Monday, February 27, 2012

Fundamental vs. Technical - Opposites or Alternates


We have now completed our studies of fundamental and technical analysis.  The practitioners of each form of investing mock and belittle the other.  Random walkers, like Professor Malkiel, criticize both of them for various perceived shortcomings.  Bradbury K. Thurlow in his work, Rediscovering the Wheel, Contrary Thinking & Investment Strategy, did a very good job of laying out the differences between these three investment philosophies as follows:

A majority of both professional security analysts and individual investors would support the thesis that careful fundamental analysis (i.e. of a company's earnings record and outlook) is prerequisite to any responsible investment decision.

The antithesis, believed by technical analysts for many years, is that the price of a stock at any given moment discounts all known relevant information and that first-hand knowledge of same is redundant in the decision making process.

According to academic Efficient Market Theory (more respectable that Granville's thought, but related to it) pertinent knowledge is discounted in the price structure before anyone can legally profit from it.*

It may be presumptuous on my part, given my lack of expertise when compared to these eminent financial writers, but I would suggest that fundamental and technical analysis may each have a place in an investor's arsenal.  An investor's personality will, undoubtedly, tend to bias his or her choice toward one or the other of the two strategies.  A person with a deliberate bent for accounting factors might not be attracted to the "quick draw" nature of short term, technical trading moves.  Conversely, a person looking for quick "in and out" trading in the market will find a long-term fundamental approach utterly dull and smothering.  So, to a certain extent, an individual's personality will probably lead him or her to either fundamental or technical ways of investing.

Notwithstanding the psychological attractions of each form of investing, all investors in the market share a common goal:  making a profit.  The follow-on to that common goal could be, however, the time it takes to book the profit.  Viewed from this perspective, the issue of which form of investment strategy is better might be recast as an exploration of an investor's goals and time horizons for the money available at the time. If a 30 year old, busy furthering his or her career, is investing for retirement and has little time or inclination to devote to the task, then a fundamental "buy it for keeps" approach may make the most sense.  Finding a small portfolio of companies which meet all of his or her requirements for value investments may be all that is needed at this point in the person's professional/investing life.  That may change in the future, but for now such a strategy fits the bill.

At some other point in time and with funds to be devoted to a different investment goal, the same person, seeking a profit in a number of days, weeks or months as opposed retirement funds needed several years hence, may find a short term technical strategy attractive.  Please note the qualifier in that last sentence, "with funds to be devoted to a different investment goal."  The money put into long-term, fundamental value investments for retirement is not disturbed.  Different investment funds, which the person can afford to lose without suffering lasting financial damage, could be devoted to short term, technical trades.

Yes, it may be possible to have it both ways.  The danger lies in the fact that it is difficult enough to master one, much less, two strategies.  The level of difficulty increases, probably logarithmically, in attempting to learn a second set of rules and strategies.  More to the point, funds initially invested with a long term goal should be left untouched and not be converted and used for short term trading gains.  With that caveat in mind, an individual is free to step up and take a shot.

* Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy by Bradbury K. Thurlow, Fraser Publishing Company, copyright 1981, page103

Comments are always welcome.

Monday, February 20, 2012

It's Not Prices; It's People - Some Final Words on Technical Analysis (2)


As I wrote in the last blog, market action is really people action.

In his book, A Random Walk Down Wall Street, Professor Malkiel summed up technical analysis as follows:

Most chartists believe that the market is only 10 percent logical and 90 percent psychological.  They generally subscribe to the castle-in-the-air school and view the investment game as one of anticipating how the other players will behave.  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.*

Conversely, he felt that fundamental analysts believe the market to be 90 percent logical and 10 percent psychological (or emotional).  It is interesting that Professor Malkiel refers to the stock market as "the investment game" and to the people trading and investing in it as "players."  With a nod to Gustave Le Bon, he also refers to them as "the crowd."

In  the book, The Money Game, the author, writing under the pseudonym Adam Smith, marveled at the fact that the very famous and controversial economist, John Maynard Keynes, also referred to investing as a game.  While teaching economics at Cambridge, Keynes successfully invested for himself and the school, supposedly only devoting half an hour a day to the task.  In his famous economic text, The General Theory of Employment, Interest and Money published in 1936, Professor Keynes described investing in a number of ways, all based on the idea that the successful investor is one who outwits the crowd.  He likened investing to party games:

This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years does not even require gulls amongst the public to feed the maws of the professional;--it can be played by professionals amongst themselves.....For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs--a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbor before the game is over, who secures a chair for himself when the music stops.**

Keynes went on to compare investing with a popular newspaper contest of his time.  The object of the competition was to pick out the prettiest faces from hundreds of photographs with the prize going to the contestant who picked the faces also preferred by the entrants as a group.  As Professor Keynes pointed out, the person picking the six prettiest had to decide which faces the group at large would choose when each of them is competing in the same way.  He described the problem as follows:

It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest.  We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be.  And there are some, I believe, who practice the fourth, fifth and higher degrees.**

This is the essence of technical analysis.  Indeed, the goal of technical analysis is learning from charts what the people in the market have been doing previously (maybe just yesterday) with an eye to anticipating their next moves.  The chartist's strategy is to take a trading position in a stock which appears most likely to either increase or decrease in price, thereby netting a profit ahead of the investing crowd.  Yes, it is possible to make money on a stock in decline; what is called "shorting" a stock.  This is a trading tactic we will explore in greater detail in a future blog.  We will also discuss two of technical analysis' offspring in the future: market timing and momentum trading.  However, we have finished our exploration of this trading strategy for now.

* 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.

** Excerpts from The General Theory of Employment, Interest and Money, John Maynard Keynes, copyright 1936, republished in the Great Minds Series by Prometheus Books 1997, pages 155-156

Comments are always welcome.

Monday, February 13, 2012

It's Not Prices; It's People - Some Final Words on Technical Analysis (1)


We are now finished with our look at the technical aspects (the "how to") of technical analysis.  The thing that must be remembered is that charts and the technical indicators they reveal record market action, price and volume, which is nothing more that the collective actions of the investors and traders in the market.  Humphrey B. Neill explained it best in his 1931 classic Tape Reading & Market Tactics.  Neill described the true purpose of technical analysis or "tape reading" as he called it as follows:

In the first part of this book I have described the various kinds of people comprising the purchasers and sellers of stock.  The important point to remember here is that all of those people are human beings, just as you and I are.

Let us get that picture clearly in mind.  The ticker tape is simply a record of human nature passing in review.  It is a record giving us the opinions and hopes of thousands of people.  We must dismiss from our minds all other facts.*

Author's emphasis in bold. 

Technical analysis or charting in various forms has been around for scores of years.  It went by a different name back in Neill's day.  Back then technical analysts were referred to as "tape readers".  They received their market information from a ticker tape machine.  The ticker tape machine, which was connected to stock exchanges over telegraph wires, printed out narrow strips of paper with stock trades, including stock symbols, prices and volumes for all stock trades shortly after they happened on the floor of the stock exchange.  All of the brokerage firms and stock trading shops had the machines in order to keep up with the daily market action almost as it happened.  

The ticker tape machines provided stock trading reports on a delayed but close to real-time basis.  Use of ticker tapes phased out when television and computers took over the job of providing virtually instantaneous market action.  The streaming electronic boards with stock symbols, prices and volumes on financial television broadcasts and in brokers' offices have replaced the old paper tape.  The narrow strips of tape served a second purpose.  They were used as confetti and thrown out office windows during parades on New York City streets.  Hence the term "ticker tape" parades.

The hey day of the tape reader occurred in the early 1900s when stock market manipulation (referred to then as "operations") by secret investor pools and groups of corporate insiders  was rampant.  Back then the strategy was one of quiet accumulation and managed distribution of large amounts of a target stock.  These days such an operation might be called a "pump and dump."  It was only after the crash of 1929 and the establishment of the Securities & Exchange Commission ("SEC") in America that such activities were banned in this country.  Whether such illegal activities continue today, despite the prohibition, is a topic for another day.

As the tape was received, the tape reader looked for price and volume movements which signaled that a stock market "operation" might be under way.  The insightful trader would try to interpret what "they" were doing and buy the target stock to profit from the manipulated run up of a stock's price.  The trader hoped to sell out his or her position before the inevitable crash of the stock when the group had unloaded all of their holdings on an unsuspecting public attracted to the stock by its market action.  As I indicated above, it's really all about the people in the market.

Like most stock market strategies, the popularity of technical analysis waxes and wanes.  In his book, Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, a Wall Street broker and author, looked at the history of technical analysis:

Forecasting techniques in this field move through distinct life cycles.  If rationally conceived, as technical analysis certainly was, they achieve success before they are recognized, they achieve more success as skepticism increasingly questions their validity, the success becomes spectacular as skepticism is destroyed and replaced by universal belief.  Then they begin to fail.  People then achieve success by going directly contrary to the recognized technique, a period of anarchy ensues in which the technique and the anti-technique neutralize one another.  It is at this stage that Mr. Malkiel's random behavior is most clearly observed.  The technique is then discredited and gradually falls into disuse.**

To paraphrase the oft cited biblical quote, "To every investment strategy, there is a season.Technical analysis was popular again in the 1960s and once again fell out of favor after the stock market crash of the early 1970s.  Given all of today's advertising by on-line brokers about their electronic trading platforms, it would seem that following charts may be in vogue yet again. We will conclude our discussion of technical analysis in the next blog.

*Excerpt from Tape Reading & Market Tactics, Humphrey B. Neill, republished by BN Publishing, pages 32-33

** Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy by Bradbury K. Thurlow, Fraser Publishing Company, copyright 1981, page 116

Comments are always welcome.

Monday, February 6, 2012

Making A Chart


If a person has an interest in technical analysis, it would seem logical that the individual would want to start studying charts.  There are two ways to do that: seek advice or do it yourself.  The person looking for advice could subscribe to a technical analyst's newsletter and follow the author's recommendations.  The goal then becomes finding the newsletter that resonates with the individual with the hope of making at least enough money to pay the subscription fee.  The do-it-yourself type must start by making a chart of the stock or the market in which he or she is interested.  Whether it is a bar chart, a point and figure chart, a candlestick chart or one of the many other types available, picking the form of chart is the first decision that must be made.  The type of chart to use is a personal decision, much like the financial metrics selected by a fundamental analyst for his or her stock screen.

The computer has made charting a lot easier.  The computer literate chartist has several free stock chart websites from which to choose.  Some of the top sites include StockCharts.comYahoo Finance and Bigcharts.comGoogle Finance also provides technical charting, but it is a little more difficult to navigate the site.  This link to YouTube will explain how to use the technical tools at Google Finance.  It is a clunky video without sound, but you should be able follow the steps shown to get to Google charts on the particular stocks you want to follow.

The old fashion way of charting involved pencil and graph paper with daily notations of the price movements of the chosen stock or market. Justin Mamis in his book, The Nature of Risk, Stock Market Survival & The Meaning of Life, had the following to say about making charts:

You may not believe this, or want to accept it in this computerized era, but once you start keeping even a handful of charts yourself you'll see (and feel) the difference.  The very nature of how the stock is behaving rises to the surface via your pencil's posting the volume and the pattern.  Of course, it's not perfect; it isn't even close to perfect.  Sort of like Churchill's backhanded compliment about capitalism, it's just better than anything else, and certainly better than nothing.  What happens is that the market "talks" to you as the language of its ticks becomes recordable on your chart paper.  Keeping your own charts is the way the market's language can be heard most directly.  To paraphrase a more important statement:  All the rest of technical analysis is commentary.*

Author's emphasis in bold.

Mr. Mamis repeated his advice about keeping your own chart in his later book, When To Sell, Inside Strategies for Stock Market Profits.  Reminding his readers that charting did not take all that much time out of their day, he wrote:

It's taken you far longer to read this than it will to keep up with these statistics each day.  We repeat: Don't rely on someone else to do what will take you so little time.  You'll find you get a much better feel for what is actually happening by keeping your own hand and mind in.**

Regardless of which type of chart the individual decides to use, the goal remains the same: see what is happening with a stock or a market and then decide how to turn that information into a profit.  We will continue our study of technical analysis in the next blog. 

* Excerpt from The Nature of Risk, Stock Market Survival and the Meaning of Life by Justin Mamis, copyright 1991, page 221

** Excerpt from When To Sell, Inside Strategies for Stock Market Profits by Justin Mamis, copyright 1994, is used with the permission of Mr. Mamis and Fraser Publishing Company

Comments are always welcome.