Transcript Lecture Presentation to accompany Investment Analysis

Chapter 13
Technical Analysis
Underlying Assumptions
of Technical Analysis
1. The market value of any good or
service is determined solely by the
interaction of supply and demand.
2. Supply and demand are governed
by numerous factors, both rational
and irrational.
2
Underlying Assumptions
of Technical Analysis
3.The prices for individual securities
and the overall value of the market
tend to move in trends.
4.Prevailing trends change in reaction
to shifts in supply and demand
relationships
5.These shifts can be detected in the
action of the market
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Technical View of Price
Adjustment to New Information
Exhibit 13.1
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Advantages of Technical
Analysis

Not heavily dependent on financial
accounting statements
Problems with accounting statements:
1. Lack information needed by security
analysts
2. GAAP allows firms to select reporting
procedures, resulting in difficulty
comparing statements from two firms
3. Non-quantifiable factors do not show
up in financial statements

5
Advantages of Technical
Analysis


Fundamental analyst must process new
information and quickly determine a new
intrinsic value, but technical analyst merely
has to recognize a movement to a new
equilibrium
Technicians trade when a move to a new
equilibrium is underway, but a fundamental
analyst finds undervalued securities that may
not adjust their prices as quickly
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Challenges to Technical
Analysis

Assumptions of Technical Analysis

Empirical tests of Efficient Market
Hypothesis (EMH) show that prices do
not move in trends
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
Technical trading rules
The past may not be repeated
 Patterns may become self-fulfilling
prophecies (預言)
 A successful rule will gain followers and
become less successful
 Rules require a great deal of subjective
judgement.

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Technical Trading Rules
and Indicators
Stock cycles typically go through a
peak and trough(低谷)
 Analyze the following chart of a
typical stock price cycle and we will
show a rising trend channel, a flat
trend channel, a declining trend
channel, and indications of when a
technical analyst would want to
trade

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Typical Stock Market Cycle
Stock
Price
Exhibit 13.2
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Typical Stock Market Cycle
Stock
Price
Exhibit 13.2
Declining
Trend
Channel
Peak
Flat Trend Channel
Sell Point
Rising Trend
Channel Declining
Buy Point
Trend
Trough
Channel
Buy Point
Trough
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Contrary-Opinion
Many analysts rely on rules
developed from the hypothesis that
the majority of investors are wrong
as the market approaches peaks and
troughs
 Technicians try to determine whether
investors are strongly bullish or
bearish and then trade in the
opposite direction
 These positions have various
indicators

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Contrary-Opinion Rules
Mutual fund cash positions
 Credit balances in brokerage
accounts
 Investment advisory opinions
 OTC versus NYSE volume
 Chicago Board Options Exchange
(CBOE) put/call ratio
 Futures traders bullish on stock
index futures

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Time-Series Plot of Dow Jones
Industrial Average and the Bullish
and Bearish Advisory Services (1)
Exhibit 13.3
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Time-Series Plot of Dow Jones Industrial
Average and the Bullish and Bearish
Advisory Services (2)
Exhibit 13.3
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Time-Series Plot of Dow Jones Industrial
Average and the Bullish and Bearish
Advisory Services (3)
Exhibit 13.3
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Follow the Smart Money
Indicators showing behavior of
sophisticated investors
 The Barron’s Confidence Index
 T-Bill - Eurodollar yield spread
 Short sales by specialists
 Debit balances in brokerage
accounts (margin debt)

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Other Market Indicators
 Breadth
of market
 Advance-decline
 Diffusion
index
 Short
interest
 Stocks above their 200-day moving
average
 Block uptick-downtick ratio
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Stock Price and Volume
Techniques

The Dow theory – oldest technical trading
rule




Importance of volume



1. Major trends are like tides in the ocean
2. Intermediate trends resemble waves
3. Short-run movements are like ripples
Ratio of upside-downside volume
Support and resistance levels
Moving average lines
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Stock Price and Volume
Techniques
 Relative-strength
(RS) ratios
 For
individual stocks and industry
groups
 Bar
charting
 Multiple indicator charts
 Point-and-figure charts
 Overall feel from a consensus of
numerous technical indicators
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Sample Bullish Price Pattern
Exhibit 13.8
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Daily Stock Prices for Stryker Corp. with
Indications of Support and Resistance
Levels
Exhibit 13.9
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Daily Stock Prices for Concord EFS with 50-Day
and 200-Day Moving Average Lines and a 14Day Relative Strength Index Compared to the
S&P 500 Index
Exhibit
13.10
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How to Read Industry Group
Exhibit 13.11
Charts
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A Typical
Bar Chart
Exhibit 13.12
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Sample Point-and-Figure Chart
Exhibit 13.13
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