TechAnlysis - Prof. Ali Reza Lecture Notes: Technical...

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Prof. Ali Reza Lecture Notes: Technical Analysis Technical analysis (TA) starts out with the view that past performance of a security affects it future performance. There are patterns to security prices and these patterns repeat themselves. Thus, relying on these patterns, one can forecast prices. With these forecasts one can make investment decisions and beat the policy of buy-and-hold. The view that there are patterns to prices and these patterns repeat themselves is contrary to the view that security markets are efficient (the Efficient Market Hypothesis). Under the EMH news arrives in the market in a random fashion; stock prices respond fully and instantaneously; so prices are random (Maurice Kendall, in the early 1950s, was among the first to note that stock prices were random) and there is no room to beat the market. Those supporting the EMH argue (and it seems that they show) that random prices can sometimes appear as though they follow patterns; only with statistical analyses can one show that these patterns are merely illusions. Indeed, if one uses randomly generated prices and compare them with the S&P500, it would be nearly impossible to tell which is which. Given the view held by TA, tech analysts concentrate on past prices and volumes, to discover patters in them, and use such patterns to predict the future course of prices. Underlying the TA view is a set of assumptions: 1. The market value of goods are determined by the interaction of demand and supply 2. Demand and supply are determined by many rational and irrational variables: economic variables that fundamental analysis uses, as well as opinions, moods and guesses. 3. Prices of securities tend to move in trends which persist for some time; minor fluctuations are superimposed on these trends 4. Trends change as the demand and supply change. These changes can be detected in the action of the market itself. The last is important: TA relies heavily on what is going on in the market – the contention is that the market itself is the best source of information/data (as opposed to using data/information about the firm through its business plan and financial statements, which might be confusing and inaccurate; in any case, the contention is that accounting information can be manipulated. Finally, financial statements lack some very critical information: the attitude of employees and their loyalty to the firm; customer goodwill; general attitude of investors toward the company. Therefore, TA doesn’t rely on financial statements). There is no controversy about assumptions 1 and 2. Those who believe in the EMH reject assumption 3 – under EMH prices adjust so rapidly that there is no room to make money when new info arrives in the market. TA proponents feel that the price adjustment is rather gradual – and if you can identify the start of a movement to a new price, one can make money. Regarding the 4th assumption: in my judgment both sides’ arguments make some sense. Many think that the
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This note was uploaded on 09/08/2010 for the course BUS 172A at San Jose State University .

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TechAnlysis - Prof. Ali Reza Lecture Notes: Technical...

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