Investments: Analysis and Behavior Chapter 13- Technical Analysis ©2008 McGraw-Hill/Irwin

13-2 Learning Objectives Learn the graphing tools of technical analysis. Identify stock price patterns. Know how trading volume relates to price patterns. Learn technical indicators for measuring market activity. Understand how investor sentiment is measured and used.

13-3 Chapter 6 argues that markets are efficient. Chapter 7 illustrates EMH anomalies. Chapter 8 argues that if investors are not always rational, then markets may not be fully efficient. If markets are nearly efficient, what tools may be useful for investors to make money? These tools are detailed in Technical Analysis. Inefficient Markets

13-4 Supply and Demand Fundamental Analysis: stocks prices are related to the value of the business. Technical Analysis: stock prices are the result of supply and demand forces for the stock.  Priced more like a commodity.  Technicians try to understand and measure the changing supply and demand.  Market Technicians Association (

13-5 Plotting the Market – measuring trends Price charts:  Resistance lines and Support lines  Channels and Breakouts

13-6 moving averages

13-7 Dow Theory Developed by William Hamilton from 1902 to 1929 New primary market trends are confirmed between DJTA and DJIA.  Secondary trends  Tertiary trends

13-8

13-9 Charting Price Patterns Head and Shoulders

13-10 Continuation patterns Reversal patterns

13-11

13-12 Market Cycles Economists talk about the business cycle Technicians look for market cycle  Kondratieff, or K-waves 60-year cycle  40-week cycle  80-week cycle

13-13 Volume and Price Volume is used to confirm the strength of a trend.  Increasing volume supports increasing price trend.  Divergence Source: MSN Money

13-14 Selling and buying pressure measures Money Flow Dollar value of trades at an uptick less value of trades at a downtick Up/Down Ratio Dollar value of trades at an uptick divided by the value of trades at a downtick Money Flows--Top Gainers CompanyExch Last Price% Chg. Money Flow Uptick volume Downtick volumeRatio Block Trades Uptick volume Downtick volumeRatio CitigroupNYSE SPDRAMEX MerLynNYSE HewlettPkNYSE AmExpressNYSE

13-15 TECHNICAL INDICATORS Condition of the Market:  Breadth—how many firms are participating in the rally. Advances and declines Advance/decline ratio  Overbought and oversold  TRIN ratio <0.35 overbought 0.35 to 0.6 very bullish 1.5 to 1.85 very bearish >1.85 oversold

13-16 Market Breadth Measures Data source: (January 24, 2006). NYSEAMEXNASDAQOTC BB Advancing Issues2, , Declining Issues1, , Unchanged Issues Total Issues3,4361,0803,1801,978 New Highs New Lows Up Volume1,585,999,550243,224,6121,188,539,914505,671,486 Down Volume875,383,650106,015,090805,549,381554,470,602 Unchanged Volume41,660,37031,142,10072,784,810794,041,622 Total Volume2,503,043,570380,381,8022,066,874,1051,854,183,710

13-17 Momentum Indicators Rate of Change (ROC): shows the amount prices have changed over a given time period. Moving Average Convergence/Divergence (MACD): Calculated by subtracting the value of a 26-period exponential moving average from a 12-period exponential moving average. Then take a 9-day exponential moving average of the MACD. The MACD trading rule is to sell when it falls below its 9-day signal line and to buy when the MACD rises above the 9-day signal line.

13-18 Sentiment Indicators Sentiment: The mood of investors drive markets.  Investor actions Odd lot trades (contrary indicator) Mutual fund flow Broker account credit and debit balances Short interest Put/call ratio  Surveys

13-19 AAII Investor Sentiment Survey Measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market in the short term: weekly. Consumer Confidence Survey The survey of 5,000 households is conducted for the Conference Board by NFO WorldGroup: monthly. University of Michigan Consumer Sentiment The Index of Consumer Sentiment (ICS) is based upon consumer responses to each of five survey questions on spending plans. ABC News/Money Magazine Consumer Comfort Index The index is based on ratings of the economy, buying climate, and personal finances: rolling 4-week sample of 1,000 adults. Investor’s Intelligence Newsletter reviews other investment newsletters and reports the percentage that is bullish on a weekly basis. ( Merrill Lynch Sell Side Indicator This indicator is based on a survey of Wall Street Strategist asset allocation recommendations: monthly. Robert Shiller’s Stock Market Confidence Indices Yale Professor Rober Shiller compiles four different indices based upon surveys of individual and institutional investors: One-Year Confidence Index, Buy-on Dips Confidence Index, Crash Confidence Index, and Valuation Confidence Index. (icf.som.yale.edu/confidence.index)

13-20 Stock Rotations Sector Rotation  Sometimes investors like, technology, other times they like energy… Value/Growth Rotation Capitalization Rotation  Small versus large companies

13-21 Sectors in and out of favor

13-22

13-23 Criticisms of TA Not much statistical analysis support for technical trading rules. Subjective judgment is part of the decision making. The brain sees patterns in random data