Technical and fundamental analysis are often considered binary opposites when it comes to investing in stocks, however a clever combination of both can potentially enhance the timing of your buy and sell decisions, especially within the current highly volatile market.
While stock-pickers traditionally like to sit on just one side of technical/fundamental divide, by marshalling the benefits of both, you can receive a more complete picture of a company and what’s happening on the share market.
Until you know what a company is worth, it’s impossible to apply a ‘value investor’ mentality to stock selection. This is where fundamental analysis – if used properly – can be well worth the effort.
By analysing historical financial data, along with forecast earnings and profit projections, you’re simply in a better position to predict future company performance and growth.
Remember, if you’re investing in the share market based on fundamentals and not just speculating or gambling on share price momentum, you’re actually buying a piece of a company.
That’s why it’s critical that you understand the underlying business you’ve bought into.
If you make no attempt to understand a company’s underlying business, by default you’ve relegated the share market to a form of gambling.
By drawing on financial ratios - like return on equity (ROE) and net debt to equity, plus key qualitative indicators like management capability, earnings sustainability and a company’s competitive advantage - you can determine the all-important value of a company.
Only once you have an idea of the company’s true value are you in a position to determine whether the current share price makes for an attractive entry point, relative to future projections.
Contrary to popular opinion, what you actually pay for a company’s shares is the single most important determinant of future returns.
Simply buying a quality company at any old price, parking it in the bottom drawer and relying on share market momentum to do the rest - the way investors did during the 20-year bull market run - is fraught with danger.
It’s equally dangerous buying ‘falling daggers’ within a down market on the pretext that price and value are mutually exclusive.
They’re not, and the direction within which a share price is heading is often a good determinant of whether it’s a ‘value-play’ or a ‘value-trap’.
As a value investor, your primary goal is to buy quality stocks trading at a discount to their true 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 presented with opportunities to capitalise on negative announcements or unfavourable macroeconomic data, which can and do trigger share market corrections.
Recent deliberations over the US Federal Reserve’s (The Fed’s) decision to finally raise interest rates is a classic example.
Seasoned value investors refer to is as ‘buying on the dips’ and within the highly volatile trading environment, it’s not unusual for the share market to move well over 200 basis points (pbs) - aka 2% - in any trading week and on occasion on any single day.
While even the highest quality stocks can get caught up in negative market sentiment, the mispricing this throws up can represent some tantalising buying opportunities.
To the uninitiated, technical indicators – which 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 by itself won’t help you identify the best stocks to buy.
However, 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.
What exactly can technical analysis add to your stock research that fundamental analysis can’t?
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 buy-back program.
Get the latest news and media direct to your inbox