lecture20 - Lecture 20: Technical Analysis Steven Skiena...

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Lecture 20: Technical Analysis Steven Skiena Department of Computer Science State University of New York Stony Brook, NY 11794–4400 http://www.cs.sunysb.edu/ skiena
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The Efficient Market Hypothesis The Efficient Market Hypothesis states that the price of a financial asset reflects all available public information available, and responds only to unexpected news. If so , prices are optimal estimates of investment value at all times. If so , it is impossible for investors to predict whether the price will move up or down. There are a variety of slightly different formulations of the Efficient Market Hypothesis (EMH). For example, suppose that prices are predictable but the function is too hard to compute efficiently. . .
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Implications of the Efficient Market Hypothesis EMH implies it is pointless to try to identify the best stock, but instead focus our efforts in constructing the highest return portfolio for our desired level of risk. EMH implies that technical analysis is meaningless, because past price movements are all public information. EMH’s distinction between public and non-public informa- tion explains why insider trading should be both profitable and illegal. Like any simple model of a complex phenomena, the EMH does not completely explain the behavior of stock prices. However, that it remains debated (although not completely believed) means it is worth our respect.
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Technical Analysis The term “technical analysis” covers a class of investment strategies analyzing patterns of past behavior for future predictions. Technical analysis of stock prices is based on the following assumptions (Edwards and Magee): Market value is determined purely by supply and demand Stock prices tend to move in trends that persist for long periods of time. Shifts in supply and demand cause reversals in trends. These shifts can be detected in charts/graphs.
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Many chart patterns tend to repeat themselves. There have been long and loud debates of the relative merits of technical analysis and fundamental analysis , which assesses the profitability and prospects of the given security.
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Technical Analysis: Pro Many professionals use it. Many amateurs use it, too. How can this be if it has no value? M. Taylor and H. Allen, “The Use of Technical Analysis in the Foreign Exchange Market”, J. International Money and Finance, June 1992, 304-314. surveys foreign exchange dealers and find that the vast majority place some weight on technical analysis. Since market prices reflect supply and demand, any under- standing of popular trading strategies can potentially provide an edge.
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Given the diverse strategies and goals of different traders (e.g. hedging and risk reduction vs. profit maximization) there may be positive investment opportunities even in an efficient market. Certain technical analysis methods seem to mirror natural
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lecture20 - Lecture 20: Technical Analysis Steven Skiena...

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