Passive Investor’s Bible

Most stock investors follow one of two approaches — technical analysis or fundamental analysis — or a mix of the two. In this well-researched book, A Random Walk Down Wall Street, Burton G Malkiel, professor of economics at Princeton University, points out the shortcomings of the two approaches and then argues in favour of passive investing. Essence of the two approaches Technical analysis is the making and interpretation of stock charts. Its practitioners study the movements of stock prices and volume of trading to get a clue about the future direction of stock prices. Fundamental analysts, on the other hand, focus on determining the intrinsic value of the stock. By estimating the rate at which a company’s earnings and dividends will grow, and using a suitable discount rate, they arrive at the stock’s intrinsic value. If this value is above the market price, they recommend a buy on the stock. Pros and cons of charting When charting might work. Chartists believe their approach works because history has a habit of repeating itself. Malkiel grants that charting might work in certain circumstances. First, it might work due to herd instinct. When investors see a favourite speculative stock rising, they jump on the bandwagon. The initial price rise fuels optimism and causes the stock to rise further. Second, different categories of investors get information about a company at different points of time. Insiders are the first to know about a favourable development. They then tell t

This article was originally published on July 14, 2011.