What stocks to invest in = discount brokers and technical analysis « PRACTICAL STOCK INVESTING



What stocks to invest in

The stock market can be considered as the place where the financial characteristics of publicly traded companies meet the hopes and fears of potential equity investors.  Fundamental analysis addresses the former issue, technical analysis the latter.

In the US of the Roaring Twenties, technical analysis served both functions.  Depression era reforms that forced companies to release accurate and readily understandable financial statements had not yet been enacted.  So the trading activity of “insiders,” detected by carefully watching price and volume movements, was the best gauge one could get of how firms were actually doing.

Since that’s no longer the case, why do online brokers (Merrill Edge is the only exception I know of) provide such lame information on company fundamentals?

Several reasons, I think:

–brokers earn their revenue from trading, not from investment results.  (For what it’s worth, there’s a strong belief in the professional investment community that there’s an inverse correlation between the amount of trading a portfolio manager does and investment performance.)  So it makes some business sense that they should provide tools that make trades easy to do, with an old-style video game-like interface that makes it seem important and fun.


–a fundamental research effort is a headache.  It’s difficult to create and sustain.   It’s expensive, as well.  Arguably, offering proprietary research also exposes the broker to liability if the recommendations don’t pan out.  The user needs some accounting/economic background to understand what’s being said.  The broker who provides fundamental research has an obligation to consider whether a recommendation is suitable for a given client–opening another can of worms.  And, of course, an emphasis on fundamentals runs the risk of refocusing clients away from frequent trading, to the detriment of profits.

–discount brokers do offer a kind of fundamentals-based product through actively-managed mutual funds and ETFs, as well as through their sponsorship of networks of financial planners for whom they provide back office services.  Offering fundamental research might put brokers into competition with those planners.  And the fundamentally-based fund offerings carry a much higher price tag than DIY trading.

 

– What stocks to invest in

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