1. Chapter 16 Technical Analysis

2. Chapter Summary • Objective: To examine the basic principles of technical analysis and show how they relate to the efficient market hypothesis. • Charting • Technical indicators

3. Technical Analysis • An attempt to exploit recurring and predictable patterns in stock prices • Technicians’ beliefs: • Shifts in market fundamentals can be discerned before their impact is fully reflected in prices • Market fundamentals can be perturbed by irrational factors • These presumptions are in contradiction with the weak form of the EMH

4. Charting • The Dow theory • Primary trend • Secondary or intermediate trends • Tertiary or minor trends • Support and resistance levels • Recent variations • The Elliot wave theory • The theory of Kondratieff waves

5. Other Charting Techniques • Point and figure charts • The figure has no time dimension • It traces significant upward or downward moves in stock prices • Candlestick charts • Used to summarize price data • Aid in identification of trends

6. Summary Reminder • Objective: To examine the basic principles of technical analysis and show how they relate to the efficient market hypothesis. • Charting • Technical indicators

7. Technical Indicators • Sentiment indicators • Flow of funds indicators • Market structure indicators

8. Sentiment indicators Trin statistic or:

9. Sentiment Indicators (cont’d) • Odd-Lot trading • Confidence Index • Put/Call ratio • Mutual fund cash position

10. Flow of Funds Indicators • Short interest – total number of shares of stock currently sold short in the market • Some technicians interpret high levels of short interest as bullish, some as bearish • Credit balances in brokerage accounts

11. Market Structure Indicators • Moving averages • Breadth • The most common measure – the spread between the number of stocks that advance and decline in price • Relative strength • The ratio of the price of the security to a price index for the industry

12. The Value Line System • Value Line ranks 1,700 publicly traded stocks according to their anticipated 12 months price appreciation. • Components of the stock ranking procedure: • Relative earnings momentum • Earnings surprise • A value index

13. Can Technical Analysis Work? • Self-destructing patterns • Once a useful technical rule is discovered, it ought to be invalidated once the mass of traders attempts to exploit it • A new view of technical analysis • Brown and Jennings propose a more complex framework than the EMH • They envision an economy where many investors have private information regarding the value of a stock