Tools and Strategies

Question 1

Dow Theory

Answer 1

a momentum indicator theory that claims a market is in an uptrend (will go higher) if one of its averages advances above a previous
important high and is accompanied or followed by a similar advance in the other
• 3 Movements: Primary trend, Secondary reaction, Daily fluctuations
• Criticism: Current reflection, Not an accurate predictor, Limited to Dow industrial and transports indices, More helpful for seeing big picture (not short term bets)

Question 2

Technical Analysis: Relative Strength

Answer 2

Measures the extent to which a security has out or underperformed either the market as a whole or its particular industry
RS = (% change in security price)/(% change in industry price index)
Breadth often measured as the spread between the number of stocks that advance and decline in price

Question 3

Technical Analysis: Sentiment Indicators: Trin Statistic

Answer 3

Trin = [(# advancing)/(# declining)] / [(volume advancing)/(volume declining)]

Ratios > 1 are bearish

Question 4

Technical Analysis: Sentiment Indicators: Confidence Index

Plus four examples of other sentiment indicators

Answer 4

Confidence Index:
–The ratio of the average yield on 10 top rated corporate bonds divided by the average yield on 10 intermediate grade corporate bonds
– Higher values are bullish

• 4 More examples
–Put/call ratio
–VIX
–Short interest
–Flow of funds

Question 5

Technical Analysis: Sentiment Indicators: Put/Call Ratio

Answer 5

• A rising ratio may signal investor pessimism and a coming market decline
• Contrarian investors see a rising ratio as a buying opportunity

Question 6

Technical Analysis: Momentum Oscillators:

Relative Strength Indicator (RSI)

Answer 6

• Momentum based indicator
• Computed on a rolling time period
• RSI lies between 0 and 100
• Values above 70 represent overbought situations
• Values below 30 represent oversold situations

Question 7

Technical Analysis: Momentum Oscillators: Stochastic Oscillator

Answer 7

• Momentum based indicator
• Based on observation that in uptrends, prices tend to close at or near the high end of their recent range
• In downtrends, prices tend to close near the low end of their recent range
• Underlying driver is supply and demand

Question 8

Technical Analysis: Momentum Oscillators:
Moving Average
Convergence/Divergence (MACD)

Answer 8

• Momentum based indicator
• Is the difference between a short term and long term moving average of the price of the security
• Constructed with two lines:
– MACD line = difference between two exponentially smoothed moving averages (12 and 26 days)
– Signal line = exponentially smoothed average of MACD line (9 days)

Question 9

Technical Analysis: Bollinger bands

Answer 9

Bollinger Bands are envelopes plotted at a standard deviation level above and below a simple moving average of the price. Because the distance of the bands is based on standard deviation, they adjust to volatility swings in the underlying price.

Bollinger Bands use 2 parameters, Period and Standard Deviations, StdDev. The default values are 20 for period, and 2 for standard deviations, although you may customize the combinations

Question 10

Intermarket Analysis (applied to inflation)
Do they move in the same direction or opposite?
Low probability of being tested
• Inflation vs Deflation
Stocks and bonds?
Bonds and commodities?
U.S. Dollar and commodities?

Plus Stocks and commodities for deflation?

Answer 10

• Inflation
Stocks and bonds move in the same direction
Bonds and commodities move in opposite directions
U.S. Dollar and commodities move in opposite directions
• Deflation
Stocks and commodities move in the same direction
Stocks and bonds move in opposite directions
Bonds and commodities move in opposite directions
U.S. Dollar and commodities move in opposite directions

Question 11

Tactical Asset Allocation

Answer 11

• TAA offers a greater opportunity for risk management and better risk adjusted returns but there is no guarantee.
• TAA carries an implicit risk of opportunity cost compared to SAA if one experiences poor results.

Question 12

Dynamic Asset Allocation

Answer 12

• used to describe several asset allocation methodologies
• commonly refers to an asset allocation strategy that maintains equity exposure but also protects against loss of capital
• DAA offers more opportunity for risk management than SAA and a more tightly defined methodology compared to TAA.
• example: CPPI constant proportion portfolio insurance