Tuesday, January 10, 2012

Fundamentals, Investing and Trend Following

The vast majority of investors and longer-term traders use some form of fundamental analysis when selecting stocks to invest in. This is all well and good, but what triggers a buy or sell in their investments?

The usual story is that, once they believe that a particular company has good prospects and the fundamentals look promising, they will start to buy, with the intention of holding their positions until such point that the fundamental story changes. The trick is to realise when there is a danger of overstaying their welcome, and to exit their positions before losing the bulk of their profits. This is where a trend following system, geared towards longer term trading and investing, can be invaluable.

Although longer term investing can be profitable even when there are adverse general market conditions, it should be remembered that, in a sharp downtrend in the markets, even the strongest and best stocks fundamentally will suffer, as was seen in late 2008. Of course, when a downtrend like that starts, it is not known whether the affected stocks will rebound at least back to its former highs, or will even continue further downwards.

In the past, I have suffered abuse from the 'fundamentalists' on a bulletin board when my own trading system signalled the end of an uptrend in a particular stock, and therefore I exited my position with a nice profit. However, those who solely used their fundamental analysis accused me of de-ramping the stock (as if I could influence the markets!!!) and rubbished my own analysis. The stock in question was just below 50p at the time, having peaked at 60p a couple of weeks prior.

The investors I left behind continued to champion this particular stock, and some of the posters on the bulletin board in question 'loaded up' their position to almost absurd levels, so confident were they that soon they would be holding significant profits.

As of last week, that particular stock was at the 15p level, with a lot of investors now holding massive losses after 'buying on a pullback' which was actually a new trend - downwards. Some of those still holding shares are even blaming the directors for the lack of  recent positive news flow from the company for their losses!

Now, this may be an extreme example, but you only have to think about stocks such as Enron to know that people who were once sitting on huge profits in some of their investments managed to ride the share price all the way down, losing all of their hard earned profits. Enron fell from around $100 to 50c, with the true fundamental picture becoming apparent late in the day. You can also think of those who made (and lost) fortunes in the dot com bubble when prices collapsed there too. In these cases, it was not only individual investors, but hedge fund managers who also commited the same crime of not exiting their positions when the trend reversed - greed took over and they decided to load up even more.

Those of you who have read about Nicolas Darvas will know that he used a basic system marrying fundamental and technical analysis back in the early 1960's and did very well.

No system is perfect, and my intention is not to poke fun at those who have lost money by holding on too long - far from it. Everyone invests or trades to make money, however there is always someone on the other side of a winning trade, who loses money. Sometimes it is me, sometimes it is those who follow the company 'story'. Either way, if you are able to combine the two in your longer term holdings, I would be amazed if your overall returns did not improve.

1 comment:

  1. I have to say that the information here was the most complete that I found anywhere. I am definitely bookmarking this to come back and read later.

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