Calculation of Technical Analysis Indicators

SIMPLE MOVING AVERAGE

A simple moving average is derived by calculating the average (mean) price of a security over a specified number of periods. Simple Moving Averages can be calculated by considering either the open, high, low or close data points for the security in question. But the predominant method is to compute considering the close data point or the closing price. For example: a 7-day simple moving average is calculated by adding the closing prices for the last 7 days and dividing the total by 7.

For eg. 8 + 9 + 10 + 11 +12 +13 + 14 = 77

Divide this by 7 will give the SMA = 77 / 7 = 11 for the 7 data points.

The calculation is repeated for each price bar on the technical charts. The averages derived then joined to form a smooth curving line which is called the moving average line. In the above example, if the next closing price in the average is 15, then this new period would be added and the oldest day, ie. The first one which is 8, would be dropped. The new 7-day simple moving average would now be calculated as follows:

9 + 10 + 11 +12 +13 + 14 + 15 = 84

Divide this by 7 will give the SMA = 84 / 7 = 12 for the 7 data points.

So at any point of time the 7 day SMA would reflect the average for the last 7 days only …as new days data gets added the oldest data gets dropped out and hence reflecting the last 7 days statistics for the 7 day SMA for the particular day.

Simple Moving averages are called as lagging indicators and hence work well only when the prices are trending. Otherwise they give misleading signals. The practice normally used by analysts and chartists is to follow the 10 day SMA to 30 day SMA for predicting the short term trend. The most reliable method often followed is whenever the current price of the stock crosses the 200 day SMA it is a strong buy signal and if the price of the stock drops below the 200 day SMA it is a strong sell signal.

EXPONENTIAL MOVING AVERAGE (EMA)

In order to reduce the lag in simple moving averages, analysts often use exponential moving averages (also called exponentially weighted moving averages) which puts more weight on the recent data or the recent prices as compared to the old data or prices. The specified period of the moving average decides the weightage applied to the most recent price. The more short the EMAs period and the more weight that will be applied to the most recent price. To make it simple and easy to understand considering a 10-period exponential moving average weighs the most recent price 18.18% while a 20-period EMA weighs the most recent price 9.52%. Calculation of EMA is a little complex compared to the SMA. The important thing to keep in mind is that the exponential moving average puts more weight on recent prices. Obviously, it will react quicker to recent price changes than a simple moving average. The formula is

EMA(current) = ( (Price(current) - EMA(prev) ) x Multiplier) + EMA(prev)

For a percentage-based EMA, "Multiplier" is equal to the EMA's specified percentage.

For a period-based EMA, "Multiplier" is equal to 2 / (1 + N) where N is the specified number of periods.

For example, a 10-period EMA's Multiplier is calculated like this:

This shows that a 10-period EMA is equivalent to an 18.18% EMA.

WHICH ONE TO USE SMA or EMA ?

EMA due to its more sensitivity to recent price movements is often preferred by most technical analysts for predicting short term trends. Similarly SMA is often preferred by most technical analysts for predicting medium to long term trends of a security.

Since sensitivity can bring in often false or misleading signals this subject has been debatable always. Since Moving Averages is a very helpful tool it should be used in conjunction with other indicators as well. The best strategy would be to use these averages and experiment by self on live data of the market and conclude which suits you the best.

Income Tax rule on

TYPES OF CAPITAL GAIN: Depending on how long you held the asset, the capital gain is classified either as short-term or long-term.

Short-term capital gain: If you sell the asset within 36 months from the date of purchase (12 months for shares or mutual funds)

Long-term capital gain: If you sell the asset after 36 months from the date of purchase (12 months for shares or mutual funds)

Section -1 Property and Others

Short-term capital gain: A short-term capital gain is added to your total income. Depending on which tax bracket you fall under, you will be taxed.

Long Term Capital Gain: Long-term capital gains are taxed at a flat rate of 20% irrespective of your income slab. Long-term capital gains is computed by deducting from the full value of the consideration, the expenditure incurred in connection with the transfer, the indexed cost of acquisition, and the indexed cost of improvement.

However, tax benefits are available under Section 54 of the IT Act. This tax can be avoided by re-investing the profits in a residential property if either of these conditions are satisfied - a fully constructed residential property is purchased within a period of one year before the sale or two years after the sale, or if you construct a residential property on your own within a period of three years after the sale.

Section-2 Shares and Mutual funds

CASE-1 Sale purchase through a Recognized stock exchange where STT is deducted:

Long Term Capital gain is exempt from tax and Short term Gain is taxed at a flat rate of 10%.

CASE-2 Sale purchase through a recognized/un-recognized exchange where STT is not deducted:

Short-term capital gain: A short-term capital gain is added to your total income. Depending on which tax bracket you fall under, you will be taxed.

Long-term capital gain taxed on shares and mutual funds: You can pay the tax on long term capital gains on shares and mutual funds either at the rate of 20% with indexation of the initial cost price or 10% without indexation which ever method the tax burden is less.

Capital loss: Sometimes, you do not make a profit. You sell at a lower rate than at what you bought. This is a capital loss. The tax in this case would be Nil but it can help reduce tax burden on other gains as you can set off capital loss as follows:

• Long-term capital loss can be set off only against a long-term capital gain.
• Short-term capital loss can be set off against any type of capital gain, long-term or short-term.

You need not incur the loss and gain in one single year. A long-term capital loss can be carried forward for eight years to be set off against a long-term capital gain. A short-term capital loss can be set off against any income under the head capital gains (whether short-term or long-term) and can also be carried forward for eight years. In both cases, these eight years start after the financial year when the loss is incurred.

understanding of Support and Resistance

 

Support and Resistance

 

There are two components to trend, direction and duration. Markets trend in three directions, up, down and sideways. Markets do not move consistently in one direction, but tend to be erratic. Within this erratic behavior a trend will be present. Trends are characterized by a series of peaks and troughs. An uptrend is a series of rising peaks and troughs, a downtrend shows a series of descending peaks and troughs. A sideways tend is a series of horizontal peaks and troughs, with prices moving within a range, failing to make new highs at the top of the price range and failing to make new lows at the bottom of the price range.

Trend duration is also made up of three-time periods; major, intermediate and minor. The major trend will have duration of six to eight months or longer and is best illustrated by weekly and monthly bar charts. Within the major trend significant corrections or reversals of trend will be present; these would be intermediate and minor trends within the major trend. The intermediate trend lasts from three weeks to three months, and the minor trend is anything less, from two to three weeks in duration.

Support and resistance are tools used by technicians to help them identify and follow price trends. Horizontal lines are drawn on the bar chart to indicate areas of support and resistance. The troughs or reaction lows on a price chart are identified as support. Support is an area on the chart where buying pressure overtakes selling pressure and the market reacts higher. Usually support is identified by a previous reaction low or trough on the bar chart. Resistance is an area on the chart where selling pressure overtakes buying pressure and the market reacts lower. A resistance level is identified by a previous price high or peak on the bar chart.

The concepts of support and resistance are critically important tools used by technicians to help them identify and follow trends. Lines are drawn on the chart to indicate areas of price support, price resistance and price trends. In an uptrend, the resistance levels represent pauses in the uptrend, which serve to temporarily halt the price advance. In like manner, in a downtrend, support levels will temporarily halt a price decline. Trend lines are drawn above or below the market action depending upon the direction of the move. During an uptrend a line would be drawn from the first significant low to the next, extending across the page from left to right. (See example 5) If the uptrend is valid you will find the price will move to, or close to, the uptrend line on corrections and then move higher. Each time a trend line is tested and holds, the more significant it becomes. Each time a previous support or resistance level is being tested the prevailing trend of the market is critically analyzed by the technician. Failure to exceed a previous resistance peak in an uptrend, or to break a previous support low in a downtrend, provides a warning that the existing trend may be changing. The testing of these support and resistance levels form pictures on the charts that suggest either a trend reversal or simply a pause in the prevailing trend. The basic building blocks on which price patterns are based however, are support and resistance.

 

Support and resistance levels reverse roles once they are decisively broken. In other words if the price penetrates a resistance level, then it will generally move upward to the next resistance level, such that the previous resistance level will now become an area of support. The longer the period of time that prices trade in a support or resistance area, the more significant that area becomes. For example, if prices trade sideways for three weeks in a support area before moving higher, that support area would be more significant than if only three days of trading had occurred. The reason for this is that there are now more participants in the market with a vested interest in that support area which will hold prices up

The ABC of index funds

To understand index funds it's useful to look at two different kinds of investment strategies for stocks.

The first is active investing. It means a determined effort to identify and purchase good stocks.

An active investor will carefully research an individual company, its financial statements, general business strategies and so on and try to determine the value of its stock compared to its current price. 

If the stock of a company is undervalued (less than its actual worth) s/he will purchase the stock and continue to monitor the company's fundamentals. If and when s/he finds the stock price to be overvalued (more than its actual worth) s/he will sell the stock.

Obviously this involves a lot of effort in doing research and may involve significant costs when the investor buys and sells the shares regularly.

What is indexing?

A passive strategy, also known as indexing, is much less complicated and involves tracking an index like say the Sensex or the Nifty and building a portfolio with the same stocks in the same proportions as the index.

In other words there is no effort to beat the index: merely to earn the same return. This portfolio will passively track the two indices and reflect the corresponding change in them.

• What's your mutual fund gyaan?

If these two indices increase in value your portfolio will follow suit. If their value drops so will your portfolio's worth.

An index fund is a mutual fund, which follows a passive indexing strategy instead of picking individual stocks.

Indexing may seem a strange strategy but there is a lot of research backing it up. The obvious advantage is that an index fund doesn't have to pay for expensive analysts and frequent trading.

Advantage of indexing

There is also a theory called the efficient markets hypothesis, which says that stocks are mostly priced (valued) accurately and that it is not possible to beat the market in a systematic way.

It's true that a few actively managed mutual funds may beat the market for a while but research, particularly in the US markets, has shown that it is very rare for active funds to beat the market in the long run.

Another advantage of index funds is that a broad index will be less volatile than specific stocks or sectors meaning that the investor faces less risk.

Origin of index funds

Index funds were first started in the US in the 1970's when the research that established the efficient markets concept began to trickle down to the finance industry.

There are about a thousand index funds in the US like the Vanguard 500, which tracks the S&P 500 index.

• How to pick a good mutual fund 

In recent years, index funds have been created in India as well like the FT India Index fund and HDFC Index Fund. Both these funds track the Nifty and the Sensex. (Stock mkt terms)

Index funds: Not the best option for India?

However despite their advantages, index funds may not be the best option in the Indian market today.

Indian indices like the Sensex (30) and the Nifty (50) cover a relatively small number of stocks and ignore many opportunities in the mid-cap sector.

An index fund that invests in just 30 or 50 stocks clearly doesn't offer a great deal of diversification. Contrast this with Vanguard 500 in the US, which tracks the changes in 500 stocks of the S&P 500 index.

The basic principle here is: the more the number of stocks comprising an index the better is the diversification and price discovery.

Unlike the capital markets in developed countries, Indian markets haven't been thoroughly researched which means that there may be more opportunities to beat the market by sound research.

• Want to invest in stocks abroad?

Some also argue that the Indian stock markets are over-valued today after their spectacular growth in recent years (the benchmark Sensex has gained more than 100 per cent in the last five years), which means that a passive strategy may fare poorly in the next few years.

This is because the possibility of the Sensex-comprising 30 stocks to go down is higher compared to it making gains in the foreseeable future.

Finally, one of the biggest advantages of index funds: their very low expense ratios are less relevant to India where expenses are quite high.

Any mutual fund, be it an index fund or a gold exchange traded fund or an equity mutual fund, they need to spend money on marketing the project, pay the fund manager and other such expenses. These expenses as a percentage of total money collected to run the scheme is the expense ratio.

US index funds like the Fidelity Spartan 500 have expense ratios as low as 0.1 per cent, while Indian index funds have expense ratios as high as 1-1.5 per cent. This isn't that much lower than active funds like the HDFC equity fund with expense ratios of around 2 per cent.

Is it a potentially rewarding investment vehicle?

This does not mean that Indian investors should permanently ignore index funds.

Because in a few years many of their shortcomings in the Indian context may be resolved.

As capital markets mature and the quality of research increases, it will be harder to generate high returns through stock-picking and active strategies.

With increased competition, expense ratios in Indian index funds may fall making them more attractive relative to active funds. And while the markets may be overvalued today that will not be the case indefinitely.

Thus while index funds may not be the best investment vehicle today, they are a potentially rewarding investment that all savvy investors should understand.

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