Investments Test #2 FIN 4505 Security Analvsis: 1. Fundamental Analysis o Most analysts use this. o 90% use this o Some information provides advantages. o More credibility than technical analysis 2. Technical Analysis o 10% use technical analysis. o Does NOT seem to provide that many advantages. o People who use are usually short term oriented o Major Difference - information the two use with approaches o Primarily concerned about past stock prices to predict future stock prices Moving Average: o Technique most widely used for technical analysis o 3 Day Moving Average: Day 1 Day 2 Day 3 Day 4 Day 5 Stock Prices: 200 201 202 203 201 3DMA 204 203 202 201 200 199 198 2010123 2020234 2020345 -3DMA -Intersection Day 1 Day 2 Day 3 Day 4 Day 4.5 Day 5 o When the lines cross (intersect): o Intersection:;; buy and sell signals o Most common type of Moving day Average in real world is 200 day moving average o The intersection on Day 4.5 would be a buy or sell signal-- - -5TOU'" fteltE. .. f\eO'ltiNtt A"'~. ... . ;. ' . ..., fill'1l ....(I "eo"", c..e 6ft ""twcd A\ PI>\"He. "t." ~"i;,,,o.\s.p !!!! r"i"l1I S . .. ttH~ ",V\d t.o .. ,dni "c.ld i .. '" ');,,,, 01 .,..ttJI~~(.'!.l o Hit and Stock Price is on top = Buy Signal o Hit and Stock Price is below = Sell Signal o Get signals after the Hit point o Does Not matter which way the trend is moving, only about which line is on top after o Does this work? o No, evidence proves it is only about 50% accurate o Not so sure it works o No concrete evidence suggests it works o Also used different averages: • 100 DMA - could give you another signal as opposed to the 200 day • 50 DMA - could give you another signal as opposed to the 200 day and 100 day o If you change the Moving average =Change hit points =change signal o Is there a reason to use one vs. the other? o No they are just numbers Efficient Markets: 1. Weak Form: Past stock prices cannot be used to predict future stock prices (hypothesis in the negative). a. If it is TRUE you cannot use past stock prices to predict future stock prices. b. If it is TRUE, Technical Analysis will not work. c. Does not affect Fundamental Analysis 2. Semi Strong Form: All publicly available information cannot be used to predict future stock prices (negative hypothesis). a. Past stock prices are publicly available information b. If true, implies that weak form must also be truec. If Semi strong true, technical analysis will not work and fundamental analysis will not work either because everyone knows information d. If Semi Strong is TRUE - you will get fair return on the market for the risk you bear e. Nothing to do in the markets because it is a waste of time because stocks are all fairly valued f. Everyone getting a fair deal g. Semi Strong can be true and still see the market doing crazy things SEMI" Ta.VE J:..,~tc'i k,,{.\'!t, off ~ FAU!. pp..\(.E. Pl: >Po )lit ...~""~ Ult'\'\t-\ .."t .......d ""~.....rlt"1 pri(.(. j"""fS 3. Strong Form: All information (public or private) can not be used to predict future stock prices (negative hypothesis). a. Mergers and Acquisitions good idea of how to this comes into play b. Ifthis is TRUE semi strong must also be true j\C>P\"£ AI'f\II-()fK.H ;;:) r ....S' DE. ;J Nf1) ":>£.1:> "' LOu If) Sf:"') I'IbT t::~EN ioN OfPOt.1\,f...... 't'f folL +W'\\l\)Ef!..~ I'll fh't l'Ao..~ fY\f:K\.-c.~ t APPLE. 1\"PflC)~(,...£s l:""E:~'fMEN'f l-N II E.C,TMIS-N1' e.4\NtLEIl-~ e.A"'~'-flJ> pue I c. /tN"'t>v fee M ,".""", of M~'-t.."ft, ~---..---~~~~.-..---Strong form being true =extreme case. No one literally thinks this is true. That is why there is insider trading laws to prevent it because it has been demonstrated that it can be pulled off. Empirical Test: 1. Random Formula - put numbers in a formula and the formula has a statistical test to show if the sequences are random or not i. EX: 2,4,6,8,10 = not random (doubling pattern) ii. EX: 1,4,7,10,13 =not random 1. If patterns are discernible then they are not random and you could anticipate what will happen next b. Let's put the stock prices for individual companies and the entire aggregate market i. If formula shows a pattern =something we could use to anticipate what will happen in the future Ii. If the formula shows no pattern =no help to us c. The formula detects whether the sequence of numbers has patterns or not d. The test has proven that 99% of the time stock prices are random and cannot help us anticipate future prices e. Shows that the Weak Form is TRUE =past stock prices do not help us predict future stock prices 2. Serial Correlation Test-'I!.\(:.t <.1W'It.E' p/l.\C-E <:ttlI\.'Nc..C ~ ~r'\ -t ttl • -«1<\ 1.00 1.. tlQ w<.<: 1<-1. Z..0Cl (I.,,;')wc:c:·...1. ....... <. ... 3 (,.1S1 t ~CiC )"'''''''"?, ...<<:. ... 1.( t~()o) (),j;ll<'£. (.HN.... E. .... c:,~... ...~c.t.. '5 :t .... ~'"'...¥-PEC1.IOC> ""c.t.1'- S 0 '1 'SI;) wee.'" CD• t. • Patterns that can Happen: -Positive Correlation ., . . . -Can use past to predict future , . -If Stock went up; Gives you a 50% chance price will go up . . -Same for if the stock goes down -Price changes tend to happen in the same direction .' . . . ... , -If this describes reality - technical analysis would work .. ..., , ", .... , . . • , ~ . .~, f .( I , ... C • -Negative Correlation -If stock went up =stock will be going down next week -Same for if a stock went down -If this describes reality =Technical analysis would work -Yes you can predict the future by looking in the past • , . I ", I • • f • • · . • -0 Correlation -If stock goes up; it's a coin toss (50% chance) - you don't know what will happen . ~ . - This Correlation is proven to be overwhelmingly found compared to the other two -Can Not use past to predict future -You could use a regression to be certain of what Correlation your data produces if you do not know what it is 1= positive slope 2= negative slope 3= horizontal slope with no line Also tried to use different forms of t and t+l and found the same results - tried all the way out to 16 weeks - Conclusion is that Weak Form is TRUE 3. Filter Technique - 1st step select size of the filter ( most commonly used is 5%) =this means stock signals 5% from the high or 5% from the low 101;) ~...--..---~.--....---o Deals with the concept of momentum o Tried filter from ~%to 20% o If small (1/2%) you are going to be buying or selling all ofthe time o If large (20%) mean you will hardly ever