One of the tenets of technical analysis is `price discounts everything’. To accept this tenet, one needs to spend at least a few years poring over the industries and companies’ performance data, trying to correlate the stock price moves to such numbers. This cumbersome exercise will finally lead to dawning of the ultimate truth – price movement in stock markets is not always rational.
That is the reason why most technical analysts believe that study of the market price is sufficient in forecasting the future trend in prices. If the stock is in an uptrend, it means that the factors affecting the price are bullish – so demand is greater than supply. The reverse is true in a downtrend i.e. the factors affecting the price are bearish – so supply is greater than demand.
Many a time charts tend to give advance signals prior to the news outbreak to the public. If we consider the ongoing talks about Bharti Airtel acquiring a stake in Johannesburgbased MTN, the news was reported in the media on May 6 on which day, Bharti crashed 5 per cent. But the stock had already hit key resistance levels and given a sell signal on April 28. Followers of technicals could have opened a short position well before the down-move. Chart 1 depicts the daily chart movement in Bharti.
Let us consider another recent example. The stock price of BASF moved up sharply from Rs 208 to Rs 258 between
May 8 and May 13. However, the news of the parent company planning to make an open offer to the Indian public was publicised only on May 15.
One of the reasons for the superiority of the study of market action is the inefficient nature of our stock markets where information is not disseminated evenly to all. Insiders who buy and sell based on news and information that is known to a select few cause signals to crop up in advance in charts.
But this tenet is not infallible. Market action is at times entirely manipulative and undertaken by unscrupulous entities with the sole intention of luring na‹ve investors into the counter. Technical indicators give false signals in such phases. There are two ways in which such stocks can be dealt with. The easier recourse would be to avoid trading in them. The second way out would be to move in and out of such stocks quickly, i.e. keep booking profits at every ascent.