Technical Analysis

Technical Analysis, what is it?

Consider this analogy.

Imagine you are vacationing in a foreign country where everything including the language, culture, climate, and food is new to you. On day 1, you do the regular touristy activities, and by evening you are very hungry. You want to end your day by having a great dinner. You ask around for a good restaurant and you are told about a nice food street which is close by. You decide to give it a try.

To your surprise, there are many vendors selling different varieties of food. Everything looks different and interesting. You are absolutely clueless as to what to eat for dinner. To add to your dilemma you cannot ask around as you do not know the local language. So given all this, how will you make a decision on what to eat?

Option 1: You visit a vendor, figure out what they are cooking/selling. Check on the ingredients used, cooking style, probably taste a bit and figure out if you actually like the food. You repeat this exercise across a few vendors, after which you would most likely end up eating at a place that satisfies you the most.

The advantage of this technique is that you know exactly what you are eating since you have researched it on your own. However, on the flip side, the methodology you adopted is not really scalable as there could be about 100 odd vendors, and with limited time at your disposal, you can probably cover about 4 or 5 vendors.  Hence there is a high probability that you could have missed the best-tasting food on the street!

Option 2: You just stand in a corner and observe all the vendors. You try and find a vendor who is attracting the maximum crowd. Once you find such a vendor you make a simple assumption -‘The vendor is attracting so many customers which means he must be making the best food!’ Based on your assumption and the crowd’s preference you decide to go to that particular vendor for your dinner. Chances are that you could be eating the best tasting food available on the street.

The advantage of this method is the scalability. You just need to spot the vendor with the maximum number of customers and bet on the fact that the food is good based on the crowd’s preference. However, on the flip side, the crowd need not always be right.

If you could recognize, option 1 is very similar to Fundamental Analysis where you research about a few companies thoroughly. We will explore the Fundamental Analysis in greater detail in the next module.

Option 2 is very similar to Technical Analysis where one scans for opportunities based on the current trend aka the preference of the market.

Technical Analysis is a research technique to identify trading opportunities in the market based on the actions of market participants. The actions of market participants can be visualized by means of a stock chart. Over time, patterns are formed within these charts and each pattern conveys a certain message. The job of a technical analyst is to identify these patterns and develop a point of view.

Like any research technique, technical analysis stands on a bunch of assumptions. As a practitioner of technical analysis, you need to trade the markets keeping these assumptions in perspective. Of course we will understand these assumptions in detail as we proceed along.

Also, at this point, it makes sense to throw some light on a matter concerning FA and TA. Often people get into the argument contending a particular research technique is a better approach to market. However, in reality, there is no such thing as the best research approach. Every research method has its own merits and demerits. It would be futile to spend time comparing TA and FA in order to figure out which is a better approach.

Both techniques are different and not comparable. In fact, a prudent trader would spend time educating himself on both the techniques so that he can identify great trading or investing opportunities.

The Regulators of INDIAN Share Market

In India the stock market regulator is called The Securities and Exchange Board of India often referred to as SEBI. The objective of SEBI is to promote the development of stock exchanges, protect the interest of retail investors, regulate the activities of market participants and financial intermediaries. In general, SEBI ensures:

1. The stock exchanges (BSE and NSE) conducts its business fairly
2. Stockbrokers and sub-brokers conduct their business fairly
3. Participants don’t get involved in unfair practices
4. Corporate’s don’t use the markets to unduly benefit themselves (Example – Satyam Computers)
5. Small retail investors interests are protected
6. Large investors with huge cash pile should not manipulate the markets
7. An overall development of markets

Given the above objectives, it becomes imperative for SEBI to regulate the following entities. All the entities mentioned below are directly involved in the stock markets. Malpractice by anyone of the following entities can disrupt what is otherwise a harmonious market in India.

SEBI has prescribed a set of rules and regulations to each one of these entities. The entity should operate within the legal framework as prescribed by SEBI. The specific rules applicable to a specific entity are made available by SEBI on their website. They are published under the ‘Legal Framework’ section of their site.

Entity	Example of companies	What do they do?	In simpler words
Credit Rating Agency (CRA)	CRISIL, ICRA, CARE	They rate the credit worthiness of corporate and governments	If a corporate or Govt entity wants to avail loan, CRA checks if the entity is worthy of giving a loan
Debenture Trustees	Almost all banks in India	Act as a trustee to corporate debenture	When companies want to raise a loan they can issue debenture against which they promise to pay an interest. These debentures can be subscribed by public. A Debenture Trustee ensures that the debenture obligation is honored
Depositories	NSDL and CDSL	Safekeeping, reporting and settlement of clients securities	Acts like a vault for the shares that you buy. The depositories hold your shares and facilitate exchange of your securities. When you buy shares these shares sit in your Depositary account usually referred to as the DEMAT account. This is maintained electronically by only two companies in India
Depositary Participant (DP)	Most of the banks and few stock brokers	Act as an agent to the two depositories	You cannot directly interact with NSDL or CDSL. You need to liaison with a DP to open and maintain your DEMAT account
Foreign Institutional Investors	Foreign corporate, funds and individuals	Make investments in India	These are foreign entities with an interest to invest in India. They usually transact in large amounts of money, and hence their activity in the markets have an impact in terms of market sentiment
Merchant Bankers	Karvy, Axis Bank, Edelweiss Capital	Help companies raise money in the primary markets	If a company plans to raise money by floating an IPO, then merchant bankers are the ones who help companies with the IPO process
Asset Management Companies (AMC)	HDFC AMC, Reliance Capital, SBI Capital	Offer Mutual Fund Schemes	An AMC collects money from the public, puts that money in a single account and then invests that money in markets with an objective of making the investments grow and thereby generate wealth to its investors.
Portfolio Managers/ Portfolio Management System (PMS)	Religare Wealth Management, Parag Parikh PMS	Offer PMS schemes	They work similarly to a mutual fund except in a PMS you have to invest a minimum of Rs.25,00,000 however there is no such cap in a mutual fund
Stock Brokers and Sub Brokers	Zerodha, Sharekhan, ICICI Direct	Act as a intermediary between an investor and the stock exchange	Whenever you want to buy or sell shares from the stock exchange you have to do so through registered stock brokers. A sub broker is like an agent to a stock broker