Security analysis (technical) and portfolio management

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Technical Analysis Module 4

description

technical analysis and portfolio management.mainly for mg university

Transcript of Security analysis (technical) and portfolio management

Page 1: Security analysis (technical) and portfolio management

Technical Analysis

Module 4

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Technical tools

• Dow theory• Moving average• Odd lot trading• Rate Of Change(ROC)• Chart pattern• Efficient market hypothesis• Random walk theory

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Dow theory

• Dow Jones proposed this theory to explain the movement of indices.

• Normally 3 hypothesis are there are developed by Dow

• No single individual or buyer can influence the major trends of the market.

• Market discounts everything• The theory is infallible.

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• Trend – it is the direction of the movement. The prices of shares can either increase or fall or remain flat.

• Three directions are known as

• Rising

• Falling

• Flat trends

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Bull market

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• The trend may be either increasing and decreasing

• If the market trend exhibits an increase it is bull market

• It is divided into 3 clear-cut peaks• Each peak is higher than the previous peak

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• Revival of market – here more and more investors are encouraged to buy scrip's, their expectation about the future is high.

• Earning phase – In this phase increased profits of corporate would result in further price rise.

• Speculation phase – Prices advances due to inflation and speculations.

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Bear market

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Bear market

• Here the fall in trends leads to bear market.• Here also there is 3 phases.• Loss of hope – here the chances of prices

moving to high level is low.• Recession in business – here companies will

be reporting lower profits and dividends.• Distress selling – shares are sold below the par

value.

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Secondary trend

• It is an intermediate trend which moves against the main trend and leads to correction.

• In bull market it results in a fall• In bear market it results in an upward trend

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Minor trend

• Here prices fluctuates daily• Minor trends tries to correct the secondary

trend movements• It is better for the investors to concentrate on

the primary and secondary trends.

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Chart pattern

• Chart are the valuable and easiest tools of technical analysis

• The graphic representation of the data helps the investor to find out the trend of the price without any difficulty.

• They spot the current trend for buying and selling

• They show the past historic movement

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Point and figure chart

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• To predict the extent and direction of price.• There is no indication of time and volume, it is

one dimensional• The price changes in relation to the previous

price• The rise in price will be marked as ‘X’• The decline in price is recorded as ‘O’

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Limitations

• Intra-day price movement is not shown.• Whole numbers are taken into consideration.

This may result in the loss of information regarding the minor fluctuations.

• Volume is not mentioned in the chart.

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Bar chart

• It is the simplest and the most common tool of technical analyst.

• A dot is entered to represent the highest price at which the stock is traded and another dot to indicate the lower price at that particular date.

• A line is drawn to connect both the points.• A line chart is the simplification of bar chart.

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V-shaped reversal

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• In ‘V’ formation there is a long sharp decline and fast reversal. The ‘V’ pattern occurs mostly in popular stocks where the market interest changes quickly from hope to fear an vice-versa.

• In the case of inverted ‘V’ the rise occurs first and then declines.

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Double top

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• This type of formation signals an end of one trend and the beginning of another.

• In double top the stock price rises to a certain level and falls rapidly, and again rises to the same height or more ,and turns down

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Head and shoulder

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• There are 3 rallies resembling the left shoulder, a head and a right shoulder.

• A neckline is drawn connecting the lows of the top.

• When the stock price cuts the neckline above, it signals the bear market.

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Inverted head and shoulder

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• Here the reverse of the previous pattern holds true.

• Connecting the tops of inverted head and shoulders gives the neckline.

• It indicates the end of bear market and the beginning of the bull market.

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Symmetrical triangle

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• Made up of series of fluctuations• Tops do not attain the height of previous tops.• Bottoms are higher than the previous bottom.• Connecting the lower tops slanting

downwards forms a symmetrical triangle.• Connecting the rising bottom, slanting

upwards becomes the lower trend line

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Up flag

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• Commonly seen on the price charts.• It occurs either a fall or rise in the value of

scrip's.• A bullish flag is formed by two trend lines that

stoops downwards.• A bearish flag will be stooping upwards.

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pennant

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• In bullish pennant ,the lower tops form the upper trend line.

• In bearish the upward trend line is falling and the lower trend line is rising.

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Random walk theory

Strongly efficient market. all information is reflected on prices.

Semi strong efficient market. All public information is reflected on security prices.

Weakly efficient market. all historical information is reflected on security prices.

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• EMH can be divided into 3 categories• Weak form, semi strong form and the strong

form

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Portfolio Management

Mod 5

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• A combination of securities is known as portfolio

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Portfolio Management

• Portfolio Management is the process of creation and maintenance of investment portfolio.

• Portfolio management is a complex process which tries to make investment activity more rewarding and less risky.

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Major tasks involved with Portfolio Management

1. Taking decisions about investment mix and policy

2. Matching investments to objectives3. Asset allocation for individuals and

institution4. Balancing risk against performance

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Phases of Portfolio Management

Portfolio management is a process of many activities that aimed to optimizing the investment. Five phases can be identified in the process:

1. Security Analysis.2. Portfolio Analysis.3. Portfolio Selection.4. Portfolio revision.5. Portfolio evaluation.Each phase is essential and the success of each phase is

depend on the efficiency in carrying out each phase.

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1. Security Analysis.Security analysis is the initial phase of the portfolio

management process. There are many types of securities available in the market including equity shares, preference shares, debentures and bonds. It forms the initial phase of the portfolio management process and involves the evaluation and analysis of risk return features of individual securities. The basic approach for investing in securities is to sell the overpriced securities and purchase under priced securities. The security analysis comprises of Fundamental Analysis and technical Analysis.

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Portfolio Analysis (PA)

• PA is a technique used to analyse organisations in relation to their environments

• Portfolio (set, collection, assortment, range, group)

• A biz portfolio may be any collection of brands / products, markets, branches / divisions, income generating assets, e.t.c

• PA is usually applied to firms with multiple SBUs (more than one product/services, customer categories, markets , divisions)

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PA Introduction– Cont.

• Helps managers in taking decisions regarding which SBUs to allocate more or less resources to at a given strategic point in time

• After portfolio analysis firm makes an informed strategic choice e.g.– To have a balanced portfolio (minimize risk

and maximize return) of all portfolios– To actively deploy a retrenchment strategy

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Boston Consulting Group (BCG) Model

• This is the most popular business portfolio matrix

• It analyses the business portfolio in relation to market share and market / industry growth

• The above 2 variables (share & growth) range from low to high

• A SBU is positioned in the model and the firms strategy is guided by the SBU’s positioning.

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Question marks

Cash cows Dogs

Industry/ market

growth rate

Relative market share

High

Low

The BCG(Boston Consulting Group) model

High Low

Stars

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BCG Sections

Stars• Business with a high market share and high

growth rate• Generate huge sums of money• Require huge sums of money to cope with

growthCash Cows• Businesses with low growth but high

market share• Generate huge sums of money at low cost• Are used to develop and promote new

businesses (they are “milked”)

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BCG Sections – Cont.

Dogs• Have low market share in an aged industry• The strategy is, normally to sell them off.Question marks (Fledglings)• Sometimes called problem children (they

need to be grown).• They generate low cash but need a lot to

tap the high growth rate.• They can be grown into stars, resources

allowing.• Too much commitment to question marks

can lead to liquidity problems.

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3. Portfolio Selection

• During this phase, portfolio is selected on the basis of input from previous phase Portfolio Analysis. The main target of the portfolio selection is to build a portfolio that offer highest returns at a given risk. The portfolios that yield good returns at a level of risk are called as efficient portfolios. The set of efficient portfolios is formed and from this set of efficient portfolios, the optimal portfolio is chosen for investment. The optimal portfolio is determined in an objective and disciplined way by using the analytical tools and conceptual framework provided by Markowitz’s portfolio theory.

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Markowitz model

• Most people think that holding two stocks is less risky than holding one stock

• They think it would be better to invest in one stock

• It is difficult to build an optimal portfolio.

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Markowitz Portfolio Theory

Using these five assumptions, a single asset or portfolio of assets is considered to be efficient if no other asset or portfolio of assets offers higher expected return with the same (or lower) risk, or lower risk with the same (or higher) expected return.

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Alternative Measures of Risk

• Variance or standard deviation of expected return• Range of returns• Returns below expectations

– Semivariance – a measure that only considers deviations below the mean

– These measures of risk implicitly assume that investors want to minimize the damage from returns less than some target rate

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Expected Rates of Return

• For an individual asset - sum of the potential returns multiplied with the corresponding probability of the returns

• For a portfolio of assets - weighted average of the expected rates of return for the individual investments in the portfolio

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Efficient Frontier

A

BN

Return

Risk

ABABN

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Efficient Frontier

A

BN

Return

Risk

AB

Goal is to move up and left.

WHY?

ABN

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Efficient Frontier

Return

Risk

Low Risk

High Return

High Risk

High Return

Low Risk

Low Return

High Risk

Low Return

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Efficient Frontier

Return

Risk

A

BN

ABABN

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Capital Asset Pricing Model

• CAPM is an framework for determining the equilibrium expected return for risky assets.

• Relationship between expected return and systematic risk of individual assets or securities or portfolios.

• William F Sharpe developed the CAPM. He emphasized that risk factor in portfolio theory is a combination of two risk , systematic and unsystematic risk.

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Elements of CAPM1. Capital Market Line – risk return relationship for efficient

portfolios.2. Security Market Line – Graphic depiction (representation)

of CAPM and market price of risk in capital markets.a) Systematic Riskb) Unsystematic Risk

3. Risk Return Relationship4. Risk Free Rate5. Risk Premium on market portfolios6. Beta - - Measure the risk of an individual asset value to

market portfolio.Assets- a). Defensive Assets and b). Aggressive Assets.

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Capital asset pricing model

• An individual seller or buyer cannot affect the price of the stock• Investors make their decision only on the basis of the expected

return• Investors are assumed to have homogeneous expectations

during the decision making period• The investors can lend or borrow any amount of funds at the

riskless rate of interest.the riskless rate of interest is the rate of interest offered for the tresury bills of governmnet security.

• There is no transaction cost• There is no personal income tax• Any amount of shares an individual can sell short.

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Security Market Line

Return

Risk

.

rf

Efficient PortfolioRisk Free

Return =

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Security Market Line

Return

Risk

.

rf

Risk Free

Return =

Market Return = rm Efficient Portfolio

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Security Market Line

Return

Risk

.

rf

Risk Free

Return =

Market Return = rm Efficient Portfolio

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Security Market Line

Return

BETA

rf

Risk Free

Return =

Market Return = rm

1.0

Security Market Line (SML)

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Security Market Line: E[Ri] = RF + βi (RM – RF)

Expected Return

Systematic Risk

RF --

SML

RM --

1 2| | β

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Provides a convenient measure of systematic risk of the volatility of an asset relative to the markets volatility.

Gauges the tendency of a security’s return to move in tandem with the overall market’s return.

Average systematic risk

High systematic risk, more volatile than the market

Low systematic risk, less volatile than the market

CAPM

1

1

1

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4. Portfolio Revision

• After selecting the optimal portfolio, investor is required to monitor it constantly to ensure that the portfolio remains optimal with passage of time. Due to dynamic changes in the economy and financial markets, the attractive securities may cease to provide profitable returns. These market changes result in new securities that promises high returns at low risks. In such conditions, investor needs to do portfolio revision by buying new securities and selling the existing securities. As a result of portfolio revision, the mix and proportion of securities in the portfolio changes.

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Portfolio RevisionThe investor should have competence and skill in the

revision of the portfolio.The portfolio management process needs frequent

changes in the composition of stocks and bonds.Mechanical methods are adopted to earn better

profit through proper timing.Such type of mechanical methods are Formula Plans

and Swaps.

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Passive Management

Passive management refers to the investor’s attempt to construct a portfolio that resembles the overall market returns.

The simplest form of passive management is holding the index fund that is designed to replicate a good and well defined index of the common stock such as BSE-Sensex or NSE-Nifty.

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Active Management Active Management is holding securities based on the

forecast about the future.

The portfolio managers who pursue active strategy with respect to market components are called ‘market timers’.

The managers may indulge in ‘group rotations’.

Group rotation means changing the investment in different industries stocks depending on the assessed expectations regarding their future performance.

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5. Portfolio Evaluation

• This phase involves the regular analysis and assessment of portfolio performances in terms of risk and returns over a period of time. During this phase, the returns are measured quantitatively along with risk born over a period of time by a portfolio. The performance of the portfolio is compared with the objective norms. Moreover, this procedure assists in identifying the weaknesses in the investment processes.

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THANK YOU……

H.A.KHAN