Economic and financial analysis

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CBEB 3302 INVESTMENT

EXECUTIVE SUMMARY

Technical analysis is the search for recurring and predictable patterns in stock prices. It is based on the premise that prices only gradually close in on intrinsic value. As fundamental shift, smart traders can exploit the adjustment to a new equilibrium. Technical analysis also uses volume data and sentimental indicators. These are broadly consistent with several behavioral models of investment activity. The Dow Theory attempts to identify underlying trends in stock indexes. Besides, the moving average, relative strength, breadths are used in other trend based strategies. Some sentiment indicators are the trin statistic, the confidence index and the pull or call ratio.

INTRODUCTION

Technical analysisis asecurity analysisdiscipline for the future direction of prices forecasting through the study of historical market data, primarily price and volume. Technical analysis generates superior investment performance by attempting exploit recurring and predictable patterns in stock prices to. Technical analysts also use indicators, which are price or volume mathematical transformations. These indicators can help determine whether an asset is trending, and if it is, its price direction. Technicians also look for relationships between prices, volume and, in the case offutures,open interest. Other avenues of study consist of correlations between changes inoptions(implied volatility) and put/call ratios with price.

Behavioural Financeare closely related fields making up a separate branch of economic and financial analysis using social,cognitiveand emotional factors in understanding the economicdecisionsof consumers, borrowers and investors, and their effects onmarket prices,returnsand theallocation of resources. Investors use technical analysis in making decision. They will either use trends and corrections or sentiment indicators. the investors looking at moving averages and breadth in trends and corrections Moving averages used to analyze a set of data points by creating a series ofaveragesof different subsets of the full data set and breadth is measuring how wide the range of the investors willing to invest and  lost in that investment.

ASSUMPTIONS

There are assumptions when analysts tend use technical analysis. First, price trends can be used to forecast and make profit. Technical analysts believe that price will move according to a trend that will be up, down or some combination. There are three types of price trend which is primary trend - long-term movement of prices, lasting from several months to several years, secondary or intermediate trends are caused by short-term deviations of prices from underlying trend line. These deviations are not selected via corrections when prices revert back to trend values and tertiary or minor trends are daily fluctuations of little importance.

Second assumption is market is not very efficient. The Efficient Market Hypothesis illustrate that at any given time, security prices fully reflect all available information. Market is not very efficient which mean that security holders do not reflect to all available information and they do not sell or buy security according to the information.

TRENDS AND CORRECTIONS

Technical analysis attempts to uncover trends in market price. This is in effect a search for momentum that can be absolute in which case one searches for upward price trends, or relative, in which case the analyst looks to invest in one sector over another.

Dow Theory

The Dow Theory attempts to identify underlying trends in stock indexes.  There are three forces are posited in the Dow Theory which are the primary trend, secondary or intermediate trends and tertiary or minor trends those affecting stock prices at the same time.

Moving average

The moving average of a stock index is the average level of the index over given interval of time such as 1 year-52 weeks. The average index value over the most recent 52 weeks is tracked by 52 weeks moving average. The moving average is recomputed each week by dropping the former observation and adding the latest.

Breadth

The breadth is a measure of the extent to which movement in a market index is reflected broadly in the price movement of all the stocks. It also can be used for sectoral indices. The formula of breadth is the spread between the number of stocks that advance and decline in price.

Breadth = Number of shares moving up - Number of shares moving down

Besides, adding that day's [net advances (or declines) as formula given: advances minus declines] to the previous total to get the cumulative breadth for every day. The cumulative series is used to discern broad market trends.

TOOLS FOR ANALYSIS

1. Price chart

There will be stock price changes in the price chart such as open stock price, close stock price, highest stock price and lowest stock price. It is looking for repeated trends. The price chart is considered as the technical indicators. The goals in using technical indicators are to better identify current and emerging trends and the points subject to trend reversals to increase profitable investing and trading decisions and reduce unprofitable ones.

Technical indicators consist of mathematical formulas usually based on price activity. For example, an average is calculated of the daily or weekly closes. Indicators in technical analysis provide a method of evaluating market activity and help us forecast the possible interruption of price trends. The price chart is the primary input and usually the particular price is the close price. The open, high and low are used far less often. An example using a value other than close is computing an average of the high for past 20 days to see how today's high compares to this average.

2. Sentiment Indicators

A stock's price chart is the main tool of technical analysis. There are couples of technical analysis software in helping analyst to do technical analysis but it needs an expensive investment to do the analysis. Sentiment indicators are used to quantify the levels of optimism or pessimism present in various markets. Sentiment indicators include a few analysis formula such as Trin statistic, Confidence Index, Put/call ratio which will be explain in detail later on. For example, some indicators will explain all the long and short positions on a particular exchange to determine whether the market is a bearish or bullish. Below are some examples of sentiment indicator that can be used to predict future changes as an option to price chart.

Trin Statistic

The strength of the market can be measured by using market volume. Market movement is indicated by the increasing of investor participation in a market advance or retreat where most of the technicians consider that market advance is more favourable omen of continued price increases when it is conjoined with increased of trading volume. Whereby, the market reversal is considered more bearish when it is linked with higher volume.

From the formula, we can see that Trin is the average volume ratio in declining issues to average volume in advancing issues. If Trin is more than 1.0, it is considered the market is moving downwards or bearish with indicator of pressure in net selling. But in the other hand, bearish condition can be an indicator that there is more buying activity in declining issues.

Confidence Index

Confidence index is where indicator designed to measureconsumer confidence, which is defined as the degree of optimism on the state of the economy that consumers are expressing through their activities of savings and disbursements. The confidence index is the average yield ratio on 10 top-rated corporate bonds divided by the average yield on intermediate-grade corporate bonds. Since the higher rate bonds will offer lower promised yield to maturity so the ratio will not exceed 100%.

When the investors have confidence to the market, they will invest in high-quality bonds, but when they are worried in their investment, they will invest in lower-quality bonds. So when consumers have enough confidence with the security market, they will invest more in the market to gain higher return from the market.

Put and Call Ratio

Put options give the investors the right to buy a stock at a fixed exercise price, it's one of ways to avoid stock price increases. In the other hand, Call options give the investors the right to sell a stock at a fixed price to avoid the stock price decreases. So the Put/Call Ratio determines the ratio of outstanding put options to outstanding call options. In a situation that puts exceed the calls, the market is moving downwards. It is merely a personal opinion on the market on deciding to invest more or to drawback the investment.

CONCLUSION

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