Investments: Analysis
and Behavior
Chapter 13- Technical Analysis
©2008 McGraw-Hill/Irwin
Learning Objectives





Learn the graphing tools of technical analysis.
Identify stock price patterns.
Know how trading volume relates to price patterns.
Learn technical indicators for measuring market activity.
Understand how investor sentiment is measured and
used.
13-2
Inefficient Markets
Chapter 6 argues that markets are efficient.
 Chapter 7 illustrates EMH anomalies.
 Chapter 8 argues that if investors are not always
rational, then markets may not be fully efficient.

If markets are nearly efficient, what
tools may be useful for investors to
make money? These tools are
detailed in Technical Analysis.
13-3
Supply and Demand


Fundamental Analysis: stocks prices are
related to the value of the business.
Technical Analysis: stock prices are the result
of supply and demand forces for the stock.



Priced more like a commodity.
Technicians try to understand and measure the
changing supply and demand.
Market Technicians Association
(www.mta.org)
13-4
Plotting the Market – measuring trends
Price charts:

Resistance lines and Support lines

Channels and Breakouts
13-5
moving averages
13-6
Dow Theory

Developed by William Hamilton
from 1902 to 1929

New primary market trends are
confirmed between DJTA and
DJIA.
 Secondary
trends
 Tertiary trends
13-7
13-8
Charting Price Patterns

Head and Shoulders
13-9
Continuation patterns
Reversal patterns
13-10
13-11
7/20/1996
4/20/2004
1/20/2004
10/20/2003
7/20/2003
4/20/2003
1/20/2003
10/20/2002
7/20/2002
4/20/2002
1/20/2002
10/20/2001
7/20/2001
4/20/2001
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10/20/2000
7/20/2000
4/20/2000
1/20/2000
10/20/1999
7/20/1999
4/20/1999
1/20/1999
10/20/1998
7/20/1998
4/20/1998
1/20/1998
10/20/1997
7/20/1997
4/20/1997
1/20/1997
10/20/1996

4/20/1996
1/20/1996
10/20/1995
Market Cycles
Economists talk about the
business cycle

Figure 15.9 The S&P 500 Index and Cycles
Technicians look for
market cycle
1600

1400
1200

80-week cycle

Kondratieff, or K-waves

60-year cycle
40-week cycle
80-week cycle
1000
800
40-week cycle
600
400
13-12
Volume and Price
Volume is used to
confirm the strength
of a trend.
 Increasing
volume
supports increasing
price trend.
 Divergence
Source: MSN Money
13-13

Selling and buying pressure measures

Money Flow
Dollar value of trades at an uptick less value of trades at a
downtick

Up/Down Ratio
Dollar value of trades at an uptick divided by the value of
trades at a downtick
Money Flows--Top
Gainers
Exch
Last
Price
% Chg.
Money
Flow
Uptick
volume
Downtick
volume
Citigroup
NYSE
46.12
0.12
126.27
182.51
SPDR
AMEX
126.68
0.26
108.21
MerLyn
NYSE
72.7
0.6
HewlettPk
NYSE
31.65
AmExpress
NYSE
52.37
Company
Ratio
Block
Trades
Uptick
volume
Downtick
volume
56.23
3.25
116.01
136.41
20.4
6.69
645.32
537.1
1.2
117.69
475.88
358.19
1.33
60.7
118.5
57.81
2.05
64.88
81.76
16.88
4.84
0.31
58.46
84.9
26.43
3.21
57.57
64.89
7.32
8.86
0.93
55.04
87.34
32.3
2.7
54.9
65.43
10.53
6.21
Ratio
13-14
TECHNICAL INDICATORS

Condition of the Market:
 Breadth—how many firms
 Advances and declines
 Advance/decline ratio
 Overbought
 TRIN
and oversold
ratio
# of advancing stocks
TRIN 
<0.35
0.35 to 0.6
1.5 to 1.85
>1.85
are participating in the rally.
overbought
very bullish
very bearish
oversold
# of declining stocks
up volume
down volum e
13-15
Market Breadth Measures
NYSE
AMEX
NASDAQ
OTC BB
Advancing Issues
2,228
583
2,000
761
Declining Issues
1,073
408
1,018
785
135
89
162
432
3,436
1,080
3,180
1,978
New Highs
248
62
189
161
New Lows
36
20
34
155
Up Volume
1,585,999,550
243,224,612
1,188,539,914
505,671,486
875,383,650
106,015,090
805,549,381
554,470,602
41,660,370
31,142,100
72,784,810
794,041,622
2,503,043,570
380,381,802
2,066,874,105
1,854,183,710
Unchanged Issues
Total Issues
Down Volume
Unchanged Volume
Total Volume
Data source: http://finance.yahoo.com/advances (January 24, 2006).
13-16
Momentum Indicators
Rate of Change (ROC): shows the amount prices have changed over a given time
period.
Moving Average Convergence/Divergence (MACD): Calculated by subtracting the value
of a 26-period exponential moving average from a 12-period exponential moving
average. Then take a 9-day exponential moving average of the MACD.
The MACD trading rule is to sell when it falls below its 9-day signal line and to buy when the MACD
rises above the 9-day signal line.
13-17
Sentiment Indicators
Sentiment: The mood of investors drive markets.
 Investor





actions
Odd lot trades (contrary indicator)
Mutual fund flow
Broker account credit and debit balances
Short interest
Put/call ratio
 Surveys
13-18
AAII Investor Sentiment Survey
Measures the percentage of individual investors who are bullish, bearish, and neutral
on the stock market in the short term: weekly.
Consumer Confidence Survey
The survey of 5,000 households is conducted for the Conference Board by NFO
WorldGroup: monthly.
University of Michigan Consumer Sentiment
The Index of Consumer Sentiment (ICS) is based upon consumer responses to each
of five survey questions on spending plans.
ABC News/Money Magazine Consumer Comfort Index
The index is based on ratings of the economy, buying climate, and personal finances:
rolling 4-week sample of 1,000 adults.
Investor’s Intelligence
Newsletter reviews other investment newsletters and reports the percentage that is
bullish on a weekly basis. (www.investorsintelligence.com)
Merrill Lynch Sell Side Indicator
This indicator is based on a survey of Wall Street Strategist asset allocation
recommendations: monthly.
Robert Shiller’s Stock Market Confidence Indices
Yale Professor Rober Shiller compiles four different indices based upon surveys of
individual and institutional investors: One-Year Confidence Index, Buy-on Dips
Confidence Index, Crash Confidence Index, and Valuation Confidence Index.
(icf.som.yale.edu/confidence.index)
13-19
Stock Rotations

Sector Rotation
 Sometimes
investors like, technology, other
times they like energy…

Value/Growth Rotation

Capitalization Rotation
 Small
versus large companies
13-20
Sectors in and
out of favor
13-21
Figure 13.9 Sometimes Large Capitalization Stocks Outperform...Sometimes Small Caps Do
$50,000
$45,000
Value of $10,000 Investment
$40,000
Investment in Small Caps
$35,000
Investment in Large Caps
$30,000
$25,000
$20,000
$15,000
Large Cap Stocks
Outperformed 1996
to 1999
$10,000
Small Cap Stocks
Outperformed 2000
to 2003
$5,000
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
$0
Data source: Yahoo! Finance
13-22
Criticisms of TA



Not much statistical analysis
support for technical trading
rules.
Subjective judgment is part of
the decision making.
The brain sees patterns in
random data
13-23