Technical Analysis of Stock Trends - Research Paper Example

INVESTMENT COURSEWORK by Student’s Name Course Code + Title Professor University City/State Date Abstract This is a research paper whose discussion entails a technical analysis of stocks to help guide investments. There are three case studies for analysis: “Rhett Runs Some Technical Measures on a Stock”, “An Analysis of a High-Flying Stock”, and analysis of Amazon stocks. Rhett’s case analysis employs “point-and-figure chart and RSI”, High-Flying employs “Mutual Fund Cash Ratio, New Highs-New Lows, Advance-Decline Line, Dow Theory, and Arms Index”, whereas Amazon’s case employs Bollinger Bands as the indicator. The paper is organized into an introduction, which gives an overview of the topic and specific issues covered in the entire paper, the discussion part provides the technical analysis, and lastly, a conclusion provides a summary of the major points. Introduction Technical analysis is crucial in the prediction of stocks’ future prices. It applies the law of supply and demand in comprehension of how the market works (Edwards, Magee, & Bassetti 2013). In analysis, some steps are paramount. First is the understanding of Dow’s theories, which apply to technical analysis and will be applied in High-Flying case analysis. The theories help in financial markets analysis. Three of Dow theories are applied: a) fluctuations in market discount other things, b) price movements can always be predicted, as well as charted, and c) history is always repeated. Second is looking for fast results through focusing on short periods and suits individuals interested in short-term investments. Third is reading of charts to identify price trends, which focus on the general direction rather than individualized fluctuations. Classification of the identified trends is done by type and period (Schabacker 2005). Fourth entails comprehending the aspects of resistance and support. The latter defines the lowest price, which a security reaches prior to more buyers coming in to increase the price through buying it. The former is the highest price that a security reaches prior to the owners selling their shares, as well as causing another fall in prices. The two levels fluctuate with time. Fifth is focusing on the volume of trading to know the trend’s validity. An increase in volume signifies that the trend is mostly valid and when the increase is minimal, it may imply a reversal of the trend. Sixth is using moving averages in smoothing out minor price fluctuations. Lastly is using indicators, such as Bollinger Bands, which will be used here, as well as oscillators to reinforce what the price movements are revealing. With the knowledge of the seven steps, an analyst will be able to analyze Brett’s and high-running stock cases technically and advise on whether to invest on the particular stocks. This will be the subject of discussion wherein seven or some of the measures described above will be applied to the two cases in answering the questions provided. In this regard, the research question is: Is technical analysis an effective method of determining the future of stocks and a means of guiding investments? Discussion The first case “Brett Runs Some Technical Measures on a Stock” is to be analyzed. This entails technical analysis of Nautilus Navigation stock using the closing share prices. The relative strength indexes are computed as follows: (a) “RSI = 100 – [100/(1 + APC up days / APC down days)]” “APC  average price change” “Day of 9/30/04–10/31/04 11/30/04–12/31/04 Perod Advance Decline Advance Decline 1 0.55 –0.75 2 0.10 –0.75 3 0.15 0.25 4 0.20 0.50 5 0.10 1.05 6 –0.18 1.25 7 –0.37 –0.30 8 –1.05 –0.25 9 -- 0.75 10 –0.25 0.90 11 –0.25 0.10 12 –0.25 0.75 13 –0.25 0.75 14 0.05 0.75 15 –0.40 0.75 16 0.65 0.25 17 0.35 –0.10 18 0.07 0.60 19 0.09 0.25 20 0.50 21 0.05 Average 0.231 –0.375 0.591 –0.430” “RSI (October): 100 – [100/(1 + (0.231/0.375))]  100 – 61.9  38.1” “RSI (December): 100 – [100/(1 + (0.591/0.430))]  100 – 42.1  57.9” In October, the RSI is 38.1, whereas, it rises to 57.9 in December. The fact that the RSI is becoming bigger indicates that the price of Nautilus Navigation is rising. Nautilus Navigation is approaching a point where its price is being overrated. With such trend, there is likelihood that the share price of Nautilus will fall. The negative impact on the share price would negatively affect the shareholders of Nautilus. 2. As noted, the RSI value is rising, indicating that the share price of Nautilus will fall. With such signal, most shareholders are likely to sell the shares to hedge against predicted risk of price decline. However, it is essential to note that the RSI value is still low and not hi9jgh enough to give a strong signal. A strong signal would occur if the RSI value rises to 70 and above. The RSI value has risen to 57.9 in December. This implies that, at this point, the signal is weak. (b) 1. “Ten-day moving averages” as well as their respective share prices Price Moving Average Price Moving Average Price Moving Average 17.20 15.85 17.31 (10/31) 16.87 17.50 19.60 18.00 16.25 17.77 16.92 16.75 19.22 18.00 (9/30) 16.62 18.23 17.04 17 18.84 18.55 17 19.22 17.29 17.50 18.59 18.65 17.32 20.51 17.69  18.55 18.44 18.80 17.60 20.15 18.05 19.80 18.4 19.00 17.90 20 18.44 19.50 18.35 19.10 18.20 20.21 18.78 19.25 18.33 18.92 18.35 20.25 19.09 20.00 18.41 18.55 18.48 20.16 19.38 20.90 18.68  17.50 18.51 20.00 19.65 21 19.02 17.50 18.46 20.25 19.90 21.75 19.52 17.25 18.38 20.50 20.12 22.50 20.08 17.00 18.23 20.80 20.28 23.25 20.65 16.75 18.04  20 20.23 24 21.20 16.50 17.81 20 20.22 24.25 21.64 16.55 17.56  20.25 20.24 24.15 22.10 16.15 17.27  20 20.22 24.75 22.66 16.80 17.06 19.45 20.14 25 23.16  17.15 16.92 19.20 20.04 25.50 23.62 17.22 16.89 18.25 (11/30) 19.87 25.55 (12/31) 24.07 2. The data above indicates that the share price is above the moving average at the end of august. The arrows in the table indicate when the moving average is above the share price. As noted in the table, there are seven times when the moving average is above share prices. The decline of share prices to $17.50 and $20.00 would have led to a sell signal in the market. On the other hand, the change in share prices from $17.15 to $20.25 and $18.55 thereafter would have led to buy signals. However, in the last instance, individuals would repurchase shares at a lower price than they had sold their shares in Nautilus Navigation. 3. As of 12/31/13, the 10-day moving average is below the current share price. This implies the moving average signal would be to purchase shares. However, it would have been more advantageous to buy shares 17 days earlier for those using the 10-day moving average. They would have bought the shares at a lower price of $18.55 instead of $25.55. he moving average and RSI indicators show that there is need for a correction in share price. However, the need for the correction has not been officially predicted. Point-and-figure chart is useful in plotting share price movements, among other things. As explained by Weber and Zieg (2003, p.56), this kind of chart is very useful in portraying the expected future behaviors and developing trends of individual stocks, as well as the whole market. The Nautilus Navigation’s shares are following an upward trend, as indicated in the chart. d) In general, the technical indicators of the market are sending a positive signal to Brett. Although the RSI index indicates that there is need for correction of share prices, the December RSI index is way below 70 (over 10 points below). At the same time, the 10-day moving average is below the share prices as of 12/31/13. The “point-and-figure chart shows that the price of Nautilus Navigation is following an upward trend”, although there are short corrections. “Case 9.2An Analysis of a High-Flying Stock” (a) To measure a value from period 1 to 5 for every four measures listed, Dow Theory will be applied DOW averages Graph The Dow averages graph indicates that there is an upward movement in the Dow Industrials. The “Dow Transportation Index” shows an upward trend in period 4; this goes on in period five. This implies that the market has turned bullish, which can be termed as a positive sign. (b) “The Advance Decline chart” “Advancing Issues (NYSE) 1,120 1,278 1,270 1,916 1,929 Declining Issues (NYSE) 2,130 1,972 1,980 1,334 1,321 Advance/Decline Plot (1,010) (694) (710) 582 608 Plot Point (1,010) (1,704) (2,414) (1,832) (1,224)” “Advance-Decline Line” The “Advance Decline Line” below is derived through adding the net decline/advance from the previous period. The “Advance-Decline Line” shows that the market has become bullish. From period 3, many stocks are showing an upward trend. This confirms the Dow Theory explained above. (c) “New Highs-New Lows” “New Highs 68 85 85 120 200 New Lows 75 60 80 75 20 NH-NL (7) 25 5 45 180” “New Highs-New Lows Graph” The graph above indicates that the “New Highs-New Lows (NH-NL)” indicator is positive. It shows that many more stocks from period 3 are closing up than down or at new highs more than at new lows. This trend continues in period five. This indication provides further confirmation to the bullish trend. (d) “The Arms Index, or TRIN”, is calculated as below: “TRIN = [(# of up stocks)/(# of down stocks)]/[(volume in up stocks)/(volume in down stocks)]”. “Advancing Issues (NYSE) 1,120 1,278 1,270 1,916 1,929 Declining Issues (NYSE) 2,130 1,972 1,980 1,334 1,321 Advances/Declines 0.53 0.65 0.64 1.44 1.46 Volume up 600,000,000 836,254,123 275,637,497 875,365,980 1,159,534,297 Volume down 600,000,000 263,745,877 824,362,503 424,634,020 313,365,599 Up/Down 1.00 3.17 0.33 2.06 3.70 TRIN 0.52 0.20 1.92 0.70 0.39” TRIN values help to determine the presence of bullish trend. Lower TRIN values indicate the presence of bullish trend, while higher TRIN values indicate the opposite. Higher TRIN figures are unfavorable for the market. In this case, the TRIN values start declining after period 3. This implies that the bullish sign appeared after period 3. The values provide further confirmation to the presence of bullish trend. (e) “The Mutual Fund Cash Ratio (MFCR) = Mutual Fund Cash Position/Total Assets Under Management” “Mutual Fund Cash (Tril.$) $0.31 $0.32 $0.47 $0.61 $0.74 Total Assets Managed (Tril.$) $6.94 $6.40 $6.78 $6.73 $7.42 MFCR 4.5% 5.0% 7.0% 9.0% 10.0%” 1. The MFCR in this case is positive. Positive MFCR indicates the presence of bullish movement. In period 5, the amount of “Mutual Fund Cash” is approximately 10% of the total assets managed. There is possibility of pent-up demand for stocks. In case the investors decide to liquidate mutual fund positions because of market down-turn, there will be available cash at mutual funds. Thus, managers will not be forced to raise more cash through sale of securities. In general, it is clear that all indicators show the presence of bullish trend. This implies that this is a good time for entry or for adding investment into the market. Comment on Time-Period: Generally, most indicators show negative trend during the first and second period. However, positive trend is observed from period three. However, it is essential to note that it is difficult to make a general conclusion about the trends over the 5 time period. This is because the time-period intervals are not defined. There is possibility that some data may not have been included or the data may have missed the trend. It is not clear whether the time intervals were short or long periods. If the intervals were long periods, more precise observations would have been derived trough the use of shorter intervals that would facilitate more accurate reading. If short periods were used, it would be vital to confirm this before engaging in the calculations. Amazon (AMZN) a) On 27th April 2012, the upper band of Amazon stocks was 211.35, which was lower than the day’s closing price of 226.85. However, this resistance level was higher than the middle band level, which was 202.59 for the day. b) During the following nine days, stock prices were higher because the lowest recorded was 223.05 and the highest 233.84. Furthermore, the resistance level (218.83) was higher than of the past nine days (211.35). c) This is what a technician would predict because the stock prices had gone way above the resistance level on 27th and hence, there was a possibility of an increase as seen after the nine days. d) Strategy a technician would have used of 27th April 2012 The technician could have used trendlines as a strategy to ensure the situation is working in his/her favor. This is because, the stock prices closed at a higher price than the average. Hence, the strategy would help to evaluate likely areas of support that could assist in determining the possibility that the trend would go on. The advantage of this strategy is that the strength of the trendline rises when more prices test the upper and lower bands (Edwards, Magee, & Bassetti 2013). Thus, it can be used in all situations. e) At around the same time, the lower band (support level) of Amazon stock went down from 164.62 on 27th to 162.01 after the nine days. f) How the stock behaved through the month of May 2012 Amazon’s stock prices went down all through the month of May. On the week of May 04, the highest price was 233.84, which was the highest for the month. On the week of May 11, 2012, the highest price sold was 230.68, May 18 week - 230.61, and the last week of 25 May- 219.98. Therefore, there was a fluctuation from 233.84 to 219.98 down the weeks. This means May is a better month to buy the stock in contrast to the month of April. During the second and third week of the month, the stocks seemed to surrender to the selling pressure because of decreased lower band, although they did not succumb. Luckily, the stocks did not at any point go break or go below the support level hence the stock was averagely performing. Week Open Close High Low Upper band (20,2) Lower Band (20,2) Middle Band (20,2) May 04, 2012 223.51 223.99 233.84 223.05 218.23 162.01 204.06 May 11, 2012 222.42 227.68 230.68 218.20 224.67 160.62 204.79 May 18, 2012 225.58 213.85 230.61 212.81 226.66 160.70 204.79 May 25, 2012 214.03 212.89 219.98 211.18 228.63 163.76 205.53 (MSN 2014). Conclusion In essence, technical analysis is an effective method of analyzing stocks and thereby exhibiting their behavior through predicting prices. It helps in predicting the future of a stock and hence, can guide an investor into the best investment to look out for. The analysis of Nautilus Navigation stock using the closing share prices and computing the relative strength indexes (RSI) between September and December of 2005 reveals that the share prices are going down. This is not a good sign to the company’s shareholders, and the problem is that they cannot sell because their signal is low. However, the prices seem to be going up as revealed by the “point and figure chart”. Overall, the behavior of “Nautilus Navigation” is a good sign for Rhett who is interested in investing in the company’s stocks. Regarding the High-Flying stocks, numerous analytical methods are employed: “Mutual Fund Cash Ratio, New Highs-New Lows, Advance-Decline Line, Dow Theory, and Arms Index”. The outcomes of the five are positive and show that the market has turned bullish. For the Amazon case, Bollinger bands are used as indicators and the analysis reveals the stocks are performing averagely and hence, investors should give them some consideration. This information could help in guiding any investor on how to analyze the market before investing. References Edwards, R, Magee, J & Bassetti, W 2013, Technical analysis of stock trends, tenth edition, CRC Press MSN 2014, Amazon Inc, Available at: http://investing.money.msn.com/investments/charts/?symbol=amzn#{%22zRange%22:%2211%22,%22startDate%22:%222008-6-27%22,%22endDate%22:%222013-6-21%22,%22frequency%22:%22w%22,%22chartStyle%22:%22mountain%22,%22chartCursor%22:%221%22,%22scaleType%22:%220%22,%22yaxisAlign%22:%22right%22,%22indicators%22:[[%22BBands%22,20,2]],%22mode%22:%22pan%22} [ Accessed 21 February 22, 2014] Schabacker, R 2005, Technical analysis and stock market profits, Harriman House Limited, Hampshire Weber, H & Zieg, K 2003, The complete guide to point and figure charting: The new science of an old art, Harriman House Limited, Great Britain. Read More