Chapter 9. Technical Analysis & Market Efficiency. Technical Analysis. Market Volume Kaplan Financial. Market volume 9-1

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1 Chapter 9 Technical Analysis & Market Efficiency Technical Analysis study of forces at work in the market & their effect on stock prices Implies that price patterns or internal market factors reveal the market's future direction before the cause is evident in financial statements 9-2 Market Volume Market volume When the market moves up (down) on high volume, the market is thought to be strong (weak)

2 Breadth of the Market Breadth of the market the difference between the number of stocks that go up in price and those that go down, on a given day may indicate strength (for a large positive difference) or weakness (for a large negative difference) 9-4 Short Interest and Theory of Contrary Opinion Short interest the number of stocks sold short in the market at any given time believed to indicate future market demand Theory of contrary opinion uses the amount and type of odd-lot trading as an indicator of the current state of the market and pending changes Measures of Overall Market Performance The relative price level approach uses three measures of overall market performance: The market P/E multiple The market's price-to-book ratio The market's dividend yield

3 Technical Analysis with Charts Charting is the activity of charting price behavior and other market information and then using the patterns these charts form to determine the future course of the market or a stock Market averages such as the DJIA or individual stock prices can be plotted Bar charts plot market or share price against time 9-7 Technical Analysis with Charts Point-and-figure charts no time dimension used to identify significant changes or changes in drifts in prices Charts are thought to hold certain formations based on underlying supply and demand The usefulness of charts comes from a technical analyst who says, "It's the formation that matters." 9-8 Random Walk Hypothesis Stock prices move up and down randomly and, therefore, give no advantage to a particular trading strategy

4 Efficient Market Hypothesis The efficient market hypothesis (EMH) Theory of market behavior a large number of knowledgeable investors react quickly to new information, causing securities prices to adjust quickly and accurately Forms of the EMH Three forms of the efficient market hypothesis exist: Weak Semistrong Strong 9-11 Weak Form All past data on stock prices and trading volume is of no value in predicting future price changes (today or tomorrow's price change is unrelated to yesterday's price change)

5 Semistrong Form Abnormal profits cannot be consistently earned by using all publicly available data Includes all technical data plus other information such as that included in annual reports to shareholders, corporate announcements, business periodicals, Internet information, and TV shows 9-13 Strong Form There is no information (public or private) that allows investors to consistently earn abnormal profits Stock prices immediately adjust to any information even if not available to every investor 9-14 Implications of Efficient Markets Proponents of concept hold that: Many return opportunities exist in an efficient market The only way to increase returns is to increase the risk of a portfolio

6 Implications for Technical Analysis Implications for technical analysis If price fluctuations are truly random, then technical theories and charting are of no value. If markets are not truly efficient, these approaches might discern gradual shifts and profits Implications for Fundamental Analysis Implications for fundamental analysis Because fundamental analysis is effectively accomplished by many investors who compete for profits, their actions eliminate opportunities for most investors Economic, industry, and company fundamental analyses are needed to separate the strong from the weak companies in order to properly select the stocks for a portfolio 9-17 So Who s Right? Although markets may not be perfectly efficient, evidence suggests that they are at least reasonably efficient