Chat with us, powered by LiveChat TOPIC 9: STOCK PICKING: A TECHNICAL APPROACHCorpor - Writemia

TOPIC 9: STOCK PICKING: A TECHNICAL APPROACHCorpor

TOPIC 9: STOCK PICKING: A TECHNICAL APPROACHCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6LEARNING OUTCOMESInvestigate the use of technical analysisas techniques for stock pickingEvaluate the success of such anapproach in light of the key academictheoriesUndertake some key technical analysisof share pricesDiscuss the use of technical analysis byfund managersCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6THE RANDOM WALK HYPOTHESISYesterday?s share price represented thecollective view of yesterday?s information.Every day starts out fifty-fifty, so that pricechanges depend on the market reaction tonew information.Thus the current share price is the bestestimate of tomorrow?s price, since it reflectsall known information and all the assumptionsthat investors have made about the future.Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6TECHNICAL ANALYSISA chartist predicts future share pricemovements by plotting charts of share pricemovements over a period of time.From these charts of price movements theythen claim to be able to see trends thatforecast where the share price will move next.Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6Famous Technical AnalystsJesse LivermoreWilliam GannNicholas DarvasEd SeykotaPeter LynchCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6TECHNICAL TRADING RULESWith the onset of computer powerand the development of certainstatistical techniques, the use ofcharts has somewhat been replacedwith technical trading rules.Put simply if certain pricemovements occur or signals appearthan a trader would buy or sell thestockCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY DIFFERENCE TO FAThose who engage in technical analysis haveno preference what company it is they trade.In fact they could know nothing about thecompany and just base their trading decisionon the charts and past price dataIn reality though many will at least look atthings like earning announcement dates andwhen key economic data will be releasedwhich could cause the stock to move.Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6LINKS TO EMHThe weak form of EMH states thatfuture prices cannot be predictedreliably by looking at past pricehistoryEspecially when the extra costs offrequent trading are factored in.Essentially proponents of technicalanalysis fundamentally disagree withthis.Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6DOW THEORYThis theory depends on the plotting of daily priceindices on charts. It originates in America, and inits pure form is related to two US stock marketindices -Industrials and Rails. Before anyconclusion may be established, the one index mustconfirm the other. In the UK there is no Rails index,but advocates of the theory claim that it can besuccessfully applied to other indices.In essence, it is maintained that there is a primarymovement in the market at all times lasting forone or more years. There are also secondarymovements usually lasting for a few weeks ormonths. The daily movements which comprise thesecondary’s are ignored.Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6Dow Theory TrendsCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6THE ROLE OF VOLUMEVolume is the number of shares being tradedeither in a specific stock or across the marketas a whole. This can be looked at either intraday, daily or weekly.Volume is used to confirm trends as highvolume would signal a stronger trend that ifany movement was only based on fewertransactions.Many chartists could also look at level 2 (onSETS) to view the levels at which major playersare prepared to buy and sell. This will often setresistance levels both on the up and downside.Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6CHART DESIGNSThere are 4 key chart types which technical analystsuse. Normally each will include volume in some way(normally plotted on a separate vertical axis.Line Charts ? Simple plot of stock pricesBar Charts ? Comprises of 4 pieces of data. High, Low,Open, Close and closing price. A blue line means thestock is up and a red line the stock is downCandlestick Charts ? Same as a bar chart but instead ofa line the open and close prices are denominated by abox.Point and figure Charts ? No account of volume or timebut instead. Movements are plotted by using X (ups)and O (downs)Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6CHART DESIGNSCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6CHART DATA FREQUENCYCharts could be constructed on thebasis ofMinutes or hourlyDailyWeeklyMonthlyYearlyCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY CHARTIST PATTERNSAfter plotting the share prices usingone of the above chart types anddata frequencies, the analysts will belooking for established patterns onwhich to make a buy / sell decision.They are assuming that the stock willfollow an established movement or?break out?Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY CHARTIST PATTERNSUpward trendCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY CHARTIST PATTERNSDownward trendCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY CHARTIST PATTERNSHead and shouldersCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY CHARTIST PATTERNSDouble tops and bottomsCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY CHARTIST PATTERNSCup and HandleCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY CHARTIST PATTERNSSupport and ResistanceCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6KEY TECHNICAL ANALYSISMEASURESMeisels measureMoving averagesMoving average convergencedivergenceStochastic?sRelative strength indexCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6MEISELS MEASUREDayThis is perhaps the1simplest measure of all.Its23based on a 10 dayrolling456period. If the markethas78risen your return + 1and if91011fallen -1. You then sumup12the 10 returns to giveanCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6MOVING AVERAGESDayThis is the most popular method.1based on calculating a rollingmoving2average for a given period. Theaim34is to eliminate noise andhighlight a56trend. When the instrumentprice7rises above its moving average,89buy signal appears, if the pricefallsbelow its moving average, whatCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6MOVING AVERAGES?The moving average, is not designed to provideentrance into the market right in its lowest point,and itsexit right on the peak. It allows you to actaccording tothe following trend: to buy soon after the pricesreachThe bottom, and to sell soon after the priceshaveReached their peak.? (metaquotes)Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6MACD?The standard MACD formula12 Dayis the difference between1998.22sessions EMA, and themoving1996.521993.47average of 12 sessionsEMA.1988.821980.80Using shorter moving1971.00averages, will gave a faster1961.44indicator, more sensitive,while1955.41longer ones will be slower,butCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6MACD?When choosing to use a moving averageyou also have to decide whether to use asimple or exponential average. The onlysignificant difference between these twomoving averages is the weight assigned tothe most recent data. Simple movingaverages apply equal weight to each day?svolume. Exponential moving averages applymore weight to the most recent volume.?(Graham, 2004, pp2)Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6STOCHASTIC?SThese are a momentum indicator which triesto establish if any upward or downward trendsare gaining or losing momentum.This will give a reading of between 0 and 100.There are various modifications made to thisformula along with changing the periods ofanalysis (which is typically 14 daysA 3-day simple moving average of STS isusually plotted alongside to act as a signal ortrigger line, called %D.Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6RELATIVE STRENGTH INDEXRelative strength index (RSI) is amomentum indicator whichanalyses recent gains and lossesto generate an overbought oroversold indicator. IAG9597100 ? (100 / 1 + RS)91RS = Average of x days’ upcloses / Average of x days’ downcloses105103?The resulting formula gives areading of between 0 and 100.Typically a reading above 70 isseen as overbought and anythingbelow 30 is oversold95Data frequency normally 14 daysbut again could be alteredCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6TECHNICAL ANALYSIS OVERVIEWThere are many more complex technicaltrading rules which individuals and companiesuse, however many of these are closelyguarded secrets. They argue that if such ruleswere published the market would eradicatesuch trendsThere has been much research into thesuccess of TA and the main finding are that itdoesn’t generate above market returns andwhere it might, excessive trading costs wouldeliminate this.Besides ?????.. do people just read intocharts what they want to believe???Corporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERYRISK MANAGEMENT AND INVESTMENT LEVEL 6Any QuestionsCorporate Finance 2008 2009 JonathanJefferyJONATHAN JEFFERY

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