Column H – Sentiment

Cameron : So, then we get to column H, where the real financial data starts, and in my spreadsheet, column H asks if the share price have a positive trend for sentiment chart? If the answer for this question is negative, then we stop. This is a go / no-go breakpoint for us in the checklist. So, let’s talk about sentiment, Tony.

Tony : Yeah. So it’s basically the wisdom of the crowd. We’re trying to see whether or not people are buying or selling the stock and whether they have some confidence in it, just from looking at the share price graph. That might sound a little bit counter-intuitive to value investors because they either don’t necessarily like looking at graphs and they tend to be fundamental analysts. So, they’re looking at the numbers and then the share price will take care of itself. I have a lot of sympathy for people who think that way, but I use the sentiment on the share price graph, it’s a bit of an insurance policy. I don’t want to hold a stock where the share price is dropping too quickly. I only want to buy stocks where they’re going up. So that’s roughly the theory behind it. And I remember listening to a podcast years ago by a gentleman who said that all he did to invest was he looked to the share price graph and if it was going from the bottom left of the page to the top right of the page, he bought, and if it was going from the top left to the bottom right, he sold. And there’s a lot of wisdom in that, I think. If you are a value investor and you think you have a compelling score on a company, and you think it’s well below its intrinsic value and even though the share price is going down, you can still buy it. But I don’t do that because typically what you have to do is to wait for it to bottom out and then start to come back up and I’d rather buy it on the way back up and then use my money for something else in between, which is more profitable. 

So, having given that sort of overview of where I’m coming from at a macro level, how do you measure sentiment? How do you know what’s happening with trends? Because sometimes we’re looking at graphs and the share prices all over the page, it’s going up and down. And I didn’t come up with this solution, but I did download a package 10 or 15 years ago that talked about a three-point trend line as a way of analyzing stocks. And there are plenty of moving averages and investors who use moving averages out there, who use them to create buy or sell signals. And this is just one of those ways of doing it. 

So how do I do it? First of all, I use a five-year monthly graph (eg a graph that shows month-end prices over the last five years), and I think that’s pretty important. I think three-point trend line analysis and other trend line analysis can work over different time periods, but if you use one which is too short it can be very volatile, so you’re buying and selling a lot, which can be expensive in terms of paying capital gains tax, but also expensive in terms of paying brokerage as you get in and out of a share. I take a longer-term view, five years, and I use the monthly graph. So, I’m not looking at weekly moves or daily moves or whatever. 

And so if you think about shares, and even an entire index, they generally trade in peaks and troughs, in a range. 

So even though they’re going up or down, they are generally testing a high point and a low point within a band. And we’re looking for times when they move out of that range, on the way up or the way down, to really say that people have had enough and they’re either selling out or buying in.

THREE-POINT SELL LINE 

If I’m looking at whether something should be sold, I’m going to start by finding the lowest trough (L1) on the graph in that five-year period. Next, I’m going to take the next lowest trough (L2) which will be either a) the next lowest trough to the right… or b) the lowest trough that is furthest to the right.

See chart for FEX attached.

And I’m going to use a ruler or a straight edge to join those two points up. And then I’m looking for the time that the share price drops below that line. Once the price drops below that line, it’s time to sell. 

THREE-POINT BUY LINE 

So, we reverse the procedure for shares that are going down in terms of looking for a time to buy. We’re taking the highest peak on the graph, then the next highest peak to the right of that, and drawing a line. And when the share price goes above that line, it’s a buy signal because there’s more buying than selling in the share price. Is that clear, Cam? Do you have any questions or comments?

Cameron : Yeah, let’s just take those line drawings a little bit more slowly, and if people are confused about this – and a lot of people always are – it’s hard to grasp without having a visual guide. You can go up to our website and you’ll see a number of videos that I’ve put up there that will give you a visual step-by-step demonstration on how this works, which makes it a lot easier I think. 

So back to when a stock should be sold, we’re looking at drawing a line between the two lowest points on the five-year monthly chart, and then you draw that line all the way to the right, to the current date, and if the price drops below that line, we sell. To know when to buy, we’re taking the highest point and then drawing a line to the right of the graph through the next highest point? 

Tony : Yes. 

Cameron : And we’re waiting for the share price to get above that line before we buy back in.

And I guess the point I want reader to understand is you don’t believe in forecasting, you don’t believe in trying to time the market. What you do is look at individual stocks, we’re looking at the market sentiment for that particular stock. It’s only the first step in 17 data points that we’re going to go through, but we are not trying to time the market. We’re just looking to see if the share price has support or not.

Tony : We are kind of timing the market, but not in the classical sense. We’re using the three-point sell line has a bit of insurance, almost like a stop loss for us to say the market for that stock is collapsing, so let’s get out. And we’re using the three-point buy line to say the market is on its way back up, now is time to buy. That’s it in a very broad sense. So, we are in a way timing the market, for sure.

Cameron : We’re not trying to guess what’s going to happen with the market, is what I’m saying.

Tony : No. We’re letting the market tell us really.

Cameron : Yes, you wait for the data to tell you when to sell and when to buy, you’re not trying to predict, it’s not predictive timing. It’s data-based timing. 

Tony : Yeah. And if anyone was any good at prediction, economists would be billionaires – and they’re not good. They’re telling us what happened, not what will happen, and likewise, almost any sort of forecast that will be wrong as much as they are right. It’s just a fool’s game.

Cameron : It’s flipping a coin. 

Tony : Yeah, exactly. 

Cameron : Now I just wanted to also mention that there’s a number of aphorisms around this that you’ve mentioned to me. We mentioned from Charlie Munger, Warren Buffett’s longtime partner, where he says “it’s time in the market that’s important, not timing the market”. And these guys like Warren Buffett and Charlie Munger, who have been doing this for 60 years extremely successfully, they’re in the same camp as you, right? They don’t believe in trying to guess what the market’s going to do?

Tony : That’s correct. They know that Mr. Market is a manic-depressive. Look, I appreciate Charlie’s advice to stay in the market, and I also think that if any of our readers are uncomfortable with the three-point trend line, they can stay invested and ride things out. I just found, especially after the 2008 Global Financial Crisis, that I would have done better if I had a stop loss on the way down and bought back when things were on the way up. So that’s why I use the three-point trend line now. So, it is going a little bit against what Charlie says, in that I am trying to time the market on the way down and back on the way up. But if anyone feels uncomfortable with that, then sure, go fully into the market all the time. I think the essence of what Charlie’s trying to say is you can’t pick the top or the bottom.

Cameron : Yeah. And we recorded a video once where we were using the GFC, the global financial crisis from 2008, and we looked at a chart of what happened with CBA. And you explained if that was playing out today, where you would have sold and where you would have bought back in, using three-point trend lines as your signal, and how you would have avoided the majority of the downturn and picked up on the majority of the upturn. 

So, back to the checklist – we’re doing column H, asking if the stock is exhibiting positive sentiment, we score it a two if it’s positive, and if it has negative sentiment, it gets a minus one. And in fact, if it’s negative sentiment, we just stop right there. Do not pass Go, do not collect 200, unless you are learning the QAV process you want to do the checklist just for experience. That’s great, but just don’t forget at the end of it, regardless of what happens with the score, it’s failed on the sentiment. So, we would not buy it regardless of what happens to the rest of the numbers when it has negative sentiment.

Tony : Correct, yes.

Cameron : Okay. So that’s a go / no-go decision.