Chapter 16

TECHNICAL ANALYSIS Multiple Choice Questions

Overview 1. a. b. c. d. The oldest approach to common stock selection is: fundamental analysis technical analysis random walk analysis value analysis

(b, easy) What is Technical Analysis? 2. a. b. c. d. Technical analysis reflects the idea that stock prices: move upward over time. move inversely over time. move in trends. move randomly.

(c, easy) 3. a. b. c. d. Market data includes all of the following except: number of shares traded. earnings. level of market indices. stock price.

(b, moderate) 4. a. b. c. d. The two primary tools of a technical analyst are: level of the market index and volume. economic indicators and level of the market index. price and volume. price and technical indicators.

(c, moderate)

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5. a. b. c. d.

Conventional technical analysis emphasizes: only the aggregate stock market. either the aggregate stock market or individual stocks. only individual stocks. only corporate securities.

(b, moderate) 6. a. b. c. d. Technical analysis differs from fundamental analysis in that technical analysis: is aimed at the market while fundamental analysis is aimed at individual stocks. is based on published market data and focuses on internal factors. focuses on the long-term trends of production. does not consider price and volume.

(b, easy) 7. a. b. c. d. All of the following are assumptions made by technical analysts except: Changes in trend are caused by shifts in supply and demand relationships. Stock price movements are independent. Security prices tend to move in trends. Supply and demand of securities are determined by various factors.

(b, difficult) Stock Price and Volume Techniques 8. a. b. c. d. Which of the following is not true regarding the Dow Theory? It is intended to forecast the start of a primary movement. It does not forecast how long a movement will last. It has a very high success rate. It is subject to many criticisms.

(c, moderate) 9. a. b. c. d. A support level is a price range: at which a significant increase in demand for a stock is expected. at which a significant increase in supply of a stock is expected. below which a stock price cannot go. above which a stock price cannot go.

(a, moderate)
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10. a. b. c. d.

Which of the following is not one of the three major variables to be decided by the investor in order to construct a moving average? price used. time period. weight to be used. type of moving average to be constructed.

(c, moderate) 11. a. b. a. b. In order to have confirmation of a major market trend under the Dow Theory, the: industrial and utility averages must confirm each other. transportation and utility averages must confirm each. other. utility average must lead the transportation average. transportation and industrial average must confirm each other.

(d, moderate) 12. a. b. c. d. A principal weakness of the Dow Theory is: its use of averages instead of indexes. its attention to general market movements. that it pays too much attention to primary trends. the many versions that are available.

(d, moderate) 13. a. b. c. d. Which of the following is true regarding the resistance level? Resistance levels tend to develop due to profit taking. It is the level at which a significant decrease in demand is expected. It is the level at which a significant increase in supply is expected. Resistance levels usually develop after a stock reaches a new low.

(c, difficult) 14. a. b. c. d. Volume and specific calendar time are not considered important in a: pie chart. point and figure chart bar chart. histogram.

(b, easy)
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15. a. b. c. d.

One rule of thumb is that a stock is attractive when the relative strength has improved for at least ---------------months. 1 2 3 4

(d, difficult) 16. a. b. c. d. Corrections are often followed by ________. channel lines. momentum. reversals. consolidation.

(d, moderate) 17. a. b. c. d. What is usually shown at the bottom of a bar chart? a point and figure chart advance/decline line closing price volume

(d, easy) Technical Indicators 18. a. b. c. d. Which of the following is a characteristic of the short interest ratio: It is: calculated daily as well as weekly. often interpreted without any additional information. between 2 and 3 in recent times. considered to be a measure of investor sentiment.

(d, moderate) 19. a. b. c. d. The advance-decline line: measures the number of stocks hitting new highs and lows. can be computed only on a daily basis. can be interpreted without reference to any market index. is sometimes referred to as the depth of the market.

(d, moderate)

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20. a. b. c. d.

A high short interest ratio is generally interpreted as: a bullish signal. evidence of a downside breakout. a bearish signal. evidence of the presence of odd-lotters.

(a, easy) 21. a. b. c. d. A daily accumulation of stocks advancing or declining is used in: volume of trading analysis. relative strength analysis. breadth of market analysis. short interest analysis.

(c, moderate) 22. a. b. c. d. Which of the following is not a contrary trading rule? Relative strength ratio Investment advisory opinions Mutual fund liquidity positions Put/call ratio

(a, difficult) 23. a. b. c. d. The short interest ratio is found by dividing the number of shares sold short by the average: number of shares outstanding in the market. daily volume of trading on the exchange. number of stocks reaching new lows. daily number of stocks bought long.

(b, difficult) 24. a. b. c. d. A put/call ratio of .70 indicates: puts have a cost 70% less than the cost of calls. there are 7 puts purchased for every one call purchased. there are 70% more puts purchased than calls. there are 7 puts purchased for every 10 calls purchased.

(b, moderate)

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25. a. b. c. d.

Technicians that utilize the CBOE put/call ratio generally believe: option investors are almost consistent losers. option investors are almost consistent winners. option investors are true technicians. option investors possess inside information.

(a, easy) 26. a. b. c. d. Which of the following would be considered a strong bearish signal? High mutual fund liquidity Bullish advisory opinion Low short interest ratio Bearish advisory opinion

(b, moderate) 27. a. b. c. d. Which of the following indicates the market is at its peak, according to contrarians? the short-interest ratio is low the bearish sentiment index is around 20 percent mutual fund liquidity is low all of the above would indicate a market peak to a contrarian

(c. difficult) Testing Technical Analysis Strategies 28. a. b. c. d. Which of the following is not one of the tests of a technical trading rule? Transaction and other costs Consistency Return Risk

(c, moderate) 29. a. b. c. d. If an investor buys a stock when its price has increased 15 percent from its previous low, the investor is employing: a contrarian indicator. a filter rule. a sentiment indicator. relative strength analysis.

(b, difficult)
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30. a. b. c. d.

If a trading rule has been tried on data other than that used to produce the rule and found to be accurate, this is known as: consistency. relative strength. out-of-sample validity. a filter rule.

(a, moderate) Some Conclusions About Technical Analysis 31. a. b. c. d. Conclusions about technical analysis suggest that: it is difficult to justify technical analysis. it has been found to be completely deficient. stock price movements repeat themselves constantly. there is complete agreement about the interpretation of technical signals.

(a, easy)

True/False Questions
What Is Technical Analysis? 1. Technical analysis focuses on economic and political factors which are external to the market itself.

(F, moderate) 2. Technical analysis focuses on timing and on the short run.

(T, easy) 3. Technical analysts agree with the fundamental analysts regarding the usefulness of accounting data.

(F, moderate) Stock Price and Volume Techniques 4. The Dow theory is intended to forecast the start but not the duration of a primary movement.

(T, easy)

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5.

A bar chart is the simplest type of chart used in technical analysis.

(T, easy) 6. In light of its high success rate, the Dow theory is seldom criticized.

(F, easy) 7. Relative strength analysis is popular because it is generally not subject to conflicting interpretations.

(F, moderate) 8. If a trend exhibits support and resistance levels simultaneously that appear well defined, the trendlines are referred to as channel lines.

(T, moderate) 9. Secondary movements are often termed technical "corrections.

(T, moderate, p. 427) Technical Indicators 10. The cash position of mutual funds is a contrarian indicator.

(T, moderate) 11. A put/call ratio greater than the typical upper limit would be interpreted as a bullish signal by the contrarians.

(T, moderate) Testing Technical Analysis Strategies 12. A filter rule specifies a breakpoint for a stock or average and trades are made when the price is greater than the filter.

(T, easy, p. 440)

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Short-Answer Questions
Stock Price and Volume Techniques 1. Explain how profit taking and support levels are related.

(moderate) Answer: The scenario is as follows: The stock price increases. Profit taking follows, driving the price down. When investors see the price as low enough, they buy, stopping the price from dropping further, thus establishing the support level.

2.

How does a point-and-figure chart compress many price changes into a small space?

(moderate) Answer: 3. By recording only significant price changes, defined as $1 or $2 or more. Thus, moves of , , and so forth are not recorded.

Explain three specific buy signals using a moving average.

(difficult) Answer: (a) The price is above the moving average, moves toward the average but does not penetrate it, then starts back up. (b) After a fall, the moving average flattens out. The price penetrates the average from below. (c) The stock price falls below the moving average while it is rising.

4.

What are support and resistance levels?

(moderate) Answer: If a stock price is falling, a support level is a price at which sufficient demand is expected to materialize to keep the stock price from dropping further. If a stock price is rising, a resistance level is a price at which sufficient supply is expected to emerge to keep the price from rising any higher.

5.

How is relative strength calculated and used?

(moderate) Answer: The relative strength of a stock is a ratio of the stocks price to a market index, industry index, or average price of the stock itself. If a stock is doing well relative to the industry, for example, it is
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expected to continue to do so in the future. A change in relative strength, however, if often followed by a change in the stocks price trend. The relative strength of an industry to the market can be considered as well as the relative strength of individual stocks. Technical Indicators 6. (easy) Answer: 7. Short sales must be covered, which creates demand for the stock at some point in the future. Investors who sell short expect to make money when the stock price goes down. How, then, can a high short-interest ratio be considered bullish?

Institutional investors are often considered to have the smart money, while small, individual investors are not so well informed about the market. Which two sentiment indicators treat both institutions and individuals alike?

(moderate) Answer: The odd-lot theory asserts that one should do the opposite of oddlot investors, because they are usually wrong. Thus, if odd-lotters are selling, smart investors should buy. Similarly, the mutual fund liquidity technique asserts that mutual fund managers act like oddlotters, buying when the should be selling and vice versa. When the funds accumulate large amounts of cash, they apparently think the market is going down, and they do not want to be holding all stocks. The contrarians argue that the opposite will occur.

8. (easy)

What four factors should be considered in testing technical trading rules?

Answer: 9.

Risk, transactions costs, consistency, and out-of-sample validity.

What is the advance-decline line? What does it tell the technician?

(moderate) Answer: The net advance for a day is the number of stocks that advanced in price minus the number that declined in price. It is also called the breadth of the market. The advance-decline line must be used in conjunction with a market average, such as the DJIA. If the advance-decline line and the index diverge, then the trend is near an end, according to technical analysts.

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Some Conclusions About Technical Analysis 10. Discuss the difference in beliefs about price adjustments toward equilibrium in technical analysis and the Efficient Market Hypothesis.

(moderate) Answer: Technical analysis depends on trends over time as prices adjust slowly toward new equilibrium levels. The EMH is based on information being quickly and completely reflected in security prices.

Critical Thinking/Essay Questions

1. Which form of the Efficient Market Hypothesis addresses the information used in technical analysis? Do studies of technical analysis methods tend to support or refute the EMH?

(moderate) Answer: The weak form EMH addresses market data. Studies tend to support EMH and refute the predictive power of technical tools, though not all agree with the findings. Apparently, technicians do not agree.

2.

How can relative strength analysis be helpful in a top-down approach to security analysis?

(moderate) Answer: Analysts can use industry relative strength to identify industries that are outperforming the market, then use company relative strength to identify companies that are outperforming the industry.

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