Technical Analysis Lec1-Investment Managment And Portfolio-Lecture Notes, Study notes of Investment Management and Portfolio Theory

Download Technical Analysis Lec1-Investment Managment And Portfolio-Lecture Notes and more Study notes Investment Management and Portfolio Theory in PDF only on Docsity! y g ( ) Lesson # 8 TECHNICAL ANALYSIS Technical analysis is entirely different from the fundamental approach to "security analysis”. Consider the following quotations from popular press articles on technical analysis: "Engage a technical analyst in a conversation about his art, and you soon feel you're in the shadowy saloon from Star Wars, where freakish aliens lounge about speaking strange languages." "Spend some time with a technical analyst and you almost need a Technical-to-English translation guide. Conversations art full of references to support and resistance levels, Fibonacci retracements, double bottoms and moving averages.” Although the technical approach to common stock selection is the oldest approach (dating back to the late 1800s), it remains controversial. The techniques discussed in this chapter appear at first glance to have considerable merit, because they seem intuitive plausible, but they have been severely challenged in the last three decades by evidence supporting the Efficient Market Hypothesis. Despite Burton Malkiel's (a well - known proponent of efficient markets) admission that “the market is not a perfect random walk," the-extensive evidence concerning the efficiency of the market has challenged the validity of technical analysis and -the likelihood of its success. Those learning about investments will in all likelihood be exposed to technical analysis, because numerous investors, investment / advisory firms, and the popular press talk about it and use it. Furthermore, it may produce some insights into dimension of the market. In fact, technical analysis is becoming increasingly interrelated with behavioral finance, a popular field of study today. In effect, technical indicators are being used to measure investor emotions. Even if this approach is incorrect, many investors act as if it were correct. Therefore, the prudent course of action is to study this topic, or indeed any other recommended approach to making investing decisions, and try to make an objective evaluation of its validity and usefulness. At the very least, an informed investor will be in a Better position to understand what is being said, or claimed, and better able to judge the validity of the claims. Although technical analysis can be applied to bonds, currencies and commodities as well as to common stocks, technical analysis typically involves the aggregate stock market, industry sectors, or individual common stocks. What is Technical Analysis? Technical analysis can be defined as the use of specific market-generated data for the analysis of both aggregate stock prices (market indices or industry averages) and individual stocks. Martin J. Pring, in his book Technical Analysis, states: “The technical approach to investing is essentially a reflection of the idea that prices move in trends which are determined by the changing attitudes of investors towards a variety of economic, monetary, political and psychological forces. The art of technical analysis for it is an art is to identify trend changes at an early stage and to maintain an investment posture until the weight of the evidence indicates that the trend is reversed.” Technical analysis is sometimes called market or internal analysis, because it utilizes the record of the market itself to attempt to assess the demand for, and supply of, shares of a stock or the entire market. Thus, technical analysts believe that the market itself is its own best source of data—as docsity.com y g ( ) they say, "let the market tell its own story." The theory of technical analysis is that the price movement of a security captures all the information about that security. Economics teaches us that prices are determined by the interaction of demand and. supply. Technicians do not disagree, but argue that it is extremely difficult to assess all the factors that influence demand and supply. Since not all investors are in agreement on price, the determining factor at any point in time is the net demand (or lack thereof) for a stock based on how many investors are optimistic or pessimistic. Furthermore, once the balance of investors becomes optimistic (pessimistic), this mood is likely to continue for the near term and can be detected by various technical indicators. As the chief market technician of one New York firm says, "All I care about is how people feel about those particular stocks as shown by their putting money in and taking their money out.” Technical analysis is based on published market data as opposed to fundamental data, such as earnings, sales, growth rates, or government regulations. Market data primarily include the price of a stock or a market index and volume data (number of shares traded). Many technical analysts believe that only such market data, as opposed to fundamental data, are relevant. For example, they argue that accounting data are subject to all types of limitations and ambiguities, an argument. Recall that in fundamental analysis, the dividend discount model and the multiplier mode produce an estimate of a stock's intrinsic value, which is then compared to the market price. Fundamentalists believe that their data, properly evaluated, can be used to estimate the intrinsic value of a stock. Technicians, on the other hand, believe that it is extremely difficult to estimate intrinsic value and virtually impossible to obtain and analyze good information consistently. In particular, they are dubious about the value to be derived from an analysis of published financial statements. Instead, they focus on market data as an indication of the forces of supply and demand for a stock or the market. Technicians believe that the process by which prices adjust to new information is one of a gradual adjustment toward a new (equilibrium) price. As the stock adjusts from its old equilibrium level to its new level, the price tends to move in a trend. The central concern is not why the change is taking place, but rather the very fact that it is taking place at all. Technical analysts believe that stock prices show identifiable trends that can be exploited by investors. They seek to identify changes in the direction of a stock and take a position in the stock to take advantage of the trend. The following points summarize technical analysis: 1. Technical analysis is based on published market data and focuses on internal factors by analyzing movements in the aggregate market, industry average, or stock. In contrast, fundamental analysis focuses on economic and political factors, which are external to the market itself. 2. The focus of technical analysis is on identifying changes in the direction of stock prices which tend to move in trends as the stock price adjusts to a new equilibrium level. These trends can be analyzed, and changes in trends detected, by studying the action of price movements and trading volume across time. The emphasis is on likely price changes. 3. Technicians, attempt to assess the overall situation concerning stocks by analyzing technical indicators, such as breadth of market data, market sentiment, momentum, and other indicators. docsity.com y g ( ) Technicians have considered a very large number of such patterns. Some of the possible patterns include flags, pennants, gaps (of more than one type), triangles of various types (e.g., symmetrical, ascending, descending, and inverted), the inverted saucer or dome, the triple op, the compound fulcrum, the rising (and falling) wedge, the broadening bottom, the duplex horizontal. Rectangles, and the inverted V. Obviously, numerous patterns are possible and can usually be found on a chart of stock prices. It is also obvious that most, if not all, of these patterns are much easier to identify in hindsight than at the time they are actually occurring. Point-and-Figure Charts: Technicians also use point-and-figure charts, types of charts are more complex in that they show only significant price changes, and volume is not shown at all. The user determines what a significant price change is and what constitutes a price reversal {$2, $3, $4, and so forth). Although the horizontal axis still depicts time, specific calendar time is not particularly important with the passage of time is basically ignored. (Some chartists do show the month in which changes occur.) These are the most important price patterns for investors who want to temper their hunches and the timing of their buy and sell decisions with solid empirical data. An X is typically used to show upward movements, whereas an O is used for downward movements. Each X or O on a particular chart may represent Rs. 1 movements, Rs. 2 movements, Rs. 5 movements, and so on, depending on how much movement is considered significant for that stock. An X or O is recorded only when the price moves by the specified amount. Moving Average: A Moving Average is a smoothed presentation of underlying historical data. Each data point is the arithmetic average of a portion of the previous data. A ten-day moving average measures the average over the previous ten days. Regardless of the time period used, each day a new observation is included in the calculation and the oldest is dropped, so a constant number of points are always being averaged. docsity.com y g ( ) Advocates of moving average in the stock selection believe that changes in the slope of the line are important. A stock whose twenty-day moving average has been trending up might become a candidate for sale if the line turns downward. docsity.com