FINC 446 - Wilson Exam 1 - TAMU

What are the four Real Keys to making money?

1) Objective Indicators

2) Discipline

3) Flexibility

4) Risk Management

What are Objective Indicators?

1. Used by all legendary traders rather than gut emotions

2. Mathematical, long historical analysis to show effectiveness

What is Discipline?

1. Investor must be loyal, faithful to their systems through good and bad times

2. Avoid pitfalls of character flaws

What is flexibility?

1. seemingly at odds with discipline

2. Indicators can change

3. When wrong, change course

4. Flexible to change minds when the evidence shifted

What is risk management?

Controlling losses

Business of making mistakes

When wrong, change course

Successful investors are Risk Managers

What are the four negative behaviors and attitudes that can lead to poor investment returns?

Failing to take losses

Being overly fearful at market bottoms and overly optimistic at market tops

Failing to take responsibility for your own money

Not following a disciplined strategy

(T/F) Crowd psychology and liquidity (potential demand) are inversely related?

TRUE

Increasing optimism --> Falling liquidity

Rising Pessimism --> Rising liquidity

What are the Nine Rules of Ned Davis Research Group?

Don't fight the tape

Don't fight the Fed

Beware of crowd extremes

Rely on objective indicators

Be disciplined

Practice Risk Management

remain flexible

Money Management Rules

Those who do not study history are condemned to repeat its mistakes

What was the stock that we tracked in class after its earnings call? (Hint: Prof Wilson kept saying Nirvana in class)

Nvidia

What is Tracking Error Risk?

It is the divergence of the Fund's performance from that of its investment objective

Further explanation if you are confused (like me)

For example: A Fund/ETF will aim to replicate 2x the percentage change of a stock. However, it cannot do this perfectly due to transaction costs, over exposure and other frictions.

(Like the 2x Nvidia ETF that we bought in class)

Principal Risks of investing in the Fund? (No shot he asks this, but, in case he does, you can't blame me)

Underlying Stock Risk

Effects of compounding and market volatility

Correlation Risk

Leverage risk

On-Demand business and Technology Services Company Risks

counterparty risk

Derivatives Risk

Exchange Traded Fund Structure Risk

Fixed Income Securities Risk

Management Risk

Market and Geopolitical Risk

Non-diversified Risk

Swap Risk

Rebalancing Risk

Trading Halt Risk

Tracking Error Risk

US treasury Risk

Tax Risk

(Good luck memorizing all of these)

What was the stock that lost a ton of value in the market due to accounting practices?

Super Micro Computer (SMCI)

What are the two main functions of Technical Analysis?

Identification

Forecasting

What is identification?

Identifies and describes past and present price action

Serves as a historical record of what has transpired in the markets

What is forecasting?

Once price or market action is identified, the technician may interpret the information to infer what the data actually means before inferring future price action

Inference based on assumptions that price patterns are repetitive to some reasonable degree

What are the three approaches to price forecasting?

Fundamental Analysis

Technical Analysis

Information Analysis

What is a Trend?

A directional movement of price that remains in effect long enough to be identified and still be profitable

An Uptrend has higher peaks and higher troughs

A downtrend has lower troughs and lower peaks

A sideways (flat) trend occurs when prices trade bound by support and resistance

Picture of Downtrend

Picture of Uptrend

Picture of Sideways trend

How are trends identified?

-Linear Least-Square regression

-Moving Averages

-Trend lines

What are trend lines?

lines drawn from top-to-top and bottom-to-bottom

Helps get a "feeling" of price direction and limits

What does the "fractal" nature of trends mean?

It is the ability of trends to act similarly over different periods

(T/F) Determining when a trend begins and ends is the same regardless of trend length and time period?

TRUE

(T/F) Pattern analysis is universal and independent of time.

TRUE (hopefully I've gotten the point across)

What are the lengths of trends?

Primary (months or years)

Secondary (weeks or months)

Short-term (days)

Intraday (minutes and hours)

What are the Basic Beliefs of Technical Analysis?

Price is determined by Supply and Demand

Price discounts everything

Prices are nonrandom

History will repeat itself

Trend lines and price patterns are fractal

Emotions are affected by earlier emotions (emotional feedback)

What are the basic tenets of Dow Theory?

The averages discount everything (pricing in information)

The market has three trends

Primary trends have three phases

A trend persists until its reversal is indicated

the averages must confirm one another

Volume must confirm the trend

Who is the father of modern technical analysis?

Charles Dow (Dow theory and Dow Index)

What industries did Dow's first stock index contain?

Railroad (9) and Industrials (2)

What are the three Dow Theory Hypotheses?

1. Primary trend is inviolate

2. The averages discount everything

3. Dow Theory is not infallible

Primary trend is inviolate

While the secondary and minor motion of the averages could be manipulated, the primary trend CANNOT be manipulated

The averages discount everything

Prices are the result of people acting on their knowledge, interpretations, and expectations

Dow Theory is not infallible

Investment requires serious and impartial study

Ideal Market picture according to Dow Theory theorems

What are the Dow Theory Theorems?

1. The ideal market picture consists of an uptrend, top, downtrend, and bottom - with retracements and consolidations in there

2. Economic rationale should be used to explain stock market action (Why Dow included industrial and railroad averages)

3. Prices trend. (Prices have a general direction in which they move)

What are the Dow Theory Trends?

Primary Trend (most important)

Secondary Trend (intermediate trend)

Minor Trend

Primary Trend

Represents the overall, broad, long-term movement of security prices

Duration of this trend can be several years

Secondary Trend

Runs counter to the primary trend

A secondary, deceptive reaction to the primary trend

Usually lasts a few weeks to months and can retrace 33-66% of the gain

Minor Trend

• The stock market is not logical in its movements from day to day.

• Typically, unimportant and can be considered noise.

What is the longest of the three trend types?

Primary trend (Can be several years. Overall, broad, long-term movement of security prices)

What is the most important factor of successful speculation?

Correct determination of the primary trend

What are primary bull markets characterized by?

1. Reviving confidence from the prior primary bear market

2.Represents the response to increased corporate earnings

3. Speculation becomes dominant and prices rise on "hopes and expectations"

What are primary bear markets characterized by?

1. Abandonment of hopes upon which stocks were purchases

2. Selling due to decreased earnings

3. Distress seeing, regardless of value, by those who believe the worst is yet to come/those forced to liquidate

Example of Dow theory trends

What is Confirmation?

the necessary means for recognizing in what direction the primary trend is headed

What are the usual method of confirming a primary trend today?

Confirmation between S&P 500 (Large Cap Stocks) and Russell 2000 (Small cap stocks)

Example of confirmation

What is the importance of Volume?

Volume can be an important SECONDARY confirmation signal

What are examples of Volume confirmation?

High market prices accompanied by less volume on rallies and more activity on declines usually suggests an overbought market

Extremely low prices with dull declines and increased volume on rallies suggest an oversold market

Example of volume confirmation

What are the criticisms of Dow Theory?

1.Investors will act after rather than before at market tops and bottoms

2.The different trends are not strictly defined

3.Dow Theory is too specific about requirements needed to identify a change in trend

(T/F) The Stock Market is logical in its movements from day to day.

FALSE (is not logical day to day)

What captures all information about the supply and demand for a security?

Price

What are the benefits of using charts?

Charts provide concise price history

Charts can provide a good sense of market volatility

Charts can be a useful tool for fundamental analysis (correlation of fundamental event to price movement)

Charts can serve as a timing tool

Chart can be used as a money management tool

Charts reflect repetitive patterns in market behavior

What is the importance of Price?

A summary of supply and demand

Represents market forces (Patterns, Volatility)

Fundamental analysis

What are the three most common types of charts?

Line Charts

Bar Charts

Candlestick Charts

Point and Figure Charts

What is the most basic type of chart, usually based on the closing price for the day?

Line chart

What are also called vertical line charts, they also record the high and low for the day?

Bar Charts

What evolved from bar charts but were visually more appealing and became widely used?

Candlestick Charts

What chart only records price changes that deviate from earlier prices by a specified amount?

Point-and-figure Charts

Line Charts

Most basic type of chart

Continuous line

Information on price and time

Only plots closing prices

useful when studying Long-Term Trends

Helps identify support and resistance levels, trends, and patterns

Bar Charts

Show at least three pieces of info (High, Low, and close price for each time interval)

Time interval = one bar

Bar Chart Example

Candlestick Charts

High and low are shown by thin line (wicks) above or below body of the candle

Filled/Red Candle = lower than open

Hollow/Green Candle = higher than open price

Example of Candlestick chart

What is a doji?

A doji is when a security's open and close are virtually equal (looks like the candle almost isn't there)

What are the two types of scales that are used on stock charts?

Arithmetic Scale

Semi-Logarithmic Scale

What is an arithmetic scale?

It shows the price units along the vertical scale at the same price intervals.

Ex) Distance of a change from $1 to $2 would be the same a change from $10 to $11 or $100 to $101

What is a semi-logarithmic scale?

Vertical distance represents the same percentage change in price

Ex) Price increase from $1 to $2 (100% increase) would show up as a way larger increase than $100 to $101 (1% increase)

Which scale does Prof Wilson say that we should use?

Semi-Logarithmic (It is better used when looking at a securities price movement over long periods of time, like 20 years for example)

What is commonly portrayed at the bottom of the price chart, with its own scale, using a vertical bar to represent the Toal volume for each interval?

Volume

When a price advance halts with high volume...

Potentially a top

When price decline halts with high volume...

Potentially a bottom

What is an Equivolume chart?

Equivolume box consists of three components (price high, price low, and volume)

How Equivolume is shown?

Price high = top of box

Price low = bottom of box

Volume = width (Wider the box the more volume that time period)

Equivolume Example

What was the tool used in class to show Fed rate cut probabilities?

CME's FedWatch Tool

What did the Fed do after the September (2024) meeting?

Cut Fed Funds rate by 50 basis points (0.50%)

What are the Keys to Profit?

1. Determine, with minimum risk of error, when a trend has begun, at its earliest time and price

2. Select and enter a position in the trend that is appropriate to the existing trend, regardless of direction

3. Close the position when the trend is ending

What is the basis of trend analysis?

Trends define a direction in prices

Trends are fractal, behavior is the same regardless of period

Trends tend to continue rather than reverse

Any particular trend is influenced by its next larger and next smaller trend

Uptrend

Higher highs (peaks) and higher lows (troughs)

Downtrend

Lower highs (peaks) and lower lows (troughs)

Trading range

Peaks and troughs at same relative level

(T/F) Trend will always be always be straight up or down

FALSE

The trend is the direction and there can be retracements and consolidations

What are trading rangers also known as?

consolidation or congestion areas

What is a resistance point?

When prices rise then reverse downward, the highest point of the rise is referred to as a resistance point

What is a support point?

When prices decline then reverse upward, the lowest point of the decline is a support point

What happens with previous support points are broken?

The previous support will become the new resistance point and vice versa

Example of resistance and support

Ways reversal points are determined? (I'm not sure if we need to know these or not)

DeMark or Williams Method

Percentage Method

Gann Two-day Swing Method

High Volume Method

How are support and resistance zones drawn?

To construct a support (or resistance) zone, draw a horizontal line through each significant trough (or peak) in the past and future

Where these lines bunch together around the same price level is the support or resistance zone

Support and resistance zone

What are the two major ways that analysts use trading ranges?

Mean reversion

Breakout Trading (We focus on this one)

What is Breakout Trading?

Once the price breaks out of the trading range, positions are put on

What are the three main tools to determine trend reversals?

Regression Line

Trend line

Moving Averages

What are trend lines?

Trend lines are drawn with a ruler

Need at least two support or two resistance levels

Accelerating and decelerating trend lines (fan lines)

Moving averages

Simple average of prices over a specified time period

Regression Line

Line of best fit for the Data

Can add standard deviation to the line to provide bounds for data