FINANCE: Women & Investing Part 5

‘Women & Investing part 5’ by Dr. Bill Dodd published in GHG (Dec 2015). In his previous articles, Bill explained the basics of investing. In this article, he shares his thoughts on when to buy & sell stocks by using the principles of fundamental analysis. 

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FINANCE: Women & Investing Part 5

written by Bill Dodd

In the previous articles in this series I have considered the basics of investing. For the most effective investment result, the combined tools of fundamental and technical analysis should be used. Fundamental analysis is a tool that is used to find those stocks which represent good value or are undervalued at their current market price and are the ones an investor would like to buy.

The answer is to use technical analysis to determine the best time to buy or sell the stock.

Technical analysis

Technical analysis is the study of the historical price and volume of a stock and uses graphs or charts of the past prices to determine the best time to buy and sell that stock. Technical analysis uses many different indicators to interpret the stock price. An indicator is a derivative of the price and provides a visual representation of price movement and interaction. A useful example of an indicator is the ‘30-week moving average’. The ‘30-week moving average’ (the red line) is drawn on a chart of the All Ordinaries Index below. This is simply an average of price of the index over successive 30 week periods. It is a simple but very useful indicator because it reduces the variability in the often erratic price movement over successive weeks. 

Consider more closely the weekly chart of the All Ordinaries Index (below) over the period 2007 to 2009, the time of the last bear market. The ‘30-week moving average’ line shows a sharp downturn in early 2008 and does not turn up again until 2009. A simple indicator such as this would have warned investors against investing in stocks during 2008. So in general terms an investor would avoid buying any stocks when the moving average is in a downtrend and buy only when the moving average is trending up. So it can be used as a simple indicator to buy or sell a stock. 

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Let’s take an example where the ‘30-week moving average’ indicator is applied to the chart of a stock: here the weekly chart of Commonwealth Serum Laboratories (CSL), over about a 5-year period from 2001. While CSL is a major blue chip investment company, investors who had bought shares in CSL in late 2001 would have lost about 80% of their investment over the next 18 months. But by using the ‘30-week moving average’ indicator, the investor would not have bought CSL shares in 2001 and have avoided the loss. 

The ‘30-week moving average’ on a weekly chart of a stock provides one simple method of timing an entry into the share market. In the above example an investor could have bought CSL in September 2003 for about $5, a company whose share price in early 2016 is close to $95.

Stock markets are often not logical

The stock or equity market involves millions of investors, so emotion frequently dominates the markets which are often not logical. To take an example: if there was a very serious disaster in the USA, causing absolute chaos, then the Dow Jones Index could fall by more than 50% tomorrow. The Australian market would follow this trend and the share price of a blue chip stock such as Commonwealth Bank (CBA) could plunge, perhaps by as much as 50%. However, CBA as a business would have lost no value over night and would in all probability continue to pay the same dividend in the future. 

This is an example of raw human emotion at work and this is where technical analysis is so important. 

Technical Analysis Software

To use technical analysis one needs access to special software package. This can cost up to several thousand dollars but there are packages available which can be used by any investor at very low cost. One example is incredible charts which is available free on the internet. Incredible Charts is such a useful software package that it is the only one that most investors would ever need to use. 

In conclusion, the price of a stock is related to the emotions of a huge number of market participants who have a perception of the value of a stock often without an understanding of the real value of the stock itself. As a result, the prices of stocks usually reflect human emotion and may fluctuate significantly, so they do not necessarily reflect the real value of the stock. The strength of technical analysis is that it is able to evaluate the emotional responses of market participants and provide the information on when to buy and when to sell a stock. 

Author of this article:

Bill Dodd is a retired academic and experienced investor. His concern at the lack of financial literacy in Australia prompted Bill to become active in investment education. Since 2009 Bill has provided courses on investing for the Australian Shareholders Association and the Australian Investors Association in all states. Bill’s website provides investor information and his ten session video course on investing is available on the Australian Shareholders Association website. This course is available at no cost to members.

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