I got an interesting email from Kyle this morning about a mutual fund manager that spoke on campus the other day. The fund manager manages a small ($12 million) socially responsible mid-cap value fund. Kyle says that, “he poo-pooed technical analysis a lot saying that it was more of a science and is only good for looking at the past”. Kyle goes onto say that he doesn’t think he really understood the connection between technical analysis and fundamental analysis. (Kyle’s a quick study and not much gets by this kid)

For what it’s worth, here’s my take on this…

Fundamental analysis is a method of valuing stocks that uses financial and economic analysis to predict where a company’s stock price is headed.

The information most often analyzed comes from the company directly and includes their financial reports (annual reports, 10-Q, 10-K, etc.), their dividend payment history, cash flow and debt management, estimates of revenue and earnings growth, product demand, competing products, and industry developments. Also examined is the impact of any regulatory and/or demographic changes.

Fundamental analysts engage in this exercise as to better understand a company’s growth potential and market stability. Long or Short positions are initiated based on the outcome of this examination.

Please read the above paragraphs again – no where in it is a discussion of price. The above paragraphs are a discussion of value. Because the world we live in is NOT perfect, value and price are 2 different things.

I AM A TECHNICAL ANALYST …

And as one, the only thing that I am concerned about is PRICE. Value has no discernable meaning to me. I BELIEVE THAT SUPPLY AND DEMAND ARE THE DRIVING FORCES IN THE MARKET AND THAT PRICES RISE OR FALL BASED ON THE RELATIONSHIP BETWEEN SUPPLY AND DEMAND.

Technical analysis comes in many shapes and sizes. There are many different charting styles (bar, candle, kogi, point & figure, etc.) and literally hundreds of different indicators. The one thing that they have in common is the study of price.

The one thing that gets my thong in a bunch is that “fundies” say that technical analysis is only good for looking at the past. Captain Obvious would say, “No kidding – a chart is a picture taken at a specific point in time”. Technical analysts by and large believe that by looking at the past, you can estimate/guess/divine future prices from past price action.

And what pray tell is looking at a company’s earnings statement? Take a look again at what a fundamental analyst looks at – THEY LOOK AT HISTORICAL DATA and attempt to ‘divine’ the future from the information.

THEY GUY WHO SAID A PICTURE IS WORTH A THOUSAND WORDS WAS A TECHNICAL ANALYST.

Usually when I get into a discussion of this sort, I’m often asked why point & figure charts instead of bar charts for my stock trading. I have no argument with those who use bar charts at all. I use bar charts when trading my forex accounts because I think they are great for trading short term (5-10 minute) time frames.

I just want to say this about volume. To many chartists, volume is an important indicator. Many of today’s momentum indicators and oscillators use volume exclusively to signal when to buy or sell.

I’m not a big fan of volume because of the sheer numbers of people/firms involved in program trading. Prior to 1985, the argument was pretty convincing as to whether or not the study of volume was important. Today, I think volume studies are inconclusive and the results are biased because of program trading. Look, if volume if big enough to move the price, this will be picked by a point & figure chart.

Here’s why I use Point & Figure Charts:

1. Bar charts can be hard to read
2. Bar charts hold an enormous amount of data and you can lose sight of the bigger picture if you get lost in the minutia
3. Formations are easily recognized
4. You can see the trend when you look at the chart – there’s no second guessing
5. Turning points are easily identified – by this I mean support and resistance levels
6. It’s easy to update by hand each night
7. They keep me in a winner longer and keep me out of a loser pronto
   

Born at Night – Not Last Night

I’ve been doing this a long time and I would be misleading everyone if I said that one method is better than the other. Even though the most hardcore proponents would chastise me for this – I think you have to use both fundamental and technical analysis if you want to stomp the market averages.

Growing up, my mother forced me to play the piano. I hated it. Making me sit on a bench for an hour was total misery, but I got pretty good at it until football made my fingers bend the wrong way. You can play a piano with either hand – left or right. You make the best music using both hands.

The same holds when it comes to trading stocks. You can use one form of analysis or the other – but why not use both? If you’re not familiar with my 5 Step Trading Approach, just: Click Here.

In closing, let me say this – all of the names on my “watch list” are there for fundamental reasons. I just don’t do the analysis myself because I am a technician.

Remember this:

I use fundamental analysis to tell me WHAT TO BUY (value)
I use technical analysis to tell me WHEN TO BUY IT (price)

That’s about it.

RAC
The Intelligent Trader

PS – Next time you meet a pure fundamental guy, ask them how the chart looks?