1 Three Approaches to Security Selection Technical Analysis Fundamental Analysis –Economic Analysis –Industry Analysis –Company Analysis Efficient Markets

2 Technical Analysis Basic Philosophy and assumptions –Market value determined by supply and demand –Supply and demand are governed by rational and irrational factors –Prices move in trends that persist –Trends can be detected by analysis of the market Dow Theory –Primary moves (tides) –Intermediate moves (waves) –Minor changes (ripples)

3 Technical Trading Rules Contrary Opinion Rules –The odd-lot theory –Short sales theory –Mutual Fund cash position –Investment Advisory Opinions Follow the Smart Money –The Confidence Index –Short sales by specialists

4 Other Market Sentiment Techniques The advance-decline line Moving Averages Support and Resistance Levels Bar Charting Point and Figure Charts

5 Efficient Markets Hypothesis A market in which prices fully reflect all known information is called efficient. Four conditions –homogeneous expectations –frictionless markets –Investors are price takers –Maximize expected utility A perfectly efficient market Economically Efficient Market

6 Efficient Markets (Con’d) Types of tests of EMT –Weak form tests –Semistrong form test –Strong form test EMT and asset pricing models –For CAPM and APT to be true, markets have to be efficient –Problem of joint test6s

7 Return Predictability Early Tests –Random walk tests –Filter trading rule tests More recent tests –Random walk tests of Lo&McKinley –Long Horizon results Schiller; Debondt and Thaler (bubles) –Return Patterns Calendar effects –Size, P/E, BMV/ D/P effects

8 Event Studies Stock Splits Earnings Announcements Initial Public Offerings Tests for Private Information Trading by Insiders Performance of Professional portfolio managers