Saturday, February 17, 2007

Which Is Better, Fundamental Or Technical Analysis?

Well I guess the answer to that question depends on who you ask. First let's take a look at what Fundamentals are.

The fundamental approach attempts to determine the intrinsic value of a commodity or a stock. A fundamental analyst is interested in things such as earnings, P/E ratios, debt, supply and demand, economic conditions,economic reports etc. The fundamentalist studies the causes of market movement. In my opinion, any significant long lasting move in a commodity or stock is caused by fundamentals not technicals. If a stock or commodity were to have a meaningful rally or decline, most likely there was fundamental reason for the move.

The problem with fundamentals is that it is hard to get accurate data in a timely fashion. Even if the data is accurate, can a trader know how to properly interpret whether the data is bullish or bearish? Assuming a trader is correct that the fundamentals are bullish, we still have the problem of how other traders will interpret the news. Many times bullish fundamentals fail to rally the market and bearish fundamentals actually trigger rallies.

The technician is interested in the effect rather than the cause of market movement. In my opinion technical analysis is another way of studying human psychology by observing price chart patterns. A technician believes that the fundamentals are reflected in the market price. The technical analyst studies things such as chart patterns, trend lines, channels, oscillators, consolidations, volume etc..

One of the strengths of technical analysis is the ability to trade just about any market in any time dimension with just the help of a simple chart. Although that may be very difficult to achieve, it is quite possible. Another strength of technical analysis is that market timing is usually superior to that of the fundamentalist who is usually either early or too late into a market move.

One of the problems I have with technical analysis is that when we chart a series of numbers that have no relationship to supply/demand, those same chart formations appear. For example, if you were to plot on a chart the amount of rainfall here in the United States, those same supply/demand patterns will show up on the chart! You'll see trend line breaks, head and shoulder tops, double bottoms...etc The fact that these "supply/demand" patterns show up in non-supply/demand data, makes me wonder about the validity of such chart patterns. In all my years of following the markets, Larry Williams is the only other author/trader that I am aware of who has made this observation and actually printed it in a book. In fact he talks about this in one of his books entitled The Secret Of Selecting Stocks For Immediate And Substantial Gains. Larry has always been one of my favorite writers and I just want to give credit where credit is due.

So where does that leave a trader. Do we use the fundamentals or the technicals? Well first of all, whoever said it has to be one or the other. My answer is to use a combination of both. I will say that the shorter your holding time, the more you need to focus on the technicals rather than the fundamentals. The opposite is true as well. The longer your time frame, the more of an important role the fundamentals will play.

I use mostly technical analysis in my trading but I like to combine my methods to increase my odds of success. For example, I would NEVER buy a stock just because my little pretty oscillator just crossed up after the market has already moved higher. I will take that oscillator buy signal if I know for example that this is a seasonally strong time of year for this particular stock or maybe the stock is in a very strong uptrend with lots of momentum or the group that this stock is in is breaking out etc.

If you are a fundamentalist and you believe a stock is going to go higher because of the low P/E ratio or maybe you just feel the stock is undervalued, you might want to buy that stock when you get a technical buy signal such as a moving average bullish crossover or maybe something as simple as a four week high which is one of my favorite long term entries.

So my advice is to use both technicals and fundamentals and if you really want to add another dimension to your analysis, begin looking at market sentiment. I think by combining methods you will increase your odds of success dramatically. It doesn't have to be one or the other.


greeener said...

i trade equities and derivatives, but notforex, any suggestions for opening a account..thanks for your time and your blog..the canadian dollar is very keen eye

Kevin said...

Hi Greener,

I really don't have any helpful suggestions when it comes to opening a forex trading account. I'm sure if you do some research online or visit some forex message boards, you will find some answers.
I will say one thing, if you do decide to open an account, make sure the firm has been around awhile.

Banker said...

I am a firm believer that fundamental's drive the market. I have said before an economy is like an ocean cannot turn it around quickly. If and economy is strong, rates will go higher and the currency should do well. If you trade from a macro perspective these SHOULD be the trades. Of course or shorter time frames you have pull backs and corrections (which may be explained as technical) but the overall trend should not change until the fundamentals do. This is just one man's opinion.

Kevin said...

Markets are fundamentally driven but technically traded.. That's my view.

Bullish Jim said...

Kevin- my thoughts exactly. You definitely need to look at both.

I feel like I make a lot more money from technicals than I do fundies for what it's worth. And even the fundamentals that have worked well for me have sort of a technical bent to them. For instance, relative strenth and P/E ratio today versus P/E ratio 3-6 months ago. The more I trade the more I think fundies don't matter all that much for stock picking. A great company can be hugely overvalued at a particular time and a terrible company's stock can make you a fortune. It's all about over-reactions to me.

You've got a great blog, Kevin.

Kevin said...

Thanks Jim,

I like your blog as well, that's why I have your link on my site...

Sandro said...

I think the good rule is:

- select the direction of the trade on fundamentals
- select the timing of the trade on technicals

I.e. you should decide to buy something strictly on fundamentals. Then you should look charts and wait when the stars are pointing that it's time to buy.


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