Topic X Behaviour of

Share Prices
(Technical
Analysis)

LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Explain the importance of Technical Analysis in forecasting the
dissection of future share prices;
2. Analyse the trends of share price movements;
3. Explain the three levels of market efficiency; and
4. Discuss the implications of Efficient Market Hypothesis on Security
Analysis.

X INTRODUCTION
In this topic, we will discuss another alternative to fundamental analysis of share
evaluation. Technical analysis is about forecasting the direction of future share
prices. Decisions are then made based on the forecast. Investors that rely solely
on technical analysis are sometimes known as Technicians. This topic also
discusses the Efficient Market Hypothesis.

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SELF-CHECK 6.1
In Topics 1 and 2, we were introduced to the concept of investment.
Based on your understanding of the investment concept, why do
people invest? What do they hope to achieve?

6.1

BASIC CONCEPTS OF TECHNICAL

ANALYSIS

Technical Analysis is a process that involves the examination of past data such
as share prices and volume of trading to forecast the direction of future prices.

It is based on these concepts as stated below:

(a)

Share price is based on demand and supply.

(b)

There are rational and irrational factors that will influence the demand and
supply.

(c)

The behaviour of prices tends to follow a trend that persists for a length of
time. This is sometimes known as a momentum. Prices do not adjust
suddenly and it will take some time before the price reaches its equilibrium.
Technicians therefore will make a decision that is early enough before the
price settles.

(d)

Another important feature is that the behaviour of price follows a certain

pattern. This pattern is thought to have happened in the past and is also
likely to occur again in the future. Technicians therefore study the present
and previous price behaviour.

6.2

TOOLS FOR TECHNICAL ANALYSIS

SELF-CHECK 6.2
We know that Technical Analysis is the process that involves the
examination of past data such as share prices and volume of trading
to forecast the direction of future prices. Based on earlier discussions
in the previous topic, how do investors obtain information on share
prices, trends, growth rates and others?

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93

Technicians tools in technical analysis can be divided into two main categories:
(a)

Market Statistics; and

(b)

Charts.

6.2.1

Market Statistics

Market statistics are summaries of the behaviour of the market and the price
movement of shares. Examples are as follows:
(i)

Market Volume
Market Volume measures the amount of investors interests in the market.
Volume is the number of shares traded in the market and its a reflection of
demand and supply. The market is considered to be strong if the volume is
high in a rising market. It is also considered strong when the volume is low
in a declining market. In the second situation technicians are expecting a
turnaround. The market is considered weak if the volume traded is high in
a declining market or low volume in a rising market.

(ii)

Breadth of the Market

Breadth of the Market measures the strength of the market in terms of the
number of shares that experience increase, decrease or no change in price.
The market is considered strong if the number of shares with increased
price is higher than the number of shares with declined price. The market is
weakening if the difference between the number of increase and decline is
getting closer.
This measure can sometimes be used as an early indicator of the strength of
the market. If the market index is rising but the number of declines is
higher than advances, then the rise in the index is not that strong. It may be
an indication of a weakening market.

6.2.2

Charts

Charts are visual summaries of the behaviour of the market and price
movements of shares.
It is the most frequently used tool by technicians. It can provide early indications
of developing trends and the future behaviour of the market.

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Charts are normally developed by registering the price of shares or index on a

time graph. The trend line can then be analysed.
The trends can be divided into:
(i)

Primary Trend
The primary trend is a long-term indicator of the price trend. If it is taken in
the perspective of the market, a rising primary trend is known as a bull
market while a declining primary trend is known as a bear market. (Please
refer to Figure 6.1).

Figure 6.1: Primary trends

(ii)

Secondary Trends
A secondary trend is a trend within the primary trend. In a rising primary
trend, there may be one or two secondary trends. Secondary trends occur
when the market declines for a while before resuming its rise. Sometimes it
is known as secondary movement.

The support line is a range of prices that analysts think will generate new
demand from investors. When this new demand goes into the market, the share
price will enjoy the next trend of price increase. Before this new demand, price
may appear to be stable or decline a little.

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The resistance line is the reverse; it is a situation where investors are waiting to
sell. Price may increase a little before this extra supply comes into the market. If
price at this resistance level cannot be maintained, then price will continue to fall.
Some commonly used charts in forecasting share price direction are:
(i)

The Bar Chart

A Bar Chart is formed by taking share prices in a specified time period. The
bar is formed by taking the highest, lowest and closing prices for the day.
The trend is then analysed. Figure 6.2 shows an example of the chart. We
can forecast the direction of the shares price by placing the resistance and
the support line on the chart.

(ii)

The Point and Figure Chart

This chart does not relate price to time. It illustrates price changes or
reversals in the direction of the price. However, it requires the analyst to
record the shares closing price on a daily basis. Figure 6.3 shows an
example of a point and figure chart. The chart is divided into columns. The
analyst will record the closing price in each space within a column. If there
is an increase in price, the record can be in a form of an X. If there is a
decrease in price, then the analyst shifts to the next column and indicates
the decrease with a 0 mark.

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ACTIVITY 6.1
Based on the chart, analyse the behaviour and price movement of
shares in Bursa Malaysia. You can then refer to The Star dated 15
December 2003 for the market analysis.

Source: The Star (2003).

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97

Figure 6.2: A bar chart

If we begin at Day 1, and the price is RM2, the first X will be in Column a. The
price continues to increase and peak at RM2.50 on Day 3. Then the price drops to
RM2.4. This is when we shift to Column b. The price continues to drop until Day
9. It goes up again in Day 10 where we will shift to Column c. The price
continues to increase until Day 20. The price drops to RM2.1 on Day 21. This will
indicate a shift to the next column, and so forth. As in the case of bar charts,
resistance and support lines can be placed on the point and figure chart to
forecast price.

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Figure 6.3: A point and figure chart

(iii) Moving Averages

A Moving Average line attempts to show a smooth general price trend. A
price trend can show a lot of volatility and offer a less meaningful insight.
There are several moving averages that can be used. Examples are 200 days
moving average or 200-MA. The 200-MA is determined by taking the
average of the previous 200 days prices. Obviously, we need 200 days of
prices before the first average can be calculated. Therefore, on the 201st day
we calculate the average of the previous 200 prices. On the 202nd day, we
take out the first days price from the calculation and include the 201st
price, and so on. So each time we will use 200 days.
Apart from showing a smooth trend line, the MAs can be used as support
or resistance lines. If the price is on the decline, the MA line will be above
the current price. If the price breaks through the MA line followed by heavy
volume, this may indicate a strong buying trend and prices may go up.
Figure 6.4 shows the trend for the Kuala Lumpur Composite Index (KLCI)
as well as its 50 days MA, from January 1990 to July 2003.

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Figure 6.4: Monthly KLCI and 50 A (January 1990 to July 2003)

6.2.3

Chart Formations

The effect of price changes due to demand and supply visualised in the form of
charts will provide formations and patterns. For example, some of these patterns
are given names like head and shoulders, pennants, scallops, and triangles.
Description of these formations is beyond this module. Knowing them is one
thing, interpreting them is another. And there is also no assurance that accurate
forecasts can be made. Figures 6.5 and 6.6 show the charts for Yeo Hiap Seng.
You are encouraged to make some observations.

Figure 6.5: Daily bar chart for YHS 100 days prior to 10 November 2003

100 X TOPIC 6 BEHAVIOUR OF SHARE PRICES (TECHNICAL ANALYSIS)

Figure 6.6: Daily price trend and 50 days MA for YHS 100 days prior to
10 November 2003

6.3

EFFICIENT MARKET HYPOTHESIS

The Efficient Market Hypothesis (EMH) stems from the idea that share prices
follow a random walk. This means share prices are unpredictable and
performing a security analysis will not help to forecast future prices.
Fama (1970) defines an efficient market as one in which prices fully reflect all
information.
Prices will be adjusted based on new information. New information, however, is
random and cannot be predicted. In an efficient market, there will be no
opportunity to obtain abnormal returns.
Investors will get returns from changes in prices. Prices will change due to new
information entering the market. If the price adjustment is correct and rapid, then
investors will not have the opportunity and the time to act. Therefore, there will
be no abnormal returns.

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6.3.1

Assumptions of the Efficient Market Hypothesis

(EMH)

There are three assumptions of the Efficient Market Hypothesis:

(a)

There are a large number of investors competing against one another and
analysing the value of securities.

(b)

Information that comes into the market is not predictable. The information
is random and there is no connection between one set of information and
another. This information must also be freely available to all investors.

(c)

Investors will react to the information rapidly and correctly.

6.3.2

Categories of Information

The above assumptions are almost similar to a perfect competition in terms of

receiving information. No one can prevent information from entering the market.
Therefore, the kind of information that is considered for analysis purposes can be
categorised into three types.
(a)

Previous market information. Previous price data, volumes traded in the

market, trends and charts.

(b)

Public information including company annual reports, economic and

industry reports and company news.

(c)

All information that is public and non-public. This will include all the
above plus all information that has not yet been made public. Examples of
non-public news are company strategies, mergers, and news on financially
distressed firms. This news is sometimes known as inside information,
because only the management of the companies know this information.
Any inside information that is obtained illegally and used to make profit is
an offence. This kind of practice is known as insider trading. In the Bursa
Malaysia and in most other stock exchanges, insider trading is illegal.

ACTIVITY 6.2
Visit the Bursa Malaysia website at http://www.bursamalaysia.com
and find more information about insider trading:
(a)

What is insider trading?

(b)

What is the punishment for it?

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6.3.3

Levels of Efficiency

In line with the three categories of information discussed in the previous section,
the market can be categorised into three levels of efficiency.
(a)

Weak Form
At this level of efficiency, prices of securities are said to reflect past
information. This means that analysing previous information is useless.
Investors studying previous prices, volumes traded and other market
information can make no abnormal profit.

(b)

Semi-strong Form
At this level, prices of securities fully reflect all publicly available
information from the past as well as the present. This level will encompass
the weak form level. This means that a market has to be in weak form
before it can be semi-strong. All information is reflected correctly and
quickly by the price. As such, although an investor has this information, he
is unable to make extra profit as the information is publicly known.

(c)

Strong Form
At this level, prices will fully reflect all information whether public or nonpublic. This information includes all company information that has not
been made public. Investors who have this information will not be able to
take advantage of it in order to get extra returns.

6.3.4

Efficient Market Hypothesis Implications

The EMH implies that if the market is efficient, it is pointless to perform any
security analysis. Technical analysis will be a useless exercise if the market is in
weak form efficiency since prices have fully reflected previous price behaviour. If
the market is in a semi-strong form, all economic and company events would
have been reflected in the price. Therefore, there is no point in performing a
fundamental analysis. Another implication is that no investor will obtain extra
returns without incurring extra cost and risks.
However, the fact that price must fully reflect all information and that this
information needs to be analysed shows that there is still a need to perform
analysis. By performing an analysis, the investor will also be able to separate
companies that are fundamentally strong from the weaker ones. Investors can
use this information to reduce their exposure to risk. In addition, there will be
investors who are willing to take risks. These investors need to perform analysis
and incur the extra cost.

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EXERCISE 6.1
1. The data below shows closing price for YHS for 60 days up till
10 November 2003. Prepare a point and figure chart of the prices.
Prepare a simple chart price against time and discuss it against the
point and figure chart.
1.80

1.90

1.83

1.81

1.84

1.90

1.82

1.81

1.82

1.83

1.83

1.80

1.82

1.82

1.83

1.80

1.80

1.84

1.78

1.79

1.82

1.85

1.83

1.86

1.82

1.88

1.81

1.83

1.82

1.86

1.82

1.82

1.86

1.86

1.81

1.90

1.89

1.83

1.84

1.91

1.86

1.83

1.85

1.90

1.88

1.84

1.83

1.90

1.89

1.88

1.82

1.90

1.88

1.90

1.82

1.89

1.86

1.92

1.80

1.90

10 November 2003

2. Price will fully reflect all information. What will happen to the
price of a stock if the company declares a rise in dividends?
3. Based on Question 2, when will the price begin to respond to the
news? Answer with respect to each level of the EMH.

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Technical Analysis is a process that involves the examination of past data such
as share prices and volume of trading to forecast the direction of future prices.

The Efficient Market Hypothesis (EMH) stems from the idea that share prices
follow a random walk are are unpredictable, and performing a security
analysis will not help to forecast future prices.

There are three levels of efficiency. They are:

(a)

Weak Form;

(b)

Semi-strong Form; and

(c)

Strong Form.