Check the charts occasionally to sense mob hysteria or panic at work

Some people in the markets use graphs of previous stocks or commodity movements in order to predict future price movements.  They are called "technicians" or "chartists."  They spend a lot of time pouring over the historic price movements and the formations these show on their charts as a way to predict what will happen next.

Ordinarily, I do not use charts to trade.  Occasionally, I will turn to them as a way to see what has been happening and to check facts if I sense mob hysteria or panic at work.  

Charts sometimes reveal a beeline rise, an indication that prices have increased far beyond actual value.  It means that people have lost perspective.  It shows the level of the hysteria.  I know that prices will eventually return to the appropriate level, so I sell short.  You need to be careful, though, that you are not selling short simply because prices are high.  Never sell short unless prices are astronomically expensive, AND you detect negative change coming.  

You can see panic in falling prices when you see them collapsing straight down day after day for extended periods.  Historically, long periods of selling have ended in "selling climaxes" when everyone finally panics and dumps to get out of the market at any price no matter what the fundamental reality might be.  Large price declines across the board should attract your attention. 

A good rule of thumb is to sell during times of market hysteria and buy during times of panic.  Always remember to buy low and sell high.


Ref:
Jim Rogers
A Gift to My Children

My occasional rumination

One of the most fascinating figure in investing is the wide range of intrinsic value one can obtain from various types of valuations and by various analysts.

It is this inability to determine the intrinsic value or the lack of consensus of what constitutes the right intrinsic value that allows the price of the market to zig-zag but always tracking the intrinsic value.  Over the short term, the price may be up or down by a wide margin.  However, over the long term, it always reflect the fundamental value of the business.

Are you a bargain hunter? Are you a trend follower?  There are more than one way to make a profit from the stock market.  There are also more than one way to make a loss from the stock market.  The rules are generally fair, though one need to watch out for manipulations in certain price movements of certain stocks. 

There are those who discard the fundamentals and only study and follow the sentiment driving the supply and demand of the stock.  Buy low and sell high.  Buy high and sell higher.  It sounds so easy for an "expert" to pronounce that those who did not do this on the first trading day of this month by following the chart would have been stupid or foolish, given the chart patterns.  To these believers, fundamentals do not matter in their trades.

On the other hand, there are those who discard the charts.  They painstakingly study the fundamentals.  They patiently analyse their thinking and behaviour guiding their investing.  They are generally followers of value investing as practised by Benjamin Graham and his students.  They track a few high quality stocks and bargain hunt when the price is right.  They have strict rules too guiding their selling.  Their achievements are not measured by the days, weeks or months, but over a long period of years.  After an initial period of investing, their returns are often positive by a huge percentage over their initial cost.  Short term fluctuating prices in the stocks of their portfolio rarely cause a capital loss in their portfolio value.  The low markets significantly reduced the compound annual growth rate returns for the whole investment when these were measured at those times.  On the other hand, the compound annual growth rate rebounded when the returns were calculated at the time when the market shot up to stratosphere. 

Those who trade protects their downside with stop loss strategy.  They often take profit when a certain percentage gain is achieved.  They may also allow the winners to climb higher at the same time moving their stop loss value higher. 

Those who employ value investing, protect the downside through buying with a margin of safety and careful stock picking.  They often allow these stocks to eventually reflect the fundamental intrinsic value.  Often the carefully chosen stock can be held for long term, without the necessity to take short term profit.  Compounding over years provide the substantial returns.  The reinvested dividend returns contitute a substantial part of the return too, this return is not enjoyed by the chartists whose investing period are often short term..

While the traders may plough in a certain amount onto a certain stock, to make big gains over a short trading period, this amount has to be meaningful and substantial.  Short term volatilities are unpredicatable and this constitutes the main risk in trading. 

On the other hand, those who value invest can usually afford to keep a large amount in their portfolio permanently.  This is safe except druing those times when the market is truly bubbly.  The volatilities in the market over the short term do not affect their investment behaviour which is strategized for the long term.  The short term volatility is often treated as a "friend" when the price can be taken advantaged of.  Over the long term, these short term volatilities - often a tinyl blip on the long term price chart - is in fact very small for carefully chosen good quality stocks.

Chartists are the astrologers of the markets

Charts are extremely popular.

Chartists believe that they can see patterns in charts which can predict future price movements.

• They like to superimpose straight lines over the charts, usually connecting a series of high or low points. Sometimes, they also have squiggly lines drawn on them as well.
• The chartists all have their own systems that they follow, normally based on the thoughts of a guru from a long time ago, or perhaps some strange pattern which exists in nature.
• And the jargon they use sounds very scientific. Expressions such as 'declining wedge' and 'fourth wave' suggest to outsiders that the systems are profound and well researched.
• The beauty for chartists is that they don't need to know anything about the market they're trading. They have no need to look at fundamentals.

You shouldn't get distracted by charts.

Chartists have no scientific basis

It is fine to look at the odd chart every now and then; it's the crazy theories that chartists use that you should be cautious on. Charts themselves are useful for a feeling of how far markets can move and how they react to news flow.

However, a few things are obvious about chartist theories.

• These ideas are not applied in the economics field which is always searching for theories on human behaviour.
• Nor do the theories have a true mathematical basis, and the chartists often do not have a mathematical background of any kind.
• How many chartists do you know who are successful? Probability would suggest that there are a few out there somewhere.

Chartists are the astrologers of the markets. They use a pseudo-science. At best, it is a clumsy way of following trends. Their methods are unsubstantiated, though extremely popular.

There is simply no reason, for example, why price moves should imitate the pattern of plant growth, star patterns or anything else.

Ref: 100 Secret Strategies for Successful Investing by Richard Farleigh