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A Beginner’s Guide To Charting

The Motley FoolAs I write this week’s Take Stock Singapore, I am saddened by the inability of US lawmakers to agree on a budget that has, in effect, left thousands of people without a job to go to because of political intransigence.

For me, it is a stark reminder that regardless of where we might live, we have a duty to ourselves to look after our own finances. Our financial destiny tomorrow will be determined by how we deploy the assets at our disposal today.

Many of you readings this week’s newsletter are investors. Some of you might be fans of technical analysis. Some of you might even be technical analysts and do not even know it.

This is not a pipe

If you don’t already know, technical analysis is the science, though some may say it is just an art, of studying historical price performance against time. And by looking at what has happened in the past, chartists believe they can predict what is likely to happen in the future.

I am sure some technical analysts might be very good at interpreting and exploiting the images of past financial data. However, whenever I am asked about technical analysis, I am always reminded of a painting by Belgium artist Rene Magritte.

In the Los Angeles County Museum hangs a painting by the influential European surrealist artist. The picture, called The Treachery of Images, shows a pipe. Below it, Magritte painted the words: “Ceci n’est pas une pipe“, which is French for “This is not a pipe.”

Magritte said people, at the time, criticised him for the painting. They claimed that since it was obviously a pipe, why then did he say that it wasn’t one.

The thought-provoking Magritte stressed that the painting is merely a representation of a pipe. He went on to explain that if he had said it was a pipe, then he would, in fact, have been lying.

In the same way that a picture of a pipe can never be a pipe, a pictorial representation of a company’s share price against time can never be a company. It cannot tell you everything you need to know about the business.

Is a picture worth a thousand words?

A company is made up of myriad of things that include human capital, financial capital and intellectual capital. When the various things that comprise a business are combined in a decisive way, they could generate a meaningful return for its stakeholders.

As investors our objective is, therefore, quite simple: It is to look for companies that can combine its various assets in a useful way that could generate a return for us.

Warren Buffett once said about his own style of investing: “Buy into, at a rational price, an easily-understandable business whose earnings are virtually certain to be materially higher fiver, ten and twenty years from now.”

Markets are not efficient

A chart, therefore, regardless of its intricacy, is unlikely to tell you everything (if indeed it tells you anything) about how a business operates.

It might tell you how the market has viewed the company in the past. But we all know how inefficient markets can be.

A chart, however, won’t tell you anything useful about a business that you, as an investor, should need to know before you invest in it.

To satisfy your own curiosity, pick any company from within the Straits Times Index (SGX: ^STI). These are 30 of the biggest companies in Singapore. Next, look at a one-year chart of those companies going back five years. Now try to predict what the chart would look like five years hence.

Billionaire value investor Seth Klarman once mused: “Markets are inefficient because of human nature – innate, deep-rooted and permanent. People don’t consciously choose to invest with emotion – they simply can’t help it.

A rich librarian

Investing should therefore be about participating in the long-term success of businesses regardless of what the charts might otherwise say. When you invest, you should try to do so in the knowledge that if a business does well then the stock should eventually follow.

Charts might provide you with a perspective of a how the share price of a stock has performed historically. But as Warren Buffett quipped: “If past history was all that is needed to play the game of money, the richest people would be librarians.”

This article first appeared in Take Stock Singapore.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.