TECHNICAL ANALYSIS

 Technical analysis attempts to exploit recurring and predictable patterns in stock prices to generate high investment returns.

Efficient Market Hypothesis  A market in which prices always “fully reflect” available information is called “efficient”. (Fama)  Any investor is not able to make excess returns in an efficient market  Therefore, if technical trading generates excess returns, then there is a violation of the weak form efficiency  Markets are not efficient

Empirical Evidence Against Technical Analysis  Overall, empirical evidence shows that technical analysis does not outperform the market → Successful past forecasting does not imply future market outperformance  Allen and Karjalainen (1999)  They use a genetic algorithm to learn technical trading rules for the S&P 500 index using daily prices from 1928 to  After transaction costs, the rules do not earn consistent excess returns over a simple buy-and-hold strategy in the test periods.

Empirical Support for Technical Analysis  Past price behavior predicts characteristics of future price behavior (high volatility stocks stay high volatility stocks)  Brock, Lakonishok, and LeBaron (1992):  Test two popular decision rules and find support for the technical strategies for foreign exchange rates and the US stock index: Moving average Trading range break

Calendar Effects  Pattern in stock returns related to either the day of the week, the week of the month, or the month of the year.  January Effect  Monday Effect  Beginning and End of the Day Effect  They go against market efficiency

January Effect  Stock returns are greater in January than in other months.  Possible trading strategy is to buy stocks at the end of December and sell them at the end of January

Monday Effect  Stock returns are lower on Monday than in other days of the week

Beginning and End of the Day  Stock returns are greater at the beginning and end of the day  Greater volatility  Volatility describes a stock with rapid and extreme fluctuations in stock prices

Market Order  A market order instructs your broker to buy or sell the stock immediately at the current price.  In a volatile market, you will probably get a price close to that, but there is no guarantee of any specific price.

Limit Order  Limit orders instruct your broker to buy or sell a stock at a particular price  The purchase or sale will not happen unless you get your price

Stop Loss  Insurance that protects you from a loss  Set the stop loss order at a price below where you bought the stock  Gives broker a price trigger that protects you from a big drop in a stock

Trailing Stop  Enter the trailing stop order as a percentage of the market price  If the market price declines by that percentage, the trailing stop becomes a market order and your broker sells the stock.  If the stock continues to rise, the trailing stop follows it up since it is a percentage of the market price. This protects your additional gains.

Short Selling

Bar vs. Candlestick Chart

Bar Chart

Candlestick Chart

NEXT MEETING Trend Lines Support and Resistance BRING YOUR LAPTOP Wednesday February 9 th at 6:00PM Bartley 36