This is the third article dealing with cognitive biases that totally screw up your decision making. The first article, Know Thyself, covered anchoring, confirmation bias, herding, hindsight bias, overconfidence, and recency. The second article, Know Thyself II, covered availability, calendar effects, cognitive dissonance, disposition effect, and loss aversion/risk aversion. Most of my education on behavioral investing came from books by James Montier, Hersh Shefrin, and Thomas Gilovich. Two great websites for this stuff are from Tim Richards and Martin Sewell.
When I started getting interested in technical analysis, there was no internet, no Amazon, only bookstores. The investing section was usually quite small and the technical analysis sub-section only had a few books. Fast forward today and things have changed considerably. Fewer bookstores and most available online. Amazon seems to dominate. Technical analysis books are everywhere; you have your giant bible-like tomes from Kirkpatrick, Pring, and Murphy. There are hundreds dedicated to a single discipline and there are still many in the “get rich quick” category.
I am not sure why there are so many vague and totally subjective analysis techniques that have become part of technical analysis. Probably because the main stream Wall Street and their marketing department, academic finance, does not follow technical analysis like they do the accepted rubbish from the ivory towers. Early in this WHY series I tried to be convincing that technical analysis’ basic premise is the analysis of price; price that is determined in the auction marketplace.
Overbought / Oversold – These terms have got to be the most over-used terms when talking about the markets. Overbought refers to the time in which the prices have risen to a level that seems as if they cannot go any higher. Oversold is the opposite, prices have dropped to a point it seems as they cannot go any lower. While this sounds simple enough, the term is usually based upon someone’s personal observation of price levels and not on sound analysis.
There are many reasons I use technical analysis instead of some of the other analysis methods, but more importantly I have faith in it. Read on!
The other popular discipline is called fundamental analysis. This method of investing is essentially based upon fundamental ratios or as they are often called on Wall Street, multiples. Many followers of fundamental analysis also break it down further into a growth or value approach. The more aggressive growth approach is the hunt for stocks that are currently not registering any multiples (no earnings, no sales, etc.) and they are sought because of the analyst’s assessment that they have potential for growth. The value approach deals with good multiples (good earnings, good dividends, etc.). The value approach is what Warren Buffet uses. Gosh, if he uses it, it must be good. Keep reading!
Why are there entire businesses setup to make forecasts? The answer is quite simple; forecasting exists because there is a giant market for it. Investors/traders thirst for forecasts. Here is the real question; why do investors want to hear/read forecasts?
“Those who have knowledge don’t predict. Those who predict don’t have knowledge.” Lao Tzu
I often hear technical analysts performing their craft on economic data, derivative data such as the AD line, and a host of other data sets that do not trade. Why would you do that? The most basic premise of technical analysis is PRICE, the price that is determined in the auction market by traders and investors making decisions. Price is an instantaneous view of supply and demand.
Webster defines Odds and Ends as different kinds of things that are usually small and unimportant. I would prefer to define them as sort of important. I’ll use this format for issues that I cannot justify an entire article on. So expect Odds and Ends II at some point.
If you buy a mutual fund you are not buying a money manager, you are buying an objective manager. Let me explain. Many, if not most will choose a mutual fund based upon its performance over a period of time or the victim of exceptional marketing. Too often I think the period of performance is void of bear markets such as the last 7 years. This does not give a valid representation of the fund’s performance over the long run. The fund rating companies show 3-year, 5-year, 10-year, and since inception or at least close to those. Many funds have only been in existence much less than the 10-year time period. Okay, I drifted off subject.
From the dictionary: Why – a noun - a reason or explanation.
I’m going to write a few articles on why technical analysis is valuable – I’m calling it the WHY series. I spent 15 years in front of advisors at the large wire houses and insurance companies selling them on technical analysis. These articles will reflect some of the concepts that seemed to work well when “selling” technical analysis. I’m sure you have been asked by non-believers why you use technical analysis; this might give you some answers.
Warning! This is a sales pitch for my latest and last book, Investing with the Trend. Instead of hearing from me, I have included a few actual reviews from readers. I basically tell people that I dumped 40+ years of experience in this book. There are many things in this book that others would never say – I did not hold back as I think some things in modern finance and technical analysis needed to be said.
Personally, I would not recommend the electronic (Kindle) version since there are hundreds of charts and tables in the book. Enjoy!