The Hindu Business Line : Examine multiple pieces of evidence

Thomas A. Meyers discusses `a winning program for investors and traders' in The Technical Analysis Course, third edition, from Tata McGraw-Hill (www.tatamcgrawhill.com).

Similar to a carpenter, the technician (as one who employs technical analysis is called) has a variety of tools in his toolbox, begins the author. "Some basic tools (like bar charts and moving averages) are used quite frequently, while other more specialised and sophisticated tools (like relative strength index and stochastics) are used less often." Technicians, like carpenters again, have their own favourite tools, mastered through experience over time.

A chapter on `the philosophy of technical analysis' opens with three key principles. The first is that everything is discounted and reflected in market prices. Accordingly, "all knowledge regardless of type (fundamental, economic, political, psychological, or other) is already reflected in market prices." Therefore, to technicians, real value is not determined by studying company financial statements, earnings reports, industry developments and so on, but by `supply and demand as reflected in trading activity.'

The first of the many technical analysis tips, sprinkled throughout the book, cites an old saying on Wall Street that advises one to sell on good news. Here's why: "Because if the actual news is as expected, it is, of course, already discounted and reflected in the market price. Therefore, you would expect no further rise in price based on that news." This may, perhaps, explain why Infosys stock hit an intra-day low of Rs 2,100 on Friday, immediately after the company announced a 52 per cent increase in its net profits of a better-than-expected Q3.

Trends persist

The second basic principle is that prices move in trends and trends persist. "The supply and demand balance sets a trend in motion," explains Meyers. "Once in motion, a trend remains intact until it ends. For example, if a stock's price is moving up, it will continue its rise until there is a clear reversal. Likewise, if a stock is moving down, it will decline until a reversal."

The third principle is that market action is repetitive, making certain patterns appear time after time on charts. "Human nature is such that it tends to react to similar situations in consistent ways," reasons the author. "As a rule, people will act the same as they have in the past." And, it helps to remember that the stock market is `a reflection of the actions of people.'

The `beauty of technical analysis', as Meyers puts it, is that it is adaptable to different markets, be they of stocks, bonds, options, mutual funds, or commodities; and you can apply it to different time horizons, such as intra-day, daily, weekly, monthly and so on.

Each chapter wraps with `true or false quiz.'

The book has chapters on topics such as major reversal chart patterns, consolidation formations, trend lines and channels, support and resistance, true value of failed signals, gaps, moving averages, relative strength analysis, volume and open interest, oscillators, relative strength index, stochastics, Bollinger bands, point and figure charting, and Japanese candlestick charting.

In the final chapter, the author draws upon his experience of having served on a jury involving a criminal case. "Reaching a not guilty or guilty verdict is in many ways analogous to deciding whether to buy or sell a security or market. Although a decision can be made on the basis of one piece of information, a better decision is normally made by examining multiple pieces of evidence," advises Meyers.

"Always keep in mind that there is no technical indicator that is correct all of the time," reads a caution. So, "examination of multiple indicators can be beneficial in determining the probable future direction of prices." However, don't analyse similar types of indicators and assume you are examining a security or market from different perspectives, counsels Meyers. "Be careful that the technical tools and indicators you use are not redundant and providing you with a biased picture of the security or market you are trading."

A book that can get you started off into the technical world.

Here is a sample, on basic chart construction: "A bar chart for a stock plots only its closing price and volume for each time period." Answer: False. Because "a bar chart for a stock plots high, low, and closing prices for each time period," and "volume is typically plotted at the bottom of the bar chart." Another question reads: "When the vertical scale on a bar chart is logarithmic, the distances between 10 to 20 and 20 to 30 are equal." False again. Distance between 10 to 20 and 20 to 30 will be equal if the scale is arithmetic. "On a logarithmic scale the distance between 20 to 30 is half as much as between 10 to 20 because it represents a 50 per cent increase in price, while a 100 per cent increase occurs from 10 to 20."

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