Security Analysis : Sixth Edition, Foreword by Warren Buffett: Additional Aspects of Security Analysis. Discrepencies Between Price and Value

of care. In order to confine our discussion within the framework of logical reasoning, we shall purposely omit even a condensed summary of the main tenets of chart reading. 1 We wish to consider only the implications of the general idea that a study confined to past price movements can be availed of profitably to foretell the movements of the future.
    1 For detailed statements concerning the theory and practice of chart reading the student is referred to: R. W. Shabacker,
Stock Market Profits
, B. C. Forbes, New York, 1934; Robert Rhea, “The Dow Theory,”
passim, Barron’s
, New York, 1932; H. M. Gartley, “Analyzing the Stock Market,” a series of articles in
Barron’s
beginning with the issue of Sept. 19, 1932 and ending with the issue of Dec. 5, 1932. See Appendix Note 69, p. 837 on accompanying CD, for a brief statement of the main tenets of the Dow theory.
    Such consideration, we believe, should lead to the following conclusions:
    1. Chart reading cannot possibly be a science.
    2. It has not proved itself in the past to be a dependable method of making profits in the stock market.
    3. Its theoretical basis rests upon faulty logic or else upon mere assertion.
    4. Its vogue is due to certain advantages it possesses over haphazard speculation, but these advantages tend to diminish as the number of chart students increases.
    1.
Chart Reading Not a Science and Its Practice Cannot Be Continuously Successful
. That chart reading cannot be a science is clearly demonstrable. If it were a science, its conclusions would be as a rule dependable. In that case everybody could predict tomorrow’s or next week’s price changes, and hence everyone could make money continuously by buying and selling at the right time. This is patently impossible. A moment’s thought will show that there can be no such thing as a scientific prediction of economic events under human control. The very “dependability” of such a prediction will cause human actions that will invalidate it. Hence thoughtful chartists admit that continued success is dependent upon keeping the successful method known to only a few people.
    2. Because of this fact it follows that there is no generally known method of chart reading that has been continuously successful for a long period of time. 2 If it were known, it would be speedily adopted by numberless traders. This very following would bring its usefulness to an end.
    2 Adherents of the Dow theory claim that it has been continuously successful for a great many years. We believe this statement to be open to much doubt—turning, in part, on certain disputed interpretations of what the theory indicated on various key occasions.
    3.
Theoretical Basis Open to Question
. The theoretical basis of chart reading runs somewhat as follows:
    a
. The action of the market (or of a particular stock) reflects the activities and the attitude of those interested in it.
    b
. Therefore, by studying the record of market action, we can tell what is going to happen next in the market.
    The premise may well be true, but the conclusion does not necessarily follow. You may learn a great deal about the technical position of a stock by studying its chart, and yet you may not learn
enough
to permit you to operate profitably in the issue. A good analogy is provided by the “past performances” of race horses, which are so assiduously studied by the devotees of the race track. Undoubtedly these charts afford considerable information concerning the relative merits of the entries; they will often enable the student to pick the winner of a race; but the trouble is that they do not furnish that valuable information
often enough
to make betting on horse races a profitable diversion.
    Coming nearer home, we have a similar situation in security analysis itself. The past earnings of a company supply a useful indication of its future earnings—useful, but not infallible. Security analysis and market analysis are alike, therefore, in the fact that they deal with data that are not conclusive as to the future. The difference, as we shall point out, is that the securities analyst can protect himself by a
margin of safety
that is denied to the market analyst.
    Undoubtedly, there are times when the behavior of the market, as revealed on the charts, carries a definite and trustworthy meaning of particular value to those who are skilled in its interpretation. If reliance on chart indications were confined to those really convincing cases, a more