Thursday, March 24, 2011

Fundamental AND Technical Analysis

Tools of The Trade
Orienteering is a sport that requires competitors to find flags hidden outdoors by using a map and a compass to navigate a course. The map shows the contours of the terrain, and uses different colours to illustrate the type of ground cover - trees, clearings, water.  The compass is used to orient the map and to guide the competitor in a particular direction. Close to the flag, the use of the map is crucial in pinpointing its whereabouts. The course could be navigated with only the map or the compass, but it would usually take longer because it is much easier to make navigational errors when not using both.

Fundamentals or Technicals?
When I hear advisors who say they rely on the fundamentals and others who say they rely on the technicals, I often think of orienteering. Why would they want to rely on only one, or the other, when both are available to them? I suppose we have all heard the expression, "Jack of all trades; master of none," but we don't need university degrees in either area to use them effectively. We don't need to know every last detail. I think we can all agree that knowing how many pennies the CEO has in her purse, is detailed, but useless information. Likewise, knowing the number of years in a row a stock has made an uptrend in the month of September is, for the most part, of little value.

Done properly, fundamental analysis tells us what we can reasonably expect to pay for a share in any company. Likewise, technical analysis can tell us whether we are close to the beginning, or the end, of any trend in the price. Armed with that information, alone, we can make intelligent decisions about what to buy and when to buy it.

Why Not Both?
I continue to hear the talking heads proclaim they are a fundamental, or a technical sort of person - and proud of it. I understand the two types of analysis represent a different approach and mindset. They are two different ways of looking at companies. That is the strength of using both types of analysis. If they both confirm a buy decision, then great. If not, then why risk it? Would you recommend a dentist who only uses half of their tools? Imagine your dentist saying, "I don't do x-rays because I don't find them very helpful!"
The problem is the two approaches are seen as either/or instead of both/and. The fundamentalists cast dispersions on the techies claiming how much more thorough their analysis is. The technical analysts claim the fundies are not even necessary. Yet, it is not the type of analysis, which is important, but the information that each yields about any potential investment. Unless, of course, we assume there is no use trying to buy at a low price because we are almost never going to sell, anyway.

The Bottom Line
So there is the rub. Why give credence to any tool that flies in the face of the sacrosanct buy-and-hold marketing strategy? Funny thing is, I'm willing to bet that most fund managers actually pay attention to moving averages and other technical signals. It would likely have a negative affect on returns if they didn't. Doesn't it go to follow, then, that the very existence of technical analysis would dispute the notion that it is impossible to time the markets? Unless, of course, technical analysis is just a lot of creative imagination.

What do you think? Which is for real, technical analysis, or buy-and-hold? 

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