Hey friends,
The post today and next time express my simple thoughts on the subject matter, gained from much experience via observation.
As you know, I focus on fundamentals to manage risk and generate profit. Another methodology for managing risk to generate returns is following technical patterns revealed by stock charts. The two methods aren’t altogether mutually exclusive in that a participant can focus/lean toward one while incorporating the other. My observations over time are that a technical trader (among other things) focuses on reading charts, engages in active trading, and uses stop losses to avoid losses while seeking to bank gains. For wealth to take place over time, this approach seeks to generate short-term low percentage gains that can accumulate into significant annualized returns by active trading. One who focuses on charts is rarely concerned with attempting to assess the true value of the business.
A person who seeks to let the fundamentals of a business dictate buy and sell decisions is one who uses primarily the financials (especially the balance sheet) and also management commentary concerning its expectations for future business potential. The intent is to gauge the true value of the business. This person sees self as owning a piece of the company and, in my view, captures the meaning of the word “investor.” Stop losses would rarely apply as one who is buying below true value would likely view a lower price as an opportunity to add shares. With fundamental investing, the losses can be steeper (than with active trading where stop losses are used) but the gains can be much larger.
While stock price matters to fundamental investors and technical traders, it matters more to technical practitioners who are in it for the very short term. Investors are there for the time when true worth of the business is recognized — and that can take some time.
With either approach, practice is key. Errors are guaranteed. Company surprises that change business valuation will happen. So, any way you slice it, the expertise for consistent success requires learning how to avoid prior mistakes and doing the needed homework.
Everyone, have a great Father’s Day!
I am barely 16 years old so I do not possess the most experience, however my observation in my few years of analyzing today’s markets is that fundamentals drive technicals. Technicals always lag behind the fundamentals and do no reveal the whole story. The primary reason for the technicals to change is price movement. Price movement is the public’s perception of the fundamentals. That is where discrepancies occur between the adjusted floor price and the stock price, and where all opportunities lie. People do not completely understand the financials of stocks, and they base all of their investment decisions on earnings and technical patterns. They forget that fundamentals drive price movement which drives technicals. To analyze technicals first and foremost causes the average person to see movements already priced in by the perception of the fundamentals. Therefore, gaining insight on the fundamentals beats any technical analysis. Technical analysis isn’t completely useless, but it should only supplement the fundamentals and selling decisions. One basing their whole strategy on them solely is prone to failure when the fundamentals negatively change and cause an instant drop in the technicals. This misleads people when the technicals turn around fairly quickly. Analyzing the fundamentals first will always give you an edge for spotting the company’s health bettering or worsening, ultimately making you a more knowledgeable and insightful investor.
I’m only 16, however I realize that technicals always lag behind the fundamentals. First, the fundamentals change. This causes a change in perception of the company’s fundamental value. This change in perception results in price movement either positive or negative based on the new fundamentals. Finally, the price movement causes a change in the technicals of the stock because charts and indicators are based on price action. Therefore, looking at technicals alone does not work because your are looking at past information that is already priced in by investors. Real opportunity for profits occurs when the general public misrepresents or does not understand a company’s fundamentals. This causes a negative change in price action and the technicals look horrible. Bargains are created here where the fundamental investor realizes that the stock is selling much below the adjusted floor price. Technical investors would never capitalize on these incredible opportunities because all they see is a down pointing chart that is misrepresentative of the company’s actual value.
Ian, thanks for your thoughtful comments. You are ahead of the curve in terms of parsing the concepts.
Paul
Another interesting point that requires some research is the investment methodologies of today’s richest investors. Billionaire investors such as Warren Buffett, Ray Dario, Carl Icahn, George Soros, just to name a few, base their investment strategies off of fundamental analysis to establish the true value of companies and realize significant profits. There are very few, if any, billionaire investors who primary base their strategies on technical analysis. Coincidence…. I think not.
Good observation, Ian.