Warren Buffett: Stopped tech analysis when I turned charts upsidedown, got the same answer. Meaning? Agree?

Question

Warren Buffett: Stopped tech analysis when I turned charts upsidedown, got the same answer. Meaning? Agree?

Answer 1

Buffett makes a good point, that technical analysis can be interpreted to make any conclusion.   But I think it is one tool, like fundamental analysis that can help an investor decide whether the odds favor investing in a particular stock or index.  One of the main ideas of technical analysis is that it shows in chart form what the buyers and sellers of a stock or index are doing.  Changes in their preference for a stock can show up in the charts and in technical analysis before there is a change in the fundamentals of the stock, which confirm the change.  

For example, you might not see a change in the earnings fundamentals until a company announces its earnings, which can be 35 days after the quarter ends.  If buyers are anticipating good earnings, the stock chart may turn up and the volume may increase before the earnings announcement confirms this.  

I think the same criticisms can be said about fundamental analysis also.  Just because a business is performing well or earning so much money per share doesn't mean that it will continue to perform.  Competitors can introduce a new product that takes sales away and you won't see that change until the next quarter's earnings are announced.  P/E ratios (a fundamental tool) can be misleading.  Companies do not have to sell at a certain P/E ratio even if they have growing earnings.  The market may decide that it no longer wants to pay 15 times earnings for a stock that is growing at 15 times.  Sometimes the market may be willing to pay more and sometimes less than the 15 times earnings.  P/E ratios can depend on the level and direction of interest rates, but sometimes it's just a market preference for that particular sector.   Take a look at the stock performance of some of the so-called great growth companies like a Wal-mart or Microsoft.  Sometimes their earnings growth continued at the same pace, but the market stopped awarding them a premium p/e ratio.

i think technical analysis can be helpful in determining resistance and support levels for stocks; however, they say that these support and resistance levels are only good if they actually hold and that all levels are made to be broken.  What they do then is to help the investor better understand the odds.  And more importantly, they can help you set up trading stops so if a stock should break below a support level, it can be sold (or bought in the case of breaking through resistance) automatically without getting into the emotional game of whether the stock will come back to the previous level.  This can help limit losses.

Not all stock charts are easy to read and in some cases the technical analysis is too difficult to assist with an investment decision.  That can be helpful and lead you to pass on that stock.

Answer 2

Well, a technical investor is someone who uses "technical analysis" a large part of which is drawing graphs and inferring trends.  Based on these trends they decide which stocks are going to rise and which are going to fall. They invest (obviously) in the ones that will rise.  The strength of technical investing is that one does not really need to know too much about a particular company and its strengths and weaknesses when you invest.  You just need to look at historical data, have the right analysis tools and you can make predictions.  The weakness of technical investing is that you really don't have a clue about the company but in addition there is always more than one way to interpret a trend.  If a stock starts rising rapidly you can say that it is on the verge of breaking out and shooting up or you can say it is at a peak and about to crash.  Technical investment is obviously a lot more complex than my simple example, but the bottom line is that it is somehow using past behavior to predict future.

Buffets complaint is exactly what I just said.  Depending on how you choose to interpret you can get almost any answer from the same data.  So ultimately you may not be as objective as you think, you are biased by your methodology.  So his vignette is saying that you can come to a certain conclusion from the current behavior (looking at the chart) and you can come to the same conclusion if the behavior was the opposite (turning the chart upside down).

And while he is using rhetoric to make his point, I agree generally speaking with what he is saying.  Technical methods may be able to predict very routine sorts of behaviors reasonably well but (like any model) if something unusual happens they are thrown completely off course.  Like a subprime meltdown or a switch to biofuels for example. You can't use methods based on the past when something in the environment is going to cause the future to be considerably different than the past.

P.S. You may like the cute link that I included below.  Watch the video.