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8-1
Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
8
Stock Price Behavior
and Marke...
8-3
“If you see a bandwagon, it’s too
late.”
“Don’t try to buy at the bottom
and sell at the top. It can’t be
done except ...
8-4
Controversy, Intrigue, and Confusion
• Our goal in this chapter is first to discuss bull markets
and bear markets, as ...
8-5
Technical Analysis
• Technical analysis differs significantly from
fundamental analysis.
• Technical analysis is a con...
8-6
Dow Theory, I.
• The Dow theory is a method that attempts to interpret
and signal changes in the stock market directio...
8-7
Dow Theory, II.
Dow Jones Industrial Average,
January 2, 2001 to October 3, 2003
7,000
8,000
9,000
10,000
11,000
12,00...
8-8
Dow Theory, III.
• Purpose: to signal changes in the primary direction.
• Must monitor two indexes:
– Dow Jones Indust...
8-9
Support and Resistance Levels
• A support level is a price or level below which a stock
or the market as a whole is un...
8-10
Market Diaries,
A Collection of Technical Indicators
8-11
Technical Indicators, Notes
• The “advance/decline line” shows, for some period, the cumulative
difference between ad...
8-12
Charting, Relative Strength
• Relative strength charts measure the performance of
one investment relative to another....
8-13
Charting, Moving Averages
• Moving average charts are average daily prices or index
levels, calculated using a fixed ...
8-14
Example: 15-Day and
50-Day Moving Averages
Dow Jones Industrial Average,
15-Day and 50-Day Moving Average
7,500
8,000...
8-15
More Chart Types
• A hi-lo-close chart is a bar chart showing, for each day,
the high price, low price, and closing p...
8-16
Candlestick Making, Basics
8-17
Candlestick “Formations”
8-18
Point and Figure Charts, I.
• Point-and-figure charts attempt to show only major price
moves and their direction.
– T...
8-19
Point and Figure Charts, II.
8-20
Point and Figure Charts, III.
8-21
Chart Formations
• Once a chart is drawn, technical analysts examine it for
various formations or pattern types in an...
8-22
Chart Formations, The Head and Shoulders
8-23
Other Technical Indicators
• The “odd-lot” indicator looks at whether odd-lot
purchases are up or down.
• Followers o...
8-24
Market Efficiency
• The Efficient Market Hypothesis (EMH) is a theory
that asserts: As a practical matter, the major ...
8-25
What Does “Beat the Market” Mean?
• The excess return on an investment is the return
in excess of that earned by othe...
8-26
Forms of Market Efficiency,
(i.e., What Information is Used?)
• A Weak-form Efficient Market is one in which past pri...
8-27
Why Would a Market be Efficient?
• The driving force toward market efficiency is simply
competition and the profit mo...
8-28
Are Financial Markets Efficient?
• Market efficiency is difficult to test.
• There are four basic reasons for this:
–...
8-29
Are Financial Markets Efficient?
• Nevertheless, three generalities about market efficiency
can be made:
– Short-term...
8-30
Some Implications if Markets are Efficient
• Security selection becomes less important, because
securities will be fa...
8-31
Stock Price Behavior and Market Efficiency
The day-of-the-week effect refers to the tendency for
Monday to have a neg...
8-32
The Amazing January Effect, I.
• The January effect refers to the tendency for small
stocks to have large returns in ...
8-33
The Amazing January Effect, II.
• The January effect refers to the tendency for small
stocks to have large returns in...
8-34
The Market Crash in October 1987
• On October 19, 1987 (Black Monday), the Dow
plummeted 500 points to 1,700.
– Inves...
8-35
The Performance of
Professional Money Managers
• From 1963 to 1998, the S&P 500 index outperformed
general equity mut...
8-36
Useful Internet Sites
• Technical Analysis Websites:
– Dow Theory: www.thedowtheory.com
– Glossary of terms: www.e-an...
8-37
Chapter Review, I.
• Technical Analysis
– Dow Theory
– Support and Resistance Levels
– Technical Indicators
– Chartin...
8-38
Chapter Review, II.
• Market Efficiency
– What Does “Beat the Market” Mean?
– Forms of Market Efficiency
– Why would ...
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Chapter 8

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Transcript of "Chapter 8"

  1. 1. 8-1
  2. 2. Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 8 Stock Price Behavior and Market Efficiency
  3. 3. 8-3 “If you see a bandwagon, it’s too late.” “Don’t try to buy at the bottom and sell at the top. It can’t be done except by liars.” -Sir James Goldsmith -Bernard Baruch
  4. 4. 8-4 Controversy, Intrigue, and Confusion • Our goal in this chapter is first to discuss bull markets and bear markets, as well as market psychology. • Then, we will consider if anyone (i.e., you) can consistently “beat the market.” • Finally we will examine some baffling market phenomena. – The “Day of the Week” Effect – The “January” Effect – The puzzling performance of professional money managers
  5. 5. 8-5 Technical Analysis • Technical analysis differs significantly from fundamental analysis. • Technical analysis is a controversial set of techniques for predicting market direction based on – Historical price and volume behavior – Investor sentiment • Technical analysts essentially search for bullish (positive) and bearish (negative) signals about stock prices or market direction.
  6. 6. 8-6 Dow Theory, I. • The Dow theory is a method that attempts to interpret and signal changes in the stock market direction. • Historically, quite popular. • The Dow theory identifies three forces: – a primary direction or trend, – a secondary reaction or trend, and – daily fluctuations • Daily fluctuations are essentially noise and are of no real importance.
  7. 7. 8-7 Dow Theory, II. Dow Jones Industrial Average, January 2, 2001 to October 3, 2003 7,000 8,000 9,000 10,000 11,000 12,000 01/01 04/01 07/01 10/01 01/02 04/02 07/02 10/02 01/03 04/03 07/03 10/03 Date Level The primary direction is either bullish or bearish, and reflects the long-run direction of the market. Secondary trends, temporary departures Corrections, reversions to the primary direction
  8. 8. 8-8 Dow Theory, III. • Purpose: to signal changes in the primary direction. • Must monitor two indexes: – Dow Jones Industrial Average – Dow Jones Transportation Average • If ONE index departs from the primary direction, this is not a signal. • However, if a departure in one is followed by a departure in the other, this is viewed is confirmation that the trend has changed. The trend is your friend…
  9. 9. 8-9 Support and Resistance Levels • A support level is a price or level below which a stock or the market as a whole is unlikely to go, while a • Resistance level is a price or level above which a stock or the market as a whole is unlikely to rise. • Resistance and support areas are usually viewed as psychological barriers – Bargain hunters help “support” the lower level. – Profit takers “resist” the upper level. • A “breakout” occurs when a stock (or the market) passes through either a support or a resistance level.
  10. 10. 8-10 Market Diaries, A Collection of Technical Indicators
  11. 11. 8-11 Technical Indicators, Notes • The “advance/decline line” shows, for some period, the cumulative difference between advancing and declining issues. • “Closing tick” is the difference between the number of shares that closed on an uptick and those that closed on a downtick. • “Closing arms” or “trin” (trading index) is the ratio of average trading volume in declining issues to average trading volume in advancing issues. Using data from the "Previous Close:" • “zBlock trades” are trades in excess of 10,000 shares. 1.6944 256,809 435,144 0/1,498384,700,63 0/1,734754,540,57 Arms ===
  12. 12. 8-12 Charting, Relative Strength • Relative strength charts measure the performance of one investment relative to another. • Comparing stock A to stock B, through relative strength. Month Stock A (4 Shares) Stock B (2 Shares) Relative Strength 1 $100 $100 1.00 2 96 96 1.00 3 88 90 0.98 4 88 80 1.10 5 80 78 1.03 6 76 76 1.00
  13. 13. 8-13 Charting, Moving Averages • Moving average charts are average daily prices or index levels, calculated using a fixed number of previous days’ prices or levels, updated each day. • Because daily price fluctuations are “smoothed out,” these charts are used to identify trends. • Example: Suppose the technical trader calculates a 15- day and a 50-day moving average of a stock price. – If the 15-day crosses the 50-day from above, it is a bearish signal—time to sell. – If the 15-day crosses the 50-day from below, it is a bullish signal —time to buy.
  14. 14. 8-14 Example: 15-Day and 50-Day Moving Averages Dow Jones Industrial Average, 15-Day and 50-Day Moving Average 7,500 8,000 8,500 9,000 9,500 10,000 10,500 11,000 1/2/02 3/6/02 5/7/02 7/9/02 9/9/02 11/7/02 1/10/03 3/14/03 5/15/03 7/17/03 9/17/03 Date IndexLevel 15-Day 50-Day Note the "whipsaw" action—i.e., plenty of buying and selling signals. This happens because 15 and 50 may be too "close" together in time.
  15. 15. 8-15 More Chart Types • A hi-lo-close chart is a bar chart showing, for each day, the high price, low price, and closing price. • A candlestick chart is an extended version of the hi-lo- close chart. It plots the high, low, open, and closing prices, and also shows whether the closing price was above or below the opening price.
  16. 16. 8-16 Candlestick Making, Basics
  17. 17. 8-17 Candlestick “Formations”
  18. 18. 8-18 Point and Figure Charts, I. • Point-and-figure charts attempt to show only major price moves and their direction. – The point and figure chart maker decides what price move is major. – That is, it could be $2, $5, or any other level. • A major up-move is marked with an “X” • A major down-move is marked with an “O” • Start a new column when there is a direction change. – Buy and sell signals are generated when new highs or new lows are reached. – Congestion area, the area between buy and sell signals—a time of market indecision concerning its trend.
  19. 19. 8-19 Point and Figure Charts, II.
  20. 20. 8-20 Point and Figure Charts, III.
  21. 21. 8-21 Chart Formations • Once a chart is drawn, technical analysts examine it for various formations or pattern types in an attempt to predict stock price or market direction. • One example is the head-and-shoulders formation. – When the stock price “pierces the neckline” after the right shoulder is finished, it is time to sell.
  22. 22. 8-22 Chart Formations, The Head and Shoulders
  23. 23. 8-23 Other Technical Indicators • The “odd-lot” indicator looks at whether odd-lot purchases are up or down. • Followers of the “hemline” indicator claim that hemlines tend to rise in good times. • The Super Bowl indicator forecasts the direction of the market based on who wins the game. – Two Conference representatives play in the Super Bowl: one from the National Football Conference and one from the American Football Conference. – A win by the National Football Conference (or one of the original members of the National Football League) is bullish.
  24. 24. 8-24 Market Efficiency • The Efficient Market Hypothesis (EMH) is a theory that asserts: As a practical matter, the major financial markets reflect all relevant information at a given time. • Market efficiency research examines the relationship between stock prices and available information. – The important research question: Is it possible for investors to “beat the market?” – Prediction of the EMH theory: If a market is efficient, it is not possible to “beat the market” (except by luck).
  25. 25. 8-25 What Does “Beat the Market” Mean? • The excess return on an investment is the return in excess of that earned by other investments that have the same risk. • “Beating the market” means consistently earning a positive excess return.
  26. 26. 8-26 Forms of Market Efficiency, (i.e., What Information is Used?) • A Weak-form Efficient Market is one in which past prices and volume figures are of no use in beating the market. – If so, then technical analysis is of little use. • A Semistrong-form Efficient Market is one in which publicly available information is of no use in beating the market. – If so, then fundamental analysis is of little use. • A Strong-form Efficient Market is one in which information of any kind, public or private, is of no use in beating the market. – If so, then “inside information” is of little use.
  27. 27. 8-27 Why Would a Market be Efficient? • The driving force toward market efficiency is simply competition and the profit motive. • Even a relatively small performance enhancement can be worth a tremendous amount of money (when multiplied by the dollar amount involved). • This creates incentives to unearth relevant information and use it.
  28. 28. 8-28 Are Financial Markets Efficient? • Market efficiency is difficult to test. • There are four basic reasons for this: – The risk-adjustment problem – The relevant information problem – The dumb luck problem – The data snooping problem.
  29. 29. 8-29 Are Financial Markets Efficient? • Nevertheless, three generalities about market efficiency can be made: – Short-term stock price and market movements appear to be difficult to predict with any accuracy. – The market reacts quickly and sharply to new information, and various studies find little or no evidence that such reactions can be profitably exploited. – If the stock market can be beaten, the way to do so is not obvious.
  30. 30. 8-30 Some Implications if Markets are Efficient • Security selection becomes less important, because securities will be fairly priced. • There will be a small role for professional money managers. • It makes little sense to time the market.
  31. 31. 8-31 Stock Price Behavior and Market Efficiency The day-of-the-week effect refers to the tendency for Monday to have a negative average return.
  32. 32. 8-32 The Amazing January Effect, I. • The January effect refers to the tendency for small stocks to have large returns in January. • Does it exist for the S&P 500?
  33. 33. 8-33 The Amazing January Effect, II. • The January effect refers to the tendency for small stocks to have large returns in January. What do we see when we look at returns on small stocks?
  34. 34. 8-34 The Market Crash in October 1987 • On October 19, 1987 (Black Monday), the Dow plummeted 500 points to 1,700. – Investors lost about $500 billion in share value. – The market lost over 20% of its value. – The volume was a record at the time: 600 million shares. • Today the NYSE has circuit breakers. – Rules that kick in to slow or stop trading when the DJIA decreases (or increases) by more than a pre-set amount in a trading session.
  35. 35. 8-35 The Performance of Professional Money Managers • From 1963 to 1998, the S&P 500 index outperformed general equity mutual funds 22 times (out of 36). • Why can’t the pros beat the averages? (You can hold a market average very easily—SPDRs)
  36. 36. 8-36 Useful Internet Sites • Technical Analysis Websites: – Dow Theory: www.thedowtheory.com – Glossary of terms: www.e-analytics.com – Drawing charts: www.stockcharts.com www.bigcharts.com http://finance.yahoo.com • Charts and other indicators: www.prophet.net www.stockta.com • Chart patterns: www.chartpatterns.com • Market Efficiency: Is astrology useful? (ed. No.) www.afund.com
  37. 37. 8-37 Chapter Review, I. • Technical Analysis – Dow Theory – Support and Resistance Levels – Technical Indicators – Charting • Relative Strength • Moving Average • Hi-Lo-Close and Candlestick • Point-and-Figure – Chart Formations – Other Technical Indicators
  38. 38. 8-38 Chapter Review, II. • Market Efficiency – What Does “Beat the Market” Mean? – Forms of Market Efficiency – Why would a Market be Efficient? – Are Financial Markets Efficient? – Some Implications of Market Efficiency • Stock Price Behavior and Market Efficiency – The Day-of-the-Week Effect – The Amazing January Effect – The October 1987 Crash – Performance of Professional Money Managers
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