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exception of overreaction, none has been shown to clearly explain asset returns.
• Technical analysis is the search for recurring patterns in stock market prices. It is based
essentially on the notion that market prices adjust slowly to new information and, thus, is
at odds with the efficient market hypothesis.
• The Dow theory is the earliest chart-based version of technical analysis. The theory posits

the existence of primary, intermediate, and minor trends that can be identified on a chart
and acted on by an analyst before the trends fully dissipate. Other trend-based theories are
based on relative strength, the point and figures chart, and the candlestick diagram.
• Technicians believe high volume and market breadth accompanying market trends add
weight to the significance of a trend.
• Odd-lot traders are viewed as uninformed, which suggests informed traders should pursue
trading strategies in opposition to their activity. In contrast, short-sellers are viewed as
informed traders, lending credence to their activity.
• Value Line™s ranking system uses technically based data and has shown great ability to
discriminate between stocks with good and poor prospects, but the Value Line mutual fund
Bodie’Kane’Marcus: VI. Active Investment 19. Behavioral Finance and © The McGraw’Hill
Essentials of Investments, Management Technical Analysis Companies, 2003
Fifth Edition

The Value Line Centurion Fund™s turnover is 200% a publication of the new rankings. Most subscribers get
year. That™s quite a bit of turnover”although by no their surveys on Friday morning, however, and buy at
means the highest in the business. The turnover is high the Friday opening”if they are lucky. An internal Value
because in a typical week, 4 of the 100 group I stocks Line rule forbids the funds to act on rank changes be-
drop down in rank and have to be replaced with new fore Friday morning.
group I stocks. It™s not impossible for traders like Cen- A day makes all the difference. A 1985 study by
turion to beat the market, but they start out with a Scott Stickel showed that almost all of the excess re-
handicap. turn on a group I stock is concentrated on three days,
What are these inefficiencies and costs? And what do almost evenly divided: the Friday when subscribers
they tell investors about the perils of in-and-out trading? read about the stock™s being promoted into group
Fund overhead is not a big item. At the $244 million I, the Thursday before, and the Monday following.
Centurion, which is available only through variable life Wait until Tuesday to buy and you might as well not
and annuity policies sold by Guardian Life, the annual subscribe.
expense ratio averages 0.6%. Nor are brokerage com- Why are prices moving up on Thursday, the day be-
missions large. Funneled at about 5 cents a share fore publication? Eisenstadt suspects the Postal Service
mostly to a captive Value Line broker, commissions eat of acting with uncharacteristic efficiency in some parts
up 0.4% of Centurion™s assets per year. of the country, giving a few subscribers an early start.
So far we have 1%. Where™s the other 10% of the Another reason for an uptick: Enough is known about
shortfall? Bid“ask spreads, for one. A stock quoted at the Value Line formula for smart investors to anticipate
39 to sellers might cost a buyer 391„2”or even 41 or 42 a rank change by a few days. The trick is to watch
group II (near-top) stocks closely. If a quarterly earnings
if the buyer wants a lot of it. With about 95 of the 100
report comes in far better than the forecast published
group I stocks at any given time in the Centurion port-
in Value Line, grab the stock. “What happens if you™re
folio, Tavel needs to amass an average $2.5 million po-
wrong? You™re stuck with a group II stock with terrific
sition in each. Some of these companies have $150
earnings,” says Eisenstadt.
million or less in outstanding shares. The very smallest
Tavel doesn™t even try to buy.
Timing explains some of the gulf between hypothet-
ical and actual results. The hypothetical performance SOURCE: Reprinted by permission from Forbes magazine, October
assumes a purchase at the Wednesday close before 19, 1987. © Forbes, Inc. 1987.

that uses this system most closely has been only a mediocre performer, suggesting that
implementation of the Value Line timing system is difficult.
• New theories of information dissemination in the market suggest there may be a role
for the examination of past prices in formulating investment strategies. They do not,
however, support the specific charting patterns currently relied on by technical analysts.

breadth, 671 odd-lot theory, 668 resistance level, 661
confidence index, 669 put/call ratio, 669 short interest, 669
Dow theory, 661 relative strength, 672 support level, 661

1. Consider the graph of stock prices over a two-year period in Figure 19.14. Identify

likely support and resistance levels.
2. Use the data from The Wall Street Journal in Figure 19.9 to construct the trin ratio for
the market. Is the trin ratio bullish or bearish?
3. Calculate market breadth using the data in Figure 19.9. Is the signal bullish or bearish?
4. Collect data on the DJIA for a period covering a few months. Try to identify primary
trends. Can you tell whether the market currently is in an upward or downward trend?
5. Baa-rated bonds currently yield 9%, while Aa-rated bonds yield 8%. Suppose that due
to an increase in the expected inflation rate, the yields on both bonds increases by 1%.
What would happen to the confidence index? Would this be interpreted as bullish or
bearish by a technical analyst? Does this make sense to you?
Bodie’Kane’Marcus: VI. Active Investment 19. Behavioral Finance and © The McGraw’Hill
Essentials of Investments, Management Technical Analysis Companies, 2003
Fifth Edition

678 Part SIX Active Investment Management

F I G U R E 19.14 Price
Simulated stock price
over time





6. Using Figure 19.15 from The Wall Street Journal, determine whether market price
movements and volume patterns were bullish or bearish around the following dates:
September 17, November 5, and January 5. In each instance, compare your prediction to
the subsequent behavior of the DJIA in the following few weeks.
7. Table 19.5 presents price data for Computers, Inc., and a computer industry index. Does
Computers, Inc., show relative strength over this period?
8. Use the data in Table 19.5 to compute a five-day moving average for Computers, Inc.
Can you identify any buy or sell signals?

1. Find the weekly price for the most recent two years for a firm from the Market
Insight database (www.mhhe.com/edumarketinsight). Also, collect the level of
the S&P 500 Index for the same period.
a. Calculate the eight-week moving average of both the stock and the S&P 500
over time. For each series, use Excel to plot the moving average against the
actual level of the stock price or index. Examine the instances where the
moving average and price series cross. Is the stock more or less likely to
increase when the price crosses through the moving average? Does it matter
whether the price crosses the moving average from above or below? How
reliable would an investment rule based on moving averages be? Perform your
analysis for both the stock price and the S&P 500.
b. Calculate and plot the relative strength of the stock compared to the S&P 500
over your sample period. Find all instances in which relative strength of the

stock increases by more than 10 percentage points (e.g., an increase in the
relative strength index from .93 to 1.03) and all those instances in which
relative strength of the stock decreases by more than 10 percentage points. Is
the stock more or less likely to outperform the S&P in the following two weeks
when relative strength has increased or to underperform when relative
strength has decreased? In other words, does relative strength continue? How
reliable would an investment rule based on relative strength be?
2. Obtain weekly price data for a one-year period for a stock from the Market Insight
database (www.mhhe.com/edumarketinsight). Use the price data to construct a
point and figure chart with price intervals of $2. Do you observe any buy or sell
signals? If so, what percentage of times do these signals turn out to be correct?
Bodie’Kane’Marcus: VI. Active Investment 19. Behavioral Finance and © The McGraw’Hill
Essentials of Investments, Management Technical Analysis Companies, 2003
Fifth Edition

19 Behavioral Finance and Technical Analysis

F I G U R E 19.15
Dow Jones Industrial
Average and market
Source: From The Wall Street
Journal, February 7, 1994, p.
C3. Reprinted by permission
of Dow Jones & Company,
Inc. via Copyright Clearance
Center, Inc. © 1994 Dow
Jones & Company, Inc. All
Rights Reserved Worldwide.


9. Construct a point and figure chart for Computers, Inc., using the data in Table 19.5. Use
$2 increments for your chart. Do the buy or sell signals derived from your chart
correspond to those derived from the moving average rule (see problem 8)?
10. Yesterday, the Dow Jones industrials gained 54 points. However, 1,704 issues declined
in price while 1,367 advanced. Why might a technical analyst be concerned even though
the market index rose on this day?
11. Table 19.6 contains data on market advances and declines. Calculate cumulative breadth
and decide whether this technical signal is bullish or bearish.
Bodie’Kane’Marcus: VI. Active Investment 19. Behavioral Finance and © The McGraw’Hill
Essentials of Investments, Management Technical Analysis Companies, 2003
Fifth Edition

680 Part SIX Active Investment Management

Trading Day Computers, Inc. Industry Index
TA B L E 19.5
1 19.63 50.0
Computers, Inc.,
2 20 50.1
stock price history
3 20.50 50.5
4 22 50.4
5 21.13 51.0
6 22 50.7
7 21.88 50.5
8 22.50 51.1
9 23.13 51.5
10 23.88 51.7
11 24.50 51.4
12 23.25 51.7
13 22.13 52.2
14 22 52.0
15 20.63 53.1
16 20.25 53.5
17 19.75 53.9
18 18.75 53.6
19 17.50 52.9
20 19 53.4
21 19.63 54.1
22 21.50 54.0
23 22 53.9
24 23.13 53.7
25 24 54.8
26 25.25 54.5
27 26.25 54.6
28 27 54.1
29 27.50 54.2
30 28 54.8
31 28.50 54.2
32 28 54.8
33 27.50 54.9
34 29 55.2
35 29.25 55.7
36 29.50 56.1
37 30 56.7
38 28.50 56.7
39 27.75 56.5
40 28 56.1

12. If the trading volume in advancing shares on day 1 in the previous problem was 330
million shares, while the volume in declining issues was 240 million shares, what was
the trin statistic for that day? Was trin bullish or bearish?


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