The Moon

Let me us a Buddhist analogy to illustrate why some people are better at using Fundamental analysis to make profitable investments.

Published accounting statements, brokerage reports, company’s spin (opps, I meant presentations), media commentaries, and so on are akin to the finger pointing to the Moon.

The finger is not the Moon. It merely helps the viewer to locate the Moon.

If we want to study the Moon, we need to observe at the Moon directly. But some students of Fundamental analysis never looked beyond the finger of the person to whom they have asked, “Where is the Moon tonight?”

And we wonder why we fall into value and high dividend yield traps… Cheap and junk are not the same thing!

The Reflection of the Moon on the water

Using another Buddhist analogy, Technical analysis is like looking at the reflection of the Moon on the water

Many rabid Moon-chasers have dived and drowned in their attempt to “fish” the Moon out of the water; mistaking the reflection for the real thing…

Fishermen who lived by the water calmly dry their net during the day and patiently wait for the right weather conditions before going out to sea.

Using wisdom handed-down through the generations, they look at the cloud patterns; feel the wind’s strength and direction; observe the rising ebbs and flows of the tides; and recollect the previous night’s night sky before boldly venturing out to sea.

There is bounty in the sea; but you want to make it back alive too!

That’s where Moon-chasers and fishermen differ.

Moon-chasers can’t let go of their obsession of the Moon – their “why” questions betray their Fundamental roots…

Fishermen don’t know or care for the “whys”. They just “know”. When the right weather conditions appear, they go fishing!

Those fishermen who are interested in the “whys” would have gone for their Phd in Meteorology – and they are called weather forecasters.

Weather forecasters don’t fish; they make a living selling their predictions.

Everyone loves a winner!

It’s not important how we make our buy/sell decisions. What’s important is that we make MONEY!

If we don’t make money, both the Fundamental and Technical schools will probably distance themselves from us. What an embarrassment we are to them!

If we make money, even if we never studied at their schools, they will probably trip over themselves to offer us their “honourary Phds”!

Well, once upon a time, people believed there’s such a thing as Phd in Options Trading. Finger watchers…

Nothing is free. We probably have to agree to have our photos taken and used in their next promotional materials. Spin!

OK, let’s skip the pleasantries (or foreplay) and jump right into it!

Technical Analysis

Traders who practice this analytical approach believe in the 3 holy grails of:

a)    Price

b)    Volume

c)    Time

Using different permutations of the above 2 or 3 holy grails, a whole plethora of indicators are invented. Some more “voodoo” than others!

And new indicators keep getting “invented” all the time – usually by “trainers” so they are market them as “proprietary systems”. Since its “voodoo”, you can put old wine in new bottles and call it whatever you like!

This is something Fundamental “trainers” watch with envy as Fundamental analysis is based on something that is taught in accounting and finance schools. If you can’t “patent” new “proprietary Fundamental systems”, how can you charge more than lecturers in the polytechnics and universities?

And you never wondered why Technical analysis trainings cost more than Fundamental Analysis trainings? LOL!

There are also 2 major sub-groups of this school:

1)    The dog that wags the tail

2)    The tail that wags the dog

The dog that wags the tail

Exponents of this school believe the price actions and volume transactions are shadows that give clues to the below 2 “perceived realities”:

 a)    Object has moved (Market fundamentals have changed).

b)    Light source has moved (Market sentiments have changed).

Just like a sun-dial, by looking at the movement of the shadow of the pin, traders try to determine the location and predict the movement of the Sun.

Not voodoo; but employing elements of science and psychology. Brains required!

The tail that wags the dog

Less competent exponents of Technical analysis tend to belong to this school.

These traders get excited and make their buy/sell decisions just because 1 line crosses another line, mumbling something like golden or death… Or when they spot something like a hammer or a star… Or when the price breaks through some self-drawn resistance or support lines…

Voodoo… Brains not needed.

The untold truth about Technical analysis

The spider weaves his web and patiently waits for his prey to get ensnared in his web.

The spider knows an insect is caught by feeling for the vibrations of his web – just like a Technical Trader will patiently wait for his indicators to signal the moment to strike.

Now there is one interesting species of jumping spiders called the Portia.

These spiders even deceive and attack members of their own species. Most surprising, they fine-tune their predatory behaviour to individual encounters.

Well, I leave it to you to figure out which sub-group of Technical analysts this jumping spider Portia belongs to ;)

Now you know what it means: “Collect school fees and teach them what to do; then you go trade against them since you can predict what they will do!” 

No, I am not going to explain via numbers and ratios. That’s so left-brained! Let me try with a right-brained approach.

Fundamental Analysis

Investors who favour this analytical approach like to comb through the published financial reports of companies with glee as they try to fish out useful nuggets of information for their buy/sell decisions.

There are 2 major sub-groups of this school:

1)      Numbers R’ Us

2)      Lazy bums

Numbers R’ Us

This group loves to dive into the balance sheet, Profit & Loss, and Cash Flow statements. Not only that, they will read and decipher every word/number in the appendixes! Numbers R’ Us are hard-core number crunchers! They would create their own spread-sheets and track the ratios of their beloved companies quarterly and annually.

I am puzzled as the only numbers I am interested in are: 36, 24, 36.

However, I treat these people with respect as they are frequently the early ones who can “smell” something is “fishy” just by looking at the numbers – especially when they don’t add up!

When in doubt, they vote with their feet and stay out.

Another interesting trait is they trust their own financial detective skills – they take responsibility for their own investment decisions. Hence you won’t find them suing the banks or blaming the authorities if they have bought Lehman mini-bonds.

For eg, if they invest in an S-chip (China companies listed in SGX), they do so with eyes opened.

Lazy bums

This group of “fundamental analysts” are outright lazy or don’t know what to look for in the numbers…

So they rely heavily on 3^rd parties to do the summaries for them. So they download brokerage reports and read what financial bloggers have to say. Listen and watch CNBC or Bloomberg commentaries – what is said in the media must be true! No?

One obvious trait is they like to quote who said what or who wrote what. They are quick to follow advice; but when things go awry, they are equally quick to “outsource” responsibility!

Eh… Are they using Fundamental Analysis? Well, they can quote the P/E ratios, net asset values, P/B, dividend yields as good as their Numbers R’ Us brethren. Just don’t ask them how these numbers were derived!

For eg, if they invest in an S-chip, they go in following the “backside” of others.

The truth about Fundamental Analysis

When you look at the Sun, you are not looking at the “real” Sun. What you are watching is the image of the sun 8 minutes ago. That’s how long the light from the Sun takes to reach Earth!

It’s the same when you look into the mirror. You are looking what you were 2 nano seconds ago. 1 nano second for the light from you to reach the mirror; 1 nano second from the mirror back to your eyes.

There lies the truth about Fundamental Analysis! Unless you are an insider, everything in the market is old news to someone else!

All published statements or reports have a time lag. The question you have to ask is how high or low in the information food chain do you belong to?

In the middle ages, buy looking at the Sun, it was the obvious “truth” that the Sun revolves round the Earth. It was Nicolaus Copernicus that pointed out that it’s in fact Earth that’s revolving round the Sun!

So next time you are doing your own fundamental analysis or reading a brokerage analyst’s report, you may want to pause and reflect:

Are you listening to the “obvious” truth (the spin others are giving you), or can you see beyond the numbers just like Copernicus?

Next post I will talk about Technical Analysis.