Is Technical Analysis the Holy Grail of Short Term Trading?

IS TECHNICAL ANALYSIS THE HOLY GRAIL OF SHORT TERM TRADING?

Introduction :

Let’s start by defining what technical analysis is. Technical analysis is a method which focuses on understanding the market sentiment behind the price trends rather than analyzing a security’s fundamental attributes. It involves the study of past market data, primarily price and volume using charts as the primary tool.

Let’s take an example: Say the stock of Reliance is trading a ₹ 1000/- and a technical analyst has recognized a pattern and given an intraday target of ₹ 1040/- for the stock with a stop loss of ₹ 980/-. It means that the trader has to buy a stock at the current market price of ₹ 1000/- and sell the stock if it reaches ₹ 1040/- making a profit of ₹ 40/- per share. He also has to sell the stock if it reaches ₹ 980/- incurring a loss of ₹ 20/-.

Now this approach has often been criticized ( Benjamin Graham , The Intelligent Investor ) or appreciated ( Jim Cramer , Get Rich Carefully ) by academicians and theorists. Nonetheless this approach is prevalent. In fact, investors or traders are amazed how technical “ experts “ are able to make such profits in such a short span of time and as a result start following them blindly, especially in a country like ours, where investor knowledge is low. Now the billion dollar question is:

DOES IT REALLY WORK?

Motivation :

As MBA students who want to make a future in finance, we want to test these unknown waters and study the same in depth.  This research is to conduct an experiment which involves creating a portfolio based on the recommendations of technical experts who give intraday and BT/ST calls. The returns of this portfolio will be compared to the market returns of that period.

This will give us an insight as to where the fault lies. Is it because of the fact that the experts are underperforming or are the traders clouded by their own judgements and perceptions.

Furthermore we would also research whether investors or traders who have market positions follow these technical recommendations or not.

Research Questions :

1. Are you a long term investor or short term trader?
2. If you are a short term investor, do you follow tips by market experts?
3. If yes, have you made profits or losses on these tips?
4. What do you think is a better strategy? Fundamental or Technical.

Literature :

Technical Analysis has been into existence for almost a century now, with William P Hamilton being able to predict day to day fluctuations in prices and starting the trend. However, Charles Dow is the name we tend to associate when it comes to technical analysis. Technical analysis is used to create positions on a short to medium term. For the sake of clarity and simplicity, we are just focusing on intraday and BT/ST calls.

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