Efficient market hypothesis

 Efficient market hypothesis

The efficient market hypothesis (EMH) contradicts the basic tenets of technical analysis by stating that past prices cannot be used to profitably predict future prices. Thus it holds that technical analysis cannot be effective. Economist Eugene Fama published the seminal paper on the EMH in the Journal of Finance in 1970, and said "In short, the evidence in support of the efficient markets model is extensive, and (somewhat uniquely in economics) contradictory evidence is sparse."^[35] EMH advocates say that if prices quickly reflect all relevant information, no method (including technical analysis) can "beat the market." Developments which influence prices occur randomly and are unknowable in advance.
Technicians say that EMH ignores the way markets work, in that many investors base their expectations on past earnings or track record, for example. Because future stock prices can be strongly influenced by investor expectations, technicians claim it only follows that past prices influence future prices.^[36] They also point to research in the field of behavioral finance, specifically that people are not the rational participants EMH makes them out to be. Technicians have long said that irrational human behavior influences stock prices, and that this behavior leads to predictable outcomes.^[37] Author David Aronson says that the theory of behavioral finance blends with the practice of technical analysis:

By considering the impact of emotions, cognitive errors, irrational preferences, and the dynamics of group behavior, behavioral finance offers succinct explanations of excess market volatility as well as the excess returns earned by stale information strategies.... cognitive errors may also explain the existence of market inefficiencies that spawn the systematic price movements that allow objective TA [technical analysis] methods to work.^[36]

EMH advocates reply that while individual market participants do not always act rationally (or have complete information), their aggregate decisions balance each other, resulting in a rational outcome (optimists who buy stock and bid the price higher are countered by pessimists who sell their stock, which keeps the price in equilibrium).^[38] Likewise, complete information is reflected in the price because all market participants bring their own individual, but incomplete, knowledge together in the market.^[38]

 Random walk hypothesis

The random walk hypothesis may be derived from the weak-form efficient markets hypothesis, which is based on the assumption that market participants take full account of any information contained in past price movements (but not necessarily other public information). In his book A Random Walk Down Wall Street, Princeton economist Burton Malkiel said that technical forecasting tools such as pattern analysis must ultimately be self-defeating: "The problem is that once such a regularity is known to market participants, people will act in such a way that prevents it from happening in the future."^[39]
In the late 1980's, professors Andrew Lo and Craig McKinlay published a paper which casts doubt on the random walk hypothesis. In a 1999 response to Malkiel, Lo and McKinlay collected empirical papers that questioned the hypothesis' applicability^[40] that suggested a non-random and possibly predictive component to stock price movement, though they were careful to point out that rejecting random walk does not necessarily invalidate EMH, an entirely separate concept from RWH.
Technicians say that the EMH and random walk theories both ignore the realities of markets, in that participants are not completely rational and that current price moves are not independent of previous moves.

Charting terms and indicators

 Concepts

• Resistance — a price level that may prompt a net increase of selling activity
• Support — a price level that may prompt a net increase of buying activity
• Breakout — the concept whereby prices forcefully penetrate an area of prior support or resistance, usually, but not always, accompanied by an increase in volume.
• Trending — the phenomenon by which price movement tends to persist in one direction for an extended period of time
• Average true range — averaged daily trading range, adjusted for price gaps
• Chart pattern — distinctive pattern created by the movement of security prices on a chart
• Dead cat bounce — the phenomenon whereby a spectacular decline in the price of a stock is immediately followed by a moderate and temporary rise before resuming its downward movement
• Elliott wave principle and the golden ratio to calculate successive price movements and retracements
• Fibonacci ratios — used as a guide to determine support and resistance
• Momentum — the rate of price change
• Point and figure analysis — A priced-based analytical approach employing numerical filters which may incorporate time references, though ignores time entirely in its construction.
• Cycles - time targets for potential change in price action (price only moves up, down, or sideways)

Types of charts

• OHLC "Bar Charts" — Open-High-Low-Close charts, also known as bar charts, plot the span between the high and low prices of a trading period as a vertical line segment at the trading time, and the open and close prices with horizontal tick marks on the range line, usually a tick to the left for the open price and a tick to the right for the closing price.
• Candlestick chart — Of Japanese origin and similar to OHLC, candlesticks widen and fill the interval between the open and close prices to emphasize the open/close relationship. In the West, often black or red candle bodies represent a close lower than the open, while white, green or blue candles represent a close higher than the open price.
• Line chart — Connects the closing price values with line segments.
• Point and figure chart — a chart type employing numerical filters with only passing references to time, and which ignores time entirely in its construction.

Overlays

Overlays are generally superimposed over the main price chart.

• Resistance — a price level that may act as a ceiling above price
• Support — a price level that may act as a floor below price
• Trend line — a sloping line described by at least two peaks or two troughs
• Channel — a pair of parallel trend lines
• Moving average — the last n-bars of price divided by "n" -- where "n" is the number of bars specified by the length of the average. A moving average can be thought of as a kind of dynamic trend-line.
• Bollinger bands — a range of price volatility
• Parabolic SAR — Wilder's trailing stop based on prices tending to stay within a parabolic curve during a strong trend
• Pivot point — derived by calculating the numerical average of a particular currency's or stock's high, low and closing prices
• Ichimoku kinko hyo — a moving average-based system that factors in time and the average point between a candle's high and low

 Price-based indicators

These indicators are generally shown below or above the main price chart.

• Advance decline line — a popular indicator of market breadth
• Average Directional Index — a widely used indicator of trend strength
• Commodity Channel Index — identifies cyclical trends
• MACD — moving average convergence/divergence
• Relative Strength Index (RSI) — oscillator showing price strength
• Stochastic oscillator — close position within recent trading range
• Trix — an oscillator showing the slope of a triple-smoothed exponential moving average
• Momentum — the rate of price change

 Volume-based indicators

Trading strategy

Posted by Videos at 11:09 PM

In finance, a trading strategy (see also trading system) is a predefined set of rules for making trading decisions.
Traders, investment firms and fund managers use a trading strategy to help make wiser investment decisions and help eliminate the emotional aspect of trading. A trading strategy is governed by a set of rules that do not deviate. Emotional bias is eliminated because the systems operate within the parameters known by the trader. The parameters can be trusted based on historical analysis (backtesting) and real world market studies (forward testing), so that the trader can have confidence in the strategy and its operating characteristics.

Development

When developing a trading strategy, many things must be considered: return, risk, volatility, timeframe, style, correlation with the markets, methods, etc. After developing a strategy, it can be backtested using computer programs. Although backtesting is no guarantee of future performance, it gives the trader confidence that the strategy has worked in the past. If the strategy is not over-optimized, data-mined, or based on random coincidences, it might have a good chance of working in the future.

Executing strategies

A trading strategy can be executed by a trader (manually) or automated (by computer). Manual trading requires a great deal of skill and discipline. It is tempting for the trader to deviate from the strategy, which usually reduces its performance.
An automated trading strategy wraps trading formulas into automated order and execution systems. Advanced computer modeling techniques, combined with electronic access to world market data and information, enable traders using a trading strategy to have a unique market vantage point. A trading strategy can automate all or part of your investment portfolio. Computer trading models can be adjusted for either conservative or aggressive trading styles.

Trader (finance)

Posted by Videos at 10:58 PM

In finance, a trader is someone who buys and sells finnacial instrument such as stocks, bonds, commodities and derevative. A broker who simply fills buy or sell orders is not a trader, as they are merely executing instructions given to them. According to theWall Street Journal in 2004, a managing director convertible-bond trader was earning between $700,000 and $900,000 on average.
Traders are either professionals working in a financial institution or a corporation, or individual investor, or day traders. They buy and sell financial instruments traded in the stock markets, derivatives markets andcommodity markets,  comprising the stock exchange ,derivatives exchanges  and thecommodities exchanges. Several categories and designations for diverse kinds of traders are found in finance, these may include:

• stock trader
• day trader
• pattern day trader
• floor trader
• High-frequency trader
• rogue trader