Bulls, Bears and Stags

Bulls, Bears and Stags

Hi there,

Let’s catch up with ‘Bulls’ and ‘bears’. The two most commonly used terms in stock markets.

A common story is that the terms ‘Bull market’ and ‘Bear market’ are derived from the way those animals attack. Bulls are supposed to be aggressive and attacking while bears would wait for the prey to come down.

Another story is that long back, bear trappers would first trade in the market and fix a price for bear skins, which they actually din’t own. Once the price is fixed , they would go hunting for bear skins. So eventually even if the prices go down, they will still be able to sell if for a high price. This term eventually was used to describe short sellers and speculators who sell what they do not own and buy it when the price comes down and makes money in the process.

However, it was Thomas Mortimer,in his book called ‘Every Man His Own Broker’ (1775) who first officially used the terms Bulls and bears to describe investors according to their behavior.

BULL MARKETS

When can you say it’s a bull market? When the prices of stocks moves up rapidly cracking previous highs , you may assume that it’s a bull market.If there are many bullish days in a row you can consider that as a ‘bull market run’. Technically a bull market is a rise in value of the market by at least 20%.

BEAR MARKETS

A bear market is the opposite of a bull market. When the prices of stocks moves crashes rapidly cracking previous lows , you may assume that it’s a bear market. Generally markets must fall by more than 20% to confirm that it’ a bear market.

STAGS

This is another category of market participant. The stags are not interested in a bull run or a bear run. Their aim is to buy and sell the shares in very short intervals and make a profit from the fluctuation. It’s a daily tussle for stags in the stock market.

MARKET TIMING

The basic idea behind stock market investment is simple- Buy low, sell high and make money. So to make money, you buy stocks in a bear market when stock prices are low and sell stocks in a bull market when stock prices are high.

However, knowing the exact time when a bear market would start or when a bull market run would come is not possible. Just when you thought the markets would go up, it may surprise you by trading low. Your strategy should be to pick up shares in the bear market and sell it when there’s a bull market run.

HERE’S THE CRUX..

• Technically a bull market is a rise in value of the market by at least 20%.Anything less than 20% would be considered as a minor rally.
• A market launches into a bull phase when sentiment turns buoyant, which is usually because of a series of positive developments that beat expectations
• Reverse is also true. A 20% or more fall in value is considered as a bear market. Anything less than 20% would be considered as a ‘correction’.
• Bear markets occur when news flow tends to be worse than expectations, causing investors to sharply punish stocks or sectors. This has happened in the US where more bad news on the sub-prime front and US economy data has stifled even the briefest of market recoveries.
• To confirm a bear market, this weakness should persist for at least two months. In bear markets, liquidity is extremely tight, volumes tend to be low and market breadth tends to be poor
• Some experts believe that for emerging markets such as India, which tend to be more volatile, the correction needs to be steeper at 30-35 per cent.
• In every bear market, there tends to be bear market rallies or a bear market pullback, where the market rises 10-15 per cent only to decline yet again. The bounce-back usually occurs when some stocks or sectors are ‘oversold’, to borrow a term used by technical analysts.
• Worst bear market conditions are followed by great bounce backs.

That covers Bulls, bears and stags.
There is an old saying which would further give authenticity to our bear story-
“Never sell a bear skin unless you have one.”

Have a nice day!

know your BLUE CHIP SHARES!!!

What are Blue-chip shares?

BLUE CHIPS

‘Blue-chips’ is one word that you’d be hearing a lot of times once you start following the stock markets. So this post is about blue chips or ‘bellwethers’ as it is sometimes called.

Blue chip stocks are large companies whose shares are considered to be relatively safe than normal shares. It gains that status from its past record of being a high growth, high dividend paying company. These companies would be leaders in its field. For example-Infosys technologies is described by Medias as an ‘IT bellwether’. It reflects the investor’s confidence in that company’s capacity to maintain its status as the leader of the pack and its past record of excellent management and of giving good returns to it’s share holders.

The term ‘blue-chip’ is coined from a game called poker where the chip with the highest value is blue in color. In stock markets, the term is used to describe the stock that has highest quality – in terms of investor confidence.

There is no hard and fast rule to find out which a blue chip company is and which one is not. A blue-chip typically would have stable earnings and dividend history, a strong asset position, high credit rating and an excellent record of being a leader in its field. These are huge companies in terms of market capitalization and revenues.

All the 30 stocks in Sensex index can be considered as blue-chip companies. You can also see the Dow Jones list of Indian blue chips at –

http://www.bluechiplist.com/indices/dow-jones-india-titans-30/

ARE THESE SHARES SAFE FOREVER?

No. These shares may be assumed to be relatively safer than others, provided, the positive factors that drive the company remain intact. Just like any other company, a blue chip company can also run into financial troubles and become dead one day. No one can guarantee you that a blue-chip will remain like that in future also.

May be, some of the future blue chips are hidden in mid caps right now. If you have managed to spot them right now, you have a chance to become a millionaire soon.

SHOULD YOU INVEST IN BLUE-CHIPS?

Of course, Yes! You must have some portion of your investments in Blue-chips. They bring the required solidity in your portfolio, since they do not fluctuate heavily like mid caps or small caps.

Investing in blue chip also requires lot money because; typically these shares will cost more. Hence, there is a necessity to valuate it meticulously.

Gold – A must in your portfolio!!!

 Gold – A must in your portfolio

Gold is the base of monetary systems around the world. It’s an asset that’s highly liquid, accepted everywhere and considered equivalent to cash.  It’s also one of the lesser volatile commodities traded internationally.

Gold is very effective in bringing solidity into your portfolio and reduces investment risk. In terms of returns, it’s not a very effective tool to bring short term profits. Gold gains in value over a period of time and hence, you will have to wait for some time (say 5-10 years or sometimes more than that) to see the real effect of gains.

How to invest in gold?

Gold can be bought in different ways. You have 7 options –

You can buy-

• Gold jewellery
• Bullion bars from jewelers that are part of the world gold council
• Gold coins issued by various banks
• Gold exchange traded funds
• Equity based gold funds
• E-Gold
• Take positions in Gold futures and profit from the price movement.

The first three options are about buying gold physically. If you have bought Gold jewellery, we are sorry to say that it’s not a right move from the investment point of view because, you would have paid an additional of 5%-30% of it’s value as making charges depending upon the design and some money on precious stones used in them. These stones are valueless and do not appreciate unless it’s a piece of diamond. Making charges paid is also a waste of money. Banks charge around 5% premium for coins sold through them. Bullion bars /coins bought through WGC networked jewellers may be the better option here since; they generally sell gold for a 2% or 3% premium. So if you want to hold gold physically, it would be better to buy it from WGC networked jewellers since they are the cheapest option.

Now, physical holding of gold risky since it is prone to loss by theft / fire or such other accidents. To protect from such losses, you will have to insure it and that will be an additional annual cost to be incurred until you sell it off. The purity of gold sold by jewellers is an issue that’s hard to crack. Again, it may be impractical to store it physically beyond a certain limit and in the case of an emergency if you go to a jewellery to sell your gold, they might not accept it straight away.

After reading the above paragraph, if you think that storing gold physically is not practical, you have the last four options – Gold ETF, equity based gold funds, e-gold and futures positions in gold.

Gold ETF is nothing but mutual fund schemes that invest only in gold. One unit would roughly equal one gram of gold. These funds are managed by asset management houses. If you don’t want investment houses to get involved, you can directly purchase e-gold launched by the national spot exchange. In both the cases, you will be holding gold in electronic format – just like investment in stocks.All you need is a demat account.

One more category of electronic gold is equity based gold funds. Equity based gold fund are basically mutual fund schemes launched by asset management companies. They do not invest directly in gold (when fund houses launch direct investment in gold, they are called gold ETFs) instead, they invest in stocks of companies that are engaged in mining, extraction and trading of gold.

The last option – taking positions in gold futures – is a risky game. All the negatives and positives of derivative instruments are relevant here also. It’s would work if you can reasonably predict the price movement of gold in the short term. It’s basically speculation (or trading, if you want to call like that) and cannot be brought under the ‘investment’ category.

How much to invest?

As a general rule, around 10 % of your investment fund can be in gold.

Which is the best option?

The best option would be to hold gold in electronic form – through ETFs or through e-gold route. In the first option, the additional amount you have to pay is the brokerage charges plus annual fund management charges. In the second case, your annual holding cost is zero. In both the cases, you don’t have to worry about the security of gold since it is held in electronic form in your demat account and the rates quoted in the exchange is 99% at par with the international gold prices.

By definition of the income tax department, gold a capital asset. Any gains from investment in gold are treated as capital gains. In the case of ETFs, it is considered as a long term capital asset after one year and in the case of e-gold and physical gold, it is treated as a long term capital asset only after 3 years. The relevance of this is that, long term capital gains are taxed at special slab rates declared by the income tax department whereas, short term gains from gold ( in the case of gold ETFs, gains made by buying and selling ETF between 1-12 months and in the case of physical gold /e-gold, gains made by buying and selling it between 1-36 months) is taxed at normal tax rates.

So we think that the e-gold route would be the best. Gold ETF comes second.

What’s the risk of investing in gold?

Generally, gold is a safe investment. It beats inflation. The risk is that sometimes, especially in boom periods, you’ll find the performance of gold to be slower than other asset classes like equities and real estate. So, the real risk lies in the opportunity loss.

With this we sum up our  24^th principle. Know that –

• Gold is an insurance against inflation.
• It’s a good investment, but not the best one since it’s a slow performer.
• It brings stability to your portfolio
• Jewellery is not a right form of investment as it’s cost  involves making charges and the purity of gold sold by local merchants are always questionable.
• Physical gold are prone to theft or other losses. Gold kept in bank lockers are not safe since, the lockers of most banks are not insured and the bank is not responsible for your assets kept in lockers.
• It’s a capital asset and hence any gain on gold would be taxable.
• Paper gold or gold held in electronic form is the best way to invest in gold.

RBI drives the market!!

RBI measures and Global cues will drive the markets.

The markets logged the biggest gain in the last two months as the rupee showed some signs of stability, thanks to the measures declared by the new RBI governor Mr. Reghuram Rajan. If we look at the last 30 days, the rupee had fluctuated between 60.77 (on 6^th August 2013) and Rs 65.24 to a dollar (6th September 2013). In between, it touched a lifetime low of 68.80 on August 28^th, spreading widespread panic regarding the economic prospects of India. The measures announced by the new governor resulted in a rise in banking stocks which was one of the worst performers for the last few months. It has also created a sense of confidence among all the market participants. This was evident from the way market responded to disappointing PMI numbers and various downgrade warnings. The sensex and the Nifty closed at 19,270 and 5,680 with a 651 and 208 points gain mainly led by banking stocks. Overseas investors have invested Rs 2600 crores into the Indian capital markets in the first week of September.

This week, the main drivers could be the IIP, CPI and export/import numbers and further policy measures from the RBI’s side. Crude oil prices and rupee movement will also be closely watched by the participants. Although there is some optimistic climate all around, the main event that may trigger a self off in emerging markets is the US FOMC meeting that’s scheduled on September 18^th.

Expect the market to trade in a range of 18,800- 19,600 for the sensex and 5,530 – 5,800 for the Nifty. The week may also see short term traders booking profits.

You may like these posts:

1. The week ahead
2. Stock markets in india
3. SBI- Should you invest in this stock?

news feeds for upcoming trading days!!!

Markets may remain volatile

The markets exhibited heavy volatility last week with the broad indices plunging 4.5% during the mid week. However, the indices bounced back and closed at 18,519 and 5471. This is the fifth consecutive negative weekly close for the Indian markets. Not only in India, but almost in all global emerging markets there were sell offs in equity and bond markets due to fears of a tighter  US monetary policy.

The rupee hit a life time low of 65.50 on Thursday making it one of the worst performing currency in Asia today. The rupee has fallen more than 20% in less than a year now. The erosion in value is a huge opportunity for FIIs and NRIs to pick up stocks since there is a double advantage of higher convertibility rates for their money and lower equity valuations in India. With the rupee rates playing havoc in the economy, it is expected that the RBI and finance minister will speed up measures for making it stable. As far as Indian investors are concerned, It’s prudent to stay off from the market since there is negative sentiments all around. The derivatives expiry for August contracts is on this Thursday hence volatility cannot be ruled out this week too.

GDP estimates for the first quarter, RBIs measures to support the falling rupee and derivatives expiry will determine the general market trend this week. We expect the markets to trade in a range of 18,100-18750 for the sensex and 5350-5600 for the nifty. Staggered accumulation of beaten down stocks is recommended.

You may like these posts:

1. Investing in Indian stock markets- A guide for NRI’s
2. How do FI investors affect stock markets?
3. Important dates for Indian stock investors.

THE ABCs OF STOCK OPTIONS !!

As a performance incentive many companies are starting to offer employees the “option” to buy company stock as a part of their compensation packages. These “options” are referred to as stock options and they provide a unique opportunity for an employee to potentially increase his or her wealth along side company shareholders. The employee receiving company stock options should have a good understanding of the characteristics of the different types of stock options in order to maximize their potential benefits.

A stock option is a right granted by a company to an employee to purchase one or more shares of the company’s stock at a set time and predetermined purchase price. The employee benefits when the value of the company stock appreciates over and above the predetermined purchase price following the granting of the stock options, enabling the holder to purchase the company stock at a discount. There are two types of stock options: non-qualified stock options and incentive stock options.

Non-qualified stock options (NQSO) are more frequently offered to employees than Incentive Stock Options because of their flexibility and minimal requirements. NQSOs afford the employee the right to purchase a set number of employer shares at a specific, predetermined price. If the employee wishes to acquire the employer stock then he or she will exercise the option and purchase the employer stock at the predetermined (exercise) price. If the stock’s value has appreciated over and above the predetermined price the employee has received the benefit of acquiring the stock at a discount. The difference between the exercise price and the market value (commonly referred to as the bargain element) will be taxable income to the employee as ordinary income, potentially as high as 35%.

The other type of stock option is the Incentive Stock Option (ISO). In direct contrast to a nonqualified stock option, there is no income tax consequence when an employee exercisers the option to buy the employer stock. The difference between the exercise price and the market value (bargain element) is only taxable upon the ultimate sale of the employer stock. In other words, a gain is only recognized when the employer stock is sold and not when the option is exercised. If the stock is held the appropriate time period before being sold, all the gains recognized may qualify for long-term capital gains treatment, a maximum rate of 15%.

Being able to take part in an ISO program allows an employee to receive a number of tax saving benefits. But with these tax benefits comes added complexity to keep track of and to understand. For example, to qualify for the favorable long-term capital gain taxation, the employee must hold the stock for at least two years from the date the ISO was granted and for at least one year from the date the option was exercised. This is commonly referred to as the “2 year / 1 year rule”. If the employee sells the stock before these requirements are met, gain on the stock is taxed as ordinary income in the year of the sale, essentially converting the ISO to a non-qualified stock option.

An additional complexity of an ISO that should be kept in mind by the employee is the potential for an alternative minimum tax (AMT) consequence upon exercise of an ISO. For this and other reasons, it remains important to work with your financial advisor and tax professional when evaluating the strategies to take full advantage of the opportunities and benefits of stock options.

stock trading PSYCHOLOGY !!!

Many of today’s highly successful traders will tell you that the general key to success in trading is to be able to comfortably take a loss. It is general knowledge among experts in the trading psychology field and among traders that the market is not predictable and it is safe to say that it never will be. In the world of trading, it is expected to take a loss; even those who are highly skilled traders know that it is inevitable. With that said, let us have a look at things you as a trader should be aware of, how you can take a loss effectively and use it towards the greater good of your trading world.

Trading psychology tells us that when a trader loses he begins to become somewhat of a perfectionist in his dealing. Many traders think that in trading, a good day will always be one that is profitable. Trading psychology experts tells us this is not true. A trader should define a good day as one where they have extensively researched and planned with discipline and focus, and have followed through to the entire extent of the plan. Yes, when a trader has mastered the art of accepting losses and working through them with a well thought out plan then good days will become profitable in time.

Because the art of trading in an unpredictable market fluctuates so greatly from one day to the next, experts in trading psychology believe that it is important that you concentrate on what you can control, instead of things that are beyond your control. Looking into the short-term you cannot expect to be able to control the profits of your trading. With that said, look at what you do you have ability to control.

You do have the ability to control the difference between good and bad days. You are able to control this factor by extensively researching the strategies you implement within your trading experiences. By learning to research your chosen strategies, thus controlling the amount of good and bad trading days you experience, you will, in the long-term begin to generate profits, which is the ultimate goal of every trader.

Trading psychology experts tell us that it is important to become realistic in trading instead of becoming a perfectionist. Perfectionist traders, relate a loss with failure, and will become obsessed with the failure, focusing only upon it. Realistic traders understand the unpredictability of the market and taking a loss is simply part of the art. The main key you must remember in trading psychology to be able to effectively limit your losses, instead of becoming obsessed with them. A common thing seen within the trading psychology world is that traders who are obsessed with their losses often have a hard time bouncing back from them, thus losing in the end.

Experts in trading psychology have organized three basic strategies you can use to effectively stop losses. These strategies are:

* Price Based * Time Based * Indicator Based

Stops that are priced based are generally used when the other two have not functioned. To make this work you will need to make hypothesis’s about the trade and identify a low point in that particular market. Then you will set your trade entries near your points, thus making sure that losses will not be overly excessive if the hypothesis fails.

Time Based stops constitutes making use of your time. Designate a holding period you allow to capture a certain number of points. If you have no achieved your desired profit within that time limit, you should stop the trade. If effectively used you should stop even if the price stop limit has not been achieved.

The Indicator based stop makes use of market indicators. As a trader, you should be aware of these indicators and utilize them extensively within your trading experiences. Look at indicators such as, volume, advances, declines, and new highs and lows.

Experts in trading psychology say that setting stops and rehearsing them mentally is a good psychological tool to use and will help ensure that you follow through.

UNDERSTANDING the STOCK MARKET !!!

Many people look to the stock market to enhance their hard-earned money more and more each year. Some people are not even aware of their investments, because they can come in the form of pensions with their place of employment. The company invests this money in efforts to increase your retirement funds. In order to fully understand what is happening with your money, you should understand how the investments work.

The stock market is an avenue for investors who want to sell or buy stocks, shares or other things like government bonds. Within the United Kingdom, the major stock market in this area is LSE (London Stock Exchange. Every day a list is produced that includes indexes or companies and how they are performing on the market. An index will be compromised of a special list of certain companies, for example, within the UK; the FTSE 100 is the most popular index. The Financial Times Stock Exchange dictates the average overall performance of 100 of the largest companies with in the UK that are listed on the stock market.

A share is a small portion of a PIC (public limited company), owning one of these shares will give you many rights. For example, you will gain a portion of the profits and growth that the company experiences, additionally you will obtain occasional accounts and reports from the chosen company. Another exciting feature of owning a share of a company is the fact that you are given the right to vote in various aspects of what happens with the company.

Once you purchase a share of a company you will receive something called a share certificate, this will be your proof of ownership. This certificate will contain the total value of the share, this will likely not be the price that is listed upon the exchange and is specifically for reasons of a legal matter. This will not affect the current value the share currently holds on the market.

Typically, as a shareholder, you will receive your profit in the form of a dividend; these are paid on a twice per year basis. The way this works is if the company makes a profit, you will as well and on the opposite end of this spectrum if they do not make a profit, neither will you. If a company does extremely well their value increases, which means the value of the share you own will as well. If you should decide to sell your share, you will only benefit from it, if the company has experienced growth.

stock OPTION TRADING --- the SAFER BET !

When I bought the futures of XYZ Company with great hopes of making a quick buck I had not foreseen the other side of the picture i.e. making great loss. The lot size on the contract was 950, which meant that for every single rupee up or down move in the stock I stood to gain or lose Rs. 950, a substantial amount by any standards. The market took a dip and my stock ended up lower by Rs. 40. In other words I lost Rs. 38000 in just a couple of weeks. Although I had time till the end of the month when the contract expired but I closed my position taking the loss. Another lower tick on the stock would have required additional margin money from me.

Did it leave me any wiser? I sure hope so because that is when I did some research and came up with a safer bet in the form of stock options.

Most Indian traders use stock futures due to the profit potential or lack of knowledge of stock options. The risk involved in stock futures makes options much more attractive.

The difference in buying a stock future and option is that the later is not obligatory.

The future is an agreement to buy or sell a security at a certain time in the future at a specified price, an option gives one the right but not the obligation to do the same.

This right to buy or sell in options comes at a price, which is called the premium.

Types of option: There are two types of options –call option and put option. A call option gives the buyer the right to buy a security on a future date at a predetermined price; Put option gives him the right to sell a security on a certain day at a certain price. The future price is called the strike price.

Benefits of Stock Options

• gives the buyer the right

• Not the obligation

• To buy or sell

• A specified underlying

• At a set price

• On or before a specified date

Now let us see how it works out :

The stock of xyz is trading at Rs. 100 and you expect it to go up to 150

In cash segment you buy 100 shares and pay Rs. 10000, (100 shares x Rs. 100)

If the stock reaches your target of 150 you make Rs 5000 by selling your 100 shares at Rs. 150/share

If the stock falls by Rs. 50 you make a loss of Rs. 5000 by selling your 100 shares at Rs. 50/share

In futures you buy a contract of 500 shares (lot size) of the same share for Rs. 50,000 (500 shares x Rs. 100)

If the price reaches 150 you make a profit of 25000 (500 shares x Rs. 50)

If the price falls to Rs. 50 you make a loss of 25000

In options you buy a call option (right to buy a security) for 500 shares at a strike price of Rs. 105 paying a premium of Rs. 2500 (assuming a premium of Rs. 5 per share for 500 shares)

If the price reaches 150 a profit of Rs. 45 per share (Rs. 150-Rs. 105) the net profit after deducting the premium of Rs. 5 per share paid by you gives you a profit of Rs. 40 per share or a total amount of Rs. 20000 ( 500 shares x Rs. 40)

The option shows its advantage if the price drops by Rs. 50. You have only bought the right to exercise an option to buy. Therefore if for some adverse reason the stock price plummets your loss is limited to the amount of premium you have paid in this case Rs. 2500 ( the premium paid by you for the right to buy 500 shares at Rs. 105)

As is clear from the example, options have a clear advantage in limiting your risk.

Buying a call option is a bullish stance where you expect the price of stock to rise and buying a put option is a bearish stance and you expect the price of stock to fall.

Selling options can be as risky as futures. The seller or writer of an option takes a huge risk in case of unfavorable price movements. He only profits from the premium he collects from the option buyer for providing assurance to buy or sell securities at a pre determined price.

the logic behind technical fundamental analysis!

Let me first say that I do not now engage in technical analysis; nor, have I ever engaged in technical analysis. I do not believe doing so would be a productive use of my time.
Having said that, I do not claim technical analysis has no predictive value. In fact, I suspect it does have some predictive value. The Efficient Market Hypothesis is flawed. It is based upon the (unwritten) premise that data determines market prices. As Graham so clearly put it in “Security Analysis”: 

 “…the influence of what we call analytical factors over the market price is both partial and indirect – partial, because it frequently competes with purely speculative factors which influence the price in the opposite direction; and indirect, because it acts through the intermediary of people’s sentiments and decisions. In other words, the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. Rather should we say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion.”

I’ve seen a lot of people cite this quote, without bothering to notice what’s really being said. Graham had a very broad mind, much broader than say someone like Buffett. That’s both a blessing and a curse. At several points in Security Analysis (and to a lesser extent in his other works), Graham can not help but explore an interesting topic more deeply than is strictly necessary for his primary purpose. In this case, Graham could have said what many have since interpreted him as saying: in the short run, stock prices often get out of whack; in the long run, they are governed by the intrinsic value of the underlying business. Of course, Graham didn’t say that. Instead he chose to describe the stock market in a way that should have been of great interest to economists as well as investors.

Data affects prices indirectly. The market is a lot like a fun house mirror. The resulting reflection is caused in part by the original data, but that does not mean the reflection is an accurate representation of the original data. To take this metaphor a step further, the Efficient Market Hypothesis is based on the idea that the original image acts on the mirror to create the reflection. It does not recognize the unpleasant truth that one can interpret the same process in a very different way. One could say it is the mirror that acts on the original image to create the reflection. In fact, that is often how we interpret the process. We say an object is reflected in a mirror. We rarely use the active “an object reflects in a mirror”.

For some reason, when we talk about the market we like to use inappropriate metaphors. We talk about wealth being destroyed when prices fall. Yet, no one talks of wealth being destroyed when the price of some product falls. When the market rises, we talk about buyers, as if there wasn’t a seller on the other side of the trade. Above all else, we talk about “the market” not as a mere aggregation of trades, but as some sort of object all its own.

The Efficient Market Hypothesis does not recognize the true importance of interpretation. Saying that data (publicly available information) acts on market prices omits the key step. After all, the same data is available to every blackjack player. Casinos just don’t like the way a card counter interprets that data.

The Efficient Market Hypothesis is not the only argument against technical analysis. There is also empirical evidence that questions the utility of technical analysis. However, empirical evidence alone is not sufficient to prove technical analysis has no predictive power. If most knuckleball pitchers had limited success, the knuckleball might be an inherently ineffective pitch, or there might be a better way to throw it. The same is true of technical analysis.

The adjective “random” is a very strange word. Although it is rarely the definition given, the most appropriate definition for random would have to be “having no discernible pattern”. The word discernible can not be omitted. If it is, we will take too high a view of science and statistics. There’s a great introduction to economics written by Carl Menger which begins:

 “All things are subject to the law of cause and effect. This great principle knows no exception, and we would search in vain in the realm of experience for an example to the contrary. Human progress has no tendency to cast it in doubt, but rather the effect of confirming it and of always further widening knowledge of the scope of its validity.”

All things are subject to the law of cause and effect; therefore, nothing is truly random. A caused event must have a pattern – though that pattern needn’t be discernible. Even if one argued there is such a thing as an uncaused event, who would argue that stock price movements are uncaused? We know that they are caused by buying and selling. Stock prices are the effects of purposeful human actions. Several sciences study the causes of purposeful human action; so, it would be hard to argue any human action is uncaused. Furthermore, each of our own internal mental experiences suggests that our purposeful actions have very definite causes. We also know that the actions of some market participants are based in part on price movements. Many investors will admit as much. They may be lying. But, there is plenty of evidence to suggest they aren’t.

 If the actions of investors cause price movements, and past price movements are a partial cause of the actions of investors, then past price movements must partially cause future price movements.

Technical analysis is logically valid. Not only is it possible that some form of technical analysis might have predictive power; I would argue it necessarily follows from the above assumptions that some form of technical analysis must have predictive power.

So, why don’t I use technical analysis? I believe fundamental analysis is a far more powerful too. In fact, I believe fundamental analysis is so much more powerful that one ought not to spend any time on technical analysis that could instead be spent on fundamental analysis. I also believe there is more than enough fundamental analysis to keep an investor occupied; so, he shouldn’t devote any time to technical analysis. Personally, I feel I am much better suited to fundamental analysis than I am to technical analysis. Of course, there is no reason why this argument should hold any weight with you. I also believe there is sufficient empirical evidence to support the idea that fundamental analysis is a far more powerful tool than technical analysis.

Even though I believe there must be some form of technical analysis that does have predictive power, the mental model of investing which I have constructed does not allow for such a form of technical analysis. In other words: logically, there must be an effective form of technical analysis, but practically, I pretend there isn’t.

Why? Because I believe that’s the most useful model. One should adopt the most useful model not the most honest model. I’m willing to pretend technical analysis does not work, even though I know some form of it must work.

Really, this isn’t all that strange. In science, I’m willing to pretend there are random events, even though I know there must not be random events. In math, I’m willing to pretend zero is a number, even though I know it must not be a number. A model with random events is useful. In most circumstances, a refusal to allow for random events would be harmful rather than helpful. The model with random events is simpler and more workable. The situation is much the same with zero. It isn’t a number. To include zero as a number, you would have to put aside the principles of arithmetic. So, we don’t do that. In school, you were taught that zero is a number, but that there are certain things you must never do with zero. You accepted that, because it was a simple, workable model.

I propose you do much the same in the case of technical analysis. You should recognize the logical validity oftechnical analysis, but create a mental model of investing in which technical analysis has no utility whatsoever.