RSW

Technical Analysis

Castle in the Air Theory
technique that uses charts of past trends in currency prices and other factors to forecast future value

Technical Analysis studies three things

Price over time (support = lowest point in the past, resistance = highest point in the past)
Volume over time
Indicators over time

Why does Technical Analysis work? 3 things

Mass psychology - those who think it is going up buy and then others follow along which increase prices further
Underreaction - leads to price momentum
Unequal access to fundamental information

Why does technical analysis fail? 4 things

Missing the boat
Predictions are early
Self defeating as more rely on technical analysis
Profit maximizing behavior makes market efficient (prices will reflect all available information already)

Consequences of overreaction and underreaction in TA

Underreaction leads to price momentum
Overreaction leads to price reversals

What is Fundamental Analysis?

...

What are the 4 things that matter for value DCF

1. Cash flow
2. Risk free rate
3. Risk (capm model)
4. Growth rate

Caveats to Firm-Foundation Theory?

Can't predict future accurately
Best analysts are poached
Faulty accounting from firms
Estimates do not converge

Efficient Market Hypothesis

Price of securities fully reflect available information - so TA or Firm-Foundation can't be utilized

Investment Companies Categories (3)

Open-End Fund (mutual funds) these funds buy and sell shares, are price once per day after market hours, do not fluctuate during the day, and net asset value on fund per share
Close-End Fund - IPO'd once and fixed amount of shares, prices fluctuate, share

Benefits of investing in mutual funds (6)

1. Diversification
2. Versatile size
3. Professionally managed
4. Liquid
5. Ease of trade/management
6. Fee/expense economy

Types of fees for mutual funds (4)

Load Fees, front-end and back-end (One-time)
Loads reduced from greater purchases, letter of intent, and purchase to existing holdings
12-b1 Fee (sales, marketing, fee to professional manage)
Management Fee
Trading Cost

Mutual Fund Categories (2)

Short Term
Investing in money-market instruments such as govt and corporate debt
Long Term
Investing with diversification and equity orientation in equities and bonds
Active - styles, market cap, sector, geography, balanced
Passive - index

Total Expense Ratio

Expense Fees as percentage of assets

ETF

Exchange Traded Fund
Open end characteristic of issue/redeeming shares
close end characteristic of trading on exchange
Both active and passive

Benefits of ETF (4+2)

1. Execution Control
2. Tax Control
3. Liquid
4. Trades like a stock
5. Margins
6. Options, sell-short

Uses of ETF

Hedging
Asset portfolio allocation
Portfolio adjustment
Momentum Trading
Statistically based trading
Risk Management

Rational Models

Believe agents will act rationally

Modern Portfolio Theory

Investors will maximize returns and minimize variance, resulting in mean-variance portfolio (efficient portfolio)

CAPM

Capital Asset Pricing Model
return = risk free rate + Beta*market risk premium
Higher beta = higher returns
Fails - no correlation to returns, but good measurement of risk and volatility

How many stocks to remove idiosyncratic risk?

40-60 suggested by Malkiel

Arbitrage Pricing Model

Using systematic risk factors to develop more returns, adding more than just the market risk premium

Farma French 3 model

Market Price premium (rm - rf)
Size premium (small - large)
Value premium (high book/market minus low book/market)

Carhart Model

1. MRP
2. Size
3. Value
4. Momentum (Up minus Down)

Farma French 5 Factor Model

1. MRP
2. Size
3. Value
4. Profitability (Robust - Weak or REV - COGS)
5. Investment (C - A or Investments growth/total assets eOY)

Behavioral Models

Agents are not rational, psychological behavior deviates from rational behavior
This is due to limited attention - cost of gathering and processing information
Heuristics (shortcuts rather than mathematical optimization)

5 Factors of why agents are irrational

1. Overconfidence - underestimate risk, overestimate ability to control events
2. Biased Judgement - illusion they are in control (hindsight error)
3. Herd Mentality - mass crowds influencing them to believe what is incorrect to be correct
4. Loss Aversio

Framing

different ways of presenting information

Active Management

Managers wish to outperform the market with new information

What does Active management maximize/minimize

Portfolio returns over benchmark returns
Tracking Error

What is tracking error

Risk due to active management - Difference between portfolio return and benchmark return

Portfolio Construction

More/less risk depends on time-horizon
Efficient Frontier is risk free rate and market return

Short-term horizon Portfolio Construction

Money-market instruments valuing liquidity and certainty of value (corporate debt and govt debt)

Long-term horizon Portfolio Construction

Equity orientation and diversification, higher risk assets and lower liquidity

Personal situation and portfolio needs categories (5)
T2RGD

1. Time-horizon
2. Risk tolerance
3. Growth
4. Distribution
5. Risk capacity

Rebalancing

Rebalancing assets to long term weights
Buy and hold will generate geometric mean but that is always lower than arithmetic so we have to rebalance
Excess return from rebalancing over weighted average growth of assets

Smart Beta

Certain qualities have produced excess returns - identify those factors - Weighting assets based on a style/strategy - assuming greater risk
Momentum
Low volatility
STyle
Size (large cap)
Value (large value)