HUMAN thinking often tends to bounce between the extremes of complex answers to simple questions or simple answers to complex questions. “I ask what time it is and you tell me how to build a clock.” Or, “What is the meaning of life? To get more sleep.”
When analyzing the stock market, most people make the same mistake. The key to the deal is found from English Franciscan friar William of Ockham—Ockham’s razor—which is usually misinterpreted as “simple is better”. What he actually proposed was that when you have to figure out something, keep the assumptions you have to make to as few as possible.
One stock analysis centers on the idea that price should/will reflect corporate value most easily from profit. The Price Earnings Ratio (PER) is used to determine what the price should be. But using PER is completely subjective. Is a stock that is priced at 30 times its profit per share too high? Is a PER of 10 too low? Nobody can answer those questions. Except, by looking historically at a company’s PER, we can determine what the market—actual buyers and sellers—thought was an economically viable PER.
Technical analysis that looks at price movement comes in three broad categories. Chart price patterns—‘Cat’s Ears’, ‘3 Rickshaws Parked At the Brothel’ or ‘The Burping Bat-Shark’—use the same techniques as meteorologists use to predict the weather and that is a compliment. Patterns of behavior in stock price —or clouds—lead to results that can be forecasted with a high degree of predictability.
Stock prices historically tend to stop going up and stop going down at particular levels, and again also tend to do this in patterns. This is all about price support and price resistance, whether measured by “Moving Average”, “Fibonacci sequences” or “waves”. It is the ebb and flow as the market trades when thinking that the price is too high or too low at any given time.
The third broad group more specifically combines price action with the amount of trading volume. This creates a measurement of momentum of price movement higher or lower. Looking at the speedometer of your car only gives a snapshot of current speed, but gives no indication if the car will be going faster or slower in the future. A stock price can be going higher but also be losing momentum, just like a car slowing down when you take your foot off the accelerator.
Measured over a comparatively long period of time, technical indicators like “Relative Strength”, “Stochastics” and “Rate of Change” can help determine if the “foot is on the gas” or not.
All methods of technical analysis can be useful, but the serious mistake that investors make is believing there is a “normal” one-size-fits-all method. One size of clothing does not fit all if you care about optimum comfort and attractiveness. Parameters for technical indicators are individually tailored and must be adapted.
However, there is one simple, basic and foolproof question to identify if a price will go higher or lower in the future. Is the stock under accumulation or under distribution?
Investors can be buying an issue without an increase in price or in trading volume. Likewise a stock can be under distribution without a price fall. We think that there is an unlimited supply of money to buy and a relatively unlimited supply of stocks to sell.
But there is a huge difference between “I have no more shares/money” and “I have no more shares for sale [or money to buy]”. Shares under accumulation will go higher; shares under distribution will go lower. Guaranteed. Just give it some time.
E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.