CHAPTER 9 Technical Analysis. McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Technical Analysis Technical analysis attempts.

CHAPTER 9 CHAPTER 9

Technical Analysis

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Technical AnalysisTechnical Analysis

Technical analysis attempts to predict changes in prices by identifying trends or patterns in market price, volume, or other market indicators.

Technical analysis is often referred to as “charting,” but charting is only one type of technical analysis.

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Technical AnalysisTechnical Analysis

Technical analysis will not will not benefit investors in an efficient market (even if it is only weak-form efficient).

If a market is weak-form efficient, security prices fully reflect all market information.

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Types of Technical AnalysisTypes of Technical Analysis

ChartingMarket structureSentiment

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ChartingCharting

One form of charting is referred to as the Dow Theory.

It attempts to identify “primary trends,” “intermediate trends” and “minor trends.”

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Charting: Dow TheoryCharting: Dow Theory

Primary trends are long-term, lasting several months or longer and are the most important.

Secondary trends are short-term deviations from the primary trend, lasting a few days or a few weeks.

Minor trends are daily fluctuations

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Figure 9.3 Dow Theory TrendsFigure 9.3 Dow Theory Trends7

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Charting: Dow TheoryCharting: Dow Theory

Technical analysts attempt to identify primary trends early enough to participate.

The problem is that it is difficult to distinguish between the three trends (except after the fact).

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Charting: Dow TheoryCharting: Dow Theory

The Dow Theory also looks for “support levels” and “resistance levels.”◦A support level is a price below which the

market should not go. ◦A resistance level is a price above which the

market should not go.

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Market StructureMarket Structure

Another category of technical analysis is referred to market structure. It includes:◦Moving average◦Breadth indicators:Advances – declinesClosing tick

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Market Structure IndicatorsMarket Structure Indicators

Moving AveragesAverage price over some historical period

(5 weeks or 200 days)When current price crosses the average a

trading signal occursBullish signal when the current price rises

above the moving averageBearish sign when the current price falls

below the moving average

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Figure 9.7 Share Price and 50-Day Figure 9.7 Share Price and 50-Day Moving Average for Apple ComputerMoving Average for Apple Computer

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Table 9.2 BreadthTable 9.2 Breadth13

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Sentiment IndicatorsSentiment Indicators

Yet another form of technical analysis is based on investor sentiment. There are many indicators of investor sentiment.

One problem: many sentiment indicators can be interpreted as either bullish or bearish.

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Sentiment IndicatorsSentiment Indicators

Odd - Lot TradingRatio of odd-lot purchases to odd-lot salesWhen ratio exceeds 1.0, it means odd lot

investors are buying more than they are selling. This is a bearish signal (contrarian): small investors are usually wrong

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Sentiment IndicatorsSentiment Indicators

Trin Statistic:

Volume declining/Number decliningTrin =

Volume advancing/Number advancing

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Technical IndicatorsTechnical Indicators

Short Interest - total number of shares that are sold short◦When short sales are high a signal occurs:Bearish interpretation: investors sell short if they believe stock prices will fall. Most short sellers are sophisticated, knowledgeable investors.

Bullish interpretation: short positions have to be covered & represent future buying.

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Other Technical IndicatorsOther Technical Indicators

The Super Bowl January performance of stock market

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