“A Picture Is Worth Ten Thousand Words”             An Old Chinese Proverb

Technical analysis (TA) and fundamental analysis (FA) are the two main methods used by market participants when buying or selling shares. Technical analysis studies the behaviour of the price-volume movement of shares and uses it to predict its future price movements. It often uses complex charts and trend lines. Fundamental analysis revolves around analysing the performance and heath of a business and its future prospect by carefully dissecting its annual report, financial statements and broad economic factors.

Fundamental analysis used to be the only investment method since decades ago but that has changed as the advent of high-speed computing has made TA easier and more widely available. Many large investment firms are making their trading decisions based on computer algorithms. There have been a boom for companies that manufacture and distribute stock charts and charting software which can produce any conceivable chart one might want to see, for security firms and individuals. Remisiers are attracting more customers with their charting tools and TA and have been making recommendations of stock trading base on that.

In this article, I will focus on what I have read about the use of TA in stock selection by individuals and market practitioners. But be caveat emptor, I am not an expert of TA, rather, I know little about TA.

Technical Analysis

Technical analysis or charting bases solely on the recent movements of the stock price and volume on the chart to make a buying or selling decision. It suggests to buy if the stock has gone up recently and sell if the price has started to come down. It makes a market timing trading decision basing on the momentum of the stock price and profit form this price movement.  

The rationale of the strategy hinges on the human psychology of crowd behavior, that the past behavior of the market players will be repeated in the future. There are various technical systems, trading rules and technical terms used such as the filter system and “stop loss” orders, Moving Average, the Elliot Wave Theory, Relative Strength, Head and Shoulders, flags and pennants, tea-cups, Oscillators, Double or Triple Top Reversal, Channels, Wedges, Diamonds, Doji, Shooting Star, Support and Resistance and numerous other bombastic and hard-to-understand terms.

Chartists are oblivious about earnings, dividends, cash flows, and no worry about the health of the companies the stocks are behind, and the overall economy in general. There are certainly many people who have made a lot of money using TA. You do hear them bragging about it in some public forums too, however, many more have lost their fortunes and are left biting the dust.

Critics of technical analysis would say that history of stock price cannot tell you how it will behave in the future. In other words, they claim that the stock price movement is a random walk, that stock price behaves like a drunken soldier, walking aimlessly and unpredictably. In science, it is Brownian motion, the random movement of particles suspended in a fluid resulting from the collisions of molecules.

Malkiel Burton, a finance professor, in his popular book “A Random Walk Down Wall Street” which is a must to read for all investment students and professionals alike, describe TA as “Strategy of building castles in the air”. According to him, a weak form of random walk theory goes like this:

“The history of stock price movements contains no useful information that will enable an investor consistently to out-perform a buy-and-hold strategy in managing a portfolio.”

According to Malkiel’s research, all of these charting techniques of searching for correlations of past price movements are spurious at best, that charting and stock price movement have no direct causal connection, yet it may be wrongly inferred that they do, due to either coincidence or the presence of a certain third, unseen factor.

In this advance technology age, it is actually very easy to simulate all those trading rules from the past and back test them if following those rules will result in consistent profitable trades. However, it appears that no academic research, nor any rigorous back testing with the huge machine power have shown that there is statistical and economic (when transaction costs are included) significance that any of those rules yield positive results. The stock market has little memory, if any.

Malkiel presented his intuitive arguments that why TA might not work. Firstly, it should be noted that the chartist buys in only after price trends have been established and sell only after they have been broken. Because the sharp reversals in the market can occur suddenly, which we often see, the chartist often misses the boat. Secondly, such techniques, even if they work initially, must ultimately be self-defeating. As more and more people use them, and some traders even tend to anticipate technical signals before they appear to make buy and sell decisions, the value of any technique depreciates. No buy or sell signal can be worthwhile if everyone tries to act on it simultaneously.

However, in the market place, it seems that most participants and especially remisiers are using TA, I believe. My remisiers friends are all using TA as far as I know and few of them knew what FA is about. My remisier, two of them are accounting and finance graduates, asked me what compounded annual growth rate (CAGR), Margin of safety (MOS), etc. are, to my surprise, which I use it so often in my FA stock analysis. Many of the largest market players, institutional investors, investment bankers, syndicates, etc. are making their trading decisions based on computer algorithms, i.e. TA. TA could be the major decision maker now.

My experience (if any) in using TA

I first used TA, or should I say the only time was during the Bull Run in 1993 and 1994 when a friend taught me how to interpret those funny charts. That time we used hand drawn charts, imagine how much time was wasted doing so while I was having a career in engineering. I remember a few of the stocks even after more than 20 years, Sriwani-w, Midf-w, etc. which I have lost considerable amount of money. I have never made any money basing on charts. I select my stocks with FA but was never successful following the trading rules such as cut-loss at 5%, and then buy back when it has gone up by 5%. Often once I cut loss, the stock went up immediately, and when I bought back, it went down 5% a short time later and I have to cut loss again. Often, I never bought back a good stock which I have sold and the shares price eventually went up by huge amount and I missed the boat. I might be bad in TA, which I have to admit, but my friends who thought he was very good, after making a lot of money before that, also lost his underwear eventually.

Losing money is one thing, the stress and time consumed in the trading activities is another. Trading using TA and looking at charts to decide on making trades all the time affect one’s life and his career.

With that little experience and realizing that most remisiers, fund managers and investment bankers also using that with their huge resources and computer power, not forgetting the rich, syndicates and insiders are everywhere in Bursa who can “paint the tapes” and I know some are doing so, I stay away from there, and play my game in my playing field according to my rules.

“Market timing may be an entertaining pastime, but not a good way to make money.” Javier Estrada

This is what John (Jack) Bogle, the founder and retired CEO of The Vanguard Group with the largest exchange traded funds in the US market said regarding the use of TA in market timing:

“In 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed, my impression is that trying to do the market timing is likely, not only not to add value to your investment programme, but to be counterproductive.”

Fundamental analysis (FA)

As a fundamental investor, I treat investing as participating in part of a business with its people, plant and equipment and products and services to sell and make money.  With that mindset, investors ask some pertinent questions when investing in a stock of a particular company;

• What business the company is doing?
• How does it make money?
• Is there any prospect of this business in the future?
• Who are the people managing this business? Are they capable and credible people?
• How has been the financial performance of the business?
• Does it bring in cash over the years?
• Is the financial health of the company alright and unlikely to go bankrupt?
• Does it pay dividend to its shareholders?
• Does it have a plan in the future for its business?
• Is it selling at a reasonable, or better, a cheap price?

I have found that is a more logical and plausible way of investing, and that is FA. I am very strong in my opinion about this. Everyone has his own opinion and should be respected too.

However, fundamental analysis has its flaws too. There are many reasons why fundamental analysis can be completely off base: random and unpredictable events, dubious financial data from companies (like those red chips companies), ignorance of risks, human failings (emotional attachments such as over-confidence, and incompetence), etc.

But who says investing to build long-term wealth is easy? Is it so easy to become very rich just by following a certain “Golden Rule”, buy and leverage up if a rule is met, and sell otherwise?

“Anyone who thinks investing is easy is stupid” Charles Munger

You must be crazy to think so. Otherwise everyone who read and follow the rule will be filthy rich now. Where got poor people around anymore?

I will explain to you what FA is and why it works for long-term and with plenty of empirical evidences.

K C Chong

ckc14invest@gmail.com