Comm W. Suo Slide 1

Comm W. Suo Slide 2  An attempt to exploit recurring and predictable patterns in stock prices  Technicians’ beliefs: Shifts in market fundamentals can be discerned before their impact is fully reflected in prices Market fundamentals can be perturbed by irrational factors  These presumptions are in contradiction with the weak form of the EMH Technical Analysis

Comm W. Suo Slide 3 The Dow Theory  Originated by Charles Dow Founder of the Dow Jones Company and editor of Wall Street Journal  Dow Theory presumes market moves in persistent bull and bear trends Often used for market as a whole, but used for individual securities also  Types of movements defined by Dow theorists Primary trends (bull or bear market) Secondary trends (corrections) Market collapses or upward surges lasting a few weeks or months Tertiary moves (little daily fluctuations) Meaningless random wiggles but should be studied to determine if relate to a primary trend

Comm W. Suo Slide 4 The Dow Theory Most Dow theorists do not think a new primary trend has been confirmed until pattern of ascending or descending tops occur in both industrial and transportation averages.

Comm W. Suo Slide 5 Head and Shoulders Formation  A series of reversals Supposed to signal that a security’s price has reached a ceiling and is expected to decline in the future

Comm W. Suo Slide 6 Head and Shoulders Formation Left shoulder— heavy buying increases price to a peak before lull in trading pushes price downward. Head—a spurt of buying activity increases price to new high. Then a lull in trading decreases prices to below top of left shoulder. Right shoulder—a moderate rally increases price but not to a new level equal to the top of the head. Confirmation (breakout)—the price falls below the neckline which is a sell signal.

Comm W. Suo Slide 7 Other Patterns  Numerous patterns have been described by technicians, such as Triangles Pennants Flags Channels Rectangles Double tops Triple tops Wedge formations Diamonds See

Comm W. Suo Slide 8 Triangles

Comm W. Suo Slide 9 Flags Pennants

Comm W. Suo Slide 10 Rectangles

Comm W. Suo Slide 11 Wedge

Comm W. Suo Slide 12 Charting Volume of Shares Traded  Technicians argue volume measures the intensity of investor’s feelings  Volume is studied in conjunction with prices  Technicians analyze resistance and support levels along with volume

Comm W. Suo Slide 13 Support and Resistance Levels  Resistance level Ceiling (peak) above which stock price is not expected to go Supply of security is expected to increase  Support level Floor (trough) below which stock price is not expected to drop Demand of security is expected to increase

Comm W. Suo Slide 14 Support and Resistance Levels  Suppose the following occurred Moderate surge in trading volume at Point A Larger surge in trading volume at Point B 3 times greater than surge at Point A May surmise that some bullish new information caused buying pressure at Point B which overcame the previous resistance at Point A

Comm W. Suo Slide 15 Congestion Areas  Technicians are unable to offer reasons for price actions like this Penetrating support line means sell Penetrating resistance line means buy  Studies examining trading range breakouts find that, after deducting commissions, return was slightly larger than riskless interest rate

Comm W. Suo Slide 16 Congestion Areas Price fluctuates in first congestion area for a while. Price rises through $50 resistance level—old resistance level becomes new support level.

Comm W. Suo Slide 17 Selling Climaxes and Speculative Blowoffs  When supply and demand are out of balance (price is moving) volume is watched closely Market is bullish when high volume is combined with a rising price Market is bearish with high volume and falling prices  Falling prices and high volume are considered bullish if a selling climax occurs

Comm W. Suo Slide 18 Selling Climaxes and Speculative Blowoffs  If one believes the end of bear market is near and high volume occurs Means last of bearish investors are liquidating their holdings Clears the way for bullish investors to start bidding up price  A speculative blowoff marks the end of a bull market High volume pushes prices to peak Exhausts bullish speculators enthusiasm, enabling bearish market to begin  A bull dies with a bang, not a whimper

Comm W. Suo Slide 19  Point and figure charts The figure has no time dimension It traces significant upward or downward moves in stock prices  Candlestick charts Used to summarize price data Aid in identification of trends Other Charting Techniques

Comm W. Suo Slide 20  Sentiment indicators  Flow of funds indicators  Market structure indicators Technical Indicators

Comm W. Suo Slide 21 Trin statistic Sentiment indicators or:

Comm W. Suo Slide 22  Odd-Lot trading  Confidence Index  Put/Call ratio  Mutual fund cash position Sentiment Indicators (cont’d)

Comm W. Suo Slide 23  Short interest – total number of shares of stock currently sold short in the market Some technicians interpret high levels of short interest as bullish, some as bearish  Credit balances in brokerage accounts Flow of Funds Indicators

Comm W. Suo Slide 24  Moving averages  Breadth The most common measure – the spread between the number of stocks that advance and decline in price  Relative strength The ratio of the price of the security to a price index for the industry Market Structure Indicators

Comm W. Suo Slide 25 Moving Average Analysis  Moving averages are used to provide a smooth reference point for Individual securities Market indices Commodity prices Interest rates Foreign exchange rates  Some use a 150-day (30 week) moving average Changes each day Most recent day is added and oldest day is dropped  Following calculation is performed  M150DAP t = (1/150)(Value t + Value t-1 + … Value t-149 )

Comm W. Suo Slide 26 Moving Average Analysis  Moving averages computed over short time frames follow daily prices more closely  Technicians analyze difference between daily price and moving average If daily prices penetrate moving average line it is a signal to take action If daily price moves down through a moving average, price fails to rise for many months  Sell signal If daily prices are above moving average but difference is narrowing  Signals end of bull market may be near

Comm W. Suo Slide 27 Moving Average Analysis  Moving average analysts recommend buying stock if Moving average line flattens and stock price moves up through moving average line Price of stock falls (temporarily) below moving average line that is rising Stock price is above moving average line, falls, turns around and rises again without penetrating moving average line

Comm W. Suo Slide 28 Moving Average Analysis  Moving average analysts recommend selling stock if Moving average line flattens and stock price drops down through moving average line Stock price temporarily rises above a declining moving average line Stock price falls through moving average line and turns around only to fall again without penetrating above moving average line  Strategy is more successful if moving average is calculated over a longer time frame

Comm W. Suo Slide 29  Self-destructing patterns Once a useful technical rule is discovered, it ought to be invalidated once the mass of traders attempts to exploit it  A new view of technical analysis Brown and Jennings propose a more complex framework than the EMH They envision an economy where many investors have private information regarding the value of a stock Can Technical Analysis Work?

Comm W. Suo Slide 30 Folklore  Examples Buy on good news, sell on bad Buy on rumor, sell on news Buy a stock just after a split to earn abnormal returns Firms wholes earning decreased relative to the market … price fell in years preceding Low priced stocks, low P/E stocks outperform high prices, high P/E stocks