Streetwise for Friday, November 2, 2018
As the year moves toward its final month, let me once again try to smooth the feathers of those readers who continue to write and complain that I never address the issue of technical analysis.
The question arises continually because investors are stalwart in their belief as to the correct approach with which to analyze stocks. Consider the question in this light; if you found a successful way to make money in the stock market, would you debate the issue? I doubt it. Instead you would likely sit back, content to watch the money roll in.
This is not the case with many purveyors of financial wisdom. The fundamentalists are continually trying to point out the flaws of those who reside in the technical world, while technical analysts, or technicians as they are often called, continue to advocate utter disregard for all fundamental factors.
The average investor could rightfully conclude that neither side has achieved complete mastery of the market. Although most investors tend to favor one methodology over the other, keep in mind that there are strengths and advantages inherent in each.
Fundamentalists believe that the way to make money in stocks is to invest in companies that are undervalued in the marketplace. For example, a pharmaceutical stock may have declined in price because of an unfortunate development with a new drug, or an expiring patent. An investor, thinking that the weakness is temporary, might consider the stock a worthwhile investment.
A fundamental analyst might also recommend purchase of a stock if the book value per share exceeds its current share price. Even if calamity should strike, thereby forcing a sale or liquidation of the company, the damage to an investor would theoretically be minimal. Theoretical being the key word.
Therefore, fundamentalists dwell on the basic value of a company and the probability that the company under scrutiny will be able to bring increased profits to the bottom line with a resulting increase in the share price.
On the other hand, a technical analyst is not concerned with a company’s name or what it does, much less its fundamentals. To a technician that information is factored into the current share price at any moment in time. The technician is only concerned with share price and trading volume.
For example, suppose XYZ Pharmaceuticals normally trades 200,000 shares a day and always seems to fall back when it approaches a price level of $25 a share. A technician would be very interested if XYZ suddenly traded 350,000 shares and closed at a price of $28 a share.
To a technical analyst, the steep rise in trading volume and the high closing price are important signs that a stock could be ready for a significant break-out or advance.
Therefore, the analyst would consider purchasing XYZ stock with little or no investigation into the financial health of the company. The technical analysis may be totally correct, and you might read soon afterward that XYZ is announcing a major new drug.
Technicians live in a world of charts, graphs, and indicators that require frequent computer computation. Fundamentalists often scoff at the seemingly never-ending stream of calculations employed by technical analysts.
The true fundamentalist believes that the value of a company’s shares will be recognized in the long run and is therefore usually prepared to sit with a stock until his or her patience is rewarded.
Using the fundamentalist approach, an investor will often single out stocks that exhibit long-term potential with minimum risk. Unfortunately, the time frame to attain success will be viewed by some as excruciatingly long.
Technicians often have a short time horizon, sometimes moving in and out of a position in a matter of minutes or hours. Furthermore, technicians have a greater tendency to sell stocks short. This is due to the belief that technical indicators predict not only movement, but also direction.
Which school of thought has a higher probability of success? Smart investors will study both theories and try to draw on the best features of each one.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddInternational.com.