CHAPTER 12
BEHAVIORAL FINANCE AND TECHNICAL ANALYSIS
Teaching Guides for Questions in the Text
12-1. Investment decisions are made by individuals and those decisions are affected by
human behavior. Various human traits such as overconfidence and familiarity (excessive
12-2. Traditional financial theory is build upon the belief that investors are rational and
that irrational behavior does not affect investment decisions. Behavioral finance suggests
12-3. Technical analysis seeks to identify securities for possible purchase primarily by
analyzing past price behavior for trends and patterns. It also uses similar techniques to
determine the direction of the market on the premise that individual stocks will follow the
market.
12-4. The sell signal in the Dow Theory is a decline in either the industrial average or the
transportation average that is subsequently confirmed by a decline in the other average.
12-5. A moving average adds the most recent entry and deletes the oldest entry before the
average is recomputed. When a stock’s price equals the moving average (e.g., when a
12-6. If many investors believe a type of technical analysis, it may give self-fulfilling
predictions. For example, if a buy signal is given and investors seek to buy the stock, its
price will be driven up and thus fulfill the prediction given by the analysis.
Many technical indicators such moving averages may be obtained for no cost through the
Internet. The individual, however, has to interpret the graphs.
For technical analysis to be useful, it must predict price behavior and not just mirror past
price behavior. There must be a sufficient lag between the signal to buy or sell and the
subsequent price movement for the investor to perceive the signal and act. Unfortunately,
this need not be the case, because the signal may take time to develop and be perceived
12-8. While some empirical research does support technical analysis, most does not.
Without verification that technical analysis results in superior performance, there is little
support for it (at least among some investors and portfolio managers). Results from using
technical analysis may even be inferior after adjusting for the brokerage fees generated by
12-9. While the Dow dog approach to selecting stocks is not a technical approach, it is not
a fundamental approach either. Dow dogs are defined as those ten (of the thirty stocks in
the Dow Jones industrial average) with the highest dividend yields. These ten stocks are
12-10. This question asks students to locate moving averages through the Internet and to
interpret them. I use this assignment as the basis for a class presentation, with one of the
stock’s assigned to one group of two students and the other assigned to a different group.
At the end of the presentation, each group must decide to be long or short in the stock.
Investment Assignment (Part 5)