Fundamentals, Elliot, Technical Analysis, and Mr Market
Fundamentals, Elliot, Technical Analysis, and Mr Market
Most of these terms can be better explained on Wikipedia, for example: http://en.wikipedia.org/wiki/Elliott_wave_principle
Elliot's Wave Principle is one form of technical analysis that attempts to forecast trends in the financial markets. It has grown to a rather large following here on CAPs thanks to being explained and "taught" by GoodVibe and it's showing the resistance/bottom of the S&P plunge in early March.
Technical Analysis (TA) is used to analyze what has happened and make can also be used for prediction on what might happen next.
Both Elliott and TA use resistance levels which occur when there are more sellers than buyers, or more buyers than sellers, at a given price, to predict what might happen next. Trend lines and resistance levels can be plotted and used to help "guess" whether a movement up or down might be expected.
Fundamentals require no technical analysis, but can involve substantial math when applied against a company's financial reports. When the markets seemed to have more consistency, pre-recession, fundamentals were used by many investors. Attempting to determine the fair market value of a company can be difficult, future earnings, competition, management, the economy, etc all play in.
Rather than do the "work" themselves many people feel the analysts, who are "in the know," with the most experience factor all of that into a stock price day to day, and the average investor just needed to follow along. Buffett proved quite successful looking at fundamentals of company's and searching for those that had strong cash flow, good products, and expected future growth.
Strangely, many people still feel that the analysts are the ones to follow, despite few analysts predicting any of the major market moves in the last six months. I call this the lazy sheep mentality. Using fundamentals and/or TA requires more work than most investors want to do on their own.
Mr. Market, however, sometimes looks for trends, sometimes is predictable in habits, and sometimes cares about fundamentals and what analysts have to say. Sometimes, however, he doesn't care what anyone thinks. The VIX, volitility index, especially, can move the herd.
I blogged that the fear of missing out has pulled many investors back to the market, despite the analysts calls that we are/were in a bear market rally. Add in speculators, government interventions, greed, envy, and a host of other human characteristics and Mr. Market is in control now. While Elliott works on the priciple that the markets/investors have rhythms, in this stage of the recession I think too many people are clanging the cymbals at the same time and distrubing the rhythms
Does that make the other forms of analysis wrong? No, it just means we have to adapt.
For example, check out some of the sub-$5 stocks for companies with a forward P/E that is positive, cash in the bank, and you have the makings of a company that Mr. Market might run up in anticipation of earnings well beyond what fundamentals or TA might suggest. Even some with net negative tangibles have been taken to new six month highs (LEA, TEN, AXL, TLB, banks, etc) Toss in a relatively early (from a monthly perspective) expiration of options this Friday and you get additional volitility.
As a fundamentalist, who ALSO uses TA to look for trends, one now has to now factor in the Market's drive to get back in and make a buck or two. Stocks will be ran up, shorts will cover, some investors will move on to another and the cycle continues until something "spoils" the party.
I believe in TA, in fundamentals, and I respect Mr. Market. As far as Elliott, I'd rather see a trend start and miss investing in it by a day or two, or ride it a day or two too long, than I would try to predict one in this point of the recession. Many Fools have been caught short when Mr. Market started clashing his Cymbals in support or disbelief in the government, a Fed quote, a Buffett quote, or a flu bug.
Rationale or not, it doesn't really matter. Mr. Market is in control. There are more individual investors than ever and they have "fun" in pre-post, and the first two hours of the day. When they run out of steam between 11:00am and 12:30 we get a lull and then the institutional investors swing the big axes and the individual investors jump back in.
So if we are in an awkward time where Mr. Market, Fundamentals, and TA don't always converge. Is that because one of them is wrong? Perhaps it's our use of one of them without the others that are wrong. Or perhaps we need to adapt our views of one of them.
In one application of this, my preference would be not to invest in companies that are losing money, fundamentally, it is not a good thing to do. My "new" fundamentals, at least for a short period of time, now includes trying to factor in some positives for companies that are not losing money faster than they can cut costs, have money in the bank, and have a management that seems to be adjusting and have a product that should recover when the economy does, (6, 12, 18 months from now). Then wait for Mr. Market to set a trend.
As far as Elliott, I am starting to wonder if those trying to apply Elliott's principles in this environment are missing out. I see a few CAP's players who were doing pretty well on thier gut and fundamentals who are taking it on the chin the last few weeks.
Still, to each his own. There is no one right answer. I just believe that a mix, or a reevaluation of our methods needs to be considered in this phase of the recession. I understand some follow astronomy and use that for investing. I don't have a problem with that model either if it works for you, but do expect Mr. Market to react to some space debris, sunspots, or a comet, (scheduled or not), from time to time.
If Mr. Market wants to drive, then I'm happy to follow close behind, but ready for him to hit the brakes without any warning, or turn without any signal. Living in New England, that really isn't too hard to do. I have no plans to predict what Mr. Market will do, since I know he is irrational, but that's his choice.
I'm also ready to pass Mr. Market a Kleenex if he thinks he is catching the flu. I'd be happy to pass Elliott one as well.
Good luck, I think that might be as valuable as any tool that previously had merit.