a stock demonstrates a repeated ability to establish a price that is successively higher than the previous price.

Ideally it can be seen in a bull market. On the other hand, ascending bottoms shows when the price goes down consistently but are still considered to be a bullish indicator not similar to ascending tops. Descending tops is the exact opposite of ascending tops and is a bearish indicator.

In the last bull period various stocks had seen an upward rally. However, post-crash the stocks declined drastically. This reversal in the price movement, which is contrary to the prevailing uptrend, is known as retracement. A similar term for retracement can be pullback. It means a fall of a stock price from its peaks, signalling a minor pause of an upward trend. It is difficult to say whether a pullback should be used as buying opportunities after a large upward movement.

The pullback and retracement could result in panic selling and can result in a sharp fall in the price of an underlying asset. This type of panic selling situation is termed as being oversold and creates a buy opportunity. On the contrary, when the demand for a certain asset unjustifiably pushes the prices that do not support the fundamentals, it is said to be overbought. The similar situation was seen in January 2008. Now, finally, after the stock has fallen drastically and there is less probability for the downside, the stock stays in range through an area of support or resistance. This is said to be a breakout for the stock.

‘Support’ is a level below which the stock would not go, other things remaining constant. When a stock falls to extremely low levels, it becomes a bargain and at these lower levels buying takes place. For example, Infosys at Rs 1,100 levels would be seen as an attractive buy by many and since the fundamentals are strong, they would expect the price to improve when the market does and would therefore go in for buying. So, Rs 1,100 level then becomes a support for Infosys. Only exceedingly bad news could break this support.

Just the opposite is the ‘resistance’ level where the price does not move above that level. This is because the market has valued the stock at certain levels and when that level is reached, there would be more sellers wanting to cash out. So when that happens there are more sellers in the market place causing the price to fall. It is only when there is some real strong reason where the valuation perception of the company has changed or is likely to change, and some good news is expected, that the resistance level is breached. Buying close to the support and resistance levels could be dicey for an investor. Traders who like to take risky bets, would also be aware in such times. They would rather have a definite trend emerge and then take their position.

Essentially, knowing these factors could help you know the sentiment and the price band in which you are buying a stock. Over dependence on either fundamental or technical factors, could be a recipe for disaster. Hence, a blend of both will enable you to take a more learned call on the stocks that you buy or what your wealth manager prescribes.

The Indicators

Just like in fundamental analysis we use economic indicators to estimate the company’s future profitability, indicators are used extensively in technical analysis to predict changes in stock trends or price patterns. Indicators are ideally shown below the price chart. While analysing charts one should use more than one indicator simultaneously to reduce the probability of errors or bias. “Indicator is based on price, volume, and volatility. Only one parameter, for instance price, cannot tell the depth of the market” suggests Mayur Shah, technical analyst. Indicators will suggest buy and sell level.

Common indicators used to predict future prices are moving average convergence-divergence (MACD) indicator and the relative strength index (RSI). Apart from common indicators we would also look at money flow index, stochastic oscillator, accumulation/distribution line.

Moving average

Moving average (MVA) is a method to arrive at the average price of a security over a specified time period. It is a type of indicator used extensively by technical analysts to know the exact trend in the stock price by removing the day-to-day volatility. Moving average can be calculated for 20, 30, 50, 100, and 200 days.

The higher the number of days taken for calculation, less volatile is the price over that period. Ideally, if the moving average price is higher than the security price, it signals an oversold position and overbought position in the case of lower MVA price than security price. MVA is used in other indicators like MACD. MVA can be calculated in two ways. One is simple and other is exponential moving average.

RSI

Relative Strength Index indicates a market’s current strength or weakness. It compares the magnitude of a stock’s recent gains to the magnitude of its recent losses and turns that information into a number that ranges from 0 to 100. It takes a single parameter, the number of time periods to use in the calculation. Ideally, a 14-day period is taken into consideration.

If the price goes down continuously, the RSI would go down drastically. Generally a buy signal is generated when the RSI moves from a band of 30. If the price closes higher than the previous high, it signals strength in the market and vice versa in the case of a weak market.

MACD

The MACD indicator is primarily used to trade trends and should not be used in a ranging market. Signals are taken when MACD crosses its signal line, calculated as a 9-day exponential moving average of MACD. It can be displayed as two lines representing the oscillator and its moving average or as a histogram showing the difference between the oscillator and its moving average.

A buy signal is given when the MACD graph is in an oversold condition below the origin and the MACD line crosses above the signal line. A sell signal (negative breakout) is given when the MACD graph is in an overbought condition above the origin and the MACD line falls below the signal line. The important crossovers of the MACD line to the signal line occur far from the zero line (the horizontal axis). The amount of divergence between the MACD line and the signal line is important; the greater divergence, the stronger the signal.

Money flow index

The Money Flow Index (MFI) is a momentum indicator that measures the strength of money flowing in and out of a security. One should look for divergence between the indicator and price action. A reversal is imminent when the price moves higher but RSI does not. MFI is related to the Relative Strength Index, but where the RSI only incorporates prices, the Money Flow Index accounts for volume. Just like RSI, MFI also ranges from 0-100. In this above level 80 is said to be the upper band and below 20 is the lower band.

Stochastic oscillator

The Stochastic Oscillator is designed to indicate when the market is overbought or oversold. It is based on the premise that when a market’s price increases, the closing prices tend to move toward the daily highs and, conversely, when a market’s price decreases, the closing prices move toward the daily lows. This indicator displays two lines, %K and %D. %K is calculated by finding the highest and lowest point in a trading period and then finding where the current close is in relation to that trading range. %K is then smoothed with a moving average. %D is a moving average of %K.

Closing levels that are consistently near the top of the range indicate accumulation (buying pressure) and those near the bottom of the range indicate distribution (selling pressure).