A lot of people who watch activity on the Nairobi Stock Exchange tend to believe that the market does not operate on fundamentals. Others seem to believe that this market operates on a crowd mentality and ignoring fundamental aspects of the companies in question. Without agreeing or disagreeing with any of these theories I would just like to take a step back and ask why prices move up and down. Is it because it is a good or bad company? Is it because results are expected to double? Is it because some form of corporate action i.e. dividend, rights issue, bonus or split is anticipated? Is the company expanding operations? All of these and many more could have an influence on the price direction of the share.
The study of Behavioural Finance has become extremely popular in the Western markets. Why? We commonly hear that share price x has risen and fallen because of a level of supply and demand. It is common sense that a share price will move up if demand is higher than supply and will fall if supply is higher than demand. That great! But even with that we must remember that it is people with real feelings and emotions who determine that level of demand and supply. These emotions are depicted in the way they will buy or sell shares. Words commonly used in the investment world to summarise these emotions are bullish and bearish. In between this there are also always levels of fear and greed. It is at the end of the day people’s perception (lead by emotions or control of emotions) of a particular share that will determine whether they want to buy and sell hence creating demand and supply for that particular share. Perception is what is then influenced by factors given before such as corporate actions, result announcements, expansion strategies etc.
The perfect investor would then have to be one who can predict how the crowd will be behave in a certain situation (e.g. new announcements) and make his investment earlier so that this anticipated behaviour will benefit him. Unfortunately very few people if any at all can claim to be able to do that. You would have to be able to read thousands of minds at the same time. Fortunately there are ways that have been developed to keep learning and understanding investment behaviour. Investors do tend to react in the same way, make the same good decisions and unfortunately make the same mistakes. Investor behaviour develops patterns.
Fundamental analysis is extremely important in understanding a company and ensuring a good level of understanding in what you are investing in. It is a powerful tool and cannot be avoided in any investment strategy. Its downside is that it does not take into account human behaviour. There a several companies on the NSE that are undervalued simply because of the perception surrounding those companies and vice versa. Fundamental analysis will point out these companies but the investor will have to make a decision on whether he is willing to wait for the perception to change because that is the only time he will see a return on investment. Technical analysis on the other hand combines well with fundamental analysis to provide additional information to investors. Technical analysis looks at price and volume movements of specific stocks, industries or indices to determine how they have performed over time. It even focuses on movements that have happened when certain events such as announcements occur. These patterns (just like investor behaviour) have a tendency to repeat themselves and investors tend to react in a similar manner over time. The downside to technical analysis is that it does not tell you whether the company is good or bad in terms of profitability, management, corporate governance etc like fundamental analysis would.
As much as we cannot predict price movements, the combination of both fundamental and technical analysis in any stock portfolio would be an added advantage.
Published in the Business Daily
[facebook]