Technical analysts consider the market to be 80% psychological and 20% logical.

Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. 

Psychological or logical may be open for debate, but there is no questioning the current price of a security. After all, it is available for all to see and nobody doubts its legitimacy. 

The price set by the market reflects the sum knowledge of all participants, and we are not dealing with lightweights here. These participants have considered (discounted) everything under the sun and settled on a price to buy or sell. These are the forces of supply and demand at work. 

By examining price action to determine which force is prevailing, technical analysis focuses directly on the bottom line: 

• What is the price? 
• Where has it been? 
• Where is it going?

Even though there are some universal principles and rules that can be applied, it must be remembered that technical analysis is more an art form than a science. As an art form, it is subject to interpretation. However, it is also flexible in its approach and each investor should use only that which suits his or her style. Developing a style takes time, effort and dedication, but the rewards can be significant.

Chart Analysis: Technical analysis can be as complex or as simple as you want it.

Chart Analysis

Technical analysis can be as complex or as simple as you want it. The example below represents a simplified version. Since we are interested in buying stocks, the focus will be on spotting bullish situations.




Overall Trend: The first step is to identify the overall trend. This can be accomplished with trend lines, moving averages or peak/trough analysis. As long as the price remains above its uptrend line, selected moving averages or previous lows, the trend will be considered bullish.

Support: Areas of congestion or previous lows below the current price mark support levels. A break below support would be considered bearish.

Resistance: Areas of congestion and previous highs above the current price mark the resistance levels. A break above resistance would be considered bullish.

Momentum: Momentum is usually measured with an oscillator such as MACD. If MACD is above its 9-day EMA (exponential moving average) or positive, then momentum will be considered bullish, or at least improving.

Buying/Selling Pressure: For stocks and indices with volume figures available, an indicator that uses volume is used to measure buying or selling pressure. When Chaikin Money Flow is above zero, buying pressure is dominant. Selling pressure is dominant when it is below zero.

Relative Strength: The price relative is a line formed by dividing the security by a benchmark. For stocks it is usually the price of the stock divided by the S&P 500. The plot of this line over a period of time will tell us if the stock is outperforming (rising) or under performing (falling) the major index.

The final step is to synthesize the above analysis to ascertain the following:

• 
  
  Strength of the current trend.
• 
  
  Maturity or stage of current trend.
• 
  
  Reward to risk ratio of a new position.
• 
  
  Potential entry levels for new long position.
  

http://www.stockcharts.com/school/doku.php?id=chart_school:overview:technical_analysis

Technical Analysis is the forecasting of future financial price movements based on an examination of past price movements.

Technical Analysis:  Techniques for predicting market direction based on

• (1) historical price and volume behaviour and 
• (2) investor sentiment.

Learn more here:
www.stockcharts.com
Select "Chart School."
www.e-analytics.com
Glossary of technical terms

www.prophet.net
The number one website on technical analysis according to Forbes and Barron's.

and:
www.chartpatterns.com
www.stockta.com


Technical analysts:  These investors essentially search for bullish or bearish signals, meaning positive or negative indicators about stock prices or market direction.


Dow Theory:  Method for predicting market direction that relies on the Dow Industrial and the Dow Transportation averages.

Learn more here:
www.dowtheory.com
www.thedowtheory.com


Support level:  Price or level below which a stock or the market as a whole is unlikely to fall.

Resistance level: Price or level above which a stock or the market as a whole is unlikely to rise.

Relative strength:  A measure of the performance of one investment relative to another.

Moving average: An average daily price or index level, calculated using a fixed number of previous days' prices or levels updated each day.

Hi-lo-close chart:  Plot of high, low and closing prices.

Candlestick chart:  Plot of high, low, open, and closing prices that shows whether the closing price was above or below the opening price.

Point-and-figure chart:  Technical analysis chart showing only major price moves and their direction.

Can you, or indeed anyone, consistently beat the market?

Can you, or indeed anyone, consistently beat the market?

In other words, is the market efficient?  This is a question that every investor needs to think about because it has direct, practical implications for investing and portfolio management.



If you think the market is relatively efficient,

• then your investment strategy should focus on minimizing costs and taxes.  
• Asset allocation is your primary concern, and you will still need to establish the risk level you are comfortable with.  
• But beyond this, you should be a buy-and-hold investor, transacting only when absolutely necessary.  Investments such as low-cost, low-turnover mutual funds make a lot of sense.  
• Tools for analysing the market, particularly the tools of technical analysis, are irrelevant at best.  
• Thus, in some ways, the appropriate investment strategy is kind of boring, but it's the one that will pay off over the long haul in an efficient market.

In contrast, if you think the market is not particularly efficient,

• then you've got to be a security picker.  
• You also have to decide what tools - technical analysis, fundamental analysis, or both - will be the ones you use.  
• This is also true if you are in the money management business; you have to decide which specific stocks or bonds to hold.

In the end, the only way to find out if you've got what it takes to beat the market is to try.

• Be honest with yourself:  You think you can beat the market; most novice investors do.  Some change their minds and some don't. 
• As to which tools to use, try some and see if it works for you.  If it does, great.  If not, well, there are other tools at your disposal.  

****Select A Good Stock Market Strategy For Good Returns

Select A Good Stock Market Strategy For Good Returns

Sunday, February 28th, 2010

Stock market can be a good money maker if you know how to play the stock market correctly. A lot of people get into the stock market thinking they can make big money but then lose money by making some rash decisions.

These decisions most often are based on gut feel and not on solid research. Stock market research is the key to making money in the stock market. There are two types of stock market research that can be done in the stock market. Each of the types of research can lead to good amount of money if proper investing discipline is followed.

The two types of research that can be done is

• the fundamental research and 
• the technical analysis research. 

 Both of these styles are very different and require different kind of discipline and methodology while buying the stocks.
In fundamental research you research a stock which has a long term potential and then keep on accumulating this stock for future gains.

• The time horizon for this type of investment strategy can be really long like say two years to four five years. 
• This type of style requires the art of stock picking to be perfected in terms of their fundamental strengths. 
• Also the attributes of this kind of a stock trader are that they are patient and have immense amount of perseverance. 
• They know the art of stock picking and can wait for some time to pick a good stock.

In the Technical research the main emphasis is on trending and the traders thrive on the volatility of the market.

• Based on the trending they buy and sell stocks. 
• Stock quality is important but not to the extent as in fundamental research. 
• Also the main aim here is to make money on a short term basis and do not hold the stock for long. 
• They exploit the inefficiencies in the system as a tool for buying and then selling or offloading the stock once they reach a threshold profit percentage or the stock reaches a particular trend. 
• These traders can also make money in a bearish market.

So if you are investing in the market you will need to enough discipline to follow any approach. There is no middle path and the middle path will not make you enough of profits. So make sure that you follow one strategy and make money from it. Remember patience is a virtue in any business.

New stock market for beginners need to learn about trading strategies. The author recommends stock market for beginners strategies for getting to know how to select a good stock.

The Best Strategy For Trading On Stock Market

The Best Strategy For Trading On Stock Market
By: Wall Street Window
Tuesday, February 02, 2010 11:59 AM


I've been a successful stock trader for over a decade now and thanks to the Internet my reputation has spread. I have a free email investment letter with over 50,000 subscribers in it and get questions from them all of the time.

Probably the most common question I get is what is the best strategy for trading on the stock market?

Well any strategy has got to incorporate some risk management principles and a real plan when it comes to making trading decisions.

Most people don't do this though.

They just turn on the TV and buy when some hot news comes out or read a story in a magazine and get in what looks like a hot stock.

But when you make money like this it is just look and odds are you are going to end up losing money. Even if your stock goes up you won't know what to do with it.

So first of all you need a good strategy when it comes to picking out stocks and making trades. Personally I've looked over decades of market data to figure out what chart patterns appear the most consistently before a stock goes up and then looked at the fundamentals that these stocks seem to have the most in common.

I call this combination the Two Fold Formula. I look for stocks that have both

• a low valuation and 
• high earnings growth. 

Most growth investors ignore valuation and just look for price, but I've found that when you usually find your best winners when you look at both.

One of my favorite indicators to do this is the PEG ratio. Unlike the P/E ratio, which just looks at one years worth of earnings the PEG ratio takes the price of a stock and compares it to its projected earning growth for the next five years.

So by using the PEG ratio you can make buy decisions based upon the price you are paying for earnings growth.

This can give you a great list of the 50 hottest stocks to keep an eye on.

After that l look for a specific chart pattern and technical condition that I've also found to be common to the biggest winners.

To me this is the best strategy for making money in the stock market and I spell it all out for you free in my Two Fold Formula guide. You can get it when you join my free email list.

I believe in providing maximum value for people on my list. This is not a list of pitches and hype, but real information that will make you money in the stock market.

 http://www.istockanalyst.com/article/viewarticle/articleid/3829746

Modern trading making earnings multiples obsolete

Modern trading making earnings multiples obsolete
by Grace Chen on May 19, 2008

Price to earnings multiples were once the basis of investment decisions. The analysis was simple: the return divided by the stock price should properly valuate a certain company. But with many companies all over the map in both PE and PEG ratios, investors are looking for other guidelines for evaluating an investment. Technical trading has all but taken over the short term trader, and it looks ready to conquer the long term as well.

Old value investors

Warren Buffett dominates the field of value investing. Rather than following the world’s hottest stocks, he looks for companies that are considerably undervalued, both by assets and what he believes the company is really worth. While he’s made a large fortune from his studies on value investing, the markets are seemingly turning out of his favor. Valuing a company is no longer as easy as looking for cheap assets, as many companies have little assets to back their valuations. Others trade at huge multiples of their earnings, while their competitors enjoy smaller ratios, and even others are destined to stay cheap forever due only to the nature of the business.

Case in point

It seems that many companies are selling for high premiums, even with little to back up their valuations. Take for example the internet stocks. Google sells for a PE ratio of 41 but a PEG of 1.02. While Google does sell for an extreme premium over its earnings, adjusted for growth Google is still in the buy range. Compare these statistics to the lesser rival Yahoo, which trades for a PE of 33 and a PEG of 2.8. Even prior to the failed Microsoft bid, Yahoo traded at a similar PE and PEG ratio; for the most part, it’s horribly overvalued.

Traditionally, you would think that the two valuations would come to meet each other in the middle. Google’s price would ultimately rise while Yahoo would shed a few points to come back to earth. Though this is what the rational person would think, it seems like Yahoo will forever enjoy being overpriced and Google will always be under priced. In fact, Google has never traded for a PEG ratio higher than 2. Yahoo has traded for both extremely high PE ratios and PEGs, though its data is somewhat skewed by the y2k internet bubble fiasco.


Has technical analysis beat out fundamentals?

It appears as though technical traders have finally won over the market. By looking at today’s measurements, Yahoo’s stock is kept afloat largely by technical support and resistance, while Google is much the same. The difference in trading techniques even from just 2004 to today would suggest that stocks are now traded more independently than ever. Rarely are stocks compared to reasonable value to their competitors by investors. The new age of trading is systematically making investors “one stock” types, those only willing to trade the ups and downs and day to day of a specific stock, rather than comparing it to its competition.

Investing at its roots has been crippled. The sustainability or profitability of future results are rarely calculated in many investors algorithms. Technical analysis has instead brought trading to a whole new level, where stocks are nearly as good as any other commodity. The earnings of a company no longer matter, nor do its assets, nor its valuation. The digits in the stock price are the few things that matter to most modern day traders; forget the business behind the ticker.


http://www.investortrip.com/modern-trading-making-earnings-multiples-obsolete/


Comment:  Ohhhh!!!!!

The Professionals' Trade Secrets or What Methods do They Use?

In order to make a profit in the stock market, an investor must have some ideas regarding how the prices of stocks behave.  If he knows the behaviour patterns of stock prices, he may be able to forecast correctly what the price of a stock will be in the future. 

If his forecasted price is higher than the present market price of a particular stock, he ought to buy and reap the profit when the price rises to his forecasted level.  The reverse also applies in that if he thinks the price of a stock he is holding will decline in the future, he ought to sell it now and buy it back later on when the price will be lower. 

Stock market investment has become a very sophisticated, very scientific pursuit in the West and several schools of thought, that is, ways of thinking regarding how the stock prices behave, have been developed.  Each school is different from the other and may even be totally opposite; each attracting different supporters. 

There are what may be termed THREE 'legitimate ' schools of thought and AN 'unofficial' one. 

The unofficial school of thought is generally called

• 'The Greater Fool Theory' or'Buy from a Sucker and Sell to a Sucker' 

while the three legitimate schools are as follows:

• (1)  Random Walk / Efficient Market Theory (Hypothesis)
• (2)  Technical/Chartist School; and
• (3)  Fundamentalist School.

The stock market behaviour knows no boundary in place and time.  These various stock market theories developed in the West can be applied here too and a serious investor has to be familiar with these theories. 

Which of these four schools of thought is/are applicable to the local Malaysian market?  I am of the bias opinion that the fundamentalist school of thought is the one most applicable here.  It is most likely that many do not agree.

No expert agrees exactly with another regarding stock values. 

"There is no such thing as a final answer to stock values.  A dozen experts will arrive at twelve different conclusions" - Gerald Loeb


Ref:  Stock Market Investment in Malaysia and Singapore by Neoh Soon Kean

The Fundamental vs. the Technical in Stock Buy and Sell Decisions

The Fundamental vs. the Technical in Stock Buy and Sell Decisions
Author: Dr. Winton Felt

Positive technical signals tend to precede good financial reports from a company. That is, the technical patterns precede and anticipate the fundamental reports. Stock price patterns reflect the buying and selling of all the people who have intimate knowledge about the company. The rest of the investment world creates the noise in stock behavior that accompanies the pattern created by those with knowledge. That is why sell strategies based on fundamentals are too slow in a volatile market.

Before the crash in 2000, many investment managers had relied on "fundamentals" to tell them when to sell. However, as the market crash approached it was often the case that by the time the company announced that earnings were going to be "soft," the stock had already declined. Sell strategies based on fundamentals (earnings, cash flow, order backlog, etc.) turned out to be much too "sluggish" in relation to market action and in comparison with sell signals based on technical analysis (volume & price patterns of the stock). The problem was compounded by the fact that analysts were often far from accurate in their forecasts regarding the financial prospects of companies. Some of the shortcomings of fundamental analysis are addressed by technical analysis.

Technical analysis offers its proponents the opportunity of responding in "real-time" to a stock's behavior. Technicians do not have to wait for the next quarterly report from the company. In other words, technicians can quickly respond to what is (current stock behavior) rather than wait to see if what ought to be (projections by fundamental analysts) actually happens (if the company actually generates the earnings expected by analysts). Each company has links with suppliers, competitors, officers, and employees. These in turn have families and friends. Many of these people are investors. There are also outside investors, thinkers, reporters, and others who are watchers of these people and their companies. The total knowledge of all these people is reflected in stock behavior. The cumulative effect of all the buying and selling activity of these people, and of those who watch these people, defines the regions of supply and demand (resistance and support) evident in the market activity of the stock and consequently in the patterns evident in the stock's behavior.

That is why stock behavior often precedes a company's announcement about earnings performance over the last quarter. The suppliers of a company know if that company has been increasing or decreasing orders for the supplies, equipment, or support needed to produce products or deliver services (people associated with these suppliers and their friends buy and sell stock). The competitors of a company know who is exerting the strongest pull on customers (people associated with these competitors and their friends buy and sell stock). Family members of employees and all their friends also have a general "feel" for how well a company is doing even without the use of "insider information" (these people and their friends also buy and sell stock). The sum total of all this "knowledge" is reflected in stock behavior much faster than analysts can get their next quarterly report written and published. Statistically, their combined actions reduce "noise" ("noise" is created by the actions of the uninformed) and increase order or "pattern" in stock behavior.

After the last market crash, portfolio managers and strategists proclaimed that the old "buy and hold" philosophy of investing is no longer viable. They said, "the market is simply too volatile for that kind of approach. Even well-established companies can go bankrupt. The slightest bad news can cause a stock to plummet." Lately, some managers are once again investing with the prior intent of holding all positions for several years (though some do say they will sell if the fundamentals change). It is as if they have learned nothing from their recent experience. Such an attitude tends to lock an investor or advisor into a pattern of thinking that all losses are only temporary, and everything will be fine five years from now anyway.

The problem with this mentality is that it reduces vigilance. Why bother to watch a portfolio closely or even to think about strategy issues if everything will work out in the long run? What are these advisors being paid to do? We know from past experience that everything may not turn out okay in five years. We can recite a very long list of stocks that have dropped over 60% from what they were five years ago and they still have not come close to recovering (I actually named a number of these companies in another article). Many of these stocks no longer exist or are now virtually worthless.

The point is that all these stocks looked good to many of the analysts who studied the fundamentals of these businesses. There were, after all, some honest analysts who joined the dishonest ones in repeatedly recommending their purchase and who gave glowing reports about their prospects. These stocks were touted as great investments at prices that later proved to be much too high (they did not seem particularly high at the time because they had been much higher before that). Nevertheless, some of the analysts who studied these companies really believed that they were very good picks. They kept recommending these stocks even though they kept falling. Why? They did so because they concluded that these stocks ought to go higher. Technicians who study price, volume, and various other stock behavior patterns, on the other hand, sold when their stop-losses were triggered or when technical sell signals were registered. They did not argue with themselves that these stocks ought to go higher. They acted on what was, not on what ought to be. They were the smart ones.

Yes, some day these stocks may recover. However, an investor who ejected himself from these situations could have been accumulating profits during the following years rather than watching his stocks decline or hoping for a recovery some day. Those who merely hang on through "thick and thin" are the real gamblers. Contrary to their own opinions of themselves, they are not really investors but speculators guided by hopes and dreams. They have no real sell disciplines. They merely buy "good companies" and blindly hold on with no plans for selling except "someday, at a profit." It is far better to get rid of losers and to keep the winners. If you do not "weed your garden," you will end up with nothing but "weeds." If you keep pulling the weeds, your garden will have only flowers. The same is true of your portfolio. It is the percentage of time that most of a portfolio is invested in rising stocks that determines how good performance will be. Eject the losers and the winners will lift the portfolio.

We prefer to invest in companies whose long-term financial prospects are good because, in the long run, it is earnings that drive stock prices. In other words, a stock that is in an up-trend because the company is doing well financially (good fundamentals) will tend to hold that up-trend better than a stock that is rising only because of unjustified momentum. However, as the basis for a primary selling discipline, fundamentals leave much to be desired. They tend to evolve at a rate that is inherently too sluggish for them to serve in that capacity, especially in volatile markets. Poor fundamentals still give us a good reason to sell. However, a stock will usually give a technical sell signal long before the company reports the poor fundamentals. Stockdisciplines.com traders prefer to respond to whatever signal they get first. You can benefit from their experience by using the same approach. They found that the first sell signal is almost always technical rather than fundamental in nature. If you make it a practice to sell only when the fundamentals are deteriorating, then you must reconcile yourself to much larger losses.

The same things may be said regarding the buy side of investing. We usually see technical buy signals before the company makes a positive earnings report. In other words, all those "watchers" of the company mentioned above know the company is doing well so they have been buying its stock and have therefore caused the technical buy signal to be generated. The profile of a stock's accumulation pattern can reveal much about whether there is something substantive behind the new buying activity. When the fundamentals are released, those who bought the stock because of the technical buy signal will benefit from the new surge of buying that follows the release of positive fundamentals.

Even so, we have a very high regard for fundamentals. If we get a technical buy signal, we like to check the stock's fundamental profile in Value Line, Morningstar, or in The Valuator before we make a purchase. If the technical signal is good but not outstanding, then outstanding fundamentals can make a big difference in how we see a stock (fundamentals tend to have momentum). However, if a stock has a lousy technical profile, we are not going to be interested regardless of how attractive a stock is fundamentally (it doesn’t pass the "smell" test). There are also times when a stock's technical pattern is so compelling that we can feel justified in basing our buy decision on technical measurements, patterns, or signals alone. Good financial reports often follow in the wake of positive technical signals.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

About the Author:

Dr. Winton Felt has market reviews, stock alerts, and free tutorials at http://www.stockdisciplines.com Information and videos about stock alerts and pre-surge "setups" are at http://www.stockdisciplines.com/stock-alerts Information and videos about traditional as well as volatility based stop losses are at http://www.stockdisciplines.com/stop-losses

Article Source: ArticlesBase.com - The Fundamental vs. the Technical in Stock Buy and Sell Decisions

http://www.articlesbase.com/investing-articles/the-fundamental-vs-the-technical-in-stock-buy-and-sell-decisions-899280.html

As an investor can I rely on technical analysis?

Wednesday July 1, 2009

As an investor can I rely on technical analysis?
Personal Investment - A column by Ooi Kok Hwa

Investors need proper training as this area requires a lot of subjective judgement and experiences

ALL the famous investment gurus in the world, like Benjamin Graham and Warren Buffett, say that we should not try to time the stock market because we will not be able to predict its movement.

However, professional technical analysts believe that investors are able to time the market by looking into the historical price trends and trading volumes. They believe that the weakness in fundamental analysis is it is unable to provide the timing to buy or sell stocks.

Fundamental analysts are able to detect good quality stocks for long-term investments. However, they do not know when to accumulate or to dispose the stocks.

Technical analysts believe that a lot of good fundamental factors for certain stocks may have already been reflected in the stock prices. As a result, any investor who would like to purchase the stocks may not be able to make gains as the stock prices have already included the good fundamental factors.

Nevertheless, if investors know technical analysis, they may be able to discover the stocks much earlier than the others. A lot of time, these fundamental factors may not be made known to the public.

However, some investors, who are aware of these fundamental factors, may start accumulating the stocks. Technical analysts believe that these early actions can be detected by looking into charts.

Technical analysis is based on the interaction between the supply and demand for the stocks, which can be caused by the rational and irrational factors.

Technical analysts believe that prices move in trend and can persist for a long time until something happens to the stocks.

Even though technical analysts do not know all the factors that influence the buying or selling of all stocks, they believe that investors are able to know the actual shifts in the supply and demand of stocks by looking into their market price behaviour.

One of the advantages of technical analysis is that it is simple to use. Compared with the fundamental analysis, investors do not need to read financial statements before using technical analysis. Nevertheless, investors are still required to have adequate knowledge on how to interpret various types of charts.

Given that there are many types of charts, investors may get confused as some charts may indicate buying signals while others may indicate selling signals.

Sometimes, when there are too many investors using different types of charts, the effects may be neutralised between each other.

For market efficiency believers, they postulate that it is not possible make any gains by merely looking into stock prices and volumes because they believe that the stock market may have reflected all these factors. They label this phenomenon as weak-form of market efficiency.

In most academic researches on testing weak-form stock market efficiency (testing the market based on stock prices and volumes), they discovered that investors cannot consistently outperform the market.

Fundamental analysts believe that by merely looking into technical charts alone may sometimes cause investors buying into poor fundamental stocks.

However, technical analysts argue that these negative factors can also be detected using charts because poor fundamental stocks will normally face heavy selling by investors.

The technical charts will indicate when the stocks start facing selling pressures and investors need to sell the stocks once the charts indicate the selling signals.

Some investors believe that there may be self-fulfilling prophecy on technical analysis.

When many people are using the same technical chart on one company and the chart shows a buy on the stock, many investors will follow to buy the stocks. These may cause the stock prices to go up and reinforce the idea that the technical rules work.

We believe that investors need to know both fundamentals as well as technical analysis as these two methods can complement each other. Both methods have their strengths and weaknesses.

Sometimes we may want to use fundamentals to identify the stocks for purchase, then, use technical analysis to gauge when to buy the stocks; or we can use technical analysis to select stocks and use fundamentals to confirm the quality of the companies.

In conclusion, as technical analysis requires a lot of subjective judgement and experiences, we believe that investors need to have a proper training in this area. Interested investors are encouraged to read books related to this area to have better understanding.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

http://biz.thestar.com.my/news/story.asp?file=/2009/7/1/business/4228156&sec=business

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

Technical Forces That Move Stock Prices

Technical Factors

Things would be easier if only fundamental factors set stock prices! Technical factors are the mix of external conditions that alter the supply of and demand for a company's stock. Some of these indirectly affect fundamentals. (For example, economic growth indirectly contributes to earnings growth.)

Technical factors include the following:

Inflation - We mentioned inflation as an input into the valuation multiple, but inflation is a huge driver from a technical perspective as well. Historically, low inflation has had a strong inverse correlation with valuations (low inflation drives high multiples and high inflation drives low multiples). Deflation, on the other hand, is generally bad for stocks because it signifies a loss in pricing power for companies. (To learn more, read All About Inflation.)

Economic Strength of Market and Peers - Company stocks tend to track with the market and with their sector or industry peers. Some prominent investment firms argue that the combination of overall market and sector movements - as opposed to a company's individual performance - determines a majority of a stock's movement. (There has been research cited that suggests the economic/market factors account for 90%!) For example, a suddenly negative outlook for one retail stock often hurts other retail stocks as "guilt by association" drags down demand for the whole sector.

Substitutes - Companies compete for investment dollars with other asset classes on a global stage. These include corporate bonds, government bonds, commodities, real estate and foreign equities. The relation between demand for U.S. equities and their substitutes is hard to figure, but it plays an important role.

Incidental Transactions - Incidental transactions are purchases or sales of a stock that are motivated by something other than belief in the intrinsic value of the stock. These transactions include executive insider transactions, which are often prescheduled or driven by portfolio objectives. Another example is an institution buying or shorting a stock to hedge some other investment. Although these transactions may not represent official "votes cast" for or against the stock, they do impact supply and demand and therefore can move the price.

Demographics - Some important research has been done about the demographics of investors. Much of it concerns these two dynamics: 1) middle-aged investors, who are peak earners that tend to invest in the stock market, and 2) older investors who tend to pull out of the market in order to meet the demands of retirement. The hypothesis is that the greater the proportion of middle-aged investors among the investing population, the greater the demand for equities and the higher the valuation multiples. (For more on this, see Demographic Trends And The Implications For Investment.)

Trends - Often a stock simply moves according to a short-term trend. On the one hand, a stock that is moving up can gather momentum, as "success breeds success" and popularity buoys the stock higher. On the other hand, a stock sometimes behaves the opposite way in a trend and does what is called reverting to the mean. Unfortunately, because trends cut both ways and are more obvious in hindsight, knowing that stocks are "trendy" does not help us predict the future. (Note: trends could also be classified under market sentiment.) (For more insight, check out Short-, Intermediate- and Long-Term Trends.)

Liquidity - Liquidity is an important and sometimes under-appreciated factor. It refers to how much investor interest and attention a specific stock has. Wal-Mart's stock is highly liquid and therefore highly responsive to material news; the average small-cap company is less so. Trading volume is not only a proxy for liquidity, but it is also a function of corporate communications (that is, the degree to which the company is getting attention from the investor community). Large-cap stocks have high liquidity: they are well followed and heavily transacted. Many small-cap stocks suffer from an almost permanent "liquidity discount" because they simply are not on investors' radar screens. (To learn more, read Diving In To Financial Liquidity.)


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Greater Fool Theory

Greater Fool Theory

One of the assumptions of the discounted cash flow theory is that people are rational, that nobody would buy a business for more than its future discounted cash flows. Since a stock represents ownership in a company, this assumption applies to the stock market. But why, then, do stocks exhibit such volatile movements? It doesn't make sense for a stock's price to fluctuate so much when the intrinsic value isn't changing by the minute.

The fact is that many people do not view stocks as a representation of discounted cash flows, but as trading vehicles. Who cares what the cash flows are if you can sell the stock to somebody else for more than what you paid for it? Cynics of this approach have labeled it the greater fool theory, since the profit on a trade is not determined by a company's value, but about speculating whether you can sell to some other investor (the fool). On the other hand, a trader would say that investors relying solely on fundamentals are leaving themselves at the mercy of the market instead of observing its trends and tendencies.

This debate demonstrates the general difference between a technical and fundamental investor. A follower of technical analysis is guided not by value, but by the trends in the market often represented in charts. So, which is better: fundamental or technical? The answer is neither. Every strategy has its own merits.

In general, fundamental is thought of as a long-term strategy, while technical is used more for short-term strategies.