The Lowdown on Technical Analysis
Wise Words from Warren’s Wife
A Smart Package
I just read a fairly scathing post on the Web supposedly detailing why technical analysis of stocks is useless and why fundamental analysis is the only reasonable method for those who actually want to make money in the market.
I was less than amused.
For one thing, the whole piece was so dismissive that it amounted to “Numbers Rule and Charts Drool!”
For another thing, the writer set up a straw man of the sort that a logic teacher would have sent him to the corner for in years past.
By asserting that technical analysis was useless when used only by itself and only for long-term stock investing, the writer set it a challenge that it was never designed to meet.
The piece also cited an academic paper on technical analysis that “proved” that technical analysis produced crappy results in more than 50 countries!
Then, just to heap up the abuse, the writer gave a list of famous investors (including Benjamin Graham, Warren Buffett and Peter Lynch) who used fundamental analysis to build great fortunes.
It’s true, but it’s not fair.
Guess what, drag racers also don’t do well on NASCAR tracks and marathon champions tend to come up a little short in sprints.
Personally, I find this kind of sand kicking distasteful, but here are a few rebuttals.
First, anyone who uses technical analysis as a complete guide to stock investing is either a swing trader or an idiot. Such a person would have to ignore the wealth of revenue and earnings data available on the Web, plus give the cold shoulder to market analysis, sentiment, macroeconomic trends and seasonal factors.
Second, headline investors like Ben, Warren and Peter built their legends by handling enormous amounts of money in mutual funds. And it’s close to impossible for large mutual funds to respond in a timely way to technical signals. It takes miles and miles to turn an aircraft carrier around once it has a head of steam up. Big funds operate on valuations and economic projections because those factors fit the constraints imposed by their lack of agility and their long time lines.
Third, the research paper that “proved” that technical analysis didn’t work in more than 50 countries is a red herring, the kind of scurrilous statistic that would have the logic teacher pointing toward the corner with the stool and the dunce cap again. Yes, it’s true, if you design your analysis to show that the mindless application of technical analysis is a bad idea everywhere, that’s just what it will do.
My own approach to stocks, and the one that I use to make selections for the Cabot China & Emerging Markets Report, is about as eclectic as I can make it. I am deeply interested in the general health of the market and which way the indexes are going. I know that it’s just as hard to swim against the tide in the market as it is in the ocean.
I also want the strongest fundamentals I can find, looking for companies that are growing revenues and earnings as quickly and consistently as possible. There’s no substitute for growth, especially when you’re trying to pick stocks that will also be attractive to the whales who control the market.
Then, I want to understand the company, its appeal of its products and the size of the potential opportunity.
And finally, I use technical factors in two ways. First, a good chart can tell me when a stock has positive momentum, good volume support and is under-or outperforming the broad market. Technical screens locate likely candidates for further analysis and tell me when to buy and when to sell. There’s nothing like a breakout from a cup-with-handle base to grab a technician’s attention. Even the market timing indicators that Cabot uses to gauge the health of the market are technical in nature.
Taken together, I call this the SNaC approach (for Story, Numbers and Chart). As a growth investor with an average holding period of around six months for a stock, I will take every scrap of information I can get. Using the nimbleness that comes from being an individual investor with easy-to-buy/easy-to-sell positions is one of my favorite advantages.
I don’t have a single bad thing to say about fundamental analysis, but I think anyone who uses it all by itself is making a big mistake. Do your research. Watch which way the wind is blowing. Pick your spots. Be ready to jump before the ax falls.
A few years back, there was a lot of buzz about Warren Buffett’s monumental donation to the Gates Foundation. It deserved that buzz, because it was (and remains) the largest charitable contribution of all time. But it was also remarkable because it amounted to the second-richest man in the world (now third) giving the bulk of his wealth to the richest man in the world (now second), who, in turn, left the helm of the company that he built in order to pay more attention to the best way to give away the bulk of their combined wealth.
But one aspect of the story that I especially like is the reaction of Buffett’s children and grandchildren. Warren has said that he doesn’t believe in dynastic fortunes, but the amazing thing is that his progeny don’t seem to believe in it either. In an interview with National Public Radio, Nicole Buffett (one of Warren’s granddaughters who’s an artist in San Francisco) talked about how proud she was of him and how her family was raised to basically ignore Warren’s billions and just get on with making a living for themselves.
Late in the interview, Nicole talked about five sayings that her grandmother, Warren’s wife, used to drill into her kids and grandkids. They’re pretty basic, which is what you’d expect from a down-to-earth, value-investing family, and they’re also pretty good.
1.) Show up.
2.) Tell the truth.
3.) Pay attention.
4.) Do your best.
5.) Don’t be too attached to the outcome.
The first four are exactly the kind of sentiments you’d expect to find embroidered on satin pillow in your grandmother’s house. But number five is a more profound and unexpected piece of advice, and a great lesson for all investors.
Investing, especially growth investing, always requires a leap of faith. You can do all your homework on a stock, check the fundamentals, analyze the chart, read the coverage from analysts and commentators (and newsletters like ours), and calculate its potential for hours on end. But eventually you have to make the decision to push the BUY button. And then the fun begins.
I know from talking with many Cabot subscribers that some investors follow the progress of their stocks with an interest that borders on obsession. For some people, having a stock that goes down can ruin an entire day, in the same way that others are buoyed or bummed by what the bathroom scales tell them in the morning.
The problem is, that doesn’t make them better investors. In our growth publications, we fully expect that a few of the stocks we recommend will curl up and die like cut flowers. We don’t like it, but experience has taught us this over and over. And if you can’t tolerate buying stocks and then selling them when they turn up their toes, you may not have the right temperament to be a growth investor. As Warren Buffett’s wife would say, you’re too attached to the outcome.
Obviously I’m not suggesting that you shouldn’t care about making money. But being too attached, taking it personally every time one of your stocks takes a dive, can only hurt you as an investor. It will make you too reluctant to jump into stocks that seem like less than a sure thing. And it can also cause you to hold onto losers longer than you should because you don’t want to finally admit that they’re not going to be the huge winners you’d hoped for.
The lesson is to keep your investments, especially your growth stocks, in perspective. Picking winners doesn’t make anyone a better person. And getting tagged with a few losers is all part of the game. It’s the process that counts–cutting losses short, letting winners run and staying in sync with the market. Do those three things and you’ll be ahead of 80% of investors.
People have been trying to follow Warren Buffett’s investing advice for years. But maybe listening to what his wife has to teach can also be helpful.
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Today’s stock pick is a nod in the direction of fundamentals. Bridgepoint Education (BPI) is a San Diego-based, for-profit, post-secondary education company that has a great history of growing earnings. Bridgepoint was founded in 2004, and features a combination of traditional programs at a couple of universities, but well over 90% of all enrollments are online. The story is a good one, as for-profit institutions have pushed the possibilities for online higher education far beyond their old limits. In a challenging employment environment, online classes keep costs down and offer access without the restrictions of geography.
Beginning in Q3 2008, Bridgepoint began a series of seven quarters that featured triple-digit earnings growth. Revenue also increased at triple-digit rates right up to the two most recent quarters. And the numbers for the most-recent quarter–a 133% jump in earnings on an 85% gain in revenue–were disappointing only by comparison with previous blowout reports.
BPI is a relatively young stock, having come public in April 2009, and it began 2010 trading at 15. The stock is now around 25, after a huge surge in March, and is digesting its gains. The technical cue to look for is a breakout above its old high of 27.5 on heightened volume.
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Editor’s Note: Paul Goodwin is the editor of Cabot China & Emerging Markets Report, the #1 newsletter for the last five years, according to Hulbert Financial Digest. The Report is up 244% for the last five years versus a 14% gain in the market. Don’t miss out on the next five years of monster growth! Join us today.