Using technical tools for investments

Using technical tools to make lucrative investment decisions

By Shrikant Chouhan 

Everyone uses technical analysis to identify “when to buy/sell” along with fundamentals which normally supports to the theory of “why to buy/sell”. But I feel that in the market, buying or selling always starts on the basis of futuristic fundamentals, which is difficult to guess based on current fundamentals.  Of course, with the help of macroeconomics we can come on a broader conclusion but then there always remains the scope for “if and but” that many a time makes it difficult for analysts to take a concrete decision, whether to buy or sell  in an euphoric scenario like the rise of 2008 and the recent fall of 2011. 

The constant macroeconomic change affects major corporates of the country. In our opinion they are at the top of the hierarchy of the market participants.  Based on their comfort or uneasiness they start reacting to it. Then the action of corporates’ spreads into other layers of participants like insiders, operators, mutual funds/ Institutions in a step by step mode. By the time it comes to retailers half of the story/trend gets over but then they don’t have any choice but to accept. 

These major participants “except retailers” who wish to act in real terms with a “buy or sell”, however, have to act only on the platform of the Stock-Exchange. The Stock Exchange provides us the real time data of price and volume of each tick and each day. Here the technical analysis comes into the picture as it mainly follows the “price and volumes” with some simple deviation methods which we is known as an ‘oscillator’.

No matter how smart these major participants and may execute their trades silently, if any technical analyst can read the price properly with the help of other tools then he/she can be an early detector of the climax. Here for T.A. don’t have to wait for results to come or some data. If the price starts seem to diverge negatively/positively which is an indication of reversal in the prevailing trend then T.A. can act accordingly and take the benefit of it scientifically and with some specific strategy put in place.

Technical Analysis is primarily divided into two parts. One is “Charting” that includes price and volume. The other part is “Quantitative”, which is a study of deviation and correlations.  To read the “Price”, Japanese candlestick method is the most efficient method that covers emotions of market participants. Above all technicalities of the stock, people are just trying to read the future of the stock. And it is this intensely human quality that makes the stock market so dramatic an arena.  In brief, reading emotions of participants is an essential part, which candlestick theory covers properly as compared to Bar chart or Point and figure theories to read simple price chart.

An oscillator is an indicator that fluctuates above and below a centreline or between set levels as its value changes over time. Oscillators can remain at extreme levels (overbought or oversold) for extended periods, but they cannot trend for a sustained period.  Here we mean to say the price may go to an extreme level with a rise in multiples but oscillator cannot as the underline rule is to set the price action in a certain basket like for Relative Strength Index (major oscillator) is always oscillated between the range of 0 to 100.  An important criteria is to understand at any specific point of time is that whether the instrument (stock/commodity) is overbought or oversold, whether it is into strong hands of bulls or bears and whether it is trending or diverging negatively or positively. In the stock market it is essential for any analyst to understand the direction of the trend and with the help of RSI (Relative Strength Index) we can come on certain conclusion and on the development of the pattern we can take concrete call on the direction of the market.

However, friends it doesn’t come so easily, it requires lot of time devotion, passion and strong mentality to work on probabilities. It’s not difficult for those who have considerable experience in this field. Those who don’t have time to work on it but to invest and trade in this market then they must require access to the analysis of experienced analysts or they have to find out from the industry and have to follow his/her advice at least for a particular period with a use of efficient money management that we will cover in our coming series of technical analysis.      

(This is the first article of our four-part series on 'Technical Analysis'. Shrikant Chouhan is the head of technical research at Kotak Securities.)