Chapter 15

1. Lecture Presentation Softwareto accompanyInvestment Analysis and Portfolio ManagementEighth Editionby Frank K. Reilly & Keith C. Brown Chapter 15

2. Chapter 15Technical Analysis Questions to be answered: • How does technical analysis differ from fundamental analysis? • What are the underlying assumptions of technical analysis? • What major assumption causes a difference between technical analysis and the efficient market hypothesis?

3. Chapter 15Technical Analysis • What are the major advantages of technical analysis compared to fundamental analysis? • What are the major challenges to the assumptions of technical analysis and its rules? • What is the logic for the major contrary opinion rules used by technicians?

4. Chapter 15Technical Analysis • What are some of the significant rules used by technicians who want to “follow the smart money” and what is the logic of those rules? • What are the breadth of market measures and what are they intended to indicate? • What are the types of price movements postulated in the Dow Theory and how are they used by a technician?

5. Chapter 15Technical Analysis • Why is volume of trading important and how do technicians use it? • What are support and resistance levels and how are they used? • How do technicians use moving-average lines to detect changes in trends?

6. Chapter 15Technical Analysis • What is the rationale behind the relative strength line for an industry or a stock and how is it interpreted? • How are bar charts different from point-and-figure charts? • What are some uses of technical analysis in foreign security markets? • How is technical analysis used when analyzing bond?

7. 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

8. Underlying Assumptions of Technical Analysis 3. Disregarding minor fluctuations, the prices for individual securities and the overall value of the market tend to move in trends, which persist for appreciable lengths of time 4. Prevailing trends change in reaction to shifts in supply and demand relationships. These shifts, no matter why they occur, can be detected sooner or later in the action of the market itself.

9. 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

10. 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

11. Challenges to Technical Analysis • Assumptions of Technical Analysis • Empirical tests of Efficient Market Hypothesis (EMH) show that prices do not move in trends • Technical Trading rules • The past may not be repeated • Patterns may become self-fulfilling prophecies • A successful rule will gain followers and become less successful • Rules require a great deal of subjective judgement

12. Technical Trading Rules and Indicators • Stock cycles typically go through a peak and trough • 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

13. Typical Stock Market Cycle Stock Price Exhibit 15.2

14. Typical Stock Market Cycle Stock Price Exhibit 15.2 Declining Trend Channel Peak Flat Trend Channel Sell Point Rising Trend Channel Declining Trend Channel Buy Point Buy Point Trough Trough

15. Contrary-Opinion Rules • Many analysts rely on rules developed from the premise 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

16. 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

17. 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)

18. Other Market Indicators • Momentum Indicators • Breadth of market • Advance-decline • Diffusion index • Short interest • Stocks above their 200-day moving average • Block uptick-downtick ratio

19. Stock Price and Volume Techniques • The Dow theory – oldest technical trading rule • 1. Major trends are like tides in the ocean • 2. Intermediate trends resemble waves • 3. Short-run movements are like ripples • Importance of volume • Ratio of upside-downside volume • Support and resistance levels • Moving average lines

20. 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

21. Technical Analysis of Foreign Markets • Foreign stock market series • Technical analysis of foreign exchange rates • Technical analysis of bond markets

22. http://www.mta.org http://www.bigcharts.marketwatch.com http://www.stockcharts.com The InternetInvestments Online

23. End of Chapter 15 • Technical Analysis

24. Future topicsChapter 16 • Equity Portfolio Management Strategies