Several months ago, Deb Forrester received a substantial sum of money from the e
ID: 2649849 • Letter: S
Question
Several months ago, Deb Forrester received a substantial sum of money from the estate of her late aunt. Deb initially placed the money in a savings account because she was not sure what to do with it. Since then, however, she has taken a course in investments at the local university. The textbook for the course was, in fact, this one, and the class just completed this chapter. Excited about what she has learned in class, Deb has decided that she definitely wants to invest in stocks. But before she does, she wants to use her newfound knowledge in technical analysis to determine whether now would be a good time to enter the market.
Deb has decided to use all of the following measures to help her determine if now is, indeed, a good time to start putting money into the stock market:
? Advance-decline line
? New highs-new lows indicator (Assume the current 10-day moving average is 0 and the last 10 periods were each 0.)
? Arms index ? Mutual fund cash ratio
Deb goes to the Internet and, after considerable effort, is able to put together the accompa- nying table of data.
Questions
a. Based on the data presented in the table, calculate a value (where appropriate) for periods 1 through 5, for each of the 4 measures listed above. Chart your results, where applicable.
b. Discuss each measure individually and note what it indicates for the market, as it now stands. Taken collectively, what do these 4 measures indicate about the current state of the market? According to these measures, is this a good time for Deb to consider getting into the market, or should she wait a while? Explain.
c. Comment on the time periods used in the table, which are not defined here. What if they were relatively long intervals of time? What if they were relatively short? Explain how the length of the time periods can affect the measures.
Explanation / Answer
a) Dow Theory. Students should graph the DOW averages. The graph is presents as follows:
Students should recognize that the upward trend in the Dow Industrials is confirmed by the Dow Transportation Index in period 4, and continues in period 5. This would be a positive sign that the market has turned bullish.
(b) Advance-Decline Line. The Advance Decline chart based on the data from the table:
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)
The Advance Decline Line, adding the net advance/decline from previous period (Plot Point):
Based on the rising Advance/Decline line, it appears the market has turned bullish. Many more stocks are closing up than down since period three. This confirms the reading from the Dow Theory above.
(c) New Highs-New Lows (the NH-NL indicator):
New Highs
68
85
85
120
200
New Lows
75
60
80
75
20
NH-NL
(7)
25
5
45
180
The problem states that the current NH-NL 10 day moving average is 0 and that the past 10 periods were 0. Therefore, students should begin with zero and add each period while subtracting zero for the moving average. The graph presents as follows:
The NH-NL Indicator is very positive. This is further confirmation of the bullish trend because many more stocks are closing at new highs than at new lows since period three. The trend has accelerated in period 5.
(d) The Arms Index, or TRIN, is calculated as follows:
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
Higher TRIN values are interpreted as bad for the market, while lower TRIN values are interpreted as a bullish sign. Here again, it appears that the market swung into a bullish trend in after the third period, as evidenced by the declining TRIN. This is further confirmation of the bullish trend.
(e) The Mutual Fund Cash Ratio is calculated as follows:
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%
The MFCR is also positive, again confirming the bullish trend. Funds are holding a large amount of cash in period 5 at 10% of total assets. There could be pent-up demand for stocks even with the other positive indicators already in play. In addition, if the market turns down and investors liquidate mutual fund positions, the funds will have available cash and will not be forced to sell securities to raise cash.
This problem has been designed to give students a positive experience with market analysis and get them excited about it. As such, the trends are all up, up, and away. Students should certainly conclude, based on the data presented, that all signs point to a bullish market and now would be a good time to invest in the market.
Time Period Comment: Some students may point to changes in the trends over the 5 period time horizon and express concern that they may have missed the trend. This is healthy skepticism and should be encouraged. Since the time periods are not defined, this could be a valid observation. One way to address this issue is to discuss the time period as an issue, and conclude that if the time intervals were long periods, the student would want to use more and shorter intervals to gain a more accurate reading. If, on the other hand, the time intervals were relatively short, students may want further confirmation before jumping in.
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)
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