Finance Principles: Efficient Markets and Investment Strategies

Principles Of Finance 

Introduction - Principles Of Finance 

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The most debatable topic amongst all the investors, economists and participants in the market is whether the market hypothesis is efficient or not. This report helps to get deep insight on market efficiency based on technical analysis as compared to the economist perspective. Discipline followed to evaluate investments and identify the trading opportunities. Price movement and volume are gathered from trading activities. It is noticed that as per historic trading activities along with price change technical analysts predict the future price of new goods and services

The pattern of head and shoulders consists of three components:

In the graph line of head and shoulder graph, the price rise to the peak after a trend which is long bullish. The price again rises and forms a second high above the peak that was initially created. 

Technical Analysis of EMH

Efficient market hypothesis is highly controversial and often disputed among economists. (Gaebelet al, 2021). Deadweight loss is often observed in case of a certain product, market inefficiency creates a certain cost to society. Supply and demand not being equilibrium created this situation of deadweight. The third time, the price rises to the level of first peak only, before it declines once more as shown in the graph below. The analysis states and supports that the generation of the variables of alpha. Market timing is regarded as an important factor that guides the decision of investors for buying undervalued stocks at fair prices. Over the period of 10 years, 23% of the managers have been able to outperform the market index (Sheng, 2021).

Figure 1: Head and shoulder graph

(Source: Statista, 2022)

The head and shoulder graph indicates a bullish to bearish reversal trend and provides evidences for end of an upward trend in the market. These patterns are proven to be the most accurate when defining the price actions and patterns of change in the market and they are proven to reach the target for up to 85% of the time (Shiravi, 2019).

Figure 2: Efficient market hypothesis

.(Source: Statista 2022)

Implications of EMH

The important implication of EMH is that beating the market is not possible. This is because an efficient market has no abnormal opportunities. According to scientific evidence there are three versions of EMH (Hannigan et al. 2018). The EMH that is weak has the information that is trading volumes as well as past pricing. As everyone has access to more information than the past trading data, this version of EMH has the strongest support but it is least significant. Therefore, the fundamentals do not have much knowledge provided about the possibility of investors beating the market or not. The second or semi-strong EMH acknowledges that the information in question is that, which is publicly available. Past price movements are analyzed using the price action analysis. This is the act of studying, reading and interpreting the movement of price over time. This often uses pie charts and graphs. A market’s directional bias can be determined by reading the price action of a market. Changes or continuation in market sentiment. Is reflected by price action setups.

In technical analysis the relative strength index is a momentum indicator that usually measures the price changes that have occurred recently. This evaluates overbought or oversold conditions in the price of other assets and stocks.

Sentiment indicators show how a group of consumers or investors have positioned themselves and what their current beliefs about the economy or market are. The sentiment indicators are on the other hand not timing signals. An extreme reading on the traders’ commitment doesn't mean that the price of assets will reverse immediately. Also it might happen that the price stays where it is while the trader unwinds the position and the reading becomes unavailable without a significant price reversal (Zanichelliet al, 2019).

Technical analysis is used to predict the upcoming price trends. To evaluate the intrinsic value of a particular stock fundamental analysis is used. Multiple economic factors are taken into account in fundamental analysis whereas technical analysis is conducted by analyzing the patterns provided in the charts and price movements (Hannigan et al. 2018). Long term traders participate in fundamental analysis whereas in technical analysis, short term traders or swing participate. Technical data always looks into previous data whereas the fundamental analysis takes into account the previous as well as present data.

Technical analysis gets impacted due to external news whereas the fundamental analysis remains unimpacted. Fundamental analysis helps in examining the trends, economic outlook, financial data and performance of the competitors in industries that are ongoing. The expenses, revenues, assets, liabilities, debt-equity ratio, return, return on equity ratio etc are studied in fundamental analysis. On the other hand, technical analysis often uses charts such as EMH, RSI, MACD or simple moving average as indicators.

Figure 3: Active and passive portfolio strategy

(Source: Statista, 2022)

The investor interest is increased by the related market volatility in active marketing. In the above figure, 11 precent of the respondents believe that impact of Covid 19 will increase the interest of investor in passive management.

Figure

Active portfolio strategy (APS)

This type of investment strategy generates maximum value for a portfolio. This strategy usually tries to generate maximum value by using as much information that is always available and forecasting techniques to surpass a buy and hold portfolio. The Active portfolio strategy requires the buying and selling of the investments that is aimed at the broad perspective to outperform the market index at all times (Subahi, 2022). This could be achieved by following a trend analysis and adjusting the portfolio according to the dynamic market changes. The main types of choosing stocks are top down and bottom up. Analyzing the market and predicting which industries will perform the best comes under a top down approach. This focuses mainly on the current economic cycle (Spoendlin et al. 2021).

The market conditions and trends are taken into account in this type of approach. The company's financial performance is taken into account by the managers in order to choose stocks.

It is assumed that the firms in bottom up approach will continue to do well even if the markets are volatile.

Passive portfolio strategy (PPS)

Diversification maximization with expectational input is focused on in a passive portfolio strategy. The principal strategies of investments that guide the portfolio of investors are comprised of mutual funds and ETFs that are exchange traded funds that are related to diversify across various pool of investments of the individuals (Subahi, 2022).

Figure 4: Active and passive market

(Source: Statista 2022)

Conclusion

It can be concluded that the head and shoulders graph or chart depicts a bearish as well as bullish reversal of trends and signals that a trend moving upward is nearing to its end. The most reliable and trend reversal patterns is the head and shoulders graph as considered by the investors.

The analysis done by the economists on the basis of price movement is mostly not very specific or accurate since the abnormal profits and other market conditions are not taken into account.

Reference list

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Loredana, M.E., 2019. A CRITICAL THEORETICAL ANALYSIS ON THE IMPLICATIONS OF EFFICIENT MARKET HYPOTHESIS (EMH). Annals of'ConstantinBrancusi'University of Targu-Jiu. Economy Series, (6).

Hannigan, A., Basogomba, A., LeMaster, J., Nurse, D., O’Reilly, F., Roura, M., Villarroel, N. and MacFarlane, A., 2018. Ethnic Minority Health in Ireland—Co-creating knowledge (EMH-IC): a participatory health research protocol. BMJ open, 8(10), p.e026335.

Zanichelli, V., Huttner, A., Harbarth, S., Kronenberg, A.O. and Huttner, B., 2019. Antimicrobial resistance trends in Escherichia coli, Klebsiella pneumoniae and Proteus mirabilis urinary isolates from Switzerland: retrospective analysis of data from a national surveillance network over an 8-year period (2009-2016). Swiss medical weekly, 149, p.w20110.

Spoendlin, J., Blozik, E., Graber, S., Rauch, M., Marxer, C., Rüegg, S., Meier, C., Winterfeld, U. and PanchaudMonnat, A.E.M., 2021. Use of valproate in pregnancy and in women of childbearing age between 2014 and 2018 in Switzerland: a retrospective analysis of Swiss healthcare claims data. Swiss medical weekly, 151, p.w20386

Statista, 2022. Distribution of active and passive investment funds in the United States in 2010 and 2020, by type. Available at https://www.statista.com/statistics/1262209/active-passive-investment-funds-usa/ [ [accessed on 13^th June2022]

Researchgate, 2022Active and passive portfolio strategy 2019. Available at https://www.researchgate.net/figure/Passive-strategy-portfolios_tbl2_5216716 [accessed on 13th June 2022]

Peón, D., Antelo, M. and Calvo, A., 2019. A guide on empirical tests of the EMH. Review of Accounting and Finance.

Subahi, E.A., Ata, F., Choudry, H., Iqbal, P., AlHiyari, M.A., Soliman, A.T., De Sanctis, V. and Yassin, M.A., 2022. Extramedullary haematopoiesis in patients with transfusion dependent β-thalassaemia (TDT): a systematic review. Annals of medicine, 54(1), pp.764-774.

Shiravi, S., Letafatkar, A., Bertozzi, L., Pillastrini, P. and Khaleghi Tazji, M., 2019. Efficacy of abdominal control feedback and scapula stabilization exercises in participants with forward head, round shoulder postures and neck movement impairment. Sports Health, 11(3), pp.272-279.

Sheng, J., Xu, S., An, Y. and Yang, J., 2021. Dynamic portfolio strategy by loss-averse fund managers facing performance-induced fund flows. International Review of Financial Analysis, 73, p.101609.