Notes 9

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Three Approaches to
Security Selection
• Technical Analysis
• Fundamental Analysis
– Economic Analysis
– Industry Analysis
– Company Analysis
• Efficient Markets
1
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)
2
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
3
Other Market Sentiment
Techniques
•
•
•
•
•
The advance-decline line
Moving Averages
Support and Resistance Levels
Bar Charting
Point and Figure Charts
4
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
5
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
6
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
7
Event Studies
• Stock Splits
• Earnings Announcements
• Initial Public Offerings
• Tests for Private
Information
• Trading by Insiders
• Performance of Professional
portfolio managers
8
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