Forum Archive Index - May 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

>
>
>
>Nick states "The wedge in this case has been caused not by normal
>stock action but by 50 million new shares entering circulation"
>This IS normal stock action. He might just as pointlessly state
>"The wedge in this case has been caused not by normal stock action
>but by a reaction to the recent mine accident" (or lowered profit
>forecast, terrorist attack, etc) Nick, you seem to think that price
>falls and their associated chart patterns somehow don't count if
> they are associated with known events. Not so 
>
>





I'm not a chartist but I do know enough about mathematics in 
general and graphing in particular to know that something is missing 
from this answer.  And I don't think it is an issue of known vs 
unknown events either.

The question as I understand it as posed by Gerry is that AUO has had 
a huge cash issue of shares and he wonders if this has somehow 
screwed up the chart.  I think Gerry's concerns are valid and 
 a more extreme thought experiment example of what has 
happened might help show any disbelievers why.

Let's assume that AUO had only just been listed on the market at the 
time all of those new shares were issued.   Now what does a chart 
tell us about what has happened?   Clearly the answer is nothing. 
At time zero when the shares were issued there is no price 
history no sales or closing prices to plot and consequently no chart. 
A chart can't tell us anything when it doesn't exist!.  Therefore a 
chart can't tell us anything about a new issue of shares.

Now, you might argue that this thought example provides no insight as 
to what has happened because it is not comparable.   AUO *was* listed 
before the cash issue, and so the price of the pre-existing AUO 
shares fully reflected the fact that the cash issue shares were about 
to come into existance.  So therefore the chart is valid.  This is, 
in essence, Phaedrus's position.  While essentially correct, I 
believe one must take into consideration another chart which Phaedrus 
hasn't mentioned to get the full picture.

If a 1:1 cash issue (I'll use that ratio to make the maths easier for 
this example) is announced, then even before any rights trading 
happens, existing shareholders suddenly have an extra obligation.  At 
the point the cash issue is announced there are in effect two charts 
that exist side by side.  One chart is a horizontal line (because it 
isn't yet tradeable) at the price level of the cash issue.   The 
second chart is the price level of the head share.   This second 
chart (which is what Phaedrus considers as the only chart) will not 
only carry the market sentiment of the head share but also the market 
sentiment expressed as volatility of the upcoming cash obligation.   
Nevertheless the true picture of what is happening to the share can 
only be deduced by combining *both* charts (as I see it).

After the new shares hit the market following the trending signals of 
both charts is easy.   When the new shares hit the market this means 
the first chart and the second chart have combined, and you can carry 
on any charting of the share as normal.  The problem occurs when you 
want to start comparing what is happening 'today', with a price 
movement that happened before those new shares came onto the market.

Now we go back to the time of two charts.  The chart that is the 
horizontal line tells us nothing on its own because the cash issue 
obligation is not yet tradeable.   Because the new shares cannot be 
traded, all the volatility of both charts is reflected in the head 
share chart.   So therefore we only need study one chart - or do 
we?  

If you subtract a constant value (like a cash issue obligation per 
share) from any chart, whatever the constant value is, it won't 
change any breakout signal you get from the chart.  Nevertheless at a 
time a cash issue is announced there is often a step change downwards 
in the price of the head share.  I would argue that this is not a 
normal event because the share price plunge is associated with an 
upcoming real cash obligation.  Note that this is *quite different* 
to the case of a lower profit forecast or a terroist attack.   As 
soon as the creation of new shares is announced you in effect have a 
second chart running parallel to the original chart (as I see it).  
If the cash issue is on a 1:1 basis then accounting for the combined 
existance of both the original and this second chart is easy.  You 
take the closing price of the head share and subtract from it the 
cash issue obligation associated with that share.  Effectively a cash 
issue creates a sudden debt for the shareholder that must be 
accounted for in the share price if you are truly to compare the 
'before' and 'after' scenarios.

Now we move into the time period where the rights issue is tradeable. 
During this time we must take the closing price of the head share, 
add to it the closing price of the associated right (which will also 
be listed on the sharemarket) and subtract the upcoming cash payment 
due as a result of the share issue.  This will give us the price we 
need to plot for the head share over the period of the rights issue.

The third time period we need to consider is when rights trading has 
stopped and the new shares are issued.  Only then can we revert to 
looking at a single chart without making any adjustments to the bare 
end of day closing figures.

My argument in a nutshell is this.  Between the time that the 
existance of a significant number of new shares is notified and they 
finally start trading you will need to make adjustments to the price 
fed into the head share chart.  If you don't make those adjustments 
it won't affect the 'end of trend'/'beginning of trend' short term 
signals.  But you will have failed to account for the extra capital 
brought into the company as a result of the cash issue.  This means 
that any medium term trendline that covers this period will almost 
certainly give you a misleading picture of the overall share price 
trend.




>
> 
>I am focuss A central tenet of Dow Theory is that the price
>discounts everything. All information, the sum total of all
>opinion, fact, rumour, knowledge, news and fundamentals is
>reflected in the price. The current chart formation is the markets
>reaction to an event that happens to be common knowledge. It gives
>us important information as to how the market perceives AUO.
> 





A chart of the AUO head share price  would give you important 
information as to how the head shares of AUO are perceived.   But if 
you buy in after a cash issue you are in effect buying a combination 
of the old head shares and the new shares that have been issued.   
Studying a chart of *only* the head shares will give you incomplete 
 information.   This is because It isn't *only* the pre-existing head 
shares that you have bought if you buy in after the cash issue is 
announced.  Comments Phaedrus?

SNOOPY



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