10.6 Predicting the market

Predicting market movement

Obviously the most important challenge for any investor or market player is predicting the stock market. Technical analysts use various past data to predict the behavior of the future market. Given the Indian method of data collection, one may also use the following methods to understand future market movement:

1. Price vs. Volume change
2. Advance decline lines
3. New high and new low indicator
4. Use of derivative data selectively

Price versus Volume Change:

Technical analysts believe that price and volume are closely related. There are four rules for price versus volume change:

1. A rising index with an increasing volume will indicate a bullish market and a ‘buy’ signal as it reflects unsatisfied demand in the market
2. A falling index with decreasing volume shows a bullish signal
3. When volume tends to increase as the index declines, it is a bearish signal
4. When volume tends to decrease as the index rises, it is a bearish signal

As the BSE/NSE provides daily volume data, by plotting volume as well as market index one can draw an inference about the market movement. Similarly, you can plot the volume data of individual securities along with their price movement chart to find a ‘buy’ or ‘sell’ signal.

Advance-Decline Line:

Every day a number of securities advance from its previous closing rate. Similarly, several of them fall from the previous day’s closing price. The cumulative net difference between the number of issues advanced and declined is used as an indication of the breadth of the market. When such data is plotted, it is called an advance-decline line.

A hypothetical situation is given here to show how it is arrived at. Note that the sign change (plus or minus) has nothing to do with actual figures. It simply shows the direction. Analysts generally specify the initial cumulative rate - a very large number, say 25,000 - so as to keep the cumulative difference positive. If you plot it on a daily basis, you will get the advance-decline line. For analysis, you have to view the advance-decline line against the plot of the BSE index.

The rules are as follows:

1. A rising BSE index with a falling advance-decline line indicates that in spite of a rise in about 30 blue chips in the BSE index, many small stocks are beginning to turn down. This is an indication of a weakening market and gives a bearish signal.
2. A fall of BSE index with a rising advance-decline line gives a bullish signal
3. Technical analysts also believe that when the cumulative number of advances exceeds declines by 2,000 over a ten-day period, the market may be ‘overbought’, meaning that it is susceptible to some reactions. Similarly, if the cumulative number of declines exceeds advances by 2,000 over a ten-day period, the market may soon have a rebound. If you are keen about plotting this chart, you can refer to the newspaper The Economic Times, which gives the daily share market advance-decline data.

New-High and New-Low Indicator:

A rising market should normally view an expanding number of stocks hitting new high prices and decreasing new low prices. (We have already mentioned 52-week low and high prices and it’s available on any stock on BSE/NSE websites) Conversely, a declining market is usually accompanied by an increasing number of new lows and a decreasing number of new highs. Many technical analysts believe that when the movement of new-high and new low data diverges from the movement of market index, the movement of the former will usually provide a clue for the future price movement. For example, see the data table below: This has been taken from http://in.fi nance.yahoo.com/advances. You can see such tables on various websites such as Google and others which give you an indication of market moment.