Technical analysis: Relevance and reliability in our capital market

Md. Rezaya Rabbi Prices of securities in stock market fluctuate daily on account of continuous buying and selling. Every investor wants to buy securities at a low price and sell them at a high price so as to set a good return on his investment. He, therefore, tries to analyse the movement of share prices in the market. Fundamental and technical analysis are commonly used for this purpose. Fundamental analysis is the determination of intrinsic value of a share, based on current and future earnings capacity whereas technical analysis concentrate on historical share price, trade volume, market indice and tries to forecast future movement of share price. The philosophy behind technical analysis is in sharp contrast to the efficient market hypothesis (EMH). This hypothesis states that the capital market is efficient in processing information. An efficient capital market is one where prices fully reflect all available information. The capital market is considered to be efficient in three different forms: the weak form, semi-strong and strong form. Among them, the weak form from efficient market perspective repudiates technical analysis. The weak form of the EMH says that current prices of stocks already fully reflect all the information that is contained in the historical sequence of prices. Therefore there is no benefit in studying historical sequence of prices to gain abnormal returns from trading in securities. Now we need to know Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE) to understand which form of efficient market hypothesis is involved there. Most of the research conducted on Bangladesh capital market concluded that both of the exchanges are not efficient in weak form. Our exchanges do not follow random walk theory and it is possible to make abnormal profit by trading at a specific pattern on a regular basis. All the results provide strong support for, and illustrate significance of, technical analysis in Bangladesh capital market. There are over 5000 technical trading rules used in the analysis. Those who doubt the value of technical analysis (TA) for investment decision question the usefulness of these rules. Over the years hundreds of studies have been conducted to test the efficacy of technical trading rule. The majority of the studies concluded that positive result could be gained from using technical analysis. Dhaka stock exchange is one of the emerging markets and there is evidence that technical trading rules perform better in an emerging market than a developed market. But like any other practical discipline, especially one working with an indefinite and fickle subject such as the marketplace, technical analysis has problems. It has many flaws, is difficult to learn, is subject to error and bias, and often falls on its face. Nevertheless, technical analysis can be extremely useful to investors wishing to profit from timing and trend-riding while limiting risk. Fundamental analysis helps in identifying undervalued or overvalued securities. But technical analysis helps in identifying the best timing of an investment, i.e, the best time to buy or sell a security identified by fundamental analysis as undervalued or overvalued. Thus, technical analysis may be used as a supplement to fundamental analysis rather than as a substitute to it. The two approaches, however, differ in terms of their database and tools of analysis. Fundamental analysis and technical analysis are two alternative approaches to predicting stock price behaviour. Neither of them is perfect nor complete by itself. The writer is an MBA and at Department of Finance, Dhaka University. He can be reached at e-mail : reyad_rabbi@yahoo.com