Human nature is not changeable.? If people do significantly less well managing defined contribution assets on average than a comparable index fund, then they should not be managing their own assets, much less concentrating into a small number of stocks.? I don’t care what Baruch says (whoever he is), or what my friend Josh says.? Markets are complex, and investing is hard, not easy.
Just as I believe that most people don’t have the capacity to run their own businesses, the same is true of investing.? Both require a lot of discipline, and most people do not have a lot of discipline.
It takes time to learn how to analyze investments.? I think of people taking the CFA courses/exams, and I say to myself, “”Yes, better than nothing, but we need practical experience to truly train them.”
As an aside, when I went to take CFA exam level one, a few younger people snickered at me and said, “Who’s the old guy?”?? (Note: I was 34 at the time; the beard probably didn’t help, and I sometimes let it grow longish back then.)? I turned to them and said, “I am an actuary.? I have already been through a set of ten-plus exams far more difficult than the CFA exams.? I am skilled in compound interest, accounting, statistics, economics, modern portfolio theory, and mathematics to a degree that AIMR does not consider. I am battle-tested in exams more difficult than this, where we had to read far more, and wonder whether we would be tested on minutiae such that AIMR would never consider for CFA candidates.? Further, I have lived under an ethics code for ten years, so I get the AIMR code.? Do you get it?”? After an uncomfortable silence they looked away, and I did too.
My portfolios are concentrated by industry, but diversified within industries.? I have worked hard at my theories for around 18 years now, with my current strategy running for 10+ years.
It is not easy to do well in investing.? First, you may not understand the basics of valuation.? Second, you may not understand what factors can drive stock prices.? Third, you may not understand how industries move a groups.? Fourth, you may not understand how changes in the economy may affect your investments.? ANd there is more.
What’s that, you say?? You don’t need to know those things because you can read a chart?? Okay, good.? Momentum tends to work, but chart-reading after momentum may not work.? Yes, things that have gone up tend to go up further, because of disbelief among investors.? Here’s the test — how often have you made money buying negative momentum, or selling positive momentum?? My guess is that momentum incorporates most of technical analysis, and that most of the detailed technical analysis ideas are empty.? Test: show your technical analysis idea to technicians of a different flavor, and see what they say.? It’s like Evolution versus Special Creation — Evolutionists trash Creationism, but they don’t agree among themselves to any significant degree.? There are few, if any ideas, that all Evolutionists agree on except the negative, “Not Creation.”? (I had a more offensive version using Canadians and Americans.? I passed.)
I incorporate momentum into my fundamental investing.? It helps to erase the problem of value investors always being early.
Most people that I have known that have ventured into individual stocks gave up because they lost money, or didn’t make much money.? Skilled amateur investors are few.? This is my razor: if they can’t manage owning an S&P 500 index fund, what makes us think that they can manage a more volatile portfolio of common stocks?
In general, yes few amateurs are consistently good investors. However, few “professionals” are good for the customer’s investments. Either they profit at their clients expense or their methods are so convoluted they may as well be selling invisible clothing or their accountability is soft and worthless or …..
One counterexample to the argument is the National Assn. of Investment Clubs (AKA, Better Investing). Their 50 year track record out performs the DOW (most individual years and in total) and their methodology is a very simplified subset of your 8 rules. We have used their process with middle and high school student [real money] investment clubs. The students also outperformed the DOW. The process and software tools are a great metric for RTM growth. The process is very quick and easy to use and covers 70% of what I put into my own selection process. Too simplified? Not to start with and put in 5 or 10 years learning. I now look to augment their process, hence why your 8 rules and a couple of other things look very appealing.
That said, you are one of only 2 professionals who I trust for investment decisions. That because of your discipline, skills, track record and integrity. I get significant added value from you. I consider the management fees, money very well spent.
CAI — agree totally on your first two paragraphs. There could be a whole set of posts on the failures of professionals, who in addition, deduct fees.
Baruch is the chap who said: “Markets are people!”
No I’m not.
At the risk of getting the same stare you gave the hapeless CFA students, I unsurprisingly disagree.
It takes time to learn how to invest, and if you don’t start somewhere, you never will. I don’t know if as you say “most” people aren’t able to invest properly, but I do think that at least some can if they try hard and practice. And the number of those who can is much larger than the number of individuals who are currently doing it.
I think it is also something you can learn, because so much of investing skill is not innate, in my opinion, rather it really comes from an attitude, and an act of will. Discipline comes from will. The rest comes from a basic knowledge of accounting, markets and finance which anyone with a university education is capable of grasping. A lot of people without a university education are as well.
Baruch, nothing against your pseudonymity — you write good stuff, as do many other bloggers writing under a pseudonym.
I did not stare at the CFA students, the verb I used was “turned.” I didn’t write this last night, but what I said, I said with a smile. In presentations to actuarial groups I tell them that they have more than a leg up if they want to take the CFA.
But I agree with much of what you say here, enough that I will do a follow-up. Thanks for posting.
I have a pretty simple rule that I have offered to people over the years.
If you want to learn about investing, own individual stocks. Follow them through ups and downs, random fluctuations, good quarters and bad quarters. You will make money and lose money. But over time, learn what works for you, find your own discipline, and stick to it over time.
But that’s not for everyone, which is fine. Others should use funds/managers/indexes with some reasonable asset allocation methodology. You won’t learn as much but that’s fine..not everyone wants to be an investor nor is everyone suited to it.
My guess is that momentum incorporates most of technical analysis, and that most of the detailed technical analysis ideas are empty. Test: show your technical analysis idea to technicians of a different flavor, and see what they say.
I’m going to respectfully disagree on this as someone who utilizes TA quite heavily (I can forward you my silver trades both long AND short the last several months 🙂 ).
At tops and bottoms you could get pure momentum readings that are really high or low and thus misleading in that a skilled technical analyst might recognize signs of topping or bottoming action BEFORE the quantitative metrics tell you momentum is slowing. Silver probably still has a high momentum reading, but I shorted on Monday based on my chart interpretation.
Different analysts will interpret charts differently. I have a group I bounce ideas off of and we disagree, but so what. You give me 5 value investors and stock XYZ, and you’ll get 5 different intrinsic value calculations. Doesn’t invalidate the concept.
All that said, I think one has to find a skill set and stick to it. I’ve spent a lot of time and energy studying price charts. I think I’ve gotten to a point where I can “read them” to provide some edge.
I have a friend who is hardcore value investor who actually will listen to my input on the charts (sold CNQ back in 08 partially based on my TA) but no matter how much I explain things he just doesn’t “see” in the charts what is plain as day to me. That said, he runs rings around me on balance sheet analysis.
Mike, I said “most” not “all.” I know that there are some technicians that play for turning points, but I don’t think there are that many. Most technicians seem to have stops if the momentum fails, and that satisfies them.
I’ve asked before, but do you have an answer to this: Is there one technical analysis theory or many? To me it looks like there are many, with no overarching meta-theory that unites them all.
That’s why I am suggesting momentum as the meta-theory that explains 80% of TA. As a fundamentalist that employs some momentum, I am trying to be open-minded here — TA seems to be different things to different people, and for it to be called the same thing is weird.
Is there one technical analysis theory or many? To me it looks like there are many, with no overarching meta-theory that unites them all.
David,
First, let me say I am NOT a CMT, although I have thought about pursuing it (I did pass CFA Level 1 but bailed on the program after that). I got really interested in technical analysis in 2002-2003 when I was working as an analyst for a bank trust department and had regular access to Louise Yamada when she was with Citigroup. I am self-taught in that I’ve read most if not all of what are considered the classic texts, and then just extensive chart study and application.
Regarding “meta-theory” of technical analysis, I think you are confusing the theoretical foundation with specific analytical techniques. Take value investing. I’d say that the theoretical foundation of value investing is that stocks have an “intrinsic value” or fair value. Beyond that, you’ve got numerous techniques. DCF, EVA, comparable multiple analysis, private market value.
I think Graham’s description of the weighing machine versus the voting machine is instructive. Value analysis is concerned with the weighing machine. Technical analysis is concerned with the voting machine. I’d say the overarching theoretical foundation of technical analysis is that the price of a stock is determined by supply/demand pressures and that those supply/demand pressures are determined by market psychology which is constantly in flux. Technical analysis is concerned with recognizing and diagnosing what market psychology is towards a stock or asset.
To use your examples, “turning points” are price levels where it would be expected market psychology would change in that supply/demand pressures would shift (hence the use of support/resistance levels). Stop levels would coincide with price levels where the expectation is that a shift in market psychology has occurred (supply pressure overwhelms demand pressure).
Now beyond that core theory, there are different analytical techniques just as there are different analytical techniques for calculating a fair or intrinsic value. You’ve got sort of raw price chart analysis which includes things like trendlines and chart patterns (head and shoulders, triangles, etc.). If you are interested, I can point you to books I think are useful, but I will say I’m not interested in convincing anyone of anything. I’ve had the FA versus TA debate more times then you can imagine on other forums. I know it works for me in that I’ve used chart pattern analysis to shift the odds in my favor and make correct decisions a number of times over the past several years. Then you’ve got the indicator stuff like MACD, RSI, etc which is purely statistical based off the price action, but people do interpret indicators differently. Then you’ve got a branch which I would say is almost entirely quantitatively/statistical based. If you wanted to delve into this, the best blog to go through would be Trader’s Narrative by Babak. I would consider sentiment analysis really a subset of technical analysis in that you are really looking at price action through the filter of group psychology.
One general observation I’ll make (not specifically directed at you) is that I’ve found that people who are skeptical of technical analysis yet firm adherents of value analysis demand a level of accuracy from technical analysis as proof “it works” that they do NOT even come close to demanding of value analysis. The evidence suggests, and I believe, that as a general rule low P/E works to identify outperforming stocks over a longer timeframe (3-5 years, mean reversion) but no one would demand that every single low P/E stock has to outperform to prove that low P/E is effective. In terms of DCF, people can make mistakes on analyzing the business and calculating an intrinsic value. Yet few people would dismiss DCF as pure voodoo. Yet, with technical analysis, if someone can show one or a few examples where the outcome was different from the theory, that is proof that invalidates the theory. Personally, I find that view perplexing, but to each their own I guess.
I guess to sum it all up, my view is that stock prices are neither perfectly random or efficient, but neither are they 100% deterministic which is why you can’t plug in variables like an engineering or physics equation to get the answer of future stock price. Both value and technical analysis are attempts to shift the odds somewhat in your favor of where the stock price is going to be at some point in the future and take the appropriate buy/sell action.
Mike, thanks — you’ve given me a lot to think about. Now to think…