ans tech and emh theory qns

8/12/2019 Ans Tech and Emh Theory Qns

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Technical Analysis

Answers to end of chapter questions

According to the Dow theory, market trends can be classified as primary, secondary and minor trends.

Primary trends are long term trends, secondary trends are short term upward and downward

movements that help maintain the long term trend, and minor trends are day to day fluctuations. Theupward primary trend normally has a series of successive upward secondary movements, where eachsuccessive rally should be higher the previous rally and even the successive declines between rallies

should end above the previous declines. Similarly, in a downward primary trend each successive rally

should be lower than the previous rally and each decline should be lower than previous lows. Also,rallies in bull markets are longer and reactions are shorter while reactions in bear markets are longer

and rallies are shorter.

1. To have an idea of the market as a whole it may not be sufficient to study a small inde

consisting of !" or #" shares.. $or this reason it is desirable to see whether ma%ority of the share prices

are rising &advancing' or falling &declining'. The advances and declines are compared to measure thedispersion &breadth' of the market. The inde cannot continue to rise if ma%ority of stocks continue to

decline and vice versa. (ncreasing divergence between the inde movement and the cumulativedifference between advances and declines could signal a market trend reversal.

According to the Dow theory, in a rising market, volumes also increase with price rises and fall when

price decreases. (n a falling market, volumes should increase with price declines and decrease when

prices rise.

)n balance volume &)*+' measures cumulative positive and negative volume flow. (t adds the volume

when the closing price is higher than the previous day and subtracts the volume when the closing price

is lower. The cumulative total of the volume additions and subtractions forms the )*+ line which iscompared with the price chart. A rising )*+ line indicates that increased volumes accompaniedincreased prices which is a bullish sign and would confirm an up trend in price. owever, if prices are

increasing while the volume line is dropping, a negative divergence is present indicating that the price

trend may not continue.

*ar -harts use vertical bars to represent various prices for each dayweekmonth. The bar shows thehighest and lowest highest price and can have a single hori/ontal line cutting the bar to represent

closing price, or two hori/ontal lines, one to the left to show opening and one to the right to show

closing price.

-andlestick charts show the same details as bar charts, but have a different visual impact. The opening

and closing prices are used to create a bo &body' within the bar &shadow' which depicts the high and

low price. (f closing is higher than opening &up day' the bo is left empty, if closing is lower than

opening & down day' it is depicted by a black bo.

-andle stick charts also have a variety of patterns that are interpreted in a uni0ue manner.


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ine charts use a line to %oin data points such as dailyweeklymonthly closing prices, moving averages

of price, momentum etc.

Point 2 figure charts have no time scale, only registering changes when significant price increase or

decrease occurs. A column of 3s is used to show rising prices, while a column of )s shows fallingprices. Additional 3s or )s are added only when the price changes by more than a predefined amount

known as the bo si/e. 4ew columns are added only when price changes direction by more than apredefined reversal amount The chart can be made more or less sensitive to price changes to discernbetween long and short term trends by varying bo and reversal si/es. The advantage of these charts is

that they ignore minor movements and help identify trends, support and resistance.

5hen the secondary price movements seem to move in a channel, constrained by an upper or lower

limit, known as the resistance and support levels. 6esistance is the level where many sellers step in and

do not allow price to rise further. Support is the level where many buyers prevent price from fallingfurther. 5hen prices move hori/ontally between support and resistance lines the area is known as a

congestion or consolidation.

7oving averages follow price changes with a lag

8. There are various types of momentum indicators including 7A-D, 6S(, stochastics and 6)-.

!. 7arket wide analysis9 increasing divergence between the inde movement and the cumulativedifference between advances and declines could signal a market trend reversal. (ncreasing divergence

between the inde movement and the moving average of number of highs minus lows could signal a

reversal.

Single stock analysis9 if prices are increasing while the )*+ line is dropping, a negative divergence ispresent indicating that the price trend may not continue.

$undamental analysis attempts to measure the fair value of an e0uity share or other instruments by

studying the economic, industry and company information.

Technical analysis is the study of past price and volume data to forecast future price movements.

:. Technical analysis assumes that the market discounts every thing, i.e. all relevant information

including fundamental factors have already been built into the price at any given point of time, andfocuses only on the market forces of demand and supply. (t also assumes that prices move in trends and

that history repeats itself. Technical analysts believe that traders act with a herd mentality as prices rise

and fall. Although their individual actions may be based on facts or rumours, or on emotions such as

greed or panic, their collective reaction to market situations is consistent. This results in price trendsand patterns that are repeated over time, which can be used to forecast future prices.

#. The ;7 is concerned with the precision with which the market prices securities. (n efficient

markets, prices of securities should reflect all information that is relevant and available. (t assumes thatthere are a large number of informed and rational participants and stock prices ad%ust rapidly to reflect

the effect of new information. According to the efficient market hypothesis, it is impossible to beat the

market and technical analysis cannot be effective. Technical analysts on the other hand claim that


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human behaviour is not rational and claim that they can forecast the future prices based on this

behaviour.


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Chapter 12 Market Efficiency

Answers to end of chapter questions

There should be a large number of informed and rational participants, as this makes the markets li0uid.(nformation should be available 0uickly and freely to all.

The weak form of the ;7 states that current prices already fully reflect all the information available

in the historical se0uence of prices, rates of return, and trading volume data. (t implies that technicalanalysis is not useful.

The semi


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transaction costs. 7omentum and reversal effect have been found in many studies

-ompany insiders did have higher returns, but analyst recommendations were right only half the time.

6isk ad%usted returns of ma%ority of mutual funds, did not outperform the market.

Discuss any two of the following9

igher returns in =anuary, negative returns on 7onday, low P; gives higher return smaller si/e gives

higher return, higher book value to market value ratio higher returns.

>. (f markets are weak form efficient this is directly against technical analysis, but fundamental

analysis can be used to identify under over valued stocks. (f efficient in the semi

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