Do charts work for you?
I am keen to explore this topic with you. You may need a little patience. Its about charting and technical analysis, so read on.
I am reading a book that was recently gifted to me by a very well-known and highly-regarded private equity investor. If you know him, chances are he has given you a copy of it too. To say he became animated when he gave it to me is to understate just how profound he believes the contents of this book is.
I haven’t been able to put it down (partly because its worthy of careful study, but mostly because when I do, its bright yellow cover has become a magnet for a child’s curious but sauce-soaked hands and every other manner of foreign contaminant). The book is called The (mis)behaviour of markets and its by Benoit Mandelbroit.
To some this name will be familiar, but to many, if not most, his name will be new. He is the Sterling Professor Emeritus of Mathematical Sciences at Yale University and a Fellow Emeritus at IBM’s Thomson J. Watson Laboratory. He has received the Wolf Prize in Physics, the Japan Prize in Science and Technology, awards from the National Academy of Sciences in the US and the IEEE (look it up). But he is best known for being the inventor of fractal geometry and is arguably the 20th century’s most celebrated mathematician.
Don’t be afraid. The book is the Popular Science or Popular Mechanic version of his work. Its easy to read, if you have an interest.
Having a passion for and grasp of valuation theory, and of course no shortage of views of my own, I was keenly interested in Medelbroit’s dissection of the history of modern finance and its foundations having been set in the work of Pascal & Fermet’s work for aristocratic gamblers in the 1600s; then (Henri Poincare’s doctoral student) Bachelier’s application of probability theory to the frowned-upon business of trading in French Bonds in 1900 and his research Theorie de la Speculation. Then on through Benoit Medelbrot’s own PHD student Eugene Fama’s translation and expansion of the theoretical framework in what would become known as the Efficient Market Theory. Bechalier’s work has also been the basis of work by Markowitz (Modern Portfolio Theory) and Sharpe (CAPM).
I am interested in this dissection because Bechalier’s main assumptions that 1) price changes are independent (thinking tossing a coin) and 2) are normally distrubuted (the convenient but incorrect observation that there are lots of small positive and negative changes in price and very few big positive or negative changes in price) dominates Wall Street (read global stock markets) and are the basis of measuring the riskiness of stocks and of modern techniques for portfolio construction. These things are still taught at graduate school, and as a friend who is sitting them tells me, the CFA exam is replete with the stuff.
But that is my interest.
I suspect your interest may be found very early in the book on pages 8 and 9. Here is an excerpt from Mandelbrot’s own pen:
“…”Because” is the key word here: The price of a stock, bond, derivative or currency moves “because” of some event or fact that more often than not comes from outside the market. World wheat prices rise because a heat wave desiccates Kansas or Ukraine. The dollar sinks because talk of war raises oil prices. This is all common sense. Financial newspapers thrive on it; they sell newspapers and rank all the “becauses.” Financial firms make an industry of it; they employ thousands of fundamental analysts, classified by genus into macroeconomic and sectoral, “top-down” and “bottom up.” … The implicit assumption in all this: If one knows the cause, one can forecast the event and manage the risk.
Would it were so simple. In the real wold, causes are usually obscure…unknown or unknowable…it can be concealed or misrepresented…And it can be misunderstood. The precise market mechanism that links news to price, cause to effect, is mysterious and seems inconsistent. Threat of war: Dollar falls. Threat of war: Dollar rises. Which of the two will actually happen? After the fact, it seems obvious; in hindsight fundamental analysis can be reconstituted and is always brilliant. But before the fact, both outcomes may seem equally likely…
In response, the financial industry has developed other tools. The second-oldest form of analysis, after fundamental, is “technical.” This is a craft of recognising patterns, real or spurious – of studying reams of price, volume and indicator charts in search of clues to buy or sell. The language of the “chartist” is rich: head and shoulders, flags and pennants, triangles (symmetrical, ascending, or descending). The discipline, in disfavour during the 1980s, expanded in the 1990s as thousands of neophytes took to the Internet to trade stocks and insights. It truly thrives, however, in currency markets… And in the fun-house mirror logic of markets, the chartists can at times be correct. Sterling/dollar quotes really can approach a level advertised by the technical analyst, and then pull back as if hitting a wall – or accelerate as if bursting through a barrier. But this is a confidence trick: Everybody knows that everybody else knows about the support points, so they place their bets accordingly. It beggars belief that vast sums can change hands on the basis of such financial astrology…”
So what is your opinion or experience? Has charting worked for you or do you agree with Mandelbroit? As you know, I don’t personally use charts and while it might be challenging to argue with the Sterling Professor Emeritus of Mathematical Sciences at Yale University, I am interested in hearing from you if you have found charting singularly responsible for substantial profits. It will also be valuable to hear any stories from those whose experiences have agreed with Mandelbroit’s conclusions.Feel free to be as detailed as you like, but if you have read books or attended courses I would prefer you refrain from naming the authors or presenters.
So what are your thoughts? If you have never written before, this could be the topic that has you posting a reply to a blog for the first time. Click Leave a Comment below and start sharing your thoughts.
Posted by Roger Montgomery, 1 July 2010
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Bruce
:
Short Term technical analysis is useless. Long term technical analysis is brilliant. Have never met or seen anyone teach long term technical analysis. I have taught myself using 1 year/ 3/4 year charts. I am in the stock/index anywhere from 6 months to 2-3 years. I have being paper trading from 20011- 2014, and real trading from 2014 to now(2016). MY success rate is very good.
Bruce
Michael Hackett
:
Hi Roger,
I view TA as looking for price action resistance points and trying to predict market direction around them. I will use something like a Fib if I am in doubt about an exit or entry point but they don’t give me reason to have an opinion about direction.
It is like my commute to work every day. Some lanes are slower than others in different areas like traffic lights or places where trucks typically enter. So by chosing lanes that flow better I shave a few minutes of my travel time. However, some times for no apparent reason this will change. These changes are the real bread and butter of TA, if you can pick them up.
The problem TA has is that if everyone uses the same chart rules then they will break down. Imagine if every single person who wanted to buy stock on the ASX used Value-able. It would cause havoc and the book would be all but useless except as a contra indicator.
IMHO of course
Roger Montgomery
:
I’m speaking at the Bulls and Bears meeting in Harbord on Sydney’s northern beaches next month.
The details are at http://www.facebook.com/event.php?eid=139109826118940&index=1
Keith
:
David Land of CMC markets succintly summarises my investing strategy in a few short paragraphs.
”They may use fundamental methods to compile a short list of companies that sit within a defined grouping based on earnings or some other indicator,” Land says.
”And then they will use chart-based methods as a means of trying to set a time for buying the shares.
One of the main things that technical traders are looking to do is, essentially, to work out potentially good times to enter and exit the market.”
Roger Montgomery
:
Hi Keith,
I know David from his days at the ASX. I think your summary serves as a good close to this thread. There are a few more posts but I will not be posting any more comments or responses on this thread after this sitting. Thanks again Keith.
Robert
:
Hi Lloyd
I offer this Mos tech analysis:
It is in a long timeframe downsloping triangle which shows it will probably reverse near 15.5c and go back to 8c or lower.
It has jumped up on these volume spikes on 3 separate occasions in 2003, 2004, 2005 and failed quickly each time.
If it breaks above 15.5c I still would not buy it.
Previously on 2 occasions in 1992 and 1995 it emerged out of bouncing around inside downsloping triangles to enter very tranquil ranges. Then about 6-12mths later it formed cup & handles which were very tradeable. For cup&handles – google it or read William ONeil’s ‘How to make money in stocks’ – a classic.
In fact I wouldnt touch this – it is too volatile unless it had a great new story you trusted. It just has never ever held its gains.
Roger Montgomery
:
Hi Robert,
Thank you for that analysis. I suppose its worth pointing out that the directors have now recommended the scheme of arrangement at 15 cents proposed by AGL. I should disclose MOS was traded in-house as a post-announcement arbitrage. I will post a short column on Post Announcement Arbitrage in coming weeks.
Robert
:
Hi Roger
Name of CTA as requested – perhaps he isnt a CTA but an introducing broker.
Shane Wisdom
I am looking forward one day to doing the testing and trading myself.
Roger Montgomery
:
Hi Robert,
Thank you for answering that query. To maintain independence can’t promote the backtesting software, so removed the website links.
John
:
G’day Roger,
When I was starting out as an equities analyst in 1987, I lived next door to an elderly Hungarian chartist (who in the 1960’s had 16 chartists working for him in London hand-drawing charts).
Anyway, he taught me how to draw log charts, what patterns to look for etc and gave me a copy of the chartists bible, Dow Theory by Edwards and McGee.
We looked for stock prices that had collapsed and then flatlined or consolidated for months / years before returning to life on strong volume. In 1988, after the ’87 Crash there were plenty of bombed out risky shares that often presented short term trading opportunities – e.g. Ariadne, Bond Media…..not the sort of companies my fundamental analysis would have caused me to buy.
I’ll give an example of a stock that I more than tripled my investment before even having to pay for the stock –
In 1988? Goldquest was languishing at 2 or 3 cents and had been for a long time till it suddenly showed signs of life on massive volume, rising to 4 cents. I bought at 4.5 cents(the figures might be a little out as it was so long ago) and within 2 days they were 10 cents – I rang a broker and placed a sell order and the broker instantly sold them at 12.5 cents and sent me a cheque for the profit as I had not yet settled the purchase. The broker asked what made me buy them and I said the chart pattern. When the broker said that they were sold, a little voice inside said,” that is too quick buy them back”, but quickly the shares continued to rally to 16 cents and continued rallying upwards for a few days before the shares collapsed.
Months later when reading the accounts of an insurance fund, I discovered that they had a large position in Goldquest company-issued call options that were well out of the money close to expiry. The large trade that I saw on my chart that caused me to buy the shares, also had a magnified effect on the option price, and they then exited the options before they subsequently expired worthless.
So, yes, charting does occassionally present useful indications of price movement.
Roger Montgomery
:
Fascinating John. Thank you for sharing it. I wonder whether you had many repeats of that experience? Did it continue to work for you?
Kelvin
:
I agree with Roger’s assessment of Charlie Munger’s investment prowess.
I’m reading “Poor Charlie’s Almanack”, a book containing Charlie Munger’s various speeches and also details about the way he thinks about investment (and a whole range of other topics as well actually). Not too heavy. A fun and light read. Highly recommended.
Kelvin
Roger Montgomery
:
I have a copy of the Almanack that was a gift from Alan Kohler and it has pride of place in my library. I second the recommendation.
Andrew
:
Hi Roger,
Gee fantastic blog you have going, look forward to receiving your book in the mail soon.
Regarding the quarterly chart trend analysis here is a quarterly chart of CBA for you to post on the blog if you wish?
So this is a extremely simple ‘major trend’ analysis of CBA from 1991- to present.
The rules are as follows:
· Enter long position when current quarter crosses previous quarterly high shown as a black line underneath the quarterly bar.
· Maintain a stop loss slightly beneath the quarterly low. Stop loss moves up with every previous quarterly low
· Sell position when current quarter crosses below the previous quarterly low shown as red line.
So as you can see on the chart of CBA just using this very simple method and no technical analysis you would have entered and exited 11 trades on CBA in 19 years for 9 profitable trades some as you can see extremely profitable whilst the losses were minimal. (I will leave it up to you to calculate the approx entry prices and exit prices based on this methodJ).
Andrew
Roger Montgomery
:
Thanks Andrew. Here is the link to your chart.
http://rogermontgomery.com/wp-content/uploads/2010/07/CBA-chart.pdf
Robert
:
TA hasnt made me much money but I expect it will as my skills and ability to trade a plan improves. The largest financial benefit so far has been to save me and other relatives from losing money, particularly in July 2008 when the market by any simple TA observation of the chart was in a downtrend and with a monthly timeframe had the 2003 lows in sight. Ray Barros’ book called The Nature of Trends was very helpful to me in seeing the possibility of those falls.
More recently I have saved money from not investing in recommended value stocks (not from this site) that are in obvious downtrends (lower highs & lower lows).
One thing I need to work on is the psychology of getting on board clear uptrends when I am still scared the last downtrend is about to resume.
Concerning moving averages, I know of a CTA in the US who has a fully tested system based on triple moving averages using a basket of futures markets that has very good returns and MAR (a risk measure), low max drawdowns etc. Moving averages and breakout systems (eg – enter on a new high made in the last X days) have similar results – they are all catching trends. Tests show that trends identified by the system persist sufficiently for profits to more than cover all the losses from when they fail early.
Resources here include Michael Covel’s book Trend Following and Curtis Faith’s Way of the Turtle.
Roger Montgomery
:
Thank you Robert,
…for the thoughts and suggested readings Robert. Do you have the name of the CTA? Do they have a website?
Scott
:
Yeah agree with Roger…can we see the losing trades :)…how did your technical models manage your losses.
May I ask how you went in May? Did your technical systems help you avoid significant drawdowns?
Keith
:
WARREN BUFFETT AND MY “LUCKY” AMP LTD. TRADE
=============================================
Warren Buffett’s experience with the 1963 American Express Salad Oil scandal gave me the confidence to enter the “lucky” AMP Ltd. trade that netted me a nice 25% capital gain after 35 days or 274% p.a. return.
At the time, AMP through mismanagement had brought a hundred year old Australian institution to its knees. The AMP stock price plunged from over $20-00 when it initially floated to all time lows under $5-00.
Even though AMP was in serious trouble, the selling was overdone as its “consumer franchise” was still strong.
AMP customers would still be willing to do business with AMP the next day just like how American Express cards were still acceptable to merchants and clients alike.
With the intervention by NAB into the market with a takeover offer the value was quickly realized allowing me successfully complete the investment and move on to other potential prospects.
Echoes of that early confrontation are still being played out between AMP and NAB as we watch them in a high stakes squabble over control of AXA Asia Pacific.
For the record, I don’t have any current financial interest in AMP, AXA or NAB, but if I did, I would prefer to be an AXA shareholder rather than either AMP or NAB shareholder as investing history shows the price paid by for “victory” will be at the expense of its shareholders.
Roger Montgomery
:
Hi again Keith,
Have you been reading my work on the massive premium being offered for AXA? Keith, you are clearly a very successful investor. There are lots of readers here that would like to be so I invite you to share with humility a little more detail for their benefit.
Kelvin
:
Hi, I agree with Lloyd’s point regarding TA and MOS.
I believe the best investment process is to use fundamental analysis to come up with an investment candidate and then to use valuation as well as TA to help guide entry and exit points, to maximise probability of success as well as to reduce risk. I don’t believe that one should use TA alone for making buy decisions. One needs to do the bottom up analysis first.
(Although I believe that one could be justified in making sell decisions based on TA alone for risk management/ position sizing purposes).
For example, when I look at a resource stock, I would look at the following amongst other things:
– Grade of the resource (% content per tonne of the metal/mineral)
– Amount of reserves/ resources/ possibility of expansion of reserves/ mine life
– Where the mine sits along the cost curve compared with other mines
– Stage of the project, ie. resources or reserves or pre-feasibility or bankable feasibility
– Any need for risky new technology for mineral processing (think those nickel laterite disasters)
– Location of project/ sovereign risk
– Quality of management
– Any off-take contract/ hedging arrangements
– Capital structure and any need for further capital raisings
– NPV analysis
and so on etc etc.
Only if the project and the company are high quality would I consider buying. However, I would invariably use TA to help guide entries and exits, without which my results over the last few years would not have been nearly as good (if nothing else just to avoid collapses in prices after big run-ups –in truth I have found TA to be more responsible for me avoiding losses than making profits, which for the overall portfolio over time is just the same as money in the bank).
Kelvin
Roger Montgomery
:
Thanks Kelvin,
I just keep wondering whether the idea of buying based on price patterns is logical. Can the price today, tell you whether it will be higher or lower tomorrow. I accept that price changes are not independent of the last one. By that I mean the study of prices cannot be approached the same way as one might approach the study of coin tossing. But is there persistence? It may be that we simply haven’t reached the point of understanding price behaviour well enough to gain a truly statistically significant approach. Obviously there are those that have but because the game of money has such high stakes, the truth may never be shared as a great scientific discovery in another field may be.
if there are any final thoughts on this subject let me know in the next few days. I will stop the posts on this thread at that time, lest the quality of the posts deteriorate or it slides into something personal between otherwise civilised investors.
Tom
:
fundamentals and specifically broker recommendations kept people holding their Enron shares right to the bottom and eventual delisting and liquidation.
P+F charting took you out at ~$85, support and resistance took you out below $80 and MA crosses took you out below $70. Even if you’d bought the top, you’d at least still have 75% of your money vs having nothing.
markets are about sentiment. price action is determined by sentiment. if anything FA is the most specualtive of all. At least looking at a chart, I can see some history of sentiment.
The problem with TA is that it is not sanctioned in the academic circle, because academics believe in random-walk theory and EMH. TA is the complete opposite, about pricing based on previous pricing and trends. They can’t believe in both; it’s even more hypocritcal than a professor on +$120k teaching the benefits and greatness of Marxism/Communism (yes, i’ve met one.)
Roger Montgomery
:
Its an interesting take Tom,
It seems investors presented with the same set of fundamental facts can reach entirely different conclusions, just as chartists can. Jim Chanos, with whom an acquaintance has just secured a position saw accounting irregularities and strange footnotes, namely subsidiaries set up with external investors, but run by Enron execs and trading with Enron!!! He shorted the stock and did indeed put his firm Kynikos (greek for cynic I believe) on the map.
I remember working at BT as a trader in the early 1990’s an Richard Farley was the head of the proprietary trading desk. He made hundreds of millions of pounds profit for himself after being poached to trade privately. Richard would say that charting is a very crude form of trend recognition.
Keith
:
In the past I have made money from holding WOW for a few years.
Mon 10 Nov 2003 Buy $10.80
Fri 13 Mar 2009 Sell $24.57
$13.77 gain after 5.34 years
23.83% p.a. simple annualised average return (not compounding)
Not all trades are about making gains, preserving capital is also important. For example a recent Woolworths (WOW) trade.
Mon 22 March 2010 Buy $28.43
Mon 28 June 2010 Sold $27.47
Actual Loss of $0.96 a share.
Current price Wed 07 July 2010 $26.68
Avoid a further loss of $0.79 a share.
Roger Montgomery
:
Thanks Keith,
I am guessing Lloyd is not the only one reading your posts that would now like to see you chat about your technique.
Lloyd Taylor
:
Keith,
Thanks for the clarification.
To be honest, your buy and sell triggers appear to be more about fundamentals than TA. Similarly, I move in and out of some select stocks regularly, based on movements around my calculated IV for each stock – buy low and sell high, be it in a matter of days, weeks, months or years.
My equity portfolio approach is a core long term holding of A1’s businesses, which I don’t trade, plus a lesser exposure to select “trading” stocks that are quality companies, but not necessarily A1’s. Nevertheless, I have a clear view of their value and business outlook and play the market volatility (mispricing) that inevitably occurs. I am happy to hold these trading stocks for an indefinite period knowing that they have a high degree of long run certainty as to value and I don’t require a huge margin of safety as the buy trigger, yet I am happy to sell them at a premium to my calculated value, knowing that in all liklihood they will some day fall back below value. In a volatile range bound market like that we seem to be in at present (some might consider this a charting or TA derived insight) this can add a bit of alpha to the portfolio, and provides some respite from the boredom of waiting for the lifetime investment bargain to come along.
By now Roger is probably wimpering in the corner at my approach, but hey there are many ways to make money in the equity market and it helps if you are lucky (or more to the point, make your own luck)!
Regards
Lloyd.
Roger Montgomery
:
Not whimpering Lloyd, just astounded at the casual reference to ‘adding a bit of alpha’.
Keith
:
Only after I quit full time employment to become a professional share trader in April 2006, did my investing time horizon shift from years to months as I became less an investor and more of a trader.
For example, I bought and sold CSL Ltd (CSL) shares.
CSL Completed Trades
——————————
Fri 03 June 1994 Buy $2.30 (Initial Public Offering)
Thu 24 May 2001 Sell $40.00 (Tech Boom insanity)
Thu 26 Feb 2004 Buy $15.70 (Share Purchase Plan)
Mon 23 Oct 2006 Sell $57.29 (Tidying up an odd lot from SPP)
CSL Current Holdings
—————————
Wed 07 May 2003 Buy $5.00 (Split Adjusted)
Thu 15 May 2003 Buy $4.45 (Split Adjusted)
Fri 29 May 2009 Buy $29.00
Keith
:
Another from my trading diary – Tabcorp Holdings (TAH)
BUY 20000 TAH @ $6.90 on Fri 04 December 2009.
SELL 20000 TAH @ $7.04 on Wed 07 April 2010 12.04 pm = Brkrge A$127.01 = A$140,672.99
Dividends have been paid, now selling out of Tabcorp at near term highs of just over $7.00.
Delivering a profit of A$2,597.09 in Capital Gains after an average of 124 days with an annualised return rate of 5.54% p.a.
I also received on Monday 22nd March 2010 dividend on 20000 TAH @ $0.30 in fully franked dividends of A$6000.00 with imputation credit of $2571.43 equates to a $8,571.43 gross dividend cash return.
Hence total return is $11,168.52 on a capital cost of $138,075.90 = 8.1% return or 23.8% p.a. annualised return.
Keith
:
Another one from my trading Diary was BHP Billiton (BHP)
Thu 10 Dec 2009 – Buy 2000 BHP @ $39.99
Thu 29 Jan 2010 – Buy 3000 BHP @ $39.81
SELL 5000 BHP @ $44.88 on Tue 06 February 2010 10.00 am = Brkrge A$202.41 = A$224,197.59
Delivering a profit of A$24,635.88 in capital gains after an average of 87 days with an annualised return rate of 51.83% p.a.
I also received on Tuesday 23rd March 2010 dividend on 5000 BHP @ $0.46470715 in fully franked dividends of A$2,323.54 with imputation credit of $995.80 equates to a $3,319.34 gross dividend cash return.
Hence total return is $27,955.22 on a capital cost of $199,561.71 = 14.0% return or 58.81% p.a. annualised return.
Kelvin
:
Hi Roger, I came across the article on the FN Arena website.
These cross overs certainly worked for me, over dozens of junior mining and oil and gas companies as well as BHP, RIO and WPL (my background is in resource finance and until recently I concentrated 100% on resources stocks since 2004). These cross overs helped me to stay in up-trends and to get out and preserve my capital before prices collapsed, and then helped me to get back in again as commodity prices recovered.
I haven’t tested this approach on industrial companies as yet, other than the JBH example set out previously. My instinct is that it applies best to resources companies as they are basically derivatives of commodity prices and if you get the trend of the commodity price right you’re 80% there (think the oil price going from $60 in mid 2007 to $147 in July 2008 and then down to $32 in Jan 2009, and the price of WPL basically tracking that). Applying this to industrial companies might be more problematic and I’m trying to figure out whether it applies.
On why it works – its not that prices inherently have predictive power, its that once a longer term trend is in place (longer then 3-4 months – thats why the longer term 200 day moving average is used) its likely that the trend will continue and extend. Now why is that?
From a macro-economic perspective, its likely to be because markets, especially in the last 15 years, have become prone to asset price boom and bust cycles. The reason is that ever since Nixon took the US off the gold standard in 1971 to pay for the Vietnam War, the US economy has built up a monstrous and unstable edifice of debt (private & public sector debt totalling around 360% of US GDP in 2010) and this debt goes to fuel asset bubbles like the internet bubble, the housing bubble etc. When these bubbles collapse and debt deflation occurs and the real economy is damaged and the stock market tanks, the US government lowers interests rates and increases government spending and thereby generates more private and public debt which inflates the stock market back up and causes bubbles in new asset classes.
Hence the boom and bust cycle in asset classes continue and thats why trend following, both up and down, has a good chance of working in this environment.
Kelvin
Roger Montgomery
:
I think thats right Kelvin. It will work if the trends run for long enough. I guess only perfect foresight would tell us whether that were the case.
Kelvin
:
Thanks Roger. I think with the aid of good macro-economic analysis one can have good confidence about whether a trend will last for more than a year, whether it be the rise of China and the resultant rise in commodity prices or the burst in the US housing bubble, both of which were predicted years ahead by high quality macro analysis. Charting will help with recognising/timing these trends as they unfold in real time.
Peter
:
I would like to put this thought out there.
Does anyone know of any Chartist or technical trader who can fit into the same shoes as Warren Buffett.
Think of that for a minute.
Warren is listed as probably the 2nd richest man in the USA, He has been investing using a fundamental approach for probably over 50 yrs. He has stood the test of Time. He has traded through Bull Markets, sideways and Bear Markets. The Merits of his approach to investing is proven without a doubt. – He is a value investor, he still invests and is the 2nd richest man in the US.
I have heard of Chartist and technical traders make untold riches in short time spans, but were are they today ?
Most technical traders would surely know of Richard Dennis. He reportedly turned $400 Dollars (USD) into $200 million Dollars in about 10 yrs. Then what Happened ? His trading system stopped working, he made heavy losses for himeself and clients, he was taken to court etc.. He started a number of investment operations and they were all closed down because they made losses. I dont think he is trading any more.
Most of the stories I here follow the same sequence for technical traders. Rags to riches then to mediocrity (or back to rags ).
Do we have the equivalent of a Warren Buffett in the Technical Analisys arena ?
After all Technical analisys has been around for just as long as Fundamental analisys.
(PS. anyone trading less than 10 – 15 yrs doesnt qualify because he has not traded in enough different Bull and Bear markets. I am looking for someone who’s Technical approach has stood the test of time.)
If we can’t find one, then their could be a subtle message here, as to the merits of each approach.
Roger Montgomery
:
Great question Peter! Post your responses here.
Kelvin
:
Paul Tudor Jones. He uses Elliot Wave as an input, but of course charts are only one of his many inputs.
Roger Montgomery
:
Hi Kelvin,
Elliot wave has a special place in Mandelbrot’s heart!
Keith
:
Its all well and good to try and pick out one failure to prove the point, but it ignores the disconnect between how a gifted investor/trader works his magic and what mutual fund trustees expect from their fund managers.
In Richard Dennis’s case, his instinctive ability to take heart stopping risks and endure terrible losses long enough to grab the spectacular gains he was admired for.
When you manage money for others, Trustees have no tolerance for losses and will withdraw their money and go elsewhere once losses start showing up, just as bet would have rewarded them handsomely if they had faith in the ability of the trader to execute his plan successfully.
In the book “The greatest trade ever made”, one of the fund managers who successfully bett against subprime mortgages was driven to the brink of insanity by complaining and deserting investors as they harped on about the ever growing losses as the bubble continued to inflate.
When the payoff finally came in the form of the GFC, the remaining investors got a huge payoff and promptly withdrew the rest of their money leading him to shut down his firm.
Trustees of Fund of Funds and their investors are looking for the impossible goal of regular steady returns regardless of market conditions and investments.
Hence many flocked to the Bernie Maddoff’s “fictitious” track record of consistently steady returns through thick and thin. This decades long track record of steady returns earned him the reputation of returning positive results when no one else could. Which kept the investors on hook until he could no longer paper over the losses by luring in new marks to keep his Ponzi scheme going.
How about looking at the army of trend following investors listed by Michael Covell
http://www.michaelcovel.com/influences/
People like Ed Seykota have been trading since 1970. 40 years should be a long enough track record to consider the possibility that a technical approach has its place in the investing universe.
For the record, I have a great deal of respect for Warren Buffett as I have been studtying him since first reading about him from John Train’s “Money Masters” and “The Midas Touch” books in the early 1990s when I first started investing. I tried to emulate his methods in my own fundamental approach to investing with some degree of success.
I think if you are looking for a person to aspire to emulate, you should choose the richest Billionaire in the world Carlos Slim Helu.
His fortune of US$53 Billion was made from a life long quest to create new businesses rather than simply trading in their securities.
The number two richest billionaire in the world is Bill Gates who also built a business from nothing.
Roger Montgomery
:
Thanks Keith,
Thank you particularly for the time you have dedicated to enlightening so many about teh merits of the approach you are adopting. I am delighted to have been able to offer a discussion forum for that to occur.
Keith
:
DON’T SWALLOW THE WARREN BUFFETT MYTH
=========================================
Having spent twenty years studying Warren Buffett’s investing career, I am entranced by the complexity and humanity of a man whose many strengths and weaknesses means he can make both good and bad decisions just like the rest of us.
Warren is celebrated around the world due solely to the fact he owns the largest individual holding in a company whose name bears witness to his worst defeat as well as his greatest triumphs – Berkshire Hathaway.
It makes me cringe when I see a comment like the one posted by Peter on July 7, 2010 at 9:56 pm which reinforces a myth of Warren as a two dimensional cardboard cartoon cutout frozen in time and space.
Although Warren acknowledges his intellectual debt to Ben Graham the father of security analysis and a major proponent of the value investing philosophy, he also acknowledges the debt to Philip Fisher and his growth investing approach.
Value approach led Warren to buy Berkshire Hathaway, a cash rich American textile manufacturer in decline. Eventually, the mill operations had to be shut down and the all the workers were laid off, hardly the sign of a good business to buy and grow for the “long-term”. The only thing to survive this debacle was the name of the firm and the cash pile he was able to siphon off to buy other businesses. Berkshire Hathaway went from being a business to a holding company and the foundation of his future fame as the third richest billionaire in the world.
Warren likes to buy good companies at reasonable prices, something Ben Graham would never do, but Philip Fisher did.
Coca Cola was never a “value” stock in the way Berkshire Hathaway was a down trodden cigarette butt with a few puffs left to drag after you brush off the dirt. Coca-Cola was a growth stock with a strong consumer franchise built on the backs of America GIs stationed around the world during the Second World War providing Coca-Cola with a familiarity in countries outside America its main competitor Pepsi Co never had.
The way Warren invests now is completely different to how he invested after dissolving the Buffett partnership and taking over Berkshire Hathaway and remaking it as his investment vehicle for the future.
For a start, compounding returns on capital is a lot easier when you have millions rather than billions to invest.
Like his intellectual forefather, Ben Graham, Warren also liked to dabble in distressed situations and exotic investments.
Warren Buffett runs Berkshire Hathaway like a hedge fund, at one stage, his company even dabbled in Collateralised Debt Obligations (CDO) but had the foresight to exit the market before it imploded.
Equally, he has been making seriously large bets on currency and commodities markets often leading to significant losses.
For more information, read THE MANY MYTHS OF WARREN BUFFETT – 24 February 2010
http://pragcap.com/the-many-myths-of-warren-buffett
In recent years, he has been making huge “non-value” bets on dubious companies like US Air, Salomon Bros, and Goldman Sachs, putting his personal reputation and the company’s fortunes in risk.
For more information on this, read p.28 of Bloomberg Markets June 2010 “How Goldman outsmarted Buffett” written by his official biographer Alice Schroeder, author of the “Snowball : Warren Buffett and the Business of Life”.
For years, he ignored tech stocks, refusing to buy any stocks outside the US and pretty much stuck to a formula which was going nowhere and investing in uncompetitive American consumer goods companies (e.g. Dexter Shoe Company).
His purchase of a Chinese battery company is a bet on the future of the Electric car and a sign that he is more prepared to break his old taboos rather than remain trapped in an investing time warp for another fifty years.
Roger Montgomery
:
Hi Keith,
It is right to separate the buy and hold ‘intention’ from the reality. There are many companies that Buffett has held for a very long time and they have indeed contributed a large portion of the growth in book value of Berkshire Hathaway. But it is also true that in 2003 or was it 2006?, Buffett said he made a big mistake not selling many shares that were well above intrinsic value during the great bubble. Here’s his quote: “We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses — all of which had good gains in intrinsic value last year — but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I.” But in reality many investors can learn a great deal from reading about his investment style and his thought process. He is a walking summary of Graham, Walter, and perhaps most importantly, Munger. I think Munger’s influence while admitted to by Buffett, has been understated by the mainstream media. Despite my very great respect for Buffett’s investing prowess, I have only attended the Wesco AGM’s and not Berkshire’s.
Keith
:
POST VERSION 2.0 with corrections.
===========================
I view Fundamental and Technical analytical approaches as two different but complementary skill sets needed in the game of investing. Like in golf, you need to have a powerful and controlled swing to reach the green (Fundamental analysis – The Long Term investing) and then you switch to your putter to finesse your ball in to the cup (Technical analysis – The Short Term investing).
My most recent success using technical charts was buying and selling Telstra (TLS) shares.
I bought 200,000 TLS at $2.91 on Tue 25 May 2010 at 02.39.46 pm
I sold 200,000 TLS at $3.44 on Mon 21 June 2010 at 10.09.14 am
After paying $698.50 in brokerage, I made a net profit (before tax) of $105,301.50.
A gain of 18.093% on invested capital over the 27 day holding period.
Annualised rate of 244.759% p.a.
I got lucky, but you need to be invested at the right price and time to take advantage of the blood rush of over eager buyers to exit at a tidy profit.
Roger Montgomery
:
Hi Kieth
Thats what I like to see. Some concrete examples. Have you got a few more please?
Lloyd Taylor
:
Roger/Keith,
How did TA play a role in this gamble?
As far as I can determine from the explanation, Keith did nothing more than put a $582,000 bet on TLS coming to a satisfactory agreement on the copper network and NBN with the Australian Government.
The bet payed off. Lucky him!
But what was the role of charting and TA in all this. I am mystified by the reference to TA and putting! Its more like rolling the dice and hoping from what I infer.
Regards
Lloyd
Roger Montgomery
:
Hi Lloyd and Keith,
Care to share the strategy Keith or even a part of it? Obviously you are under no obligation to do so. Do not feel compelled.
Keith
:
Here are four more from my trading diary.
1. BHP Billiton (BHP)
================
Thu 10 Dec 2009 – BUY 2000 BHP @ $39.99
Thu 29 Jan 2010 – BUY 3000 BHP @ $39.81
Tue 06 Feb2010 10.00 am – SELL 5000 BHP @ $44.88
Brokerage A$202.41
Gross Receipts = A$224,197.59
Gross Profit of A$24,635.88
Average of 87 days = Annualised return rate of 51.83% p.a.
Tue 23 Mar 2010 Dividend paid on 5000 BHP @ $0.46470715 fully franked dividends = A$2,323.54 Imputation credit of $995.80 equates to a $3,319.34 gross dividend.
Total return is $27,955.22 on a Capital cost of $199,561.71 = 14.0% return or 58.81% p.a.
2. CSL Ltd (CSL)
==============
CSL Completed Trades
——————————
Fri 03 June 1994 Buy $2.30 (Initial Public Offering)
Thu 24 May 2001 Sell $40.00 (Tech Boom insanity)
Thu 26 Feb 2004 Buy $15.70 (Share Purchase Plan)
Mon 23 Oct 2006 Sell $57.29 (Tidying up an odd lot from SPP)
CSL Current Holdings
—————————
Wed 07 May 2003 Buy $5.00 (Split Adjusted)
Thu 15 May 2003 Buy $4.45 (Split Adjusted)
Fri 29 May 2009 Buy $29.00
3. Tabcorp Holdings (TAH)
====================
Fri 04 Dec 2009 – BUY 20000 TAH @ $6.90.
Wed 07 Apr 2010 12.04 pm – SELL 20000 TAH @ $7.04
Brokerage A$127.01
Gross Receipts = A$140,672.99
Gross profit of A$2,597.09 average of 124 days = 5.54% p.a.
Mon 22 Mar 2010 dividend on 20000 TAH @ $0.30 in fully franked dividends of A$6000.00 with imputation credit of $2571.43 equates to a $8,571.43 gross dividend.
Total return is $11,168.52 on a capital cost of $138,075.90 = 8.1% return or 23.8% p.a
4. Woolworths Ltd (WOW)
=====================
Mon 10 Nov 2003 Buy $10.80
Fri 13 Mar 2009 Sell $24.57
$13.77 gain after 5.34 years
23.83% p.a. simple annualised average return (not compounding)
Roger Montgomery
:
Great stuff Keith! No doubt there are some losing trades. Have they all been smaller in magnitude than the wins?
Keith
:
Yes like all investors, if you invest long enough you will start to lose money.
The key to survival is cut your losses early and let your profits run.
My worst losses of course were from buying Telstra shares in all three floats (T1-T3).
I held my $2.30 CSL from 1994 to 2001, only selling out at $40-00 to pay for my mistakes in repeatedly listening to the spiel from some dodgy share spruikers (i.e. John Howard’s Australian Liberal Government) buying Telstra three times in a row!
Unlike many Telstra shareholders, I was fortunate enough to pick up some CSL shares at the float.
My one great missed opportunity is turning down an offer to me to Cochlear shares in their IPO at the time because it was only giving me a 5% yield on my money!
Anyway, I hope you can spare the time to chat and sign your book after your talk on Friday 23rd at the investing expo.
Cheers
Keith
Roger Montgomery
:
Hi Keith,
Thanks again. I would be delighted to sign your book for you as you have contributed a great deal to the discussion. I am not sure however that the book will delivered by the 23rd. The latest update I sent out was that it would arrive at the distribution house on the 26th.
Peter
:
Hi Keilth
Wow ! Great work. I wonder if you can share what technical signals you used to refine your entry and exit points.
Keith
:
LUCK AND TECHNICAL ANALYSIS
===========================
I use both fundamental and technical analysis techniques and have provided the specific details of one successful trade.
Fundamental Analysis (FA) said “Buy” while Technical Analysis (TA) said “Sell”.
Another example of this sort of “Luck” was an old trade in AMP Shares.
Thu 24 Jul 2003 – BUY $4.91
Thu 28 Aug 2003 – SELL $6.21
I held AMP for 35 days achieving 273.74% p.a. return.
I happily sold to National Australia Bank (NAB) on the day it announced its first takeover offer for a financially distressed AMP.
I find the more I learn about investing, the “luckier” I become.
I firmly believe you need to have good preparation to be in the position to take advantage of opportunities.
B. Reducing Telstra’s overweight position in my share portfolio
==============================================
The Telstra trade was a exercise in persistence rather than pure luck.
The market looked like it was heading into another global downturn with European banking woes and the faltering American recovery
In the last few months of the 2009-10 financial year, I was selling out of an overweight Telstra position,
BUY $2.96, $3.14
SELL $3.09, $3.19
… for small profits.
If I hadn’t sold out of those earlier Telstra share positions before the announcement, I could very well have been talking about a few hundred thousand dollars profit instead of the $105K I did make!
The 200,000 TLS shares were always intended to be my long term share holding (for the s[T]ock drawer like my CSL shares which I were bought for an average price of $7.16), but events turned “long term” into only 27 days.
C. Mr. Market goes Mad over Telstra!!
============================
This is classic example of the manic behaviour of “Mr. Market” reacting to “Good news”.
The market euphoria over a Memorandum of Understanding (MOU) provided an investment opportunity for the rational investor.
Mr. Market instinctively misjudged the benefit and was prepared to pay much more than any rational investor had for Telstra in recent times.
During the pre-open single buy pricing period, I saw a single buyer wanting to buy one million Telstra shares; I had no choice but to indulge the manic behaviour of Mr. Market by selling him my entire share of the business.
D. Technical Analysis – more “Art” than “Science”.
=====================================
I find that Technical analysis is more “Art” than “Science”.
Appropriate entry and exit points are very dependent on the stock, market and the changing dynamic as buyers buy and sellers sell. The old saying, you need to “cut the cloth to fit the suit” applies.
I constantly reassess the situation and adjust my entry or exits based on my experience and instincts.
It may turn out to be too optimistic or too pessimistic.
On occasions I have been able to achieve a perfect exit point for the short term (which of course is the Luck part).
Other occasions, not so great an exit point.
An example, of a less than perfect exit was my recent Platinum Asset Management (PTM) Trade.
Wed 07 Jul 2010 Buy $4.48
Fri 09 Jul 2010 – Sell $4.62.5
$1400 profit from 43 hours holding time, for a 570.1% p.a. rate of return.
In hindsight, I sold far too quickly, as I left another $2000 profit for the lucky punter who bought my 10,000 shares for $4.83 at yesterday’s market close.
But I ignore Hindsight Harry as just another “Kook” who likes to jump out and scare novice investors.
One day, I plan to use my share trading diary to write a book about the (mis)adventures of twenty years of Australian share investing.
In the meantime, I will keep on trying to improve by reading books by successful investors like you Roger.
E. Buying your book at Melbourne Investor Expo.
====================================
I am planning on attending the Melbourne Investor Expo on Friday 23rd July at Brumby’s barn.
If you are interested, I can bring along a copy of my Share Trading diary for you to have a quick look.
I would like to pick up a signed copy of your book on the day if you are still selling them.
Roger Montgomery
:
Hi Keith,
I won’t have any books to sell on the day. They are consigned to the website only at http://www.rogermontgomery.com. I would however be delighted to see your trading journal. I would be happy to sign it instead!
Peter
:
Hi Roger
As Donald Rumsfeld famously tried to explain at a press conference of progress in Iraq….
You have know knows, unknown knowns, known unknows and unknown unknows.
By definition, charting a future is based on history i.e. known knows. That leaves unknown knowns, known unknows and unknown unknows to chance…if you know what I mean.
I’m with Mandelbrot on this one.
Regards and look forward to Value.able
Roger Montgomery
:
Hi peter,
Thanks for sharing that. I have certain;y been leaning the same way. Its hard not to be at least a little intrigued by the very good results some people seem to be obtaining from disagreeing with him though.
Bernie
:
G’day Roger
I have 2 views on charting :
1…even if you don’t like it, so many do. This, compounded by computer automated chart-based trading, then makes charting self-fulfilling to some degree at least. So I believe it cannot be ignored.
2…Having selected a stock I’m interested in, I make casual charting observations (ie I don’t strictly follow charting as such – also: there are far too many variants) to assit with timing my entry/exit points. My observations cover Elliot Wave Theory, MACD and Moving Averages to determine my best timing.
I’m looking forward to your book which will help me identify candidates in the first place which I shall then apply the above to determine timing.
…Bernie
Roger Montgomery
:
Hi Bernie,
I have to admit that has been my motivation. I wanted to know whether there was some benefit in using something else to refine the purchase decision. My experience tells me you can produce perfectly acceptable results without it and so adding another degree of freedom simply may be a step too far. Without that extra degree, you do need to be patient, which is also my experience. Buffett did say that it works, if you aren’t in too much of a hurry.
keith hopper
:
Hi Roger
I don’t know if you play golf, but i love the sport. My other passion is physics, and my whole world revolves around the principles of both … and that’s how I justify the decisions I make … and then there is the share market which provides the dollar equivalent of the endorphins that drive me.
In golf, when putting, the technicians will tell you to assess the slope and grain of the green while the fundamentalists will tell you to keep your head still, watch the ball, and make a smooth stroke. The object is always to get the ball in the hole.
In physics, the Law of Conservation (pick one, it’s just an analogy) says that the total amount doesn’t change. The amount of energy in the universe remains constant but exists in many forms (including mass) and is constantly changing from one form to another.
In philosophy, the truth is what you believe the truth to be, so everything you do is truth driven rather than fact based.
In economics, there is supply and demand. If there is an over-supply it’s as hard to sell something at a profit as it is when there is low demand (which is just two ways of saying the same thing … and the bearish way of putting the vice versa).
The energy of the share market is cash. You putt (misspelt deliberately to be punny) your money in according to your philosophy of investment and enough traders share your believe you will make a profit … otherwise you don’t (did I mention luck and it’s relationship to timing … you need to be Irish to understand that concept).
Roger Montgomery
:
Very Funny Indeed Keith! And perhaps if you leave the room and close the door, the debt is not really there either. Alternatively, if nobody is in the forest to hear it, a stock market crash makes no noise. Thank you.
Peter Ferguson
:
Roger,
Being both professionally interested and fascinated by investment markets I have been intriged by charting for many years. In fact I completed a post graduate diploma subject in technical analysis. Unfortunately I failed the subject, I think, as a result of my complete lack of artistic ability and inability to interpret maps. I just couldn’t grasp the identification of concepts such as those quoted by Mandelbrot in your article such as head and shoulders flags, pennants etc. I draw pathetic horses and dogs for my kids.
Therefore I have dubious qualifications to make the following observations. I don’t that I am alone however, as many promoters of charting also seem to have dubious qualifications.
The introduction to the course was based on the work by W.D. Gann and I seem to remember some rather unkind words spoken about him by his son. When I researched this memory I found the following statement by Alexander Elder:
” They claim that Gann was one of the best traders who ever lived, that he left a $50 million estate, and so on. I interviewed W.D. Gann’s son, an analyst for a Boston bank. He told me that his famous father could not support his family by trading but earned his living by writing and selling instructional courses. When W.D Gann died in the 1950s, his estate including his house, was valued at slightly over $100,000. The “legend” of W.D.Gann, the giant of trading, is perpetuated by those who sell courses and other paraphernalia to gullible customers.”
W.D.Gann’s basis of knowledge is an interesting mix. He discovered his theories in the Bible and found proof in astrology and mathamatics.
Rene Rivkin replied to my question to him on the merits of charts by saying that as far as he was concerned charting had so much going for it, with only the one negative, he had never seen a chartist with any money.
So many of us seem to have mates who had a bit of a go and fell in a heap over the past few testing years
I am sure that there are some credible chart followers who are genuine investors. However it has been my experience that the followers of charts seem to be very very short term in investment time frame. It seems quite common to here things like ” I bought in at 12 cents and sold 2 weeks later at 24 cents.”
There is a group who has been trying to sell me charting software for some time now. Their follow up of consists of a weekly report showing the trading results for just the past week.
Chart followers seem to be mainly those who believe that stock investing is about being in the right place at the right time, a bit of luck invoved.
Inspite of those negative remarks I have found charts both interesting and useful. Even though I don’t ever try to predict market directions I can’t help but look.
I don’t think that either specific stocks or markets can be exempted from trends or momentum even though the hundreds of years data appears to be a bit of a mess. But you would think that patterns must emerge.
I find it interesting and insightful and simple to idenify market trends according to one of Charles Dow ‘s most basic trend concepts, higher highs and lows in upward trends and lower highs and lows in downward trends.
From reading about the man I don’t believe that Dow saw his charts as the be and end all of investing, but as a means of guidance.
While gaining no signpost for future direction and leaving us in uncharted waters, so to speak, a basic Dow chart shows us that the long term upward trend of the Dow Jones that commenced in 1975 ended in 2008.
I think that the basic charting concept that everything that is known about a stock is reflected in its price is incorrect. Any mathematical conclusion is based on market behaviour not knowledge of the underlying asset. Therefore a chart can never take the place of a fundamental approach to understanding the value of a stock.
I make the comparison. The numbers stack up statistically to suggest that the St George Dragons are travelling quite nicely at present. However it is the knowledge that this is a good outfit that gives those stats credibilty and a belief that this situation may well continue.
Alternatively when I walk into Coniston Hotel there is a guy there who backs dog races and as soon as he sees me he tells me that it’s a night for the number 7. Now his stats may be equally as strong as the case for the Dragons, but of course there is no reason to conclude that this trend will continue.
The major superannuation and managed funds funds own quite portion of stocks in Australia. On any one day thousands of shares are traded by these funds, enough to make a mark on any chart. The reason for the trades may be to correct tracking error, to reweight according to market capitalisation, to move with the crowd, or any other reason best known to themselves. Whatever reason to base a future trend on that trading has about as much logic as expecting number 7 to keep winning.
For individual stocks I find it beneficial to look at a chart when a decision has been made to buy a particular share, just to monitor an entry point.
By definition all charting data must be past tense. I believe a real problem for the charting industry is found in that past tense. There seems to be a drive to be more specific and determine trends early and predict future directions. My experience shows that this leads to so many false readings of trends.
I have found that using 50 and 20 exponential moving averages provides an easy (using yahoo finance) compromise for both stocks and markets. That is as long as it is used just to obtain a little insight into where we are.
Just finally your comment 2, price changes are normally distributed etc. Is that incorrect. I just accepted it for years.
Regards
Peter
Roger Montgomery
:
Hi Peter,
I couldn’t agree more. Valuations must be justified by economic performance of businesses. Price changes in the short term are justified largely by sentiment whose changes are much like the waves in a tempest and unpredictable. What I am interested in is whether anyone has found a method that works to produce substantial gains. There have been a few investors here on the blog that have demonstrated to themselves they have something. Many have also been willing to share their methods. Amazing.
In relation to your last question, the normal distribution curve -constructed using the mean and the variance – was used by Markowitz to posit that variance and standard deviation are good proxies for risk and standard deviation is just the square root of variance. predicts that 68 percent of price changes will be small and be within 1 standard deviation of the average. Ninety five percent will be within two standard deviations and 98 per cent will contain 3 standard deviations. In other words there’s a big fat middle, full of the small changes in price and then there are thin tails describing the occasional ‘big’ positive and negative price changes.
Taking data from the Dow Jones between 1916 and 2003 Mandelbrot notes that there were 1001 days that the market moved by more than 3.4%. According the the Bell Curve there should have been no more than 58 such days. The Bell Curve also predicts there should have been just be just 6 days where the market moved more than 4.5% however there were….wait for it…366 such days. And ccording to the normal bell curve, there should be only one day that moves more than 7% every 300,000 years. But in the time period examined, there were forty-eight such days!
So do you think price changes are normally distributed?
Lloyd
:
I think you’ll find that the market movements are log-normally distributed. Layman’s terms: lots of small moves with a very long tail of big moves – a very asymmetric distribution meaning that the mean and associated deviation calculated on the basis of an assumption of a normal distribution is quite unrepresentative of what may happen in any sample period.
Regards
Lloyd
Roger Montgomery
:
Thanks Lloyd,
Fat tails. Many more large movements than a normal distribution curve predicts but not log-normal (there are two tails). Mondelbrot did make this observation about Bachelier’s assumption.
David
:
Hi Roger,
I suggest that there is a time and place for technical analysis. It can be a handy tool for buying ‘value’able companies when you can maximise the difference between instrinsic value and price; however here are just a couple of short-comings that most new users (like myself) are trapped by.
1. The technical analyst is using historical trends to plot the future. When they are right, they sprouk about how the chart told them they were correct. When they are wrong, they can point to other factors and stimuli that were missed as part of their analysis, which should have given them the right read. Our psychy wants us to believe that we are smart enough to predict the right outcome and hence we will continue to search until we find ‘the key factor’ that we missed.
2. Experience, perseverence and patience are required to become good at technical analysis; most people have made significant losses in short-term trading by the time they reach this point and have lost faith in their system.
3. You learn a new trick and try to apply it to everything. If I only had 5 cents for everytime I’ve heard ‘head and shoulders’.
Roger Montgomery
:
Thanks for that insight into your personal experiences David. I am absolutely certain you are not alone!
Luke
:
Hi Roger,
I am a long term investor, but think charts can definitely help refine entry and exit points. I have been using a mathematical technique known as breakpoint analysis on trading volumes to pickup changes in sentiment in stocks, and i think this has really helped improve my timing.
One thing blog readers may be interested in is ASX has a free online trading game where you can trade theoretical money over a 3 month period. This could be a good oppurtunity for readers to test there theories and learn without burning real money. The next round starts July 29. I will be putting my method up against the game to see how well it is really helping me.
Regards
Luke
Roger Montgomery
:
Thats Great Luke,
I was the ‘voice’ of the public and schools ASX share market games this year, answering questions from Tony Hunter of the ASX so I am more than happy to recommend it. Do you happen to have a link for everyone?
Luke
:
Hi Roger,
This is the link to ASX sharemarket game.
http://www.asx.com.au/resources/education/games/index.htm
Roger Montgomery
:
Excellent Luke. Thank you very much. Here it is everyone. if you are interested in participating in the game and testing your method.
Rici Rici
:
I use charts as a ‘filter’ of potential new information.
In normal market conditions movements in the price of a stock can signal new information.
If there a significant movement in price, then i try to work out what is the catalyst of that price movement. If the catalyst is new information then i try to work out whether it has a material impact on intrinsic value (most of the time it doesnt).
Basically the procedure is:
(a) significant price movement
(b) check the asx site for ‘official’ news release, also check for movements in directors holdings (since the directors will know about their own company)
(c) google the company for any news release.
(d) check for updated research by the various brokers( i am not interested in their buy/sell recommendation, just the information within the report).
In a market governed by fear, obviously this doesnt work so well (since fear is the overriding factor, not market information)
Roger Montgomery
:
Hi Rici,
Thanks for sharing. Do you find it difficult to define and therefore identify ‘normal’?
Rici Rici
:
No i dont find it difficult to define a ‘normal’ market, bull market and bear market.
A normal market is one that is boring, this is characterised by the fact that there is little media attention.
A sustainable bull market is characterised by the fact that the media talks about ‘time in the market’ not ‘market timing’, issues such as the ‘attractiveness of margin loans’ gain far more attention, interrigation of results is not as important and the upwards movements in prices, the pool of new money into funds management increases at an exponentional rate, ect ect
A bear market, the media highlights D&G, makes comparisons with the great depression, starts asking questions ‘is investing in equities worthwhile?, headline statements your superannuation is down x% make front headlines.
I would characterise the current environment as only mild bear market, why? because the majority of retail investors have been on the sidelines ever since the GFC. Alot of the movement in the ASX 200 has been created by institutional and hedge fund plays, not retail investors. Unfortunately retail investors tend to arrive at the party late (note i am refering to the overall market here, i think if there is an area that still has alot of retail focus its resources)
Roger Montgomery
:
Thanks for that Rici,
Clarification is good. I just wonder whether these are specific enough to be able to alert you in a timely fashion to the change in definition?
david
:
Hi All and Roger,
What a great read. If all the people above got together I am sure you would give all these fund managers a run for their money.
I use both forms of trading, I am not that experienced but read and listen as much as I can.
I use FA to form a price that I believe is fair value and then use the charts to time my purchase.
The big thing to get right is not the trades that you do or the companies you buy but more so the ones you don’t do and the companies you don’t buy, eg Telstra as a FA stock has been terrible but when it was $2.85 and then sold it at $3.20 it was a good TA stock. or QBE which is a good FA stock but has looked really poor as a TA option. Qbe is looking quite good now for both reasons in the next few weeks.
Thanks Dave
Roger Montgomery
:
Hi David,
Thanks David. One of the themes that keeps appearing is the attempt to successfully combine the two. Very interesting.
Manny
:
A good mate of mine was a day trader and used charts, Macd and Fibonacci etc. He started out with $10K, it dropped to $3K and then worked his way up 7K in profit and walked away. He did hundreds of trades to make this profit and paid out about 7K in brokerage. He had no idea about what companies he was trading he just looked at the stock code.
So yes you can make money, but if he stopped when he was down $7K it would be a different story. But he stopped when he was 7K ahead. So there is an example for you Roger of someone who did well using charting.
Last year, I was very interested in AHE at 48cents, it was on a PER of less than 3 and its ROE was around 10%. So I got him to chart it for me and his advice was to buy in and sell out at 60cents. I did this and made 24% in 3 days. After I sold out the share price then fell back to 50 cents. I thought wow, he was right about taking the profit look the price fell back around the support line he advised me on. In the short term the charting method proved correct. But in the long run it was a poor decision to take the profit. A few months later AHE was $1.20 and a year later its $2.25. (it paid out 21cents in dividends over 3 half year reporting periods)
Looking back it was foolish of me to sell out at 60cents because I am a value investor and I valued it at around $2 at the time. I missed out on a 5 bagger. I later purchased $10K worth at $1.20 (twice what I sold it for) and have held on to it. Sitting on a 2 bagger including the dividends.
What I learned from my friends trading method using charts, is he made a lot of money with a lot of work. In the short run Charting can be accurate and you can make money.
But if you buy 1 good company at a price way below its worth, and hold it through the short term price movements, you can make even more. If I held the parcel I bought at 48 cents I would have received half my money back in dividends, plus a 5 bagger share appreciation.
It is possible when value investing to achieve a 5 bagger or 10 bagger, not so with charting. I realize though that they are 2 totally different strategies.
My mate said that when comparing returns from the charting method to value investing is that as a charter his expectation is to make a higher return using charting because of all the extra work involved compared to the buy and hold approach.
I agree – if you spend the time ‘working’, using charts and trading, you should expect to get paid for it. You should also expect to get paid for buying and holding by receiving passive income through dividends.
Some may prefer to see companies not pay out a dividend and retain the earnings if the company has a high ROE. My view is that this also can be risky. Not many Directors have proven a 100% success rate in allocating capital. I would have preferred HVN to pay out a higher dividend than retain the earnings and waste it on the Ireland expansion and the Offis mistake. It’s these types of mistakes that are very common that make me think I would prefer the higher payout ratio so I can decide how to allocate the cash, unless allocation of capital is proven.. like ARP who end up paying special dividends anyway. But this is a different discussion which warrants further discussion.
Roger Montgomery
:
Hi Manny,
I do indeed agree with your proposition that to assess the success or otherwise of an approach, it is useful to compare it to buying and holdings. I am also rather fond of your summation: “What I learned from my friends trading method using charts, is he made a lot of money with a lot of work. In the short run Charting can be accurate and you can make money. But if you buy 1 good company at a price way below its worth, and hold it through the short term price movements, you can make even more. If I held the parcel I bought at 48 cents I would have received half my money back in dividends, plus a 5 bagger share appreciation.”
Thanks for the contribution Manny.
Phil
:
I use charts as part of my analysis. They tell you a lot about a company at first glance, particularly if there is a clearly defined up or downtrend. I also use several other indicators that tell me other things about the stock, such as Volume, RSI, MACD, DMI, OBV, CCI, Slow Stochastic,Bollinger Bands & Moving Averages.
I enjoy candlestick charting in particular & like to not only analyse and discuss certain candles, but also identify certain chart patterns.
I believe the more information you can gather before making either an entry or exit decision the better. I have seen too many traders & investors badly burnt by simply following the “sheep” or acting on a “hot tip”.
Roger Montgomery
:
Hi Phil,
Great input and thank your for positing it. I wondering if you think that the chart can tell you a lot about a company or do you think it tells you a lot about what other people think about a company?
Phil
:
Hi again Roger,
I’d have to say that it’s a mixture of both.
I know a lot of TA traders simply “jump on” a stock based on price and volume spikes. Strangely, history seems to show that a “good” announcement soon follows with many stocks. Of course, that wouldn’t be a reason to sell would it ?
Some companies have a long history of such spikes. There are many stocks that are daytrader playthings. Some people have learned that you don’t want to hang around long in stocks like that or you will be on the end of yet another capital raising at prices that are heavily discounted to the current share price.
It’s also very easy to spot stocks that are being manipulated when you are looking at low volumes. A good rule of thumb is that usually, if a stock runs up hard it will correct sharply at some point. A chart and it’s indicators will show you this information. It’s a bit like a traffic light at a busy intersection really. Go through a red light and the odds are that someone is going to smash into you.
Roger Montgomery
:
Hi Phil,
I agree with your comments about volume increases ahead of announcements. It seems some secrets aren’t kept as well as others. On the traffic light metaphor, I think the issue, for many people who have written about their experiences here, is all the green lights that change to red when they are half way across the intersection!
Andrew
:
Ok well my trading method is to make 25% when i’m right and lose 10% when i’m wrong. That means I can be wrong 5 out of 10 times and still make a profit. No great inevention but something I learnt from a technical trader. I am a subscriber to a great report and have learnt a great deal through his education (and made good money:)). So to make 25% I naturally trade the more volitile trending stocks (obviously WOW TLS etc do not rise 25% quickly in price so they are not trading stocks) I look for set ups where there appears to be strong support just under the current price (minimise risk to 10%) and it is trending strongly making monthly or quarterly highs. That way the risk reward is more in my favour. If i’m right and the stock rises upwards of 25% I will sell half effectively capturing a free trade! I then take a more fundamental view on the remaining half and follow the trend longer term only selling the final amount when it breaks the previous quarterly low (check out a quarterly chart it’s amazing how often a stock that breaks the previous low after a long rally continues lower for 9-12months before rising again). That provides a strong signal that the stock’s trend is over. I use trading software that scans for those type of trades. Two other methods I use involve going against the trend. They involve using bollinger bands and the RSI (Relative Strength Index). These trades are often less than 3weeks and involve selling all of the trade if sucessfull as they still in a major downtrend so i’m only looking for a short term oversold reversal before resuming the downtrend (AAX recently for example) Hopefully that covers the basis of my trading? As I have mentioned when it comes to longer term holds I follow Roger’s method as the short term noise is somewhat irrelavant. I must point out though Roger I really believe anyone who imploys leverage through margin loans must employ stop losses to protect their capital. Constantly feeding the margin calls is not unlike pumping more money into a failing business? even if the fundamentals are there and the stocks recover within 2-3 years you will most likely be broke long before due to so many margin calls missing the recovery in price as you have been forced to liquidate the portfolio.
Roger Montgomery
:
Hi Andrew,
Great stuff. I don’t employ leverage this way either. I am sure there are a bunch of people who would like to see one of your ‘quarterly charts’. Feel free to send it through via email if you like and I will post it for you – if you are happy to share it of course. To remain independent I have removed the references to the newsletters lest they be seen as promotional.
Andrew
:
Oops sorry about that, didn’t want to the post too sound likethe method was invented by myself :) I will email you through a chart Roger describing the very ‘basic of methods i’ve spoken about. I will pick a company and plot the method or you can suggest a quarterly chart if you wish?
Roger Montgomery
:
Hi Andrew,
On behalf of everyone reading the blog, thank you. I am sure there are many people keen to see how you go about it.
Joe Flood
:
I have traded entirely by charting over the past thirteen years, on and off, with mixed success that has steadily improved over the years. It is not for neophytes or the faint hearted – in my first year I lost $100 000 and it took quite a number of years and a great deal of practice to get it back.
I suppose I have tried practically everything but now rely on a combination of Elliot wave and simple pattern recognition. It doesnt always work but the idea is to gamble only when the odds are well in your favour and put in hard stops when things go wrong, as they frequently do. The way I look at it – it’s better than getting your legs broken counting cards in blackjack.
What I can say is I have successfully predicted every major turn in the market since about 1998, to within a few weeks. Doing so online has frequently led to ridicule as trend traders can never believe their market is about to collapse. However – turning this prescience into hard money is not so easy – though it has stopped me losing money,
I have been in cash since December 2009 but am looking to re-enter before long.
JF
Roger Montgomery
:
Hi Joe,
WIth a track record like that, I am sure nobody here would object to hearing your forecast for when the next turn is expected. Feel free to let us all know if you are happy to do so. Thank you for your post Joe.
Peter Ferguson
:
Joe,
You are an absolute genious.
Can I register for your next tip?
Peter
Kelvin
:
Hi Roger,
I think that fundamental analysis, valuation, macro-economic analysis, and technical analysis all have value. Why don’t we only buy/invest in a stock when all of these analytical approaches give you a green light? Surely that would be investment heaven and would improve the probability of the success of an investment/ trade? The beauty of being a DIY investor is that we are not constrained by a mandate to hold a certain proportion in equities, and can basically just hold cash (and earn 6% interest in the present environment ) unless we’re really sure. As one great trader said (I can’t remember who), only do something if there is something to do.
On technical analysis, I must say I don’t understand all the “head and shoulders, flags and pennants, triangles (symmetrical, ascending, or descending)”, as per the quote from Mandelbrot’s book. Its all too complicated for me. But all that is chart theory. For me, technical analysis’ value lies in chart facts, as in – is the price trending or churning? If trending, is the trend consistent or becoming inconsistent? Is it accelerating or decelerating?
Personally, I monitor price charts all the time. This can help me avoid losses, and can also help me make money. Overall though, I think the value of this type of technical analysis lies more in helping to avoiding losses than making profits.
AVOIDING LOSSES
1. The first rule I have is that when the price of a stock increases exponentially, such that it goes parabolic and becomes almost vertical on a chart, sell it. It indicates euphoria, and generally precedes a crash or at least a short term correction
2. The second rule is that when the 50 day moving average (MA) crosses below the 200 day MA (I think its known as the death cross), sell it. This could have avoided a lot of losses for investors who had invested in ABC Learning Centre, Centro, Enron, Timbercorp, Babcocks etc. without the investors having to know anything about how bad those businesses actually were. The point is somebody knew, probably a fundamental analyst who was much smarter than me, and they were selling. Yes, this is a lagging indicator, and I would have suffered the initial part of the price fall, but hey I would have protected most of my capital. But what if it gives a false signal and the price turns back up? This is where the next part comes in.
MAKING PROFITS
This is the opposite of rule 2 for avoiding losses above. If the 50 day MA crosses above the 200 day MA, buy it (even if you’ve sold it previously because the 50 day MA crossed below the 200 day MA).
Of course, all this works best in a trending market. In a churning market, you’d get whipsawed out frequently. That is why I have chosen the longer term moving averages to capture the longer term trend, and not the 20 day or 30 day moving averages etc. But its entirely up to the individual which MAs they use.
And of course, all of this works better in conjunction with fundamental analysis. If your fundamental analysis tell you ABC Learning Centre is not a good stock, then don’t even consider buying it in the first place. Only focus on those companies that, based on your fundamental analysis, are ultra high quality.
EXAMPLE
I will leave with an example.
Lets say using my fundament analysis, I determine that JB Hi Fi is a high quality company that I want to invest in. What would I have done with it using the 50 day MA and 200 MA rule over the last five years? (you can look at the chart of JBH to confirm the following):
I would have bought it in December 2005 for around $4.00, sold it in Feb 2008 at around $10, bought it back in August 2008 at $13.50, sold it in November 2008 at $8.00, bought it back in April 2009 at $13.00, and sold it recently in April 2010 at $19.00. All the while monitoring the fundamentals of JBH to ensure it continues to be worth investing in.
Of course, from the above it is clear that the weakness of this approach is that you get whip-sawed re the middle two trades, and this is the clear downside of this system. But still I’m ahead.
And of course, one can say that if I had just stuck to true value investing, without the “help” of technical analysis, I would have bought JBH in November 2008 at $8.00 (if my calculation of the intrinsic value of JBH then was much higher), instead of selling it and would have made serious profits rather than just decent profits overall.
But that is why I said the value of this type of technical analysis lies more in helping to avoid losses or potential losses – what if after the Lehman collapse in October 2008 the macro-economic environment played out differently, and the governments of the world did not stimulate to the extent they did, and the world entered an actual depression? The consensus earnings forecasts upon which I based my calculation of intrinsic value of JBH would have been way too high, but technical analysis would have saved my bacon.
I want to emphasize that I did not make the above trades with JBH, but am just back testing this approach using historical price data.
Roger, I would be very much interested in what you think of my above thoughts.
Many thanks.
Kelvin
Roger Montgomery
:
Hi Kevin,
I think you have really laid out quite clearly your approach, which will be of particular value to those for whom charting is foreign. While I think comparing the basic buy and hold approach to buying great businesses at cheap prices shows up the obvious flaw and expense in the alternative you propose, I am not qualified to critique your particular choices of indicators. I am sure however that there are plenty of people reading this blog however who are and so I invite them now to offer Kevin any suggestions. Thanks for your post Kevin, and hopefully someone with a great deal of trading experience is willing to offer you some guidance.
Kelvin
:
Hi Roger,
Thanks for your response.
Yes, the basic strategy of buying great businesses at cheap prices and then holding is obviously a far superior strategy to my proposed approach as highlighted by the JBH example above.
Which led me to think – what is it about the buy and hold value investment strategy that I’m trying to improve upon by overlaying with technical analysis?
On reflection, the issue for me with the buy and hold value investment strategy (but it may not be weakness with the strategy, it may just be that I don’t understand it well enough) is that it doesn’t take into account macro-economic/ top down forces, which might impact on consensus earnings forecasts and hence my calculation of intrinsic value. To me its fine not to take top down forces into account with companies like WOW, COH and CSL, but with cyclical companies whose earnings are impacted by how well the general economy is doing, I am not comfortable with a purely bottom up approach.
(Roger, am I mistaken in having these concerns about the buy and hold value approach?)
But given my concerns exist at the moment, I thought perhaps a better technical indicator to overlay the value approach might be only buy a cyclical stock if the 50 day MA of the S&P ASX 200 index is above the 200 day MA of that index, and sell the stock if the 50 day MA of S&P200 falls below the 200 day MA, and buy it back again if the 50 day MA of S&P200 goes back above the 200 day MA (assuming of course that the fundamentals & the valuation of the stock from a bottom up approach remain attractive). This so that we only hold cyclical stocks when the general economy and the stock market is doing well.
Using this indicator, my JBH example above would now work out this way:
Buy in December 2005 at around $4.00, sell in Jan 2008 at $11.80, buy back in June 2009 at $14.14, and sell in June 2010 at $19.67.
Even with this modified approach, its obvious that an investor would have been better off by just buying at $4.00 in December 2005 and holding all the way (and delaying paying capital gains tax)!
So may be my rationale for wanting to overlay technical indicators is not valid, or may be I need to search for more sophicated indicators.
As I said, all of this is just back hypothetical testing of historical data to test out certain theories, as I did not actually enter the above trades. And I am certainly not advocating people to sell JBH, particularly as I just went to JBH to buy a computer today and the pricing was competitive and the service excellent. Its obviously a great business.
Nevertheless, it would be interesting/instructive for me to see how the general market and the stock price for JBH plays out for the next 12-18 months, given that using my approach above one would have sold JBH at $19.67 in June 2010 but JBH’s intrinsic value is above $20.00 and therefore a buy and hold investor would not have sold it.
By the way, I would just like to say a big thank you to Lloyd for his comments regarding Mosaic above – they are really instructive.
Thanks.
Kelvin
Roger Montgomery
:
Hi again Kelvin,
Yes, Lloyds insights into a sector that is understood only superficially by so many is very “valuable”. Regarding your modified approach- applying your indicators to the index rather than the stock, may miss the very real prospect of a company rising in price even when the index is falling. What happens to the opportunities that may have otherwise been acquired during periods for the index that ultimately prove to be false sell signals for you? I am no expert on this subject Kelvin, so I will wait for someone else to weight in, suffice to say that you cannot base a strategy on the results from one company. I am reasonably certain you will have a few responses and suggestions in short order.
Kelvin
:
There is an article yesterday (5 July 2010) by RFVandyck on 50 day and 200 day moving average crosses:Here are some excerpts:
Global economic momentum has taken a few steps back and investors have responded through fear and concerns. It will take a while yet before we will have more clarity into exactly how long this economic slowdown will last and how deep it will go.
In the meantime, equity markets have retreated by some 15% from their peaks in April. This, in response, has put severe stress on technical indicators used to gauge the underlying trend for risk assets.
The most recent ominous sign to result from weeks of dominant selling pressure on global share markets is a so-called “Black Cross” for US equities, otherwise known as a “Dark Cross”, otherwise known as “the Cross of Death”.
Even for investors not familiar with technical analysis, the name for this signal probably gives away sufficient clues as to its potential importance. This is not a positive signal, and that’s putting it mildly.
investors got all excited last year in June, because that was when the 50 M/A moved above the 200 M/A.
Alas, since peaking in January, and then again in April, global equities have reversed course. This has had a significant impact on trendlines. As a result, the 50 M/A for the Dow and the S&P500 indices has now crossed the 200 M/A on its way down. This is the opposite of what happened in June 2009.
“Like outside reversals, we pay heed to “Dark Crosses,” for history has shown that those who don’t pay a price for their indecision.”
The Chinese equities market as well as Australian indices, have already seen the 50 M/A break below the 200 M/A.
The past eight years show:
– a Black Cross was generated in early 2002 which then was followed by a sharp downturn
– by mid-2003 a Golden Cross appeared on ASX200 price charts which proved the starting signal of a four-year lasting bull market
– a Black Cross became fact in early 2008; what followed was a savage bear market, seldom witnessed in modern history
– but a Golden Cross again followed in June 2009 and share markets entered the next stage of their recovery rally from March-lows
Should investors now expect the worst?
A quick investigation of the All Ordinaries index over the past 45 years (since 1965) teaches us that Black Crosses are often a signal of mayhem coming, but not always. Sometimes the 50 M/A merely dips below the 200 M/A, but it never breaks significantly below it, setting up a share market bottom from which the next rally can take place.
It is this scenario that is at present keeping market bulls’ hopes alive: that fears about a significant sell-off will prove to be without merit, and that a rally will take off instead. Maybe this is why some chartists adhere so much importance to whether the 200 M/A is still trending upwards, or not.
At this point in time, it is only the 50 M/A that is falling. The 200 M/A for Australian indices is merely tracking sideways. The same holds true for major US indices. Of course, if the tide doesn’t turn and share prices fail to again move higher in a sustainable manner, the 200 M/A too will eventually turn course and start trending south.
As a matter of fact, as of Friday 120 from Australia’s top 200 individual companies have now generated a Black Cross on price charts, including the ones mentioned above, plus the likes of Telstra ((TLS), Woodside Petroleum ((WPL)), QBE Insurance ((QBE)) and Woolworths ((WOW)).
Roger Montgomery
:
Hi Kelvin,
I can’t republish the whole article but thank you for sending it. Where did you read it? As I read it I wondered whether the cross over is just another way of saying the shares have all gone down in price. This of course is self evident. If the share prices themselves don’t contain predictive power then a tool that has prices as an input must be equally unable to predict. WHether one uses the MA or not, you have to first believe that prices have some predictive power. Before reaching any conclusions, I would like to see someone run a test on say 1000 observations of the 50 day crossing the 200 day (you can add the filter of a rising or declining 200 if you want) and then after taking every signal, whether there was a better than 50% frequency of profitable occurrences.
Lloyd Taylor
:
Roger/Kelvin,
Try this for the reality/statistics behind the black cross: “The kiss of the death cross”
Commentary: Death cross over last two decades has not been that bad an omen: http://www.marketwatch.com/story/track-record-of-the-death-cross-2010-07-09
Dow’s average gain over subsequent… Following a “death cross” 114-year average
Month -0.6% +0.5%
Quarter 0% +1.6%
Six Months +1.8% +3.2%
Year +2.4% +6.4%
It is not what is portrayed to be based on the statistics of market performance after the Black Cross event. Statistically it does not presage the end of the world as we know it, despite the media hysteria!
Regards
Lloyd
Roger Montgomery
:
Thanks Lloyd. Those of you who are enamoured of moving averages whether they be simple moving averages, exponential moving averages, moving average crossovers or moving average convergence/divergence histograms should go back over time and check the results including using out-of-sample data. As I mentioned previously, I suspect those who have been successful in investing using charts or trading algorithms are using something a little more involved than moving averages. The behaviour of a moving average, which is entirely dependent on price as an input, is such that it must ‘follow’ prices with a lag based on the numbers of days/weeks etc used to calculate it. Therefore every major correction in history must result in the price falling below the average. Looking back at those times, the average will appear to the untrained eye, to look as though it had predictive power. But before allocating capital, it is essential one checks all the signals.
Lloyd Taylor
:
Roger,
You’re correct again! The Moving Average tells you what happened by way of share price action in the period of the averaging. Unfortunately, with the 50 day/200 day crossover most of the share price action, be it up or down, has already occurred in the fifty days prior to the crossover. In more than sixty percent of the back history examples I have examined the point of crossover does not presage any material continuation of the share price trend, be it up or down. Sometimes the momentum/trend continues, but most of the time it doesn’t and you’ve missed most of the action, or incurred most of the pain (depending on on which side of the 200 day average your playing) in waiting for the crossover.
Now if you can come up with a “minus 50 day” (i.e. averaging the future 50 days price movement) then you will catch my attention. So far no-one has realized the dream!
Regards
Lloyd
Roger Montgomery
:
Thank Lloyd,
Finding a genuine edge is the great challenge.
Kelvin
:
Lloyd, I agree. By itself statistically it does not presage the end of the world as we know it.
But from a macro-economic perspective the debt position of the developed world is such that you know the “Big One” is coming, and a Black Cross event just tells you that there is an increased chance this might be it. Of course it could be a false signal and could come at a later point in time.
Kind regards,
Kelvin
PS. Its fun thinking about these things while watching the Tour!
Scott
:
Well I think Technical Analysis works and sometimes it doesn’t. Perhaps the trick is to know when its going to work and when its going to fail…i guess its an imperfect art.
Not sure there is any concrete data out there that will support the hypothesis that it works? I’m pretty sure I’ve read alot of stuff that supports its unreliability….but then you see alot of people with superb TA based records, so its abit of a conundrum.
Nevertheless, I use technical analysis alot – but I guess its something that I just always understood from day 1 and worked for me. Was never good at fundamentals/numbers so did not have many options.
I find technical analysis works best if sentiment and valuation/fundamentals align at the time bullish/bearish breakouts/patterns/price action are occuring.
For instance if a stock appears to be breaking out but valuation looks stretched and sentiment is excessively bullish, theres a chance the stock may be creating a breakout bull trap (then again you could be completely wrong and look stupid)
Also I use technical analysis with currency trading and align news events with chart patterns/setups/contrarian thinking. I find this assists in helping timing but its still very subjective in terms of how you interpret the news feeds and chart patterns. I’m not sure its possible to learn this.
I will also sometimes interpret chart patterns differently to what the text books say. I find the more people that are aware of technical patterns at a particular moment (e.g. the newswires are preaching a head and shoulders bottom) the more unreliable they become.
Anyways, Just my 2 cents ;)
Roger Montgomery
:
Thanks Scott for adding another dimension to the discussion with your comment about charts being less reliable when more people are referring to them in a particular scenario.
Yolanda
:
Hi Roger,
I am new to the game of trading stocks – have read some of “The Intelligent Investor” (as a working Mum it is hard to find the time to finish it) and your introduction of “The (mis)behavior of Markets” has sparked my interest. It sounds like a really interesting book. As a newbie to all things stocks and shares, I don’t pretend to be an expert, but the idea of technical analysis didn’t sit well with me. I couldn’t quite put it into words other than to say I thought of it like predicting the weather – the forecaster looks at all the environmental factors and gives an estimate of temperature and the probability of rain. However, the weather has a chaotic aspect to it and sometimes they are correct, and sometimes they are not and you don’t take your umbrella and get drenched. While I am happy to gamble my comfort on the weather forecast, I am a little less keen to gamble my money. Maybe this book will help me organise my thoughts a little better on the subject!
Thanks for such an interesting blog post!
Yol
Roger Montgomery
:
Hi Yolanda,
For a newbie your articulation of the subject is excellent. Whether it has been fundamental investors or technical traders, both seem to be saying that you need to fond something you are comfortable with personally.
john
:
If the stock market approach is simplistic, Invest-fundamentals, Trade-technicals. Unfortunately, money has a tendency to “cloud” one’s judgement.
Roger Montgomery
:
Thank you John,
Would you like to elaborate? Its sounds like you are onto something and building on a theme I have identified from the responses too.
john
:
Trade with paper money and win, trade with real money and the mind intensity sky-rockets into a myriad of complexities that influences rational. Play a game of cards-for fun- so what about the result. Put $1 down.. I hope you lose, if only… the impact of money over-rides what people might be secretly, or deeply, feelling. It’s an emotion that we are not taught to respond to in a positive way. No one likes to lose money! How do we re-act to it? Share market- an investment if one can look past the immediate future. The fundamentals are right- it’s a game. Just play and let the results look after itself. You have an inner feeling that justice will prevail. To trade, one chases a short term objective. How can one achieve a trading plan in a short term?- Use the charts. It can become a passion…I hope this will happen, I hope that will happen. I hope everyone else is wrong. I can’t be wrong all the time. The mind clouds over and rational can be retrenched to the backburner. Cheers, John.
Roger Montgomery
:
Thank You John,
Very interesting perspective into the way emotions can infect the framework. Buffett said temperament was as important.
Gavin
:
Hi Roger
Just re-read the comments and there are many more than when I first responded. One in particular from caught my attention.
I agree totally with him that the key to success regardless of whether you use Technical or Fundamental is a positive expectancy.
To me neither tool is predictive. The future is simply unknowable.
I think the best possible expectancy using fundamental analysis can be obtained by identifying business with a track record of consistently high ROE – The mathematical expression of a sustainable business moat. Buying such companies should put the odds in your favour because over time they have the potential to become multi-baggers and/or pay out large cash flows. If you are wrong you can only loose at the most, what you have put in, and hopefully less if you remain vigilant.
The future is not guaranteed – business conditions can and do change, you must keep abreast of business developments and limit your losses when circumstance have changed for the worst. This is equally important as buying right in the first place.
Give yourself the best chance of great reward by buying consistently high ROE businesses at the right price. (ie a margin of safety)
Limit your risk by being vigilant as the future reveals itself.
High potential reward through thoughtful buying of quality businesses when the price offers a margin of safety and minimisation of risk through constant vigilance = A positive expectancy.
Roger Montgomery
:
Thats sounds like a rational response to me too Gavin.
Gavin
:
I’m an ex chartist – It is how I put a reasonable kitty together.
Nowadays I consider myself retired from speculating and am trying to master investing.
To my wife and sweatheart – May they never meet. This is how I think of Technical and Fundamental analysis. Both wonderful but not compatible. (well not for me anyway)
Charting requires you to think of your account in terms of being “ever current”. Market value plus cash is the basis for risk management. It’s a game of probabilities, of risk and reward. The price is always right – nothing else matters.
TA needs a positive expectancy to work – sort of like the casino has zero in roulette. The reality is every signal is not valid – but technical analysis can’t distinguish valid price signals from invalid. You have to take every one and let your positive expectancy win out over many occurrences which means lots of trades and lots of work.
Investing to me on the other hand is the swapping of a capital amount for a future cash flow. Price is what you pay now – value is what unfolds in the form of future cash flows. The markets appraisal “via current price” is totally irrelevant unless it is far enough from value for you to want to transact.
Buy right (based on fundamental evaluation of value) Hold tight (Ignoring price – unless it is to take advantage of an opportunity).
The reason I believe TA and FA are incompatible is that price must always be right in the eyes of TA and only an opportunity in the eyes of FA with no meaningful verdict on value.
Having said all the above – I still use TA to refine my entry timing – but that’s all.
I have ordered your book and look forward to it arriving.
I have been using the Walter dividend model as part of valuation method for a while – I suspect from some snippets I have caught on the BLOG that’s one cat you will be letting out of the bag in your book.
For fundamental data I use Morningstar. Quit extensive data but quite expensive. Not sure how it compares to Value Line though. They have up to 20 years of Balance sheet and P&L data. I like to base my analysis on as much data as I can get and work at an EBIT level, making separate valuations for retained and distributed earnings. I prize high ROE (before financial leverage) and I prize consistency. Companies that display both are my A1’s.
Roger Montgomery
:
Thank you Gavin,
I really seem to be fortunate to have so many articulate investors able to explain their methods, advise of their experiences and also able to educate others. As I have been saying, I don’t hold a personal view about charting but your feedback suggests there are some who are doing very well from it. What is curious is that no single method has revealed itself as dominant. There are as many different roads to success as there are traders or investors. Please keep sending through personal examples.
Ben
:
I don’t use charts most of my purchase are long term but I have about 50k or so I trades couple stock I know fairly well fundamentally so nothing scare me when price turn against me I tend to average down
No stop loss I buy low and only come out when I am on top
Sometimes it takes a day or two other time a few weeks
Other times a few months but always exit out on top
Works beautiful never a loss trade and money I make from these trades go into long term holding stock for dividend and compounding I wait when these stock get a bit of beating I snap up
Due to law suite, earning down grade or the outlook look grim and pretty damn ugly …all that get factors into the margin of safety and buy with confident
Stock I chuck into usually decent yield paying stock like CAB NVT
DMP WOW that I know again fairly well and fit my investment grade material
Roger Montgomery
:
Thank you Ben
…for sharing that simple but evidently successful approach.
swag
:
Depends on the type of trade. I only trade two at present:
i) Commodities – depend on fundamentals, gathering data re the commodity from many international sources, then may look at the technicals – e.g. MacD for reinforcement or otherwise of analysis.
ii) Futures – 3-4 technicals: stochastic, MacD, volume and AO. Generally do no set and leave, as this market can be quite volatile. Have a loss limit level and try to keep within it.
Do not touch CFDs – only feed the broker. May look at options and warrants – but still learning to walk.
Roger Montgomery
:
Hi Swag,
Thanks for sharing. As everyone can see there is indeed a bit of lingo to get used to here. “MacD” is the moving average convergence/divergence indicator. It measures the gap between tow moving average lines. I am not explaining it to recommend it to you. This is a purely didactic exercise remember. The question on everyone’s lips Swag; is it working?
swag
:
Yes, Roger. Strategies for commodities are presently at < 75% success rate.
I only trade when the fundamentals and data gathered from a wide variety of sources both stack up .
FX currently approx 60%. When first commenced this type of trade, I followed the advice of 'experts' – much to my own chagrin. Now have developed my own methods which seem to be giving me a higher success rate. I exit as soon as there is more than a 20 pip swing against the trend. Losses are now greatly reduced. As this market is highly volatile, I only trade in small amounts of $ until my understanding of fundamentals, waves etc grows. I have worked too hard for my $ to throw it away to the broker.
As stated, I am only a 'toddler' in this field, but enjoy the thrust and parry of the trade.
Who can know the mind of man, let alone the trends of market?
Roger Montgomery
:
Thanks Swag. Interesting and entertaining.
Andrew
:
I base all my short to medium term ‘trading’ on technical analysis. Whilst i agree that it tends to work better in trending markets so does fundamental analysis doesn’t it?? If a market or stock(s) are trending sideways then no one is making money.
To an extent technical analysis becomes a self fullfilling prophecy which if used wisely is a good thing, as if everyone is looking at a 200bar average and buy/sell at that point then for a shorter term trader that’s perfect as price will move accordingly.
I believe the arguments between technical guys and fundamental guys are somewhat flawed as the fundamental analysist will argue his point which is based on a longer time frame 3+years whilst the tech guy argues on shoter frames -6months. I think the answer lies in what timeframe you have. If you are an ‘investor’ buy good businesses and ignore the short term noise. If you are a trader then you are trading the noise so you can not be sucessfull if you don’t follow charts and swings etc.
What I find is most people mix it up in that they but specy companies hoping they will strike gold or whatever they are after and hold on for years with no volume in the stock whilst others buy BHP, CBA etc and sell as soon as they drop 5-10% in value
Roger Montgomery
:
Excellent Andrew,
Good to have your perspective – it brings a nice framework to the discussion. Once again Andrew I do have the same question as I posed to Swag; I am keen to know if it works for you?
Andrew
:
No doubt technical analysis has worked for me BUT only once I learn’t to understand it and settle on a method that works for me and more importantly suits my trading style. My trading method has led me to sit on the sidelines for the last 10weeks albeit two trades I have made GNS & AAX in last 4weeks and which have both been sold for profit. GNS I bought after the stock made a double bottom at around 26cents. Extreme volume came in at that level which indicated to me possible institutional buyers were picking up the stock. I bought it at 40cents and sold later at 67cents as volume started to slow. AAX similar story the stock double bottomed at around 1.90 I waited for price to cross the 5day moving average and bought at 2.12 sold at 2.47. I must note these stocks were never to be held longer than around a month as the longer term indicator the quarterly charts were bearish, It was only that they found support at near all time lows that I bought with the idea of a very short term rise in price. Other than that my market software sacns are not producing any longer term trades. This has led me to look at shorting some stocks via CFD’S. Today I shorted ASX at 28.93 based on an impulsive downtrend with a target at next support 23.52 stop loss above the previous swing high of 31.10 (to much to explain the meanings of these terms). Interesting to hear what your valuation is on ASX Roger? So we’ll see how that technical trade goes.
Roger Montgomery
:
Hi Andrew,
I am interested to see how the ASX trade goes as well! Great to have some numbers to work with. Thank you for sharing some experiences from the coal face. I am sure I speak for everyone reading the blog, what is the method that has been working for you and how does it suit your “style”?
Chris
:
As far as trading goes, I keep things very simple. I tend to use charts after making my decision. It’s an “if/then” logic.
My first step is to decide what direction a stock’s price will go. I base this on fundamentals, news, updates, rumours and the like.
My second step is to quantify this using some basic charts. IF I am right and the stock is going to go up, THEN it is likely to go up by X amount. IF I’m wrong and it goes sideways or down, is there a particular level I need to be wary of breaching?
So my use of charts is very basic and is not used to inform the initial decision. But I usually trade in mid and large cap stocks. If you were trading in small companies, it is likely that price movements will be more pronounced and unpredictable. Maybe a better understanding of charting would help me trade smaller stocks as well?
Roger Montgomery
:
Hi Chris,
In many things fewer ‘degrees of freedom’ avoids curve fitting. Thanks for sharing. Has charting been responsible for large percentage returns for you?
Chris
:
Hi Roger,
Yes, that does seem to be the case. Charting has been successful for me, often securing double digit % returns.
However I’m currently moving towards a more integrated approach to trading. Focusing on mid cap stocks, I’ll be using both intrinsic value calculations (I can’t wait for your book to be delivered!) and chart analysis. The idea is maximum safety; If I know the value of a stock, I can keep buying no matter how low it goes.
This has resulted mainly from the one very bad trading experience I’ve had. I bought a company which had just suffered a huge % hit, and the charts indicated it was an excellent buy. It was also a fantastic company that I would be happy to own long term. However, it was still trading far above its intrinsic value. Suffice to say it is yet to return to the price I paid for it. A mistake not to be repeated!
Roger Montgomery
:
An excellent reminder Chris of the importance of intrinsic values; not only to assist in generating positive returns but in avoiding the negatives ones.
Russell
:
Hi Roger,
I am continually learning, but my observations are as follows:-
Simplistically… in Technical Analysis (TA):-
Prices go up as the smart money buys in (insto’s etc. – first in and first out).
As prices lift, others get in (with the thought that if its going up it must be a good stock). The theme continues until the reverse sets in.
The uneducated usually lose out the most, on the up (in too late) and on the down by being out too late.
Simplistically… in Fundamental Analysis (FA):-
10 different analysts can have 10 different views/valuations and interpretations from the same data supplied, which can be manipulated or masked in any number of ways before publication (by those who supply the info, not by the analysts).
How many veterans with finance degrees and 20+ years in the business still got stung re the GFC!?, what chance has the average person got reading the same data?! Or worse still – being told by a fully qualified advisor that it was a good investment.
Some will still feel more comfortable with hard data (!!??) in FA.
A given stock may seldom arrive at its true fundamental price due to its perceived value. People will always pay more for a good business.
Most stocks however, will trade in a range and at times swing strongly. Anyone can buy a stock at $10 and have the potential to sell at 14, 16, or 18 etc, even if a valuation puts it at only $5. How many stocks keep trading and sustain at above their supposed valuation?
Observation and summary:
Just as two heads are better than one, being aware of both TA and FA is prudent, dismissing one completely over the other in my view is unwise.
A chart is an ongoing reflection of the market sentiment at this point in time, rather than from figures worked at 6 months ago (Annual Reports etc).
From what I have observed – TA gives one a view to what IS happening rather than what SHOULD be happening due to the FA. However, when used together, if the FA and the TA are both positive the probabilities of price increase is surely higher than relying on only one.
If nothing is certain, getting the odds and maximum probability on our side by two methods is surely better than only one?!
Roger Montgomery
:
Thanks Russell,
That is precisely what I am trying to find out. I would like to know however, if anyone can point to a trade or an investment, where they used purely technical analysis and made a substantial gain. If we can get a hundred examples of this, then we may have a very useful trend.
Joe
:
Hi Roger,
Thanks for the added invitation to make a first post.
I only took an interest in shares during last 4 years and as a newbie wondered how one could risk hard earned money on charts.
As a business operator I became heartened to learn that some people based thier decisions on fundemantals.
I can see the charting is a real measure of a stocks popularity and that may influence you as to WHEN you buy…but the fundemantals to me seem the basis of which stock it is that you are preparing to buy and will buy…just a matter of when the price is right
I bought WOW based on my understanding of fundementals and it has dropped a bit and seems to be going nowhere in share price…but I know it’s a good business… I don’t know if the stock price will rise…but buying a stock just because it is popular is bizare.
Roger Montgomery
:
Hi Joe,
I subscribe to the idea that if you buy a great business below its value and that value continues rising, in time the share price will reflect the value in the same way that arbitrage narrows pricing anomalies. What I am also interested in is whether I should ignore charts as Mandelbrot appears to suggest or whether there are some fine tuning benefits. I would still like to see some posts from people for whom charting has been responsible for substantial returns. I am looking for hard evidence.
Ben
:
Hi Roger,
I have a book at home called Trend Following by Michael Covel. Detailed in it are some of the methods various hedge funds have used to make substantial profits in the market – all technical rules based stuff. An interesting read if you ever get a chance. But you will find that there are plenty of investors who have made fortunes based on charts and technical analysis alone.
Having completed the CFA program, I can vouch for some of the things you say about risk, portfolio construction and EMH. To me, markets are very inefficient in the short-run but probably efficient over the longer-run. In fact, that seems to be something you also believe in. Also, volatility is not a very good measure of risk.
Overall, I’d much prefer to be investing based on fundamentals rather than technical rules. The reasons for the market being inefficient in the short-run are likely to always exist, so being a value investor simply makes more sense. Plus, there’s also a certain fulfilment from exercising your brain a little, rather than just following mindless rules. There are too many gray areas in technical analysis and such “financial astrology” hardly seems reliable to me either.
Looking forward to your book, cheers
Roger Montgomery
:
Hi Ben,
At this stage I am in agreement with you but of course we don’t learn anything if we don’t keep our minds open.
Stephen
:
Hi Roger
It’s like that saying you always see below performance figures, previous performance is not an indicator of future performance.
Chart’s are based on previous performance which is completely independent of future performance. There is research that proves that future movements in price are never the same as what has happened in the past.
Markets act irrationally and not according to any historical chart. It’s what happens in the future that makes prices go up or down.
Warren Buffet said himself that he tried charting, but when he turned the chart upside down, it did not tell him anything differently.
Technical analysts trade in accordance with previous movements in the share price when a lot of the time the historical share price does not reflect the future prospects of the company.
Roger Montgomery
:
Hi Stephen,
That is a very rational argument. Thank you for sharing it with everyone.
Russell
:
charting has saved me from buying many stocks too early in a correction it does improve the strike rate without question but I do not use it in isolation.
Roger Montgomery
:
Excellent Russell,
Thats great stuff. Have you got some war stories you can share – some examples perhaps?
Lindsay Hackett
:
I agree with Peter (1 July 2010). I have tested, as best I can, many indicators over lengthy periods of time (like 2 years, at various times – first started in 1985). As a forecasting technique, all have proven useless, no better than the flick of a coin. All will seem to work sometimes, but then fail dismally; chance is like that.
An interesting study of the Fibonacci indicators was done by the academic Roy Batchelor, HSBC Professor of Banking and Finance, London, and researcher Richard Ramyar. This was published under the title “Magic Numbers in the Dow” in Sep 2006. The study showed that this indicator produced results no better than chance.
If enough people employed the techniques rigourously, then the prices of stocks would tend to behave accordingly because of the self-fulfilling rule. But, unknowable, external factors will still tend to confound all.
Roger Montgomery
:
Thank you Lindsay,
Some concrete data. Very useful. But we also have Ben’s post saying Michael Covel’s book Trend Following details the fortunes made by hedge funds that use purely technical analysis.
steve
:
I used to think T/A was mumbo jumbo but it works and it works well.
The key to charting is to keep it simple and don’t over analysis stuff to much. But it is the same as any venture you get back what you put in. It takes time to understand price action and what it is telling you and it takes discipline to follow your rules when the price action turns and your stops are hit. Most of the time if a trader fails at charting it is because his/her expectations are way to high about win loss ratio’s and they take a loss personally which will kill them as a trader
Of course with all investing, money management is the key to success. Not to sure why Peter says above that when the market consolidates or congests then you lose money. If you get into the start of a trend and follow it until it tells you that it has ended then you are not giving anything back or losing.
Trend following works and is a very powerful way to make many times % what you would other wise. I call charting fingerprints left by the punters. And punters will and do make the same mistakes over and over again and that leaves certain patterns to repeat over and over again and it’s giving you an insight into what “might” be about to happen.
I don’t really understand Pete’s comment
Technical analysis signals can be lagging.
I would need him to point out which ones are. I find the ones that hardly anyone follows are the ones that give you the edge these days.
I’ve found using indicators is a total waste of time and price action is the best indicator of all. Things like RSI,MACD, MA etc etc are all lagging and don’t help that much
Charting , it works and it works very very very well if you put the time in to learn it. Better still if you can find a mentor of some type or can short cut your education.
Cheers
Steve
Roger Montgomery
:
Hi Steve,
An excellent post Steve. Thanks for taking the time to write. Sounds like you have gone beyond just charts and have developed some trading algorithms. If you are analysing ‘risk of ruin’ and ‘adverse excursion’ I suspect we might have strayed a little from the question of whether good old charting works. Clearly it has for you. Can you share with us a few examples of your wins and losses?
steve
:
Thanks Roger,
Before I did charting I actually got wiped out in the Tech Crash, so that was my worst loss. Most of my worst losses have come because I wasn’t in control of my emotions not because I wasn’t good at charting. It also helped when I did a course which simplified charting and price action to a point that it just seemed easy in the end to read a chart
I had a broker in the tech days who went purely on F/A and convinced me he was a genius. I take full responsibility for believing that. These days I keep my losses to 2% of my trading capital about 90% of the time. I still break a few rules but have nearly eradicated my bad traits all together.
I get about 50% of the calls right just like a coin flip but it’s what I do with the bad ones that count. Also having a few patterns that create a positive mental state/confidence are crucial to me because I know they work over and over again. But understand that they won’t all the time.
Some of my best trades have been on the short side , BOQ, RIO,BHP and recently WHC I was bearish when most people were bullish coal stocks ( I actually emailed someone here who has posted before me, my thoughts on WHC back in April) Long trades are done with the same pattern I used for the shorts. This pattern came up on the XJO, SP 500, FTSE, and the DOW march 2009. It suggested a major low was in place. Another simple pattern triggered a long in CBA last year
This pattern has also triggered a strong buy for TLS a few months ago when everyone else was saying all doom and gloom for it. I’m still long TLS and have had some cracker debates with some punters over the last few months who just rubbish the company based on their emotions and because they have lost money on it
So all in all my win/loss ratio doesn’t really matter to me so long as I stay disciplined and keep to my stop losses and get set into a trend just as it’s beginning which I believe charting can do.
Cheers
Steve
Roger Montgomery
:
Thanks Steve,
…and it sounds like thats what it really does come down to in trading. Thank you for bringing some real clarity to the discussion.
Reynard
:
Mondelbroit is an academic i.e. he deals in theory, and is without dirt on his boots and dirt on his hands in the market. He does not understand the use of probability in letting your profits run and cutting your losses quick. I would not give him a single dollar to manage.
My SMSF went up this past financial year due to four practices:
1. chanting 10,000 times each day the mantra that “my job in the market is to buy upward trending stocks in and upward trending market, and get out when they tip over.”
2. use of three short-term moving averages, plus the relative strength comparative indicator, plus Volume.
The rules used are when the two quickest moving averages cross the longest upward, buy. When the quickest MA moves down through the middle term MA, sell.
Of course the market must be in up-trend using the same moving averages, or you must remain in 100% cash, which I am at the moment in this nasty downward trending XAO.
Tell Mondelbroit that the theory involved is that there is a 70% chance a trend when established, will continue.
3. use of the volatility method of money management for position sizing.
4. all positions are protected at all times by 6.5% stop limits. Of course the moving averages get you out most times before a 6.5% fall, but the stops are there in case there is high volatility. Risk management and capital preservation is crucial (a practice unknown to most brokers and financial planners, who charge a premium price to just let their clients portfolios float up and down on the tide of the market, without any risk management by the use of stops. Of course all brokers rigorously use stops in their own trading books).
This four part methodology gets you into the market quick when the market trend turns into definite up trend as measured by the moving averages, and out quick when the market turns down. Ideal for the current market volatility.
The RSC ensures you buy only stocks the market is playing with, by only buying stocks with an RSC of +25% on a 26 week daily chart (+50% on a 52 week chart).
It is a deadly system for those who have the dispassion to follow it with rigorous discipline. Of course 9 out of 10 cannot as the market amplifies human emotions, leading to many errors of execution.
Roger Montgomery
:
Thank you Raynard,
Thanks for your post. Them theres fighting words! In Mandelbrot’s defence, I would argue he does appear to know something about probability. Having said that you have provided a very specific set of rules to follow all of which is based on price action. Thank you for that. I am sure you have done all of the back testing and out of sample, maximum adverse excursion analysis etc. Do you have some results you can share with us? Perhaps an example or two of a trade and how it worked out? Do you have some examples of any false signals and how many of those you get? I am sure you have piqued the curiosity of a lot of people.
Bruno
:
Hi Roger,
I’ve never used charting to decide whether or not to buy or sell a stock, I have tried to learn about it and may use it to set a buy or sell price, but only after looking at the fundamentals and future prospects. The problem I see with charting is that people are very good at picking up a trend, but very bad at picking up a cycle. I see it as a classic case of people making sheep look like independant thinkers. Just knowing that lots of other people look at charts, and only charts, makes me certain that prices overall will never reflect value, and knowing this we can take advantage of our good friend Mr market.
Its good to see Mr market has brought out his range in this years half yearly clearance sale. I’m just waiting for his top shelf items to come on sale as well. keep up the good work, I wonder if mr market can do us a better price for woolies?
Roger Montgomery
:
Hi Brune,
The voice of reason. We should be open to the possibility that there are things we don’t know and therefore should seek to explore, uncover and test.
Ian
:
Hi Roger,
I have never found a charting method that works well for me.
I have looked at some and guessed what would I do by the historical charts but I never found anything that I could be confident in. Though it does seem to me that you can use any charting method you like and it will work Ok for you when share prices are going up ;-).
Having a full time Job and a young family I have enough trouble just trying to find time to identify what are the good companies to be considering buying and don’t have rally have much time left to spend charting.
One thing that I will say about it though is that they can become self fulfilling prophecies. So if enough people believe that a price is going to move to a resistance level then it possibly will. So I find it can be interesting to listen to what a technical analyst says about a share price when you are considering buying or selling. If you are looking to buy and all the people that are following the charts are waiting for a certain level or signal before they to buy then maybe you can watch a price to see if it gets down near that level.
If charting worked all by itself and all you had to do was follow simple rules to make heaps of money then there should be some very rich computer geeks somewhere that have written the computer program that knows exactly when to buy and sell to make money. I have never met anyone that has done this.
I think charting must have some merit because as a share price rises less and less people will want to buy and you would expect buying volume to drop off until the point that nobody is stupid enough to pay more and some people who made a quick profit on the way up start to sell and then the price must stop rising or start falling. I am sure that it would be a fascinating thing to study if I had the time and can be useful for investors.
Roger Montgomery
:
Hi Ian,
I am sure many will agree with your appraisal. Thank you for taking the time to write your post.
Lloyd Taylor
:
Roger,
Sure charting works, but significantly less than 50% of the time!
Try driving a car by constantly looking at where you have been in the rear view mirror, while thinking about past patterns of acceleration and braking and you will come quickly to understand the problem with this approach.
I am with Mandelbroit on this subject.
Regards
Lloyd
Roger Montgomery
:
Welcome back Lloyd,
Thanks for sharing that insight. Would you care you express an opinion on the bid for Mosaic?
Lloyd Taylor
:
Roger,
You asked for my opinion on the acquisition of Mosaic (MOS) by AGL (AGK). In few words, it is a great deal for MOS shareholders and the flip side of this applies to AGK shareholders.
Valuation
MOS has small hydrocarbon reserves (mostly tight gas) and is amongst the higher cost gas producers. AGK is paying well over the top on the basis of reserves and associated DCF value.
Strategic Rationale
According to one media source: “The deal has analyst support. Goldman sees gas storage as a sensible path to increasing the flexibility in AGL’s wholesale gas portfolio for the longer term.”
Gas storage will be a key element in maximizing value from the large volume of pre-LNG production build-up gas that will be pushed into the east coast domestic gas market in the next five (plus?) years from the Coal Seam Methane (CSM) players. This is the result of the inflexibility of the CSM production process compared to conventional gas production.
However, to make the market in this gas it is only necessary to have flexible access the gas storage. It is not necessary to own the storage to achieve the requisite flexibility in a wholesale gas portfolio.
Gas Storage
Gas storage is a utility business with associated low single digit rates of return. The Mosaic Silver Springs gas storage facility, currently in development is of modest size and characteristics that rate it as an adequate rather than great (flexible and low cost) storage facility. Other depleted gas fields potentially offer improved gas storage potential. As a result, Silver Springs offers no sustainable competitive advantage/moat in terms of gas storage.
Capital Intensive Industry
The energy business (oil and gas specifically) is capital intensive and inherently conservative, due in large part to the dominating influence of large engineering staff who love to build own and operate things/facilities.
To be a top tier performer in the energy industry requires strident effort to decapitalze the business, an approach that 99% of industry players will not embrace for cultural reasons (or is it lack of imagination?).
AGK’s approach to gas storage is the conventional build, own and operate approach that is the bane of a capital-intensive industry. A more innovative business development model and associated business structures could achieve an increase the flexibility in AGK’s wholesale gas portfolio for the longer term, without the need to own, let alone overpay for gas storage.
A Caution
Beware acquisitions the value of which contains a large strategic premium. In my view the current play on MOS is just another variant of Peter Lynch’s “diworsification”.
No doubt the MOS defence team will come up with all sorts of elevated valuation based on spurious energy price assumptions and improved operating efficiencies in order to drive the price higher. Just don’t believe it if you are a MOS shareholder, or even worse an AGK shareholder.
Note that neither AGK (with an ROC of 6.8% and ROE 6.5%), nor MOS (with ROC and ROE 8.8%) are A class businesses.
Which leads to a General Rule
Your readers simply need to remember; the marriage of two capital-intensive donkeys will never produce a racehorse.
Regards
Lloyd
P.S. Had a great trip, driving 2,000 miles in California. Stimulus funded road works everywhere! Little other construction in evidence, but lots of shelved private sector projects. Structural imbalances are very apparent, but that is another long story. The economic situation: on life support for the foreseeable future.
Roger Montgomery
:
Hi Lloyd,
Thank you for sharing this pithy reminder. Was the donkey reference yours? Mind if I borrow it? My pre-bid (and indeed going concern) valuation for MOS is 3 cents (arbitrage opportunity aside) so agree with your contention that its a great deal for MOS shareholders. ‘Strategic’ is indeed a rather common justification for overpayment. “Sale and lease back” causes allergies in this mine-is-bigger-than-yours sector (pun intended). Good to have you back Lloyd.
Lloyd Taylor
:
Roger,
The donkey metaphor just popped out as I punched away at the keyboard. I am more than happy for you to use it. Plenty of applicable situations, often promoted by the gurus of investment banking and equities analysis, surface in any month, so there is a lot of scope for consideration of the metaphor.
My approach to achieving the wholesale gas flexibility that is presumably sought by AGK would not involve sale and lease back. Rather, it would evolve around balancing within existing contractual arrangements. As CSM build-up gas flows into the market some of AGK’s conventional gas entitlements could be left in the ground for a time creating “de facto gas storage”. This would probably involve some negotiation and trade-offs and some incremental gas haulage cost for greater flexibility within the existing conventional gas contract portfolio, but would not require capital or engineering, just some “commercial smarts”.
And you are absolutely correct to note that “mine is bigger than yours” mentality dominates the thinking in the sector, when the real issues is the capital efficiency and operational effectiveness of the business. Its not what you got, but how you use it that is the determinant of investment quality in the energy business generally and the oil and gas sector specifically. But few business management teams and certainly no analysts seem to appreciate this point!
Regards
Lloyd
P.S. I would not argue with your ongoing concern valuation of MOS. On some optimistic assumptions you might make it to five cents, so there is plenty on the table in the AGK offer.
Roger Montgomery
:
Thanks for that Lloyd,
I am reassured to hear you agree.
Lloyd Taylor
:
Roger,
Back to the subject of charting and TA; I’d like to hear from the advocates of this approach how they see the MOS opportunity.
The MOS chart sure took a big move up at the start of the month.
Where to from here on TA analysis (alone) and what move should the investor make?
Regards
Lloyd
Roger Montgomery
:
An excellent question indeed. Can it predict an even higher bid? Can it work in the absence of knowledge of the forces that caused the so-called break higher?
Michael Hackett
:
Hi,
A short disclaimer on my TA skills, as I trade forex not equities. I don’t have any charts available to me other than the asx.com.au ones. Therefore this analysis is rather long term.
There is some good resistance at $1.80 and also at $1.20. Seeing as the long term trend is down I would look at a short at $1.65 with a stop loss of $2.08. The price would have to close on a daily bar above this before I put a limit order on. This doesn’t look very liquid so I would move to break even early. Should that trade fail because of the early reversal signs then I’d wait for a whole week above $1.80. Generally I don’t want to be the first into a rally or reversal, it is too risky.
Early reversal signs on the ten year monthly ASX chart are:
1/ inverse head and sholders starting the end of 08
2/ the October 08 monthly low is lower than the February 09 low. The almost pinbar inbetween them shows some strong downward force but even with a long down trend it couldn’t continue.
Interestingly, if this was in the direction of the long term trend or I was feeling like taking some risk (maybe if I knew the company was value-able) I might have entered long in April 09 around $1.10.
Would have could have, never made a cent but it is interesting to look at these patterns :)
Roger Montgomery
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Hi Michael,
Thank you very kindly for your comments. Very interesting insights and I sense a strong conviction in the way you have presented your ideas. Just to let you know, I am no longer commenting in detail in this post.
Nick Radge
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Hi Roger,
An interesting discussion and one that will certainly generate debate.
As you’re aware I am 100% technical and have been so for 25-years. I obviously won’t state the obvious bent in my theories, so I’ll save your readers.
One thing I would like to stress for consideration is that its my strong belief that technical analysis is not what makes the money. I do not view technical analysis as a ‘predictive’ tool and therefore distance myself from those that see it that way. There are certain extensions of technical analysis that do lend themselves to ‘probable outcomes’ such as Quantitative Trading. I would classify all my own trading in this area – and trend following would be one of those.
The basis of making money in any form, technical or other, is the simple mathematics that creates the positive expectancy. Again I’ll generate vigorous debate, but at the end of the day even fundamental analysis/value investing requires a positive expectancy to be profitable.
The bottom line, in my humble opinion, is that technical or fundamental analysis are simply tools to be used to create a positive expectancy – nothing more. Neither are better than the other, except that the user must be comfortable using them.
Regards
Nick Radge
Roger Montgomery
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Hi Nick,
Great to hear from you. Thanks for adding another refining view to the discussion. Positive mathematical expectancy is something casinos use to great advantage and if the market is indeed a pari mutuel system, it makes sense to look for it here to. In other words bet big when the odds appear to be out of whack. I know that can be done with an analysis of a business and its intrinsic value, I am also interested to hear who’s doing it using charts.
Robert
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Hi Roger,
Great post. I have been investigating making money in the share market in earnest for just under a year now – and have been studying the in’s and out’s with as much intensity as possible, considering other commitments. in the last 4 or 5 years, and up until about a year ago, I was only buying shares within my superfund, and to my delight, I have done quite well. But the results were, I feel, only vaguely educated luck. And looking back, my trades were very foolish gamble’s. I decided that this situation needed correction and as a starting point began to look at who were the most successful in this game – which of course lead me to you know who (plural) – and eventually on to you. So far I have read all the most popular books on value investing,and even some on charting, and to me, the value approach just makes the most sense. Following this method, assuming there is some truth to charting, and from a purely educational standpoint, there seems to me to be a larger scope for error – which could of course cripple your ability to master any legitimate skill there is in it. I can accept that for example, that Fibonacci numbers surround us in nature, and that they somehow dictate genetic expression – only because it has been proven ,but I have a very hard time believing that collective human behaviour is dictated by some underlying math. I believe the only reason – if at all – that making money by charting is possible – is because everyone knows and follows the accepted rules – turning the situation into some kind of tautology.. happening because it happens. Without knowing mandelbrolt’s views, I guess I have come to the same conclusion (although, I couldn’t hope to express it so eloquently): that no chart can predict the unexpected event, like war or the PIGS problem. Observing the expert charters prognostications on the TV and in print, has shown to me that if they get it right at all, they get it wrong just as often. There maybe a couple of people who seem to get it right, but to follow their methods as demonstrated is just too difficult… especially at my point on the learning curve. Value investing is by its nature very careful and considered, while charting seems to promote costly hyperactivity. That’s my perspective from an amateur’s viewpoint.
But like all things, i’m more than happy to be wrong for educations sake.. Are you starting to change you views on charting?
Roger Montgomery
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Hi Robert,
Your views I would argue are expressed with extraordinary eloquence. Well done and thank you. I am not expressing any view about charting myself. I have no view. As a value investor, I am simply interested in hearing what everyone else has found and experienced.
Cam
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Roger,
Over the years I have read some techinical analysis books and looked at using the techniques in the market, but have seen similar things to what Peter said in the previous comments. It’s only in the last 6-8 months that I have begun to appreciate Buffett, Graham and also your own work to see how stepping back from the market and actually looking at the business is more valueable. Saying this though with regards to Superanuation where for the majority of us our money is tied up in a retail/industry fund, most funds to a large degree follow the market and hence we have little control over the individual stocks. I am wondering whether following the widely talked about 200 day moving average for instance would have at least allowed us to better move our super into cash in the past when the market fell during the GFC. It seems that this does prove somewhat of a barrier in the market, possibly because so many people follow it. I would be interested in your thoughts.
Roger Montgomery
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Hi Cam,
I have every confidence that a whole range of moving averages – by there very nature – would have helped in a large decline like the GFC. The problem, as I understand it is that they also may have had you exiting in declines that were brief and had you not had the temerity to re-enter may have missed substantial gains. But of course than can happen whatever the method.
James
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Hi Peter
Being classicaly educated, in simple terms free cash flow drives return on equity and combined with the doctrine of the reverting mean results in the share price.
An investors daily buy, sell or hold decision can then be made.
Share value is about “boards wisdom” over leaders and managers ability to deliver maximum free cash flow, globally.
I thought there might have been a way to eliminate risk (financial loss) through derivatives, however if you pick the market going the wrong way, you lose; at least “something” at best and everything at worst, (a practice many day traders and so-called professionals would have felt over the last 10 years).
Paradoxically, most pricing and arbitrage models have an “e” for error, which explains everything else away.
Share price charts are a result of “what was”, not “what is or will be”. What is or will be is the “minds” of leaders and managers and their ability to execute vision and manage risk and hopefully a bit of “wisdom” for good measure.
Roger Montgomery
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Hi James,
Thanks for that very insightful post. There’s seems to be a theme developing amongst the posts along these lines. I am very interested in seeing how these themes progress over the next few days. Keep in mind I am not expressing any view of charting myself. I am simply interested in the experiences of others.
JohnC
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My parents were firm believers of technical analysis and chartists’ publications. Since then, they have stopped, principally because they were not sufficiently rewarded for their efforts and spent time. From their experience and literature, I have come to understand two things about TA.
There are a multitude of ways to read & respond to the charts. There are some which are really popular but nobody, least of whom myself or my parents, has any idea who is using which method at a particular time and the size of their funds. I have heard that up to 60% of sharemarket trades in the US are now controlled by automated processes running complex algorithms, a system that I view as just an inhumanly-high-speed form of TA-trading.
In short, there is information in the charts about what other humans (or programs) are doing but it is far too fragmented and is therefore useless to me and my parents. It is akin to knowing the universal laws of physics but having no means of measuring all that is needed to predict the fall of a rock down a hill.
Where I saw the most benefit to my parents’ work before they dropped TA was the level of discipline that TA enforced. It took some of the hand-wringing, back-slapping and conflict (mental and interpersonal) out of the work. Make no mistake about it, good results from technical analysis seems to require very hard work and enough money to stay solvent during bad runs (if objectively using one’s preferred method).
By way of comparison, reading annual reports, attending meetings and presentations suddenly become less of an ordeal. Value investing brings that peace of mind that comes with being in control of one’s own decisions and conclusions. With TA, the persisten feeling is of being caught up in a stormy sea on a leaky tin boat and a broken oar.
Roger Montgomery
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Thank for that analogy John,
Thus far I have to concur as I have not seen enough examples from the posts that have been made to make any change to my approach or to convince me yet that I should begin exploring any particular avenue. I am however still keen to hear of some actual examples and remain open to being shown something powerful and new. If you have a thought go right ahead and share it.
Peter
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My thoughts on Technical Analysis are follows –
Positives.
Works well in strong trending markets.
If you follow the rules properly and use trailing stops, you can get out early to minimise losses and lock in profits before they turn into losses.
There is no emotion tied in with the stock – Its just a ticker code so you can buy and sell without much thought other than following your buy and sell signals
Negatives.
You tend to over-trade.
Brokers love it because they keep earning commission.
In a sideways market you will continually get stopped out and incur small loss after small loss which adds up to one big loss.
The price can dive through your stop loss. You are then in a dilema, because if you sell you will lose more than what you had allowed for ( what do you do then ? )
If you are carrying losses that dived through your stop loss, you will end up panic selling for much less than what the stock is worth, because you know nothing about the fundumentals of the stock and you start to lose your confidence in your buy and sell signals.
Technical analysis signals can be lagging. In the majority of cases, by the time you get a strong technical signal to buy, the stock has made its run, so you end up buying it at the top of the run, or paying too much.
In summary- You will make good money, if you start using technical analysis and you are lucky enough to have entered a market that is trending strongly upwards. However you will give it all back when the market enters a consolidation / sideways movement or when it changes direction. So in the end, you will give all your profit back and end up with zero over time. If you are not diciplined you will most likely lose money as well.
Roger Montgomery
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Hi Peter,
Thank you for sharing your insights and personal experiences. I am sure there will be a large number of investors who will be very interested in reading about this and many other experiences. If you have every tried charting or you use it now and, like Peter, can offer some insights, suggestions, ideas or warnings to other would be chartists, be sure to click the “Leave a Comment” link below.