Reading 67: technical analysis

Question 1

An assumption of technical analysis is that market prices:
exhibit identifiable trends and patterns that persist and repeat.
are the only information necessary to analyze a freely trading market.
reflect supply and demand conditions because actual transactions reflect rational decisions by buyers and sellers.

Answer 1

Technical analysis assumes persistent trends and repeating patterns in market prices can be used to forecast price behavior. Technical analysts believe prices reflect supply and demand, but that buying and selling can be motivated by both rational and irrational causes. Volume, along with price, is important information to a technical analyst. (LOS 67.a)

Question 2

Which type of price chart requires data on the opening price?
Bar chart.
Line chart.
Candlestick chart.

Answer 2

Constructing a candlestick chart requires opening, high, low, and closing prices for each trading period. A line chart requires only the closing prices. A bar chart can be constructed using high, low, and closing prices. (LOS 67.c)

Question 3

A stock has been in a downtrend for several days. When its price decreases to near $30, many investors enter orders to buy the stock and the price increases to $31. This is most likely an example of:
a support level.
a resistance level.
a change in polarity.

Answer 3

The downtrend reached a support level where buying demand sustained the price. A resistance level is a price at which selling pressure emerges that stops an uptrend. The change in polarity principle holds that breached support levels become resistance and breached resistance levels become support. With no information given on the stock’s history, we cannot determine whether $30 had once been a resistance level. (LOS 67.e)

Question 4

An analyst who uses the standard deviation of recent prices to identify overbought or oversold conditions is most likely to employ:
Bollinger bands.
a Relative Strength Index (RSI).
a rate of change (ROC) oscillator.

Answer 4

Bollinger bands are based on the standard deviation of prices over some number of the most recent periods. An RSI is based on the sums of positive and negative price changes during a period. An ROC oscillator is based on the difference between the most recent closing price and the closing price a given number of periods earlier. (LOS 67.g)

Question 5

If a stock’s relative strength chart shows an uptrend, the stock is:
increasing in price.
outperforming a benchmark.
increasing on high volume or decreasing on low volume.

Answer 5

If a relative strength chart shows an uptrend, the stock is outperforming the benchmark stock or index against which it is being measured. This does not imply that the stock is increasing in price; if the stock price is decreasing, but the benchmark is decreasing by a larger percentage, the relative strength chart will still trend upward. Volume is not an input into a relative strength ratio. (LOS 67.h)

Question 6

A technical analyst begins her evaluation of the U.S. equity market by using a computer algorithm to identify which stocks in the S&P 500 Index have shown uptrends on increasing volume over the last month. This analyst is most accurately said to be using:
a top-down approach.
a center-out approach.
a bottom-up approach.

Answer 6

Using selected criteria to narrow an investment universe reflects a bottom-up approach. (LOS 67.i)