Monday, November 28, 2011

Conflicting Commentary on Technical Analysis


You may recall Burton Malkiel's discussion of some research done on technical investing in last week's blog.  He said that the results showed little, if any, correlation between past and future prices of stock.  So, we know that Professor Malkiel does not hold much store in technical analysis.  A proponent of technical analysis might, rightly, ask for more details about the scope of the tests.

Norman G. Fosback, a well respected investment adviser and co-founder of The Institute of Econometric Research, disagrees with him.  Fosback's enduring work, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, was first published in 1976.  The twenty-second edition was printed in 1993.  In his book, Mr. Fosback took random walkers, such as Professor Malkiel, to task.  He criticized the academic studies on which their conclusions about technical analysis were based; writing that the research conducted by them was superficial and not done in sufficient depth to support their conclusion that market timing was of no value.  His research led to a different conclusion.  In referring to a table of daily price/volume relationships for the period 1965-1972 depicted in his book, he wrote:

The most important conclusions to be gleaned from the table are: (1) rising price is a relatively bullish portent for future price changes and falling price is relatively bearish; (2) rising volume is even more bullish and falling volume is relatively bearish; (3) rising price accompanied by rising volume is the most bullish of all and falling price accompanied by falling volume is consistently bearish.  Almost all price/volume tables created with alternative averaging and change parameters,  be they in terms of days or weeks, and the author has created dozens of them, show similar results and lead to identical conclusions.*

Based on his research, Mr. Fosback concluded that there was a correlation between historical price and volume levels with future price movement.

There are two types of research: deductive and inductive. The researcher either starts with a hypothesis and finds supporting facts (deductive) or starts with facts and finds the resulting hypothesis (inductive).  They are mirror opposites. Mark Twain popularized the statement, "There are three kinds of lies: lies, damn lies and statistics."  Depending on your level of cynicism, this may be one of the truest statements ever made.

I suspect that you can find research results to support just about anything you want.  As individual investors, we must decide what form of investing works best of each of us and stick to it.   Consistent application of an investor's chosen strategy is the only way to improve the results of his or her portfolio.

We will continue looking at technical analysis in the next blog.

* Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, page 148

As always, comments are welcome.



Monday, November 21, 2011

Technical Analysis - Hang Gliding / Burton Malkiel's Opinion


When I finished the blogs on fundamental analysis, I posted a blog with Professor Burton Malkiel's comments on this investment strategy from his excellent book, A Random Walk Down Wall Street.  We are about to start exploring the technical form of analysis, which  I referred to as "hang gliding" in an earlier blog.  To mix things up, this time I will start with his comments and then move on to books by proponents of this form of investing.

Although he describes it accurately, he does not have much respect for the technical form of investing.  This is how he described it: 

Technical analysis is essentially the making and interpreting of stock charts.  Thus its practitioners, a small but abnormally devoted cult, are called chartists.  They study the past - both the movements of common stock prices and the volume of trading - for a clue to the direction of future change.....Charts, of course, tell only what the other players have been doing in the past.  The chartist's hope, however, is that a careful study of what the other players are doing will shed light on what the crowd is likely to do in the future.

Malkiel referenced results of some research into technical investment rules.  He reported the following:

One set of tests, perhaps the simplest of all, compares the price change for a stock in a given period with the price change in a subsequent period.  For example, technical lore has it that if the price of a stock rose yesterday, it is more likely to rise today.  It turns out that the correlation of past price movements with present and future price movements is slightly positive but very close to zero.  Last week's price change bears little relationship to the price change this week, and so forth.  Whatever slight dependencies have been found between stock price movements in different time periods are extremely small and economically insignificant.  Although there is some short-term momentum in the stock market, as will be described more fully in Chapter Ten, any investor who pays transaction costs cannot benefit from it.

As I said, Professor Malkiel does not hold technical analysis in high regard.  Nevertheless, we will learn about technical investing in subsequent blogs and will return to A Random Walk Down Wall Street for more of Professor Malkiel's discussion of this strategy.

 The material from A Random Walk Down Wall Street by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc is used with permission of W.W. Norton & Company, Inc.

Comments are always welcome.

Monday, November 14, 2011

Word Of Mouth - Stock Tips


Robert J. Shiller, in his excellent book, Irrational Exuberance, wrote about the innate human trait of sharing information, especially in person to person exchanges:

The human mind is the product of evolution almost entirely in the absence of the printed word, e-mail, the Internet, or any other artificial means of communication.  Human society has been able to conquer almost all habitats of this planet primarily because of its own innate information processing ability.  A fundamental component of this information processing ability is effective communication of important facts from one person to another.

This superior ability to communicate knowledge has been made possible over the past few million years by evolutionary changes within the human brain that have optimized the channels of communication and created an emotional drive to communicate effectively.  It is because of this emotional drive that most people's favorite activity is conversation.....The incessant exchange of information is a fundamental characteristic of our species.

Word of mouth transmission of ideas appears to be an important contributor to day-to-day or hour-to-hour stock market fluctuations, even though direct word-of-mouth transmission cannot proceed across the nation as fast as markets move.

Human communication is basically the sharing of knowledge; something that has been going on between people since language first developed.  Any time two or more people meet, they communicate; they pass information of one sort or the other.  In light of the inherent uncertainty in the market, individual investors are always open to information that is seen as reducing investment risk.  You must remember that any such information, regardless of how presented, can be only one of three things: fact, rumor or opinion.  

As human beings, we strive to learn things in order to reduce life's uncertainty.  As investors, however, we must resist the urge to act upon one form of communication:  the stock tip.  In the last post, we ended with the caution against gambling on Wall Street.  One type of market gambling is investing on a tip from someone.  Usually that person will claim some inside information; facts not generally available to the investing public at the time.  The investor needs to "go slow" when presented with a tip.  Facts and rumors can be checked out.  Opinion is just that, which makes it no better than an investor's personal analysis of a situation.  Opinions differ.  As they say, "That's what makes a horse race."  The investor must weigh the other's opinion against his or her own information.  If the tip is truly inside information, acting on it is illegal in the USA.  Investors can't hide their trades from the government computers monitoring the market.

Although recounted in an earlier blog about Philip Carrett's book, The Art of Speculation, I feel his advice on "inside information" is worth repeating.  Avoid "inside information" as you would the plague. Looking at the psychological aspects of "tips", Mr. Carret said that they appealed to an investor's vanity since such confidential news sets the recipient apart from the rest of the market.  He recommended that the investor view him or herself as being the thousandth rather than the first or second person to get the story.  Such lack of self pride would, in Mr. Carrett's view, be "well rewarded."

SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, Reprinted by permission of Princeton University Press.

The The Art of Speculation by Philip L. Carret, remains in print today.

Comments are always welcome.

Monday, November 7, 2011

Who The Hell Are You? (2)


Having cleaned up the birthday cake crumbs from last Monday's anniversary blog, we pick up  the topic of investment vs. speculation from my October 24th blog.  We have seen how Philip Carrett and Benjamin Graham addressed the subject.  Al Frank in his book, Al Frank's New Prudent Speculator, wrote about the two words, but felt that the difference was more about semantics than investment strategy.  He cited a dictionary definition of speculation:

Engagement in any business transaction involving considerable risk for the chance of large gains.

In contrast, the same dictionary defined investment as follows:

The investing of money or capital for profitable returns.

Frank pointed out the absence of the words risk, chance or large gains in the definition of investment.  He wrote about this obvious bias: speculation = risky and investment = safe; a viewpoint with which he totally disagreed.  He explained his position as follows:

Right off, let us agree to a stipulated definition that all so-called investing in common stocks is a form of speculation.  I believe it is important at the outset, throughout the pages of this book, and indeed in our everyday thinking about the stock market, to be aware and admit that when we trade stocks or buy them for their long-term potential, we are speculators.

The point of this discussion is not to clarify the distinctions being drawn by these authors, but to suggest that you, as an individual investor, must ask yourself a question before you buy a security.  Regardless of how you may define the words, are you thinking like an investor, a speculator or a gambler?  In any event, whether you are looking for long term appreciation or quick profit, you should save the gambling for Las Vegas, not Wall Street.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

As always, I welcome your comments.