solution manual for 《investment analysis and portfolio management》 ch16.doc

chapter 16technical analysisanswers to questions1.the principal contention of technicians is that stock prices move in trends that persist for long periods of time. because these trends persist they can be detected by analyzing past prices.2.technicians expect trends in stock price behavior because they believe that new information that causes a change in the relationship between supply and demand does not come to the market at one point in time - i.e., they contend that some investors get the information before others. also, they believe that investors react gradually over time to new information. the result is a gradual adjustment of stock prices.3.the problems encountered when doing a fundamental analysis of financial statements are: (1) much of the information in financial statements is not useful; (2) there are comparability problems for firms using alternative accounting practices; and (3) there are important psychological factors not included in financial statements. also, with technical analysis it is not necessary to invest until the move to a new equilibrium begins.4.the disadvantages of technical analysis are: (1) past price patterns may not be repeated in the future; (2) the intense competition of those using the trading rules will render the technique useless; (3) the trading rules require a great deal of subjective judgment; and (4) the values that signal action are constantly changing.5.the mutual fund cash position of 10 percent is relatively high. this would indicate a bullish market because: (1) the theory of contrary-opinion states that mutual funds are the odd-lot trader of the institutional market and typically make the wrong decision by holding excess cash near a trough when they should be fully invested; and (2) the large cash positions of mutual funds represent potential buying power.6.credit balances result when investors sell securities and leave the proceeds with their broker with the intent of reinvesting the funds shortly. therefore, they can be considered a source of potential buying power. given this line of reasoning, a decline in credit balances would indicate a decline in potential buying power, which is bearish. another line of reasoning is based on contrary opinion. it is assumed that these balances are generally maintained by small investors who draw them down to invest at the peak, so this is bearish for the contrary opinion technician.7.this index indicates what proportion of investment advisory services are bearish and 61 percent is a fairly high ratio. to a contrary opinion technician this is bullish because so many of the services are bearish.8.debit balances represent borrowing by sophisticated investors, therefore higher debit balances indicate optimism on the part of these investors. the problem with the debit balance measure is that it only represents borrowing through brokers and it ignores the amount of borrowing from alternative sources.9.the dow theory contends that stock prices move in waves. specifically, these waves may be grouped into three categories based upon the period of the wave: (1) major trends for long periods (tides); (2) intermediate trends (waves); and (3) short-run movements for very short periods (ripples). the major trend (the tide) is most important to investors. an intermediate reversal occurs when some investors decide to take profits.10.the direction of a price movement accompanied by high volume is more important than if the same price change is associated with light volume. if prices decline (advance) on heavy volume it is bearish (bullish) since it indicates numerous sellers (buyers).11.the breadth of the market index is a time series calculated as the cumulative number of net advances or net declines. it indicates a peak or trough in stock prices prior to the peak (or trough) in the aggregate price series by showing a broadly based decline in the majority of individual stocks. the technician would expect that at a turning point this decline (advance) in the breadth index would be moving in the opposite direction of a rising (falling) market price index series - i.e., the aggregate price series would still be rising (falling) when most individual stocks are beginning to decline (advance).12.technicians following the breadth of market rules might interpret the event as indicative of a possible market peak. since the djia is a value-weighted series confined to 30 large well-known stocks, the past trading period indicates that while the large stocks are still advancing, the majority of individual issues are declining. due to the technical analysts belief that information is disseminated on an unequal basis, the technicians would interpret a net cumulative decline as a sign of a market turn that has not been interpreted yet by small investors who hold funds of the large, well-known stocks.13.a support level is a price range where considerable demand is expected, while a resistance level is a price range where a large supply is expected. support and resistance levels exist due to the behavior of a number of investors who are closely monitoring the market and will trade quickly at attractive price levels. specifically, a support level occurs after a stock has increased in price followed by a brief period of profit-taking at which time some investors who did not get in on the first round decide to take the opportunity to get in. a resistance level occurs after a stock has declined and when it experiences a recovery, some investors who missed selling at a price peak take the opportunity to sell.a price break through a resistance level on strong volume would be considered very bullish. this is because as the price rises to the target price set by investors, the supply increases usually causing the price increase to reverse. thus, a price breakthrough on strong volume would be bullish because it would mean the excess supply is gone.14.a moving average line indicates the major trend of a securitys price. when daily prices break through the long-term trend from below on heavy volume it is considered a bullish action. the move above the trend line may indicate a new upward change in the trend.15.if current prices break through the 50-day ma line from above on heavy volume, technicians would expect a reversal of a rising trend and become bearish. if the 50-day ma line crosses the 200-day ma line from above on good volume, technicians would again expect a reversal in rising prices and become bearish. 16.relative strength is the ratio of a firms stock price to a market price series. if the relative strength ratio is increasing during a bear market it means that the stock is not declining as much as the aggregate market. under such favorable conditions, the technician would expect the stock to likewise outperform the market in the ensuing bull market.17.technicians recognize that there is no single technical trading rule that is correct all the time - even the best ones miss certain turns or give false signals. also, various indicators provide different information for alternative segments of the market. therefore, you dont want to depend on any one technique, but look at several and derive a consensus.chapter 16answers to problems1.student exercise2.student exercise3.student exercise4.403938 x 037 x 036 x 035 x 034 x 033 x 032 x 031 x 030 x 0 x29 x 0 x28 x 0 x27 x 0 x26 x 0 x25 x24 x23 xthe price of the stock went to 38 1/2 before declining. therefore, at the current price of around 30, the chart could imply a buying opportunity since the price has risen recently from 26 to 30 without a reversal.5.a.day 4=(12,010 + 12,100 + 12,165 + 12,080)/4 = 48,355/