Do You Believe Analyst’s Forecast?

Do you believe in technical analysis? Do you think stock analysts can use charts to predict the future of a stock and thus make a winning trade?

I have a technical analysis book (All About Technical Analysis* by Constance Brown) that I bought several years when I was once considering to learn the technique, but never finished. I feel that though it could be useful tool, the price of a stock cannot really be reliably predicted because it’s not just determined by so-called fundamentals such as cash flow, growth, earnings, and profit margins, etc. in normal conditions. There are also many unforeseeable events which could drastically affect the stock price, making any prediction worthless.

One example is Xinhua Finance Media (XFML), a stock that I own. Just early this month, after the company reported strong earnings, the stock rose more than 11% in a week from $11.40 on May 1st, to $12.68 on May 7th. Then all the sudden when things looked positive (WR Hambrecht even came out with a Buy rating on May 1st), scandals in how the company disclosed information in its IPO surfaced last Friday and law suit followed and the stock tumbled more than 40% in a span of four days to close at $7.10 on Tuesday. Did anybody out there predict this?

Besides, many forecasts or predictions from analyzing past patterns are far less certain themselves. Here’s an example from one of my favorite financial books, A Random Walk Down Wall Street*, by Prof. Burton Malkiel of Princeton University.

In arguing against technical analysis, Prof. Malkiel cited the following advice from an analyst regarding the market condition and where the market is heading (not the current market):

The market’s rise after a period of reaccumulation is a bullish sign. Nevertheless, fulcrum characteristics are not yet clearly present and a resistance area exists 40 points higher in the Dow, so it is clearly premature to say the next leg of the bull market is up. If, in the coming weeks, a test of the lows holds and the market breaks out of its flag, a further rise would be indicated. Should the lows be violated, a continuation of the intermediate term downtrend is called for. In view of the current situation, it is a distinct possibility that traders will sit in the wings awaiting a clearer delineation of the trend and the market will move in a narrow trading range.

If an analyst points to the charts and gives your the above advice, do you know exactly what he/she is trying to tell you?

No clue?

Then you are not alone. Prof. Malkiel also has no idea what the analyst is talking about, but he offers a short interpretation of the analyst’s message:

If the market does not go up or go down, it will remain unchanged.

I wonder where else it can go.

So if predications and forecasts are so unreliable, a better approach may be just like the book title suggests: taking a random walk.

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