“Fundamental analysis is good for telling you what to buy but is terrible at telling you when to sell…” - Views on News from Equitymaster

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  • Dec 6, 2002 - “Fundamental analysis is good for telling you what to buy but is terrible at telling you when to sell…”

“Fundamental analysis is good for telling you what to buy but is terrible at telling you when to sell…”

Dec 6, 2002

Mr. David Linton is the CEO of Updata Plc., an investment software company in the United Kingdom. He is a prolific market commentator and appears regularly on television, including Reuters and Bloomberg TV. Mr. Linton writes “The Chartist Column” for UK’s Shares Magazine each week. He has also written several books on the science of investment. In an interview with Equitymaster, Dr. David Linton spoke about the technical analysis and how it acts as an effective tool for trading in the stock market. He also talked about the future course of movement in world indices. According to him, the technology sector seems to have seen the worst.

EQTM: How do you view the movement of the global markets in the long term or the short term, as the case may be?

Mr. Linton: My views, one should understand, are based on technical analysis. The key point, in my view, regarding the global markets today is the fact that the US markets dominate global markets. Though there may be differences of opinion regarding this argument, realistically speaking, it is hard to believe that for the next few years, we will not follow US markets. To track global stock markets, we have to take stock of what is happening in the US markets. Though I follow three US indices, there are two indices in my opinion that are really important. One of them is the S&P index, which is a much broader based index. In my opinion, this is the most important index that must be tracked. The second most important index is the NASDAQ because of the way it has impacted world indices. The third index that I track is the Dow, as a considerable fall on the Dow has a psychological impact on the global stock markets.

Now if we look at the S&P chart, the 965 levels are of a greater significance (currently it is trading at around 915 points). Technical analysis has been justified to the extent that this resistance level has been tested in 1997 during Asian crisis and after September 11 attacks. Now that the S&P has declined below 965 points, if the S&P breaches this level at the current juncture, we are likely to see a northward trend. Otherwise, it is anyone’s guess because it has become more of a ceiling in the recent past. The NASDAQ, which has relevance in the Indian context, has shown signs of revival.

After a long bearish trend, the NASDAQ is now at a 3-4 months high. This is the first time after the collapse on the NASDAQ that it has reached 3-4 months high levels. But I would still say that the psychological barrier is still the 1,500 level mark. I would also like to point that this period, i.e. the first quarter that we are heading into, have historically been a good period for the stock markets. Hence, I would say that we are nearing the 1,500 levels. In my opinion, the technology sector seems to have seen the worst.

Another key aspect of the NASDAQ currently is the fact that this index has started functioning in line with the other indices i.e. it has its periods of overvaluation and under valuation just like other indices. So now, investors will have to get used to the idea of the NASDAQ behaving like any other index.

EQTM: Coming to charting and technical analysis, what attracted you to technical analysis?

Mr. Linton: In short, I would say that ‘it worked’. When I started investing, my investment decisions were largely based on recommendations carried in newspapers. But more often than not, a majority of my investments failed from the point of view of returns. In my opinion, the underlying fact is that if it has been reported in the papers, then you have already missed the opportunity. My view is that the markets have already factored in all the news that is publicly available. So if someone gives me an investment advice, I have always tried to ask him to give me information that the markets do not possess. Otherwise it is of no use.

When we analyse charts, we are trying to analyse the effect rather than the cause. What I liked about charts is the fact that they are totally objective and an investor does not need to know why a particular stock is going up or down. Charts historically have been good at alerting me to things that have changed like a trend reversal or increased volumes. I would like to point out that if you have used fundamentals in the last two years, you would have not been as successful if you had used technical analysis following the proper discipline.

EQTM: Why has it gained so much popularity and following among investors?

Mr. Linton: Anyone who can grasp this tool will see that it works. For example, you cannot argue with a downtrend. In my opinion, most investors are very bad at selling shares. So the critical factor is the fact that irrespective of what you buy, you must get your selling price right. Fundamentals are good for telling you what to buy but they are terrible at telling you when to sell the stock you have bought. When fundamentals are telling you to sell, more often than not, it is already too late. For example, Enron, the profit warnings came in when the stock was already falling heavily on the indices. You may never see a profit warning on a stock when it is at an all time high. These are the main reasons why I like charts.

EQTM: What are the basic principles of charting?

Mr. Linton: There are four principles I strictly follow. One cut your losses. Second cut your losses. Third cut your loses and fourth let your profits run. What I would like to stress here is that if you cannot do anything else, then keep your losses small so that you do not eat into your capital to a large extent.

EQTM: Do you think that technical analysis is restricting the investor to a short-term view of the market or do you think it has wider implications?

Mr. Linton: Technical analysis work mainly for short-term trading in ways fundamentals never could. But I would like to point out that technical analysis would tell you when long-term things are happening. For example, in UK, British Petroleum (BP) breached its eight-year trend and this to me, seemed worrisome. And it turned out to be right. BP issued a profit warning four weeks later. So what I would like to point out here is that though the technical indications are short-term, they have wider long-term implications. Another example is that of the NASDAQ, which is currently showing a reversal in trend. So here, I am using the technical charts to take long-term decisions.

EQTM: Does technical analysis captures random events that impact the markets significantly like September 11, interest rate variations? Does it treat political/economical events the same?

Mr. Linton: The problem with shocks is that you can never know. As far as Iraq is concerned, markets have already factored it in prices. If an event is unexpected, then the market will react adversely. Because nothing works at that point in time.

But one thing I would like to point out though is that in case of September 11, the markets were already falling before the actual incident. In a falling trend, technical analysts tend to exit. So after the incident, technical analysis helped us understand investors’ susceptibility to such events. The charts will give you exact locations of the shock points in these cases, so that you can normally predict the extent of damage. For example, in case of an unexpected event now, we can with certain accuracy determine the support levels of the indices.

EQTM: Investment, as is believed by various schools of thought, is science and an art. You have written several books on science of investment. What makes you believe that investment is a science and not an art?

Mr. Linton: Basically investment is a science most of the time but some times it is an art. The reality is that markets do behave in fairly predictable patterns. But at some times, all the predictability goes for a toss and at those times, one has to step back and try to read the market again. Then go back again and start trading.

EQTM: On a softer note, any personalities or books that have influenced you the most?

Mr. Linton: The first book that I liked was Jack Schwager’s ‘Market Wizards’. Any one who wants to get a hang of trading must read the experiences of the best traders in the business. Secondly, I likes James O’Shaughnessy’s ‘What works on Wall Street’. And last, Edward Lefevre’s ‘Reminiscences of a Stock Operator’, which was published in the 1920s.

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