Essay: FORECASTING OF SECURITY PRICES USING RELATIVE STRENGTH INDEX

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“FORECASTING OF SECURITY PRICES USING RELATIVE STRENGTH INDEX (RSI)”

AT

SHRIRAM INSIGHT SHARE BROKER LTD

ABSTRACT

The relative strength index (RSI) is a technical indicator used in the analysis of financial markets. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading period.

The indicator should not be confused with relative strength. The RSI is classified as a momentum oscillator, measuring the velocity and magnitude of directional price movements. Momentum is the rate of the rise or fall in price.

The RSI computes momentum as the ratio of higher closes to lower closes: stocks which have had more or stronger positive changes have a higher RSI than stocks which have had more or stronger negative changes.

The RSI is most typically used on a 14 day timeframe, measured on a scale from 0 to 100, with high and low levels marked at 70 and 30, respectively. Shorter or longer timeframes are used for alternately shorter or longer outlooks. More extreme high and low levels—80 and 20, or 90 and 10—occur less frequently but indicate stronger momentum.

If the RSI is 70 or greater, then the instrument is assumed to be overbought (a situation in which prices have risen more than market expectations). An RSI of 30 or less is taken as a signal that the instrument may be oversold (a situation in which prices have fallen more than the market expectations)

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CHAPTER-1

INTRODUCTION

FORECASTING OF SECURITY PRICES USING RELATIVE STRENGTH INDEX METHOD

1.1 INTRODUCTION:

Security analysis is the analysis of tradable financial instruments called securities. These can be classified into debt securities, equities, or some hybrid of the two. More broadly, futures contracts and tradable credit derivatives are sometimes included. Security analysis is typically divided into fundamental analysis, which relies upon the examination of fundamental business factors such as financial statements, and technical analysis, which focuses upon price trends and momentum. Quantitative analysis may use indicators from both areas.

Technical analysis

Technical analysis is a method of predicting price movements and future market trends by studying charts of past market action. Technical analysis is concerned with what has actually happened in the market, rather than what should happen and takes into account the price of instruments and the volume of trading, and creates charts from that data to use as the primary tool. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments simultaneously.

Security charts are based on market action involving price. There are five categories in Security technical analysis theory:

• Indicators (oscillators, e.g.: Relative Strength Index (RSI)

• Number theory (Fibonacci numbers, Gann numbers)

• Waves (Elliott wave theory)

• Gaps (high-low, open-closing)

• Trends (following moving average).

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Fundamental analysis:

Fundamental analysis is a method of forecasting the future price movements of a financial instrument based on economic, political, environmental and other relevant factors and statistics that will affect the basic supply and demand of whatever underlies the financial instrument.

The fundamentalist studies the cause of market movement, while the technician studies the effect. Fundamental analysis is a macro or strategic assessment of where a currency should be trading based on any criteria but the movement of the currencies price itself. These criteria often include the economic condition of the country that the currency represents, monetary policy, and other “fundamental” elements.

Fundamental analysis focuses on what ought to happen in a market. Factors involved in price analysis: Supply and demand, seasonal cycles, weather and government policy.

Similarities between Technical and Fundamental Analysis:

Technical analysis and fundamental analysis both aim to help determine a buy-in price and sell price for a stock. By doing so, both analysis helps to reduce the probability of losing and increase the probability of winning.

Gambling dens earn by the concept of probability. So does technical and fundamental analysts. Technical analysts go for low risk high probability setups. Fundamental analysts reduce risks or increase probability of success by determining an intrinsic value for the company and enter with a margin of safety.

In practice, many market players use technical analysis in conjunction with fundamental analysis to determine their trading strategy. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments, whereas the fundamental analyst needs to know a particular market intimately.

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1.2 SCOPE OF THE STUDY:

Globalization of the financial market has led to a manifold increase in investment. New markets have been opened; new instruments have been developed; and new services have been launched. Besides, a number of opportunities and challenges have also been thrown open.

The role of research is to provide information to the market. A lack of information creates inefficiencies that result in stocks being misrepresented (over- or under-valued). Analysts use their expertise and spend time in analyzing a stock, its industry and its peer group to provide earnings and valuation estimates. Equity analysis is valuable because it fills information gaps so that each individual investor does not need to analyze every stock.

1.3 NEED FOR THE STUDY:

• Create awareness among investors about the Equity analysis .

• Understand the price behaviour of the selected companies traded in BSE/NSE

• Give knowledge to investors regarding RSI Tool.

• Also understand the Equity price behaviour using RSI Tool.

1.4 OBJECTIVES OF THE STUDY:

The basic idea behind undertaking security forecast project is to gain knowledge about security forecasting

• To study the basic concept of security forecasting.

• To understand the practical considerations and ways of considering equity price.

• To analyze security price behaviour of the selected industries.

• To study the current trend and trend of selected industry.

• To manage the security forecasting prices.

• To make suggestion based on Technical analysis tool RSI.

• To predict the day to day fluctuations in the stock market using Technical analysis.

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1.5 RESEARCH METHODOLOGY:

Type of the study:

The research has been based on secondary data analysis. The study has been exploratory as it aims at examining the secondary data for analyzing the previous researches that have been done in the area of technical and fundamental analysis of stocks. The knowledge thus gained from this preliminary study forms the basis for the further detailed Descriptive research. In

the exploratory study, the various technical indicators that are important for analyzing stock were actually identified and important ones short listed.

Problem Statement:

RSI (technical analysis) is the study of price movement and trend in markets in order to forecast future security prices, therefore investment timing plays a crucial role for trading in stock market. As the investors face difficulty while identifying the opportunities, so this analysis is directed towards the use RSI, which is one of the tool of technical analysis, which help the investor to analyse the prices and decide when to buy and sell.

Research Design:

The research design used in the study is analytical research. In analytical research the researcher has to use the facts or information available and analyse to make a critical evaluation of the material. As the research include analysis of the prices of shares, which is historical data and derive conclusions from it.

Sources of Data:

The data collection is done through the secondary data. The major source of the data is collected from websites of NSE and BSE. While the other data used in the study is collected from text books, business journals and periodicals, newspapers related to the stock market and from few websites which deal with the stock market.

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Sample size: –

3(Wipro, HCL and TCS) Companies are taken Security products selected for NSE/BSE. (IT is Most liquidity Industry in stock market)

1.6 Tools and Techniques:-

This Technical analysis is helpful to general investor in many ways. It provides

important & vital information regarding the current price position of the company.

Technical analysis involves the use of various methods for charting, calculating &

interpreting graph & chart to assess the performances & status of the price. It is the tool

of financial analysis, which not only studies but also reflecting the numerical & graphical

relationship between the important financial factors.

Usually the following tools & techniques are used to do the technical analysis:

Price Styles:

Price in a chart can be displayed in three styles: Bar, Line, and Candlestick.

Bar:

It gives the detailed information about every aspect.

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Line:

A line chart simply connects the closing prices from one period to the next. This type of chart is ideal for securities with no high or low price data i.e., mutual funds or that is even with the equity in case of base price.

Japanese Candlestick:

A candlestick is black if the closing price is lower than the opening price. A candlestick is white if the closing price is higher than the opening price.

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Japanese Candlestick:

2 Key Tools of Technical analysis : Charts, Indicators

Price charts:

A price chart is a sequence of prices plotted over a specific time frame. In statistical terms, charts are referred to as time series plots. Any security with price data over a period of time can be used to form a chart for analysis.

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The price chart of IBM is been taken as an example for better understanding, as technical analysts use charts to analyze a wide array of securities and forecast future price movements

Figure-1 (IBM)

On the chart, the y-axis (vertical axis) represents the price scale and the x-axis (horizontal axis) represents the time scale. Prices are plotted from left to right across the x-axis with the most recent plot being the furthest right. The price plot for IBM extends from January 1,2014 to March 13, 2015.

Indicators:

Technical Indicators are the other key tool in technical analysis. Technical indicators are graphical representations of various mathematical formulas based on the stock price and transaction volume. There are literally thousands of technical indicators out there and more are being developed daily as new finance theories are translated into mathematical formulas every day. Technical indicators’ main function is to tell when a stock is considered oversold or overbought and when a stock is considered weak or strong relative to its past action.

Statistical Tools: – 14 days Avg. Gain and Avg. Loss RSI.

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LIMITATIONS OF THE STUDY:

• The analysis was purely based on the secondary data. So, any error in the secondary data might also affect the study undertaken.

• This study has been conducted purely to understand Equity analysis for investors.

• The study is restricted to three companies based on technical analysis.

• The study is limited to the companies having equities.

• There was a constraint with regard to time allocation for the research study i.e. for a period of 45 days.

• I have taken only few companies for data analysis.

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CHAPTER-2

REVIEW OF LITERATURE

The Geography of Equity Analysis by CHRISTOPHER J. MALLOY*

Article first published online: 2 MAR 2005

I provide evidence that geographically proximate analysts are more accurate than other analysts. Stock returns immediately surrounding forecast revisions suggest that local analysts impact prices more than other analysts. These effects are strongest for firms located in small cities and remote areas. Collectively these results suggest that geographically proximate analysts possess an information advantage over other analysts, and that this advantage translates into better performance. The well-documented underwriter affiliation bias in stock recommendations is concentrated among distant affiliated analysts; recommendations by local affiliated analysts are unbiased. This finding reveals a geographic component to the agency problems in the industry.

Lo, Mamaysky, and Wang (2000) proposed a new approach to evaluate the efficiency of technical analysis. The authors applied the goodness of fit and kalmogorov – smirnov tests to the daily returns of individual NYSE/AMEX and NASDAQ stocks from 1962 to 1996 using data from the center for research in securities prices (CRSP). The authors found that certain technical patterns, when applied to many stocks over many time periods, do provide incremental information, especially from NASDAQ stocks. Authors‟ model suggested that technical analysis can be improved by using automated algorithms such as authors and traditional patterns such as head- end – shoulders and rectangles, although sometime effective, need not be optimal. By comparing the unconditional empirical distribution of daily stock returns to the conditional distribution conditioned on specific technical indicators such as head- end – shoulder or double- bottoms- authors found that over the 31 year sample period, several technical indicators do provide incremental information and may have some practical value.

Fernado, Christan, and Simon (2000) tested the profitability of simple technical trading rule based on Artificial Neural Network (ANN) model. They made a small study on „The Profitability of Technical Trading Rules based on Artificial Neural Network: Evidence from the Madrid Stock Market‟. Their results were based on applying this investment strategy to the General Index of the Madrid stock market, and suggested that, in absence of trading costs, the technical trading rule was always superior to buy-and-hold strategy for both the “bear” market and “bull” market and “stable” market. On the other hand, they found that the buy-and-hold strategy generated higher return than the trading rule based on ANN for a subperiod presenting upward trend (bull market).

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Author: James English

Published: 2001 It is already being called model of the future for the exchange of information between different countries. The chamber of representatives of the Belarusian Parliament on June 6 ratified the agreement on ensuring equal rights of citizens of Belarus and Russia to freedom of movement, choice of place of stay and residence on the territories of the States – parti. In particular, under the control of the state Corporation moved Svyaz – Bank and Globex. Interior 2009, en el sector. Dinge ber mich, meine. Forty kilometres about 25 miles from Bolgatanga, along the Burkina Faso border, is Paga, home to the Sacred Crocodile Ponds.

The author presents the theory of portfolio choice from a new perspective, recommending decision rules that have advantages over those currently used in theory and practice. Gives a comprehensive overview of creating 3d animations for the web. Some of you reading this book might find that you have all the qualifications needed, besides applied while others may become easily discouraged. Clare is married with three small children, she bakes her own bread and buys her clothes from the charity shop. Org en Arranmore Island; apart from wall images ArranmoreIsland and street.

In July, when the stakes were also left without changes, the Bank President Jean – Claude Trichet Jean – Claude Trichet reiterated that, because of professionals with time, the probability of increase of the rate will grow. His release will take place in the end of 2010, but the exact date of the beginning of sales of the game has yet to be announced. Karpin appreciated the opponents of Spartacus in the Champions League. Where can I get money changed.

Lai, Balachandher, and Nor (2001) examined the predictability of technical trading rules on the daily returns of the Kuala Lumber Stock exchange composite index for the full sample period from January 1977 to December 1999, which includes both bull abs bear periods. The random walk model was tested by applying the variance ratio and the multiple variance ratio tests on the market returns. After testing for random walk in Malaysian stock market, the predictability of two technical trading rules of the variables, length moving average (FMA) rule was examined. The results indicated non- random loss of successive prices changes. The findings indicate no random walk in the KLSE and 51 imply a potential for technical trading rules to generate above average returns. This was verified by the predictability of FMA and VMA rules examined in this study and the significantly positive returns generated by these rules even in the presence of trading cost.

Sehgal and Garhyan (2002) evaluated whether share recommendation based on technical analysis provide abnormal returns in the Indian capital market. Several returns measures have been employed including those adjusted for market trend, risk and transaction costs. The study involved 21645 recommendations for 21 companies using 13 technical indicators.

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The mean return was found statistically significant for the total period. But the gains disappear in the case of market adjusted measures. The returns were found significant for the risk- adjusted measures and also after the adjustment for transaction costs.

Moube and Jannach (2003) tried to find out which of the concepts of fundamental analysis were the most important factors and indicators for the asset managers basically for everyone questioned the first factor of look at the financial state of the company, which was usually determined by such ratios as return easy returns, sales development, future earnings, stability of balance sheets dept easily, equity ratio). Besides, majority of respondents mentioned such key valuation concepts as price to earning and price to book value.

Avadhut_Nigudkar article on “equity research career article was published in 2005

Majority of you may not know the reason. I have an answer for you. The Equity Research Career needs a structured planning. You should not have a short-term vision for this as you cannot afford to have a short-term vision for long-term benefits. Plan your career in such a way that you do not need to find a job. What is the difference between “Job Hunting” and “Career Planning”? I will tell you the difference. Career is a long-term strategy whereas getting a job is a short-term need. Only passionate and skilled people make a mark in equity research area. You need to invest your time and energy to acquire the right skills.

What are the skills required to be successful in equity research area?

Here is the list of skills:

1. Knowledge of Income statement, Balance Sheet and Ratio Analysis

2. Fundamental Analysis

3. Financial Forecasting and Modeling

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