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Ch_9 - Underlying Assumptions of Technical Analysis The...

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15-1 The market value of any good or service is determined solely by the interaction of supply and demand Supply and demand are governed by numerous factors, both rational and irrational Disregarding minor fluctuations, the prices for individual securities and the overall value of the market tend to move in trends, which persist for appreciable lengths of time Underlying Assumptions of Technical Analysis
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15-2 Underlying Assumptions of Technical Analysis Prevailing trends change in reaction to shifts in supply and demand relationships. These shifts, no matter why they occur, can be detected sooner or later in the action of the market itself See Exhibit 15.1 It shows the process wherein new information causes a decrease in the equilibrium price for a security but the price adjustment is not rapid
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15-3 Exhibit 15.1
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15-4 Advantages of Technical Analysis Technical analysis is not heavily dependent on financial accounting statements. The technician contends that there are several major problems with accounting statements: Lack information needed by security analysts GAAP allows firms to select reporting procedures, resulting in difficulty comparing statements from two firms Non-quantifiable factors do not show up in financial statements
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15-5 Fundamental analyst must process new information and quickly determine a new intrinsic value, but technical analyst merely has to recognize a movement to a new equilibrium Technicians trade when a move to a new equilibrium is underway but a fundamental analyst finds undervalued securities that may not adjust their prices as quickly Advantages of Technical Analysis
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15-6 Challenges to Technical Analysis For Assumptions of Technical Analysis Empirical tests of Efficient Market Hypothesis (EMH) show that prices do not move in trends For Technical Trading Rules The past may not be repeated Patterns may become self-fulfilling prophecies A successful rule will gain followers and become less successful Rules require a great deal of subjective judgement
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