Trading in NEPSE: Thinking Out of Box!

If you use only fundamental analysis and are getting bored of using it all the time or want to see the market from a different perspective, then this article can be of great assistance to you.  I will be trying to acquaint you on the world of technical analysis and its use to study the behaviour of price in “Nepse” stocks- thinking outside the box!

Technical analysis is the study of price only. Unfortunately, this is not taught even in top business and finance schools. Interestingly, researchers found that most of the financial market practitioners use technical analysis instead of fundamental analysis to analyse the market and security.

Fundamental analysis is a method of finding intrinsic value of security by studying economic, financial and other quantitative and qualitative information related to that security. Therefore, an investor who wants to invest in bond and uses fundamental analysis would look into the overall condition of the economy, such as interest rates, credit ratings etc. If you use fundamental analysis to select stock, you need to have information about that stock before the market to profit from investment. Ability to sense information before the market and employ it correctly while making investment can be very profitable to investors. However, it has become very difficult to know information before the market at present times due to the advancement of technology. The use of fundamental analysis, hence, is limited.

A technical analyst is also known as chartist. The job of the technical analyst is to study past price movements, make projections and invest on the dominant market group. A chartist can make predictions about what is likely to happen to price over a period of time, based on what has happened in the past

Technical analysis is based on three basic principles

1. Price discounts everything
2. Price movement is not totally random
3. History repeats itself

These principles are the basis of technical analysis. All available information in the market including economic, political and other important (quantitative and qualitative) is discounted in current price (first principle). Technicians also believe that price trends. Market can be uptrend, downtrend or flat. The job of the chartist is to find major trends (second principle). Technical analysis also believes that people have ‘memory’ and, hence, past techniques can be applied in the future (third principle).

The market was in uptrend during Jul-Aug and reaches 670 (highest price) then takes a dive. The break of the uptrend line at around 640 confirms the end of the bullish pressure and start of the bearish trend. Head & shoulder pattern is seen in around 660-620. Head & shoulder in an uptrend is a reversal pattern. It supports  our claim of bearish trend at the break of 620. The stock takes a dive after the break of that level. The bearish pressure ends momentarily at around the strong support of 540. Some bulls become bolder and buy more. New bulls also joined the party which pushes prices higher to the resistance, 620 levels. Some hogs also joined bulls in 580 but lost confidence after few days of the rally. BOK stock observes a double top after couple of days. Bearish pressure has increased after the double top pattern and the stock is sold heavily after that. The selling stops at the psychological number 500. This ends the downtrend of stock. The stock becomes cheaper at this price and bulls enjoyed buying. Some bulls exit on the resistance at previous around 540 and some joins the rally. Finally, a symmetrical triangle is observed just below the resistance 540. End of the story.

In order to make valid projection about future price you need to know few things: principles of future trend direction, market structure, chart patterns, technical indicators and market psychology. Based on these I can tell the likelihood of future trend direction, but to some extent only. We have observed that the stock rallied after it hits 500 and breaks the channel support and again bounced at 50% Fibonacci level. We can also see a symmetrical triangle just under the former support, which is now resistance. So there is greater probability of breaking price above 550 and it did. It went up and up and crossed the highest price 660, as predicted. Technical analysis helps you to find right risk reward ratio for investment and  helps you to set appropriate risk and reward price levels.

Technical analysis has its limitations but, using it with fundamentals, can make your stock selection process more interesting and objective.

Mr. Gautam Chapagain

gautam_sh@hotmail.com