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TECHNICAL%20ANALYSIS

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How is technical analysis used when analyzing bond markets? ... on past price and volume data for individual stocks and the overall stock market. ... – PowerPoint PPT presentation

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Title: TECHNICAL%20ANALYSIS


1
Chapter 16
  • TECHNICAL ANALYSIS

2
Chapter 16 Questions
  • 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?
  • What are the major advantages of technical
    analysis compared to fundamental analysis?

3
Chapter 16 Questions
  • What are the major challenges to technical
    analysis and its rules?
  • What is the logic for the major contrary-opinion
    rules used by technicians?
  • 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?

4
Chapter 16 Questions
  • What are the three types of price movements
    postulated in the Dow Theory, and how are they
    used by a technician?
  • Why is the volume of trading important and how do
    technicians use it?
  • What are support and resistance levels and how
    are they used by technicians?

5
Chapter 16 Questions
  • How do technicians use moving-average lines to
    detect major changes in trends?
  • What is the rationale behind the
    relative-strength line for an industry or a
    stock?
  • 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 markets?

6
Technical Analysis vs. Fundamental Analysis
  • Technical analysis involves the development of
    trading rules based on past price and volume data
    for individual stocks and the overall stock
    market.
  • Fundamental analysis involves economic, industry,
    and company analysis that lead to valuation
    estimates for companies, which can then be
    compared to market prices to aid in investment
    decisions.

7
Technical Analysis
  • To non-believers, technical analysis can sound
    like a lot of focus-pocus!

8
Underlying Assumptions of Technical Analysis
  • Trading via technical analysis involve a number
    of assumptions about markets
  • The market value of any good or service is
    determined solely by the interaction of supply
    and demand
  • Supply and demand are governed by numerous
    factors, both rational and irrational

9
Underlying Assumptions of Technical Analysis
  • Technical analysis assumptions
  • 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
  • Prevailing trends change in reaction to shifts in
    supply and demand relationships and these shifts
    can be detected in the action of the market

10
Advantages of Technical Analysis
  • Unlike fundamental analysis, technical analysis
    is not heavily dependent on financial accounting
    statements
  • Problems with accounting statements
  • Lack information needed by security analysts
  • GAAP allows firms to select reporting procedures,
    resulting in difficulty comparing statements
    between firms
  • Many psychological and other non-quantifiable
    factors do not show up in financial statements

11
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
    to correct prices as quickly

12
Challenges to Technical Analysis
  • Challenges to basic assumptions
  • Empirical tests of Efficient Market Hypothesis
    (EMH) show that prices do not move in trends
  • Challenges to technical trading rules
  • Rules that worked in the past may not be repeated
  • Patterns may become self-fulfilling prophecies
  • A successful rule will gain followers and become
    less successful
  • Rules all require subjective judgement

13
Technical Trading Rules and Indicators
  • Stock cycles typically go through a peak and
    trough
  • For instance, consider the following stock price
    graph over time, and then consider how a
    technical analyst would interpret the chart

14
Typical Stock Market Cycle
Stock Price
15
Typical Stock Market Cycle
Stock Price
Declining Trend Channel
Peak
Flat Trend Channel
Sell Point
Rising Trend Channel
Declining Trend Channel
Buy Point
Buy Point
Trough
Trough
16
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

17
Contrary-Opinion Rules
  • Mutual fund cash positions
  • Buy when the mutual fund cash position is high,
    sell when low
  • Assumes that mutual fund managers are poor judges
    of market turning points
  • Credit balances in brokerage accounts
  • Buy when credit balances increase, sell when
    credit balances fall
  • Investment advisory opinions
  • Buy when advisory firms become more bearish

18
Contrary-Opinion Rules
  • OTC versus NYSE volume
  • If OTC volume increases relative to NYSE volume,
    sell since speculation increases at peaks
  • Chicago Board Options Exchange (CBOE) put/call
    ratio
  • Buy when option purchasers are bearish (when the
    put/call ratio increases)
  • Futures traders bullish on stock index futures
  • Sell when speculators are bullish

19
Follow the Smart Money
  • While contrary-opinion rules assume that most
    investors are not smart, these indicators seek to
    follow the path of sophisticated, and assumed
    smart, investors
  • The Barrons Confidence Index
  • Measures the yield spread between high-grade
    bonds and a large cross section of bonds
  • Declining (increasing) yield spreads increase
    (decrease) this index, and are a bullish
    (bearish) indicator

20
Follow the Smart Money
  • T-Bill - Eurodollar yield spread
  • Decreases in this spread indicates greater
    confidence, and is a bullish indicator
  • Debit balances in brokerage accounts
  • Such balances represent buying on margin, which
    is assumed to be done by largely sophisticated
    investors
  • Increases are a bullish signal

21
Momentum Indicators
  • These indicators are meant to gauge overall
    market sentiment
  • Breadth of market
  • Advance-decline (number of advancing minus the
    number of declining issues)
  • Stocks above their 200-day moving average
  • Technicians use moving averages to compute
    general trends, and evaluate current stock prices
    relative to those trends

22
Stock Price and Volume Techniques
  • The Dow theory
  • Major trends are like tides in the ocean
  • Intermediate trends resemble waves
  • Short-run movements are like ripples
  • Key is to identify the nature of a current price
    movement
  • Importance of volume
  • Ratio of upside-downside volume
  • Price movements are not very important unless
    they are confirmed by volume

23
Stock Price and Volume Techniques
  • Support and resistance levels
  • Support level the level that a price is unlikely
    to decline below when price reaches the support
    level, demand surges for the stock
  • Resistance level the level that a price is
    unlikely to rise above when price reaches the
    resistance level, we observe selling or profit
    taking
  • Movements below (bearish) and above (bullish)
    this range provide indicators

24
Stock Price and Volume Techniques
  • Moving average lines
  • Moving average prices are calculated and track
    for several different time periods
  • When the shorter-term moving average line is
    consistently above the longer-term line, it is
    considered a bullish signal

25
Stock Price and Volume Techniques
  • Relative-strength (RS) ratios
  • For individual stocks and industry groups
  • Measure relative price changes across different
    stocks or industries
  • Other Indicators
  • Bar charting
  • Multiple indicator charts
  • Point-and-figure charts
  • Idea is to get an overall feel from numerous
    technical indicators

26
Technical Analysis of Foreign Markets
  • Some foreign market data is more limited than
    U.S. market data
  • Greater reliance on stock and volume data
  • Merrill Lynch publishes various indicators for
    several countries
  • Technical analysis of foreign exchange rates
  • Traders look for trends in exchange rates that
    could give rise to profit opportunities

27
Technical Analysis of Bond Markets
  • Many of the same indicators and trading rules can
    be applied to bond markets
  • Generally not possible to get bond market volume
    data
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