The term "fundamental analysis" gets thrown by around professional and amateur investors in ways that create unnecessary misunderstandings and debates. I have noticed that there are (at least) two different methods or approaches that users of the term may be referring to. I will call them "modeling" and "screening."
"Modeling" better captures what traditional fundamental analysis involves. It is time-consuming, difficult, and requires substantical experience. It usually refers to analysis of a company, but could also be applied to an industry or an economy. The phrase "take it apart and put it back together" describes what goes on with this type of fundamental analysis. The analyst takes the three of four financial statements (usually just the income statement, balance sheet, and cash flows, but sometimes also the statement of shareholders' equity) and studies them. By examining historical trends in the company's numbers and comparing them to other indicators like economic and industry data, he looks for a few key relationships that capture most of the variability in the data. Can revenues be explained as the product of a few volume and price series? Are there a few cost items that can explain much of the movement in expenses? Is there a measure of market size that can be used to track a company's revenues as the product of market share and market size? Can a company's capacity be measured and related to its capital spending and its production? After analyzing these questoins, the analyst endeavours to create a model, a highly simplified version of reality that condenses the available reported data and estimates of some values that may not be reported into a spreadsheet that shows the relationships between inputs and outputs. The model can then be used to project financial results into the future. As each quarterly financial report is released, the analyst compares the acutal results with the predicted results and looks for clues about what has been happening and adjusts the model to incorporate the new information or understanding. A typical senior, experienced "sell-side" analyst may cover 10 to 20 companies with this type of analysis, doing it full-time. It is not something that the typical retail investor has the time or the training to do.
For the typical retail investor, fundamental analysis takes the form of what could be called "screening". Companies can be ranked on sales growth, gross margin, EPS growth, dividend yield, return on equity, or any number of similar variables. The consensus of analyst-predicted EPS estimates can be used. This type of fundamental analysis allows the user to process data on thousands of companies in contrast to the dozen or so companies that the "modeling" analyst is limited to. Sometimes the screening will be done is a series of steps, or phases, initially screening a universe of companies to select a smaller number for further study, and then applying other criteria to the names that "pass" the previous screen. The phrase "a mile wide and an inch deep" comes to mind.
To illustrate the differences between the two approaches consider the P/E ratio. For the modeler, the P/E ratio is the price divided by the projected EPS (current year or next four quarters). The P/E is then compared to the P/E ratios of other companies and a judgment may be made about whether the P/E is higher or lower than it "should" be. It is a measure of the market's expectations about future growth.
For the screener, the P/E ratio is a measure of value. A high P/E means the stock might be overvalued, and a low P/E means it might be undervalued. The screener does not much care about whether the E is past or projected. He wants to use an E that is defined the same way for all the companies. The screener is just trying to reduce thousands of companies down to a more manageable number.
Thursday, November 11, 2010
Thursday, November 4, 2010
Resolved: Less Trading, More Studying
I am down $3,000 since inception, and am frustrated that I cannot seem to make money on trades. It is somewhat reassuring to read that it takes most people two to five years to learn to trade and that they will likely lose money during this learning period. I just got a $39.99 rebate from TOS because I have made 40 trades since opening the account. Today I am going to try something a little different. Only look at trading one name for now. Use dual time frame momentum reversal tool. Explore various studies to see how they all work and which work best for this name. Limit trading to one trade per day or two. Keep at it until I have been able to make money on this one name. Meanwhile, explore the fundamentals to see what helps most.
The name I picked is Chevron (CVX), which is in an uptrend since a low of 66.83 on 7/1/10 to a recent high of 85.79 on 10/25/10, a gain of 28%. The S&P 500 (spx) over the same period is up by 17% (1027 on 7/1 to 1198 on 11/3/10, a new high. Apples to apples, CVX to its latest, to match the time for SPX, is up 23% to 81.89. So modest outperformance relative to the market.
Why CVX? I used the TOS watchlist for New Yearly Highs. Oddly, it did not seem to use the latest daily closes for this list. I emailed TOS for an explanation.
The major trend is up. The short term trend is down, but no signal to enter. The entry point signal using low price was back on 11/1/10. Overnight the stock is up sharply from 81.89 to 84.37 in premarket. Rules say do not chase. Waiting for a pull back.
The name I picked is Chevron (CVX), which is in an uptrend since a low of 66.83 on 7/1/10 to a recent high of 85.79 on 10/25/10, a gain of 28%. The S&P 500 (spx) over the same period is up by 17% (1027 on 7/1 to 1198 on 11/3/10, a new high. Apples to apples, CVX to its latest, to match the time for SPX, is up 23% to 81.89. So modest outperformance relative to the market.
Why CVX? I used the TOS watchlist for New Yearly Highs. Oddly, it did not seem to use the latest daily closes for this list. I emailed TOS for an explanation.
The major trend is up. The short term trend is down, but no signal to enter. The entry point signal using low price was back on 11/1/10. Overnight the stock is up sharply from 81.89 to 84.37 in premarket. Rules say do not chase. Waiting for a pull back.
Thursday, October 28, 2010
QE2
The Financial Times this morning (page 9 in the print edition) carries a full page article by Robin Harding. Markets have been discounting it since August 27 Barnanke speech at Jackson Hole symposium, as evidenced by the decline in the trade-weighted dollar index.
cannot upload images today.....more when I figure out why it doesn't work
cannot upload images today.....more when I figure out why it doesn't work
Tuesday, October 26, 2010
Developing an investing/trading system
Here I am taking a fresh approach to how to invest.
1. "Cut your losses, let your winnders run". This bit of conventional Wal Street thinking seems to hold up well. The reason is that markets display persistence. Price movements that appear random in the short term actually tend to have some momentum. Stocks rising in the past are slightly more likely to rise in the future than stocks that fell in the past, which are slightly more likely to fall in the future. If one randomly enters many positions and exits all of them that show a small loss, the portfolio should beat the market because a few of the "winners" will produce outsized returns. I am assuming that the portfolio would have equal exposure to the long and short sides. I have read that this works even if the entries are random. Yes, the "shorts" are limited to 100% gains, but since prices tend to fall faster than they rise, returns on successful shorts can be faster than returns on successful longs. So this insight dictates the main strategy for exiting positions.
2. Next, I want to do something more sophisticated and targetted than just randomly entering all names in some universe from either the long or the short side. In designing this next step, the key assumption is that fundamentals matter in the long term while technical do not, while in the short term the technicals matter and the fundamentals do not. Furthermore, the technicals have no real predictive power in isolation. At best, they can only give you slightly better odds in predicitng some aspects of the future, such as how far it might go IF it goes up or vice versa. The direction of the next tick is wholly random. Also, the fundamentals are harder and harder to predict the further out in time one goes.
The process should involve dividing names into three watchlists (buy, sell, and neutral) designed to provide an edge. These three watchlists would be based on the fundamental, or the long-term, perspective. Technical indicators would then be used to determine the time to enter a position. E.g. TOS has a list of about a dozen "crossover" signals. The "buy" list gets entered only from the long side, and vice versa for the "sell" list. Neutrals could be entered on either side.
3. The process is subject to continuous improvement.
To begin, I am going to use 52 week highs and lows to create the initial lists. In TOS, one can create a watchlist via Scan> Load scan Query > Public >New Yearly Highs or New Yearly Lows. Criteria for this preset scan also include a stock price > 1.00 and volume greater than 1. You could adjust the lookback period from its defaulted value of 252 (trading days in a year).
4. Items in my daily routine before the open. Review all my positions to be sure that I know what they are and that abort stops are in place. Enter onto Excel sheet.
1. "Cut your losses, let your winnders run". This bit of conventional Wal Street thinking seems to hold up well. The reason is that markets display persistence. Price movements that appear random in the short term actually tend to have some momentum. Stocks rising in the past are slightly more likely to rise in the future than stocks that fell in the past, which are slightly more likely to fall in the future. If one randomly enters many positions and exits all of them that show a small loss, the portfolio should beat the market because a few of the "winners" will produce outsized returns. I am assuming that the portfolio would have equal exposure to the long and short sides. I have read that this works even if the entries are random. Yes, the "shorts" are limited to 100% gains, but since prices tend to fall faster than they rise, returns on successful shorts can be faster than returns on successful longs. So this insight dictates the main strategy for exiting positions.
2. Next, I want to do something more sophisticated and targetted than just randomly entering all names in some universe from either the long or the short side. In designing this next step, the key assumption is that fundamentals matter in the long term while technical do not, while in the short term the technicals matter and the fundamentals do not. Furthermore, the technicals have no real predictive power in isolation. At best, they can only give you slightly better odds in predicitng some aspects of the future, such as how far it might go IF it goes up or vice versa. The direction of the next tick is wholly random. Also, the fundamentals are harder and harder to predict the further out in time one goes.
The process should involve dividing names into three watchlists (buy, sell, and neutral) designed to provide an edge. These three watchlists would be based on the fundamental, or the long-term, perspective. Technical indicators would then be used to determine the time to enter a position. E.g. TOS has a list of about a dozen "crossover" signals. The "buy" list gets entered only from the long side, and vice versa for the "sell" list. Neutrals could be entered on either side.
3. The process is subject to continuous improvement.
To begin, I am going to use 52 week highs and lows to create the initial lists. In TOS, one can create a watchlist via Scan> Load scan Query > Public >New Yearly Highs or New Yearly Lows. Criteria for this preset scan also include a stock price > 1.00 and volume greater than 1. You could adjust the lookback period from its defaulted value of 252 (trading days in a year).
4. Items in my daily routine before the open. Review all my positions to be sure that I know what they are and that abort stops are in place. Enter onto Excel sheet.
Monday, October 25, 2010
Think Or Swim
TOS is a very impressive trading platform. Originally designed by options traders from the Chicago Board of Options Trading [?], it is now had over 1700 revisions. I have been learning to use it and have fouind it to be very rich in features and abilities. I keep learning new things I can do with it. In this blog post I will record (for my own reference) some tips and reminders.
The software lets you export to Excel with DDE from a watch list. For example, you could open a watchlist with the 500 stocks in the S&P 500 and copy/paste it into Excel along with the dynamic links to the TOS platfor so that the data updates in real time.
It is possible to scan for stocks that meet technical indicator study criteria. For example, all stocks with an ADX reading below 25 to screen out stocks trending strongle and be left with those that are trading within a range. Then combine it with a scan for "crossovers" to find cases of a short term momentum reversal.
TOS > Support/Chat > Shadow Trader goes to someone (?) who is watching the market, showing tos charts, making comments apparently doing trades. Looks like a great way to learn more. S1, S2, R1 R2 must be support and resistance levels. ESZO- e-mini futures for December. Why does he trade that instead of current e-minis themselves or SPY? He is looking at screens showing advance/decline indicators, which ssectors are doing what.
The software lets you export to Excel with DDE from a watch list. For example, you could open a watchlist with the 500 stocks in the S&P 500 and copy/paste it into Excel along with the dynamic links to the TOS platfor so that the data updates in real time.
It is possible to scan for stocks that meet technical indicator study criteria. For example, all stocks with an ADX reading below 25 to screen out stocks trending strongle and be left with those that are trading within a range. Then combine it with a scan for "crossovers" to find cases of a short term momentum reversal.
TOS > Support/Chat > Shadow Trader goes to someone (?) who is watching the market, showing tos charts, making comments apparently doing trades. Looks like a great way to learn more. S1, S2, R1 R2 must be support and resistance levels. ESZO- e-mini futures for December. Why does he trade that instead of current e-minis themselves or SPY? He is looking at screens showing advance/decline indicators, which ssectors are doing what.
Saturday, October 23, 2010
My first eight days of trading my own account
I am trying to make money trading my own account. I put $60,000 into an account with TD Ameritrade subsidiary Think or Swim and started to trade it on 10/13/10. Eight trading days later I am down 3.67%. I have read that most people lose money when they start trading. I am not exactly "starting",havnig managed over $100 million for a period of years, but I would not call what I did then as "trading". It was investing based on fundamentals and I took a view extending out several years. It worked, at least prior to the peculiar markets of 2008. Now what I am doing is much shorter-term. I am trying to make money on a day to day basis. This means I have to learn a lot about technical analysis and charts and trading techniques. I plan to use this blog to force me to really look at and learn from experience. I still like to focus on the fundamentals, but in the short term fundamentls don't matter as much as the technicals. Indeed, knowing too much about the fundamentals is probably a hindrance when it comes to trading.
My account value fell about $2,200 ($400 in commissions and about $1800 in realized and unrealized gains and losses) from the initial $60,000. What knowledge did I gain from this "tuition"? Let's dig into the data.
I traded in a number of names, but one in particular accounted for about 86% of my total losses. I will just revfiew what happened on this name in this post and save the other names for later.
DJSP cost me $1,549.27 (before commissions). My first trade was to buy 385 shares at $2.2626 on 10/13/10. Although the stock kept falling (a total drop of 56% over 8 trading days) I kept trying to "catch a bottom" with repeated entries followed by getting stopped out. In total I bought and sold 14,669 shares. Avg. price to buy was $1.83. Avg price to sell was $1.73, so a loss of only about 10 cents per share. Meanwhile the stock price fell from 2.26 to 1.04 or 1.22 per share. So my loss control worked well. On 17 opening buys, my average loss per trade was only about $90, much less than the $600 maximum loss per trade I was using in this period.
I got into the stock because I think foreclosure activity is going to continue to grow as house prices are not going to rise far enough and soon enough to bail out the millions of homowners who are underwater on their mortgages. There is no apparent way out of this mess that does not involve services that DJSP provides or could provide. (Two other names I also bought during this period that did not fall as badly are LPS and ASPS.)
The company, DJSP, does foreclosure processing in Florida, a state that accounts for a disproportionately huge share of foreclosures. This firm does about 20% of the Florida foreclosures. It is mainly owned by a lawyer, David J. Stern, but since it is not legal for a law firm to be public, this entity is only the non-legal part of the business. The background in brief (in my personal opinion or characterization) was that two entities of dubious competence got together and tried to outsmart each other with complex financial engineering. So far it appears they both lost. Or maybe Stern won since he took cash out of the deal. The resulting microcap company is a nighmare of complexity that is inappropriate for such a small company. There are 10 million shares outstanding excluding some 17 million more that could become" in the money" via warrants and preferreds if the stocks get into the $20s. One of these two "outsmarting" entities was a SPAC (special purpose acquistion company.)
Following definition of a SPAC (a blank-check company) for those not familiar:
What Does Special Purpose Acquisition Company - SPAC Mean?A publicly-traded buyout company that raises money in order to pursue the acquisition of an existing company. SPACs raise blind pool money (most of which goes into a trust) from the public for an unspecified merger, sometimes in a targeted industry. Each SPAC is typically sold at $6 per unit for one share of common stock (to be publicly-traded in the future) and two warrants that can purchase additional shares. If an acquisition is not made in two years, the money is returned to the original investors.
This particular SPAC started trying to buy a company in China. When they failed to find ont and time was runnig out on the two year clock they somehow stumbled upon Stern.
The other entity was a lawyer of apparently questionable ethics. At least there has been a lot of negative publicity about him. Hard to know the truth in this case. (No need for jokes about lawyer ethics in general here.). I should have listened more to my distaste for the guy from what I read while doing my due diligence.
The DJSP common stock was around $10 at the start of this year and last week briefly fell below $1.00. EPS was at a run rate of $1.20 ($0.30 per quarter x 4 = $1.20). So it looks really really cheap for reasons that appeared to be temporary. There were a couple of earnings disappointments and downward adjustments to earnings, and the attorney general of the state, perhaps in an effort to generate publicity for his run for the governership of the state, launched an investigation.
The key news recently that really got me turned off was that last week the entire senior management, excluding Stern, quit on the same day. No public information as to whether they were really fired or really quit of their own accord. Nothing from the company to explain what is going on. My take is something really negative has beeen uncovered in the ongoing investigations and the news will force the company to go out of business. The CFO, the COO, the general counsel. The IR person never calls back. The lead outside director has taken over the chairmanship. These senior managers had all been recently hired (this year) as Stern apparently tried to make the company at least look better managed. If that does not happen, then the next most likely explanation would be that there were a few loyalists (Stern and a few key people with him from the start) who were really running the company and the efforts to bring in professional management when they became a public company were merely cosmetic.
My Florida-based source on this one was too forgiving of the warts. It looked like it was selling for $2 or $ 3 per share on an eps outlook of over $1.00.
The lesson for me here ("listen to your gut instinct assessments of people") was not a new one for me. Just a refresher course I apparently needed.
I still think that the concept of more foreclosure activity is valid, and that the current focus in headlines of problems with "robo-signing" is a relatively minor and solvable problem. The real problem is underwater mortgages, not the short cuts taken by mortgage servicers and lenders.
Chart below is DJSP. Note that the ADX indicator was always over 20, which means that this stock was TRENDING, and the direction was DOWN. Not one to buy. MACD indicator never gave a Buy signal in that the two lines were always below the zero line.
My account value fell about $2,200 ($400 in commissions and about $1800 in realized and unrealized gains and losses) from the initial $60,000. What knowledge did I gain from this "tuition"? Let's dig into the data.
I traded in a number of names, but one in particular accounted for about 86% of my total losses. I will just revfiew what happened on this name in this post and save the other names for later.
DJSP cost me $1,549.27 (before commissions). My first trade was to buy 385 shares at $2.2626 on 10/13/10. Although the stock kept falling (a total drop of 56% over 8 trading days) I kept trying to "catch a bottom" with repeated entries followed by getting stopped out. In total I bought and sold 14,669 shares. Avg. price to buy was $1.83. Avg price to sell was $1.73, so a loss of only about 10 cents per share. Meanwhile the stock price fell from 2.26 to 1.04 or 1.22 per share. So my loss control worked well. On 17 opening buys, my average loss per trade was only about $90, much less than the $600 maximum loss per trade I was using in this period.
I got into the stock because I think foreclosure activity is going to continue to grow as house prices are not going to rise far enough and soon enough to bail out the millions of homowners who are underwater on their mortgages. There is no apparent way out of this mess that does not involve services that DJSP provides or could provide. (Two other names I also bought during this period that did not fall as badly are LPS and ASPS.)
The company, DJSP, does foreclosure processing in Florida, a state that accounts for a disproportionately huge share of foreclosures. This firm does about 20% of the Florida foreclosures. It is mainly owned by a lawyer, David J. Stern, but since it is not legal for a law firm to be public, this entity is only the non-legal part of the business. The background in brief (in my personal opinion or characterization) was that two entities of dubious competence got together and tried to outsmart each other with complex financial engineering. So far it appears they both lost. Or maybe Stern won since he took cash out of the deal. The resulting microcap company is a nighmare of complexity that is inappropriate for such a small company. There are 10 million shares outstanding excluding some 17 million more that could become" in the money" via warrants and preferreds if the stocks get into the $20s. One of these two "outsmarting" entities was a SPAC (special purpose acquistion company.)
Following definition of a SPAC (a blank-check company) for those not familiar:
What Does Special Purpose Acquisition Company - SPAC Mean?A publicly-traded buyout company that raises money in order to pursue the acquisition of an existing company. SPACs raise blind pool money (most of which goes into a trust) from the public for an unspecified merger, sometimes in a targeted industry. Each SPAC is typically sold at $6 per unit for one share of common stock (to be publicly-traded in the future) and two warrants that can purchase additional shares. If an acquisition is not made in two years, the money is returned to the original investors.
This particular SPAC started trying to buy a company in China. When they failed to find ont and time was runnig out on the two year clock they somehow stumbled upon Stern.
The other entity was a lawyer of apparently questionable ethics. At least there has been a lot of negative publicity about him. Hard to know the truth in this case. (No need for jokes about lawyer ethics in general here.). I should have listened more to my distaste for the guy from what I read while doing my due diligence.
The DJSP common stock was around $10 at the start of this year and last week briefly fell below $1.00. EPS was at a run rate of $1.20 ($0.30 per quarter x 4 = $1.20). So it looks really really cheap for reasons that appeared to be temporary. There were a couple of earnings disappointments and downward adjustments to earnings, and the attorney general of the state, perhaps in an effort to generate publicity for his run for the governership of the state, launched an investigation.
The key news recently that really got me turned off was that last week the entire senior management, excluding Stern, quit on the same day. No public information as to whether they were really fired or really quit of their own accord. Nothing from the company to explain what is going on. My take is something really negative has beeen uncovered in the ongoing investigations and the news will force the company to go out of business. The CFO, the COO, the general counsel. The IR person never calls back. The lead outside director has taken over the chairmanship. These senior managers had all been recently hired (this year) as Stern apparently tried to make the company at least look better managed. If that does not happen, then the next most likely explanation would be that there were a few loyalists (Stern and a few key people with him from the start) who were really running the company and the efforts to bring in professional management when they became a public company were merely cosmetic.
My Florida-based source on this one was too forgiving of the warts. It looked like it was selling for $2 or $ 3 per share on an eps outlook of over $1.00.
The lesson for me here ("listen to your gut instinct assessments of people") was not a new one for me. Just a refresher course I apparently needed.
I still think that the concept of more foreclosure activity is valid, and that the current focus in headlines of problems with "robo-signing" is a relatively minor and solvable problem. The real problem is underwater mortgages, not the short cuts taken by mortgage servicers and lenders.
Chart below is DJSP. Note that the ADX indicator was always over 20, which means that this stock was TRENDING, and the direction was DOWN. Not one to buy. MACD indicator never gave a Buy signal in that the two lines were always below the zero line.
Tuesday, October 19, 2010
The boy who cried wolf
Apple stock ran up on Friday, reported earnings after the close that beat expectations, and then the stock fell in after market trading. It came back some on Monday. I won't try to repeat the details of price changes and earnings reports as these are well covered elsewhere.
Much of the coverage of Apple tried to explain the post-report stock price drop as caused by something diappointing in the press release. iPad volumes were light, gross margins were a little low, and the fiscal Q1 quarter guidance was below current expectations.These factors do not explain the stock drop. Overall, the quarter was at or above most expectations, and so the few shortfalls were more than offset by the stronger areas. Apple has a habit of low-balling its guidance and then miracously beating it. So the Q1 guidance was not a believable explanation.
I think the real explanation for the stock weakness lies in investor psychology and has little to do with what Apple reported. Investors simply played a game of buying the stock before the earnings report.
Much of the coverage of Apple tried to explain the post-report stock price drop as caused by something diappointing in the press release. iPad volumes were light, gross margins were a little low, and the fiscal Q1 quarter guidance was below current expectations.These factors do not explain the stock drop. Overall, the quarter was at or above most expectations, and so the few shortfalls were more than offset by the stronger areas. Apple has a habit of low-balling its guidance and then miracously beating it. So the Q1 guidance was not a believable explanation.
I think the real explanation for the stock weakness lies in investor psychology and has little to do with what Apple reported. Investors simply played a game of buying the stock before the earnings report.
Sunday, October 17, 2010
My investing philosophy
I'm not sure where this will lead, but it seemed like a good way to assemble my own thoughts and to share them with friends I already have and perhaps find some new friends to share ideas with. I make no promises of keeping it going indefinitely. The subject is investing in public markets, mainly small-cap and micro-cap equities. The smaller the capitalization (shares time price), the less efficient the markets are, i.e. the easier it is to "beat" the markets.
This first post is to lay out my personal views about analysis and investing. There are many other approaches that can work well, too. In other words, I expect some of my readers to have other approaces that work better for them than my methods would.
Future posts will discuss specific investment ideas. I will probably not post the "best" stuff, or at least not until I have had a chance to put on my own positions, but once I have taken a position, I expect that I am better off letting others know my thoughts. They can tell me why I am wrong (which is good for me) or they can put on the same trade (also good for me).
My investing approach is based mainly on fundamental analysis, as distinct from technical analysis, because my experience is more in the fundamentals and because I believe that news from "fundamental" factors drives markets far more than technicals. Earlier in my career I was a sell-side analyst covering the paper and forest products industry and I managed a hedge fund. The fund (actually "separate accounts") was market-neutral, equities only, and narrowly constrained to include only stocks in the paper and forest products and relatred industries (e.g. metal and glass packaging, building materials, timberlands).
Fundamentals versus technicals. I think of a band of trackers in the wilderness of the Old West trying to catch a group horsethieves several days journey ahead. The "technicians" among the trackers look at broken branches, hoof marks in the dirt, recent campfires, and so on, to decide where to go next. The "fundamentalists" in the group think more about where their target might be trying to go. Obviously, both approaches are valuable. In the investing world most players can be categorized as either fundamentalists or technicians, but the most successful have learned how to combine both approaches. It puzzles me that the two groups seem to advocate one or the other approach strongly rather than thinking about how to use them both. The "conventional wisdom," with which I disagree, says to use fundamentals to decide if the stock should be on the long or short side of a portfolio, and to use technicals to decide when to buy or sell. Instead, I try to use the chart to help me better understand the fundamentals. For each past jump in volumes and change in price, I try to find what caused it by reading through news reports, 10Q filings, and so on. As for timing, I don't think TA really claims to be able to predict the direction of the next move. It just tells you how far up or down it might move, if it moves up or down.
Timeframe: A few days to a few months. Intra-day trading works for some, but I am not plugged in to a network of sources that would give me an edge, and I don't really know technical analysis well enough to think I have an edge there either. A time frame beyond a year is good for people who are managing large amouns of money and so cannot move nimbly, but at the moment I am just concerned with managing my small account.
Risk control. The conventional wisdom, and this I agree with, is to cut your losses quickly and early, and let your winners run. Because markets have some persistence, rather than being purely random, this discipline allows you to catch a few stocks that are undergoing long moves. An interesting claim I came across is that it is possible to make money with random entries, provided that a good exit discipline is followed. I like to think of investing as gambling, or a statistical process whereby one tries to make many "bets" where there is a slight statistical edge in your favor. Trying to hit a big home run is a bad idea because you risk getting thrown out of the game after three strikes. More specifically, I like the rule of limiting the maximum loss on any one "bet" to no more than 1% of your equity capital. as your equity rises or falls, this risk measure in dollar terms changes.
Screen-watching can be dangerously addictive. It is tempting to watch stocks tick by tick throughout the day, but I remind myself that my time is usually better spent studying the fundamentals. Decide where you would buy or sell, submit the orders, and go do something else.
Combine a top-down marco approach with a bottom-up company-company-by-company approach. The macro approach tells you what to look for at the company level. The company approach tells you what to look for in the macro picture.
One idea leads to another. If I study a specific company, it will lead me to competitors, suppliers, customers and others that can become ideas too. At the macro level, developments in one economic indicator lead to insights into other indicators.
Trace back to the source documents. One of the great things about the Internet is that now it is usually very easy to obtain the original documents and read them. Possibly the people who filtered the story from the originals missed something that you might interpret differently. Most people just read the news stories and often accept them as the whole truth. With investment situations, things are almost never as they appear on the surface. The stock price reflects the way things appear on the surface. I like to keep peeling back the layers of the onion until the picutre stabilizes to a simple thesis involving a few critical factors. I remember Peter Lynch's test of "can I explain it to my dog in 30 seconds?". In that same spirit, can I explain it on my blog in one paragraph?
Most of the views that one reads or hears are coming from someone who was paid to say it or is repeating someone else's view. True independent thinking is quite rare. I plan to post some tips on how to tell the difference later.
This first post is to lay out my personal views about analysis and investing. There are many other approaches that can work well, too. In other words, I expect some of my readers to have other approaces that work better for them than my methods would.
Future posts will discuss specific investment ideas. I will probably not post the "best" stuff, or at least not until I have had a chance to put on my own positions, but once I have taken a position, I expect that I am better off letting others know my thoughts. They can tell me why I am wrong (which is good for me) or they can put on the same trade (also good for me).
My investing approach is based mainly on fundamental analysis, as distinct from technical analysis, because my experience is more in the fundamentals and because I believe that news from "fundamental" factors drives markets far more than technicals. Earlier in my career I was a sell-side analyst covering the paper and forest products industry and I managed a hedge fund. The fund (actually "separate accounts") was market-neutral, equities only, and narrowly constrained to include only stocks in the paper and forest products and relatred industries (e.g. metal and glass packaging, building materials, timberlands).
Fundamentals versus technicals. I think of a band of trackers in the wilderness of the Old West trying to catch a group horsethieves several days journey ahead. The "technicians" among the trackers look at broken branches, hoof marks in the dirt, recent campfires, and so on, to decide where to go next. The "fundamentalists" in the group think more about where their target might be trying to go. Obviously, both approaches are valuable. In the investing world most players can be categorized as either fundamentalists or technicians, but the most successful have learned how to combine both approaches. It puzzles me that the two groups seem to advocate one or the other approach strongly rather than thinking about how to use them both. The "conventional wisdom," with which I disagree, says to use fundamentals to decide if the stock should be on the long or short side of a portfolio, and to use technicals to decide when to buy or sell. Instead, I try to use the chart to help me better understand the fundamentals. For each past jump in volumes and change in price, I try to find what caused it by reading through news reports, 10Q filings, and so on. As for timing, I don't think TA really claims to be able to predict the direction of the next move. It just tells you how far up or down it might move, if it moves up or down.
Timeframe: A few days to a few months. Intra-day trading works for some, but I am not plugged in to a network of sources that would give me an edge, and I don't really know technical analysis well enough to think I have an edge there either. A time frame beyond a year is good for people who are managing large amouns of money and so cannot move nimbly, but at the moment I am just concerned with managing my small account.
Risk control. The conventional wisdom, and this I agree with, is to cut your losses quickly and early, and let your winners run. Because markets have some persistence, rather than being purely random, this discipline allows you to catch a few stocks that are undergoing long moves. An interesting claim I came across is that it is possible to make money with random entries, provided that a good exit discipline is followed. I like to think of investing as gambling, or a statistical process whereby one tries to make many "bets" where there is a slight statistical edge in your favor. Trying to hit a big home run is a bad idea because you risk getting thrown out of the game after three strikes. More specifically, I like the rule of limiting the maximum loss on any one "bet" to no more than 1% of your equity capital. as your equity rises or falls, this risk measure in dollar terms changes.
Screen-watching can be dangerously addictive. It is tempting to watch stocks tick by tick throughout the day, but I remind myself that my time is usually better spent studying the fundamentals. Decide where you would buy or sell, submit the orders, and go do something else.
Combine a top-down marco approach with a bottom-up company-company-by-company approach. The macro approach tells you what to look for at the company level. The company approach tells you what to look for in the macro picture.
One idea leads to another. If I study a specific company, it will lead me to competitors, suppliers, customers and others that can become ideas too. At the macro level, developments in one economic indicator lead to insights into other indicators.
Trace back to the source documents. One of the great things about the Internet is that now it is usually very easy to obtain the original documents and read them. Possibly the people who filtered the story from the originals missed something that you might interpret differently. Most people just read the news stories and often accept them as the whole truth. With investment situations, things are almost never as they appear on the surface. The stock price reflects the way things appear on the surface. I like to keep peeling back the layers of the onion until the picutre stabilizes to a simple thesis involving a few critical factors. I remember Peter Lynch's test of "can I explain it to my dog in 30 seconds?". In that same spirit, can I explain it on my blog in one paragraph?
Most of the views that one reads or hears are coming from someone who was paid to say it or is repeating someone else's view. True independent thinking is quite rare. I plan to post some tips on how to tell the difference later.
“Analysis by clues” is one of my favorite tools when listening to a company presentation or reading about a company. In poker, it is called a "tell". Body language, dress, facial tics, questions that are
evaded or avoided, and so on. An emotional reaction to a question. Typos in a document that should not
have any. An explanation that does not quite ring true.
“Torture the numbers until they confess” is one of my favorite expressions. Continue taking the
company financials apart and putting them back together until your model really works.
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