Two approaches to analysis

Press, 19 August 1982, Page 27

Two approaches to analysis

Few human activities have been so exhaustively studied during the last .80 years, from so many angles by so many different people, as’ has investment on the stock exchange.

The rewards which may be reaped are enormous, and the penalties for ill-consid-ered investment are calamitous.

It is not the intention of this review to delve deeply into what might be called investment strategy or tactics. Rather this review attempts to provide the background to investments. Once you know the basics, regular reading of the financial press will help you to understand what the markets are doing. However, it would help beginners to know what the two basic approaches to investment analysis are about. • In the course of stock market study two quite distinct schools of thought have arisen — two radically different methods of arriving at the answers of “what" and “when."

One of those is called “fundamental" or statistical — the other is "technical."

Strictly speaking, there is a third approach, the “cyclical": this method is based on economic trends, and a mixture of the other two. The fundamentalist depends on statistics. He examines the profit-and-loss account. the balance sheet, auditors' reports, dividend re-' cords, and company policy. He analyses sales data, managerial ability, plant capacity, and the company's competition. He reads the economic reviews of banks and Government, crop forecasts, production indices, and price statistics to assess the state of business in general. The daily financial news provides him with an estimate of future business conditions. Taking all this into account, he. evaluates his stock; and buys or sells accordingly.

The term "technical" as it applies to the stock market has a different meaning from what you would find in the dictionary. It refers to the study of the action of the market itself, as opposed to the economic conditions under which companies work.

Technical factors operating on the market would be supply-and-demand conditions. interest rates, the money supply. Fundamental analysis would also take

these into account, but the technical analyst would say that the only thing that matters is to study how the market behaves. They would say that the price of a share does not only reflect the different opinions of many orthodoxappraisers. but also the hopes, fears, guesses and moods, often irrational, of the hundreds of buyers and sellers — as well as their resources and their needs.

They would say that most of these factors cannot be analysed, but all go into the melting pot which finally determines the price of the share. Technical analysts also claim that the bulk of the data studied by fundamentalists are history, and that on the contrary the market is always looking ahead. They would say that market prices take in all the fundamental information, plus some which is secret, and much else besides.

They also point out that prices move in trends. A technical analyst would claim that if he were given a chart (see other article on this page) that was an accurate record of-the trading of a share, he does not need to know the name of the company to be able to predict what the likely price movement will be. I do not believe that it is the function of a journalist to tell his readers what to think, and I would rather let the facts speak for themselves and readers to make up their own mind.

But I must confess to a bias against technical analysis. although I admit that a stockmarket analyst must take note of technical factors.

The reason why I do not like the approach is that it is what I like to call a “black box" theory. It argues that in any investigation you should only be interested in the stimulus and the response. The attitude is a hangover — a typical American attitude — from the year 1907 when the American psychologist William James categorised scientists as hard and soft. Soft were those that tried to understand (admittedly sometimes speculated) what went on inside the black box. Hard were those who said: if you kick the box in the right place and you get the right response that is all you need to know, which led to a scientific approach called “behaviourism."