How To

Combining technical with fundamental analysis makes for better buy and sell decisions

Wed 06 Jul 22, 5:45pm (AEST)
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Key Points

  • As a smart investor your ultimate goal is to buy quality stocks trading at a discount to their value
  • Technical indicators, which focus on volume and price, try to gauge the direction in which share prices might be heading
  • By analysing historical financial data, along with forecast earnings and profit projections, you’re in a better position to predict future company performance and growth

Technical analysis (aka charting) and fundamental analysis that focuses on key financial indicators are often considered polar opposites when it comes to share market investing.

But join them together and you get a more complete picture of a company and what’s happening on the share market.

Start with the fundamentals

You can’t apply an ‘investor’ mentality to stock selection if you don’t know what a company is worth.

That’s where fundamental analysis comes in. By analysing historical financial data, along with forecast earnings and profit projections, you’re in a better position to predict future company performance and growth.

Remember, as a share market investor, you’re buying a piece of a company, so it’s critical that you understand the underlying business you’ve bought into.

If you make no attempt to do so, then you’re treating the share market like a casino.

What any company is really worth

By drawing on financial ratios – like return on equity (ROE) and net debt to equity, plus qualitative indicators like management capability, earnings sustainability and a company’s competitive advantage – you can determine the all-important intrinsic value (IV) of a company.

Once you calculate a company’s intrinsic value - the sum total of the business's worth based on earnings, dividends, equity and debt - you’re better positioned to form an opinion on its future share price.

Given that what you actually pay for a company’s shares is the most important determinant in your future returns, you don’t want to pay too much for shares.

Don’t buy at any old price

The last thing you want to do is buy a quality company at any old price and hope for the best, and this is where technical analysis can help.

As a smart investor your ultimate goal is to buy quality stocks trading at a discount to their value.

That’s because over the long term, share prices typically reflect the value of the underlying business.

Value investors who are patient enough will sooner or later be able to capitalise on negative announcements or unflattering macroeconomic data, which occasionally triggers a share market correction.

It’s called ‘buying on the dips’, and it’s not unusual for the share market to move over 200 basis points in any trading month.

Use technical analysis to time trading decisions

As recent events will testify, negative market sentiment can drag down even the highest quality top stocks and can represent mouth-watering buying opportunities.

Technical indicators, that focus on volume and price, try to gauge the direction in which share prices might be heading.

This technique can help you time your entry into top quality stocks when they’re most likely to be cheaper.

Admittedly, technical analysis won’t help you identify the best stocks to buy.

But it will let you draw conclusions from trading patterns, company charts, graphs and trend lines to help you pick the best time to act on a stock.

Technical’s advantage over fundamental analysis

Fundamental analysis can’t tell you what the market thinks of a stock you want to buy.

That’s where the ‘technical stuff’ like volume indicators can help.

Notable spikes in traded volumes typically suggest that a stock has attracted abnormally high attention from the trading community and that its shares are under either an ‘accumulation or distribution’ phase.

Volume indicators can help confirm whether other investors agree with your fundamental outlook on a stock.

They can also help gauge whether a stock is gaining or losing momentum – if it’s the latter then a reversal could be around the corner.

This serves to remind you that a stock’s inclusion in or out of an index will have a material impact on the market’s interest in it and can directly impact share price momentum.

The same can be said for a share buyback program.

Useful technical charts

If you like the look of a stock based on its fundamentals and are seeking to time a trade or solidify a favourable entry (or exit) point, then these technical charts can be extremely useful.

Intraday charts let traders watch for spikes in volume, which often correspond with block trades.

Intraday charts can also be extremely helpful in deciphering exactly when large institutions are trading.

While most fundamental investors still tend to focus on the long haul, they still want to obtain a favourable buy-in price and/or a favourable selling price upon liquidating a position.

Moving averages

Pay particular attention to when a stock pushes through what called its 15- and/or 21-day moving average, as this typically indicates what’s expected to follow in the coming term.

Similarly, you can also use 50- and 200- day moving averages to determine longer-term breakout patterns.

By looking at a chart of a specific stock, industry, index or market, you can determine how that entity has performed over time when certain types of news have been released.

Remember, these patterns tend to repeat over time.

 

Written By

Mark Story

Editor

Mark is an investigative financial journalist and editor who started his career working for Marathon Oil in London. He has a degree in politics/economics and a diploma in journalism. Mark has worked on 70-plus newspapers and financial publications across Australia, NZ, the US, and Asia including: The Australian Financial Review, Money Magazine, Australian Property Investor and Finance Asia. Mark is passionate about improving the financial literacy of all Australians through the highest quality content. Email Mark at [email protected].

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