Transcript MARKET EFFICIENCY

MARKET EFFICIENCY - THREE FORMS
Weak form - random walk
•
past prices hold no information about future prices
•
can't beat buy/hold strategy
•
much evidence to support including correlation
tests, filter test - fail
Semi-strong form
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all publicly available information is immediately
reflected in price.
SEMI-STRONG FORM
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subsumes weak form since price data is publicly
available
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assumes rational investors seek information
impound quickly.
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result - prices may rise or fall with few trades - few
chances to make money
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quite a bit of information such as stock split and
earnings information are impounded quickly.
EXAMPLE: Yield curve misalignment in US. Treasury
market - takes 15 seconds to correct.
STRONG FORM
•
all relevant information reflected in stock prices
due to insiders, specialists
•
evidence shows announcements of important
information often anticipated beforehand.
•
implies outside investors should buy and hold
market.
MARKET EFFICIENCY - PROPERTIES
•Market is not always correct - just unbiased
and usually close to correct
•Price changes are independent and random - prices adjust
rapidly to new information
•Much available information
•Liquidity - price continuity - SEC & Fed
watches
•Low transaction costs
IMPLICATIONS OF MARKET EFFICIENCY
Investors should
•
define risk level
•
hold a diversified portfolio that is a combination of
the market portfolio and risk free assets
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minimize trading transaction costs
Example: May 27, 1968, submarine USS Scorpion declared missing
with 99 men within a 20 mile circle of Atlantic ocean. After 5 months
searching, it could not be found. Navy scientist, John Craven found the
sub after asking 30 submarine salvage experts to guess where it was
based on the data available. They found the sub 220 yards away from
the average guess (no one survived).
Do Bean Jar – if too many students – assume 50 above and 50
below true value as the range where the average guess falls. Ask
them to raise hands – who thinks below X, who thinks above Y
THREE FACTORS MAKE IT DIFFICULT TO TELL
WHETHER THE MARKET IS EFFICIENT
•Market variance is so large, superior investment
performance must be very large before it is
statistically significant.
•Selection bias - those with profitable investment rules do
not reveal them, hence, we can't be sure that some
managers are profitable. – Note Broker’s Trick.
•Luck - by chance some will have superior performance.
QUESTION: Some stocks have very high returns and
others very low returns even after adjustment for risk. Is
this evidence of market inefficiency? No, because some
firms may do surprisingly well for some periods.
TECHNICAL ANALYSIS
•Fundamental analysis - what we've done up to
now - economy, industry, company information.
•Technical analysis - use past price and trading
volume to predict future price.
•Technical Analysis is popular, perhaps because it is very
visual and intuitive - analysts use charts
DOW THEORY - BEST KNOWN
TECHNICAL THEORY
•THREE TIME TRENDS
primary trend
intermediate trend
short term corrections - day to day
•TWO DIRECTIONAL TRENDS
bull trend - higher highs
bear trend - lower lows
Dow Jones Industrial Index
Dow Jones Transportation Index
4000
New highs made without making significant new lows
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2000
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u 1000
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0
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Year
There is a primary bull trend from 1982 to 1994
92
93
94
Dow Jones Industrial Index
Dow Jones Transportation Index
3000
I
n
d 2000
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V
a
1000
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Index continues to make new lows without making new highs
0
90
91
Year
Within the primary bull trend there is an intermediate bear trend from mid-1989 to 1991
Dow Jones Industrial Index
Dow Jones Transportation Index
3000
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x
2000
v
a
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e
1000
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5
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7 10 11 12 13 14 17 18 19 20 21 24 25 26 27 28 31
Day in July 1989
Within the intermediate bear trend is a short-term bull trend
The Dow Transport index should make similar movements
to the dow industrials to confirm trends.
QUESTION: What is the rationale for this? Goods
transported before being sold so transportation
stocks move first.
QUESTION: Why do fewer technical analysts rely on
transport confirmation? Service sector growth
VOLUME ANALYSIS - SUPPLY/DEMAND
•Large volume signals turning points followed by weak
volume.
• Volume goes with trend
Bull market
- prices up on high volume
-prices down on low volume
Bear market
-prices up on low volume
-prices down on high volume
PROBLEMS WITH DOW THEORY
•Often late in identifying major trends
•Not much help for short term trader - or which stocks to
buy.
BASIS FOR TECHNICAL ANALYSIS
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Supply-demand determine price
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Both supply & demand are affected by rational and
irrational factors.
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Prices move in trends - trends persist because price
adjustments to new information takes time
INVESTMENT ADVANTAGES OF
TECHNICIANS
•Aren't required to get good fundamental information and
process quickly, this is difficult.
•Just interpret price and volume movements to get
information indirectly, don’t care about what a company
does.
•No need to decipher financial statements that are biased.
OTHER TECHNICAL THEORIES
•Short interest - signals latent demand - not supported
•Odd lot Theory - small investors trade incorrectly
- not supported
•New High / New Low - Bull => increase New high,
decrease new low lagging, not leading indicator
•Moving average - compare to actual, a momentum
indicator like rate of change analysis
- when actual falls below rising average - bear
- when actual rises above rising average - bull
•Advance / Decline (Breadth)- a reading of general market
•Mutual Fund Cash Position - latent demand - actually a
concurrent indicator.
•Contrary opinion - must be different to make money evidence? - only at certain times.
•Call / Put ratio - usually more calls - increase in puts is
bearish.
•Inside Information Indicators
- insider sell / buy ratio - since many companies pay
in shares - expect some to sell, if none sell - bullish
- buy / sell differential by NYSE members
- short selling by specialists
TECHNICAL ANALYSIS CAN BE APPLIED
TO INDIVIDUAL STOCKS
•PRICE LEVELS
resistance levels
support levels
•PRICE FORMATIONS
hard to tell one from another
their use reflects individuals effort to see pattern in
randomness, tests show people see patterns in
random generated pictures general trends and
sideways movements
Weekly Hi-Lo Ranges for Dial Corp's Stock Price
25
D
24
i
a
l 23
near-term resistance
secondary resistance
S
t 22
o
c
k 21
P
20
r
i
c 19
e
near-term support
secondary support
18
1993
1994
1995
A technical analyst would recommend buying Dial's stock at $20 and selling it at $24
Websites for Technical Analysis
1. Futuresource.com – has examples of formations and
trendlines.
2. Prophetfinance.com – use Prophet JavaCharts for
drawing in trendlines – interactive.
3. Stockcharts – has MarketCarpets that give a visual
of how sectors are doing day-to-day.