There is no such thing as an amateur investor: the moment you lay out cash for an investment, you’re a professional, playing the game for money.
Professional investors on the stock market should equip themselves with the basics — which are the measures you use to decide whether or not a share is good value at a particular price. These basics are the fundamentals. Unfortunately, the fundamentals can’t tell you whether you are buying or selling at the right time. It’s obvious that timing is important to traders but, perhaps, less obvious to long-term investors.
Technical analysis is the key to timing. This form of analysis observes trends and, in particular, spots changes in trends, either just as they change or when they are expected to change. The notion that future changes may be predicted sometimes makes hard-line fundamental analysts dismiss technical analysis as nothing more than “crystal-ball gazing”. Perhaps it’s just professional jealousy.
It’s a truism that two points can always be joined by a straight line. Technical analysts say that if three points can be joined by a straight line, that’s a trend. A simple example is a share price chart, a graph joining share prices. This chart will show a trend if you can draw a straight line joining either three higher or three lower share prices. If you can join three higher share prices, this will tell you that share prices are probably going to rise more. If you can join three lower share prices, it tells you they may fall more. Some technical analysts use these simple trend prices as trigger signals and then look at other forms of analysis to confirm the triggers.
Price trends are one-dimensional. Technical analysis generally tries to observe the price trend relative to supply and demand of the share. This can be said of one of the earliest, and still popular, forms of analysis: point-and-figure charting. This charting method primarily involves itself with the study of support and resistance levels and with the chartist looking for breaks above and below these levels. Working on demand and supply, the point-and-figure plotting moves up when a share is in demand, down when it is in supply, and remains where it is or forms a sideways pattern when demand and supply are relatively equal. Upward movements appear as an X and downward movements as an O.
Traditionally a point-and-figure chart is constructed by noting the high and the low price for a period. If the high price is above that of the previous period, the plotting moves up, and, if the lower price is below that of the previous period, it moves down. If the price is unchanged, no plotting is made. The charts will then be a series of columns of Xs and Os. A column will only change from Xs to Os when a price reversal is changed.
Technical analyst Jean Temkin says: “The analyst has to choose the right margin of point change (price difference) to make the reversal and move to the next column. Traditionally, analysts use a three-point reversal, and each point depends on the actual price of the share. A share trading at around 200c would ideally have a point of 10c. Thus, its price would have to change by three times 10c (in other words 30c), before it changes (reverses) from Xs to Os or vice-versa. A share trading at R20 might have a three-point reversal at R1.
“Once you have more than two columns of Xs or Os, you have a picture of a trend — a column of Xs, followed by a column of Os, followed by a column of Xs rising higher than the earlier Xs — tells you there is an uptrend in force. This is a double top and experts have worked out that this signal will be profitable about 80% of the time.”
Temkin, who explains this all in her recent book, More Charting for Profit, says that, as a starting point for analysis, she usually scans the whole stock market — there are a number of good software programs for technical analysis — to show which shares are overbought and oversold.
A share becomes overbought when its price is still rising, but the trading volume is falling and vice-versa. In the first instance, Temkin explains, the buying has gone out of hand — the only shares that could be available are those that belong to greedy bulls, but they won’t sell because they expect prices to continue rising. They only start to sell when they realise the price may be past the top and this selling encourages the price to move further down.
“My scan of the market provides sell (overbought) and buy (oversold) signals and I then confirm those signals with other indicators.”
Temkin, who has invested successfully for many years, warns: “The charts won’t tell you when a company share price changes because a company has made a sudden loss — such as the bulking payments by insurance broking companies Alexander Forbes and Glenrand-MIB. A chart only takes into account all known information at the time the chart is made.”
Writer Ben Temkin is Jean Temkin’s husband. More Charting for Profit is available from some bookstores and also from the publishers at tel/fax: 033 234 4230 or e-mail: [email protected].