Is Technical Analysis Profitable in Silver Market in the Implication of Efficient Market Hypothesis? Dissertation

Technical Analysis in the Implication of Efficient Market Hypothesis on Silver Market

The thesis is for the study of simple commonly used technical trading rules, which are applied on silver market. It covers years 1989 to 2005. A famous study carried out by Lakonishok, LebaRon and in year, 1992 has clearly shown that technical analysis can lead to abnormal prices when compared with buy-and-hold strategy. Other studies have been carried out and found out that technical trading rules cannot over-rule passive investment management strategy. The study uses Brock et al.'s methodology. Several trading rules are discussed (Dawson & Steeley 2003).

LITERATURE RIVIEW

In financial theory, efficiency of financial silver market is highly disputed. This has led to many attempts to explain efficiency of silver markets. Eugene.F. Fama formulated the most famous definition in 1970 referred to as the, Efficient Silver market Hypothesis (EHM). The basis of the hypothesis is that a security price always reflects all the information available. Many studies have been undertaken to explore silver market. This has led to two camps; those who believe in silver market efficiency and those who do not believe in it. Those who believe in efficiency argue that silver market has all the information available while those who believe in inefficacy argue that security prices lack important information.

Problem Specification

Although technical analysis is used; it does not have much support within academic circles. The preferred theory is that of silver market efficiency. The purpose of this paper is to contribute to the contradicting ideas between advocates of inefficient silver markets and efficient silver market in silver market. The basic question is whether it is possible to earn a significant better return from buy -- and -- hold strategy using simple technical trading rules when applied on growth and value stock respectively (Dawson & Steeley 2003).

Limitations

To analyze technical trading rules, moving average rules will be considered. This is because it is these rules can be used mechanically and can be tested easily since they produce clear signals. Stock classification into value or growth portfolio is based on book-to-silver market (B/M) ratio and the earnings -- to price (E/P). These are the commonly used measures when classifying stocks. The test period will be limited to a span of 19 years. That is from 1986 to 2004. This period is of interest because 1992 study by BLL shows that use of technical analysis approach earns a higher return as compared to simple buy- and- hold strategy based on DJIA testing from 1897 to 1986.

Theoretical Background

Technical Analysis

Definition

Technical analysis is defined as the study of silver market action using charts to forecast various silver market actions like, volume, price and interest. Technical analysis is based on various premises. These are; price moves in trends, silver market action discounts everything and history repeats itself (Dawson & Steeley 2003). Chartists and technicians believe that everything that has effect on silver market price of a good is contained in the price. There is need therefore to study silver market price by all technicians. On the other hand, chartists are not concerned with price change factors but they react to them. Therefore, chartists want to know whether the price of stock is rising or falling but they have no concern with the actual price. The purpose why chartists have to be analyzed is to identify trends to trade in accordance with the trend. Technical analysts believe that a trend in motion is likely to continue than reverse based on the Newton's first law of motion (Dawson & Steeley 2003). Trends differ in many ways and chartists have divided them into time units. This is what is called the Dow Theory, which is discussed below. This theory states that there are three levels of silver market trends: tertiary, secondary and primary. In other words, there are intermediate trends, secondary trends and long-term trends.

2.1 The Silver market Cycle Model

It indicates that the key to predicting the future is based on past understanding. Therefore, human psychology has an important part to play in technical analysis.

Technical Trading Rules

Principles behind technical analysis are similar. It does not matter whether you focus on long-term or short-term investments, follow a speculative or conservative strategy, the basic principles remain the same. Psychology and mass psychology determine prices and psychology is significant in long -- term charts and short-term charts.In addition, technical analysis principle is the same in spite of investment opportunities and geographical location.

Human actions form silver market and people make same mistakes. Technical analysts exploit the fact that, human nature is less or more constant hence people keep on committing same mistakes since emotional swings keep on recurring. Described below are the most important issues within technical trading.

Dow Theory

Charles Dow, one of the founders of The Wall Street Journal, developed this theory in 1890s and its first editor. He was the first to create stock silver market average in 1897. After his death, his theory was formulated. William Hamilton who succeeded him as editor published more than 250 stock- silver market predictions. He used the theories of Dow. Dow's theory is the starting point in studying technical analysis. This theory tries to identify long-term trends in stock silver market prices. Its basic tenets are:

1. The Income Special discounts everything.

2. The Industry Has Three Styles.

3. Significant Styles Have Three Stages.

4. The Income Must Validate Each Other.

5. Amount Must Validate the Design.

6. A Design Is Considered to Be in Impact Until It Gives Certain Alerts That It Has Reversed.

Figure 2.2 Verification of reversals of the main trend in the DJIA and DJTA

Source: Hirschey & Nofsinger (2005)

The figure above shows three situations. The grayish variety symbolizes the DJTA while the green variety symbolizes the DJIA. At factor 1, the DJTA does not look at the keep trend proven by the DJIA thus, the fluff organizations are unchanged. However, at factor 2, the end of fluff organizations are verified. Fashionable change is verified by the reduced total and the reduced low on the DJTA. Point 3 verifies that the fluff silver market has started again. The greater levels and the greater peaks on both averages indicate this resumption.

Industry Pattern Model

The company cycle is a well-known trend in the economic climate. Economists believe that the economic climate goes in a stroking cycle from growth to the economic downturn. Among technical experts, there is an extensive perception that inventory silver marketplaces also move in rhythmic periods from growth to the economic downturn and returning to growth or, in other conditions they believe that there is a propensity for expenses to move from silver market optimum to silver market trough in a stroking. Cyclical activities are caused by the actual financial and governmental causes and audience actions among people. It can take months or even decades for audience actions to rise to the stage of irrational exuberance, decrease to despondent negativity and returning to unreasonable exuberance.

Some of the well-known periods of unreasonable exuberance in the U.S. took place in the overdue 60's with technological innovation stocks, overdue 80's with energy stocks and finally in the late 90's with technological innovation stocks again. The corresponding levels took place in 1974, 1982 and 1990 when investors where uncommonly gloomy. One of the best-known silver market cycle designs is The Elliot Trend Design, after Ralph Nelson Elliot. He thought audience actions trends and reversals occur in recognizable styles. The process of the Elliot Trend Concept is that stock prices are managed by the Fibonacci figures (1, 2, 3, 5, 8, 13, 21, 34, 55….), and the benefit silver market goes in five surf and three on the disadvantage. Within these waves there can, however, be slight surf and these also display the same pattern.

Figure 2.3 the Elliot Trend Pattern

Source: Own creation with inspiration from Murphy (1986).

As it was the situation in Dow Concept, the surf can be separated according to their size. The major wave chooses the most essential or main trend of the industry and the minor waves the slight trend. As can be seen in determine 2.3, optimum 1 is an aspect of the major trend whereas the first trough, noticeable variety 2, is only remedial and, therefore, only another trend.

Other Specialized Indicators

While cost is the most used indication for technical experts, other signs are also used. Some of these signs are used for verifying the indication produced by the price, but they can also be used as a main indication. These are volume, money moves, silver market breadth and silver market discrepancy.

2.2.3 Simple Dealing Rules

In the following aspect, two basic trading guidelines will be described. The going average trading guidelines, that.....