By combining the fundamental with the technical you can potentially enhance the timing of your buy and sell decisions, especially in a share market where volatility is the new norm.
Technical and fundamental analysis are often considered polar opposites when stock market investing. However, together they can provide a more complete picture of a company and what’s happening on the share market.
Start with fundamental analysis
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 better equipped 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 to understand the underlying business you’ve bought into.
If you don't attempt to do so, then you’re treating the share market like a casino.
Gambling is not about investing
By drawing on these financial ratios - like return on equity 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 of a company.
Once you calculate a company’s value, you’re better positioned to form an opinion about its future share price.
Don’t overpay for shares
What you actually pay for a company’s shares is the most critical determinant of your future returns.
You can’t just buy a quality company at any old price and hope for the best. This is where technical analysis (aka charting) can help.
As a smart investor your ultimate goal is to buy quality stocks trading at a discount to their intrinsic value (IV) - the sum total of the businesses' worth based on earnings, dividends, equity and debt.
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
Negative market sentiment can drag down even the best-performing stocks.
These occurrences can represent mouthwatering buying opportunities.
Technical indicators, which focus on volume and price, try to gauge the direction of share prices.
This technique can help you time your entry at a time when the stocks are most likely to be cheaper.
Admittedly, technical analysis won’t help you identify the most promising stocks to buy.
It will, however, 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
So 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 in 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, a reversal could be around the corner.
This reminds 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 applies to 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:
The intraday chart
Traders should watch for spikes in volume, which often correspond to block trades.
Intraday charts can also be extremely helpful in deciphering when large institutions are trading.
Short-term movements
While most fundamental investors still tend to focus on the long haul, they still want a favourable buy-in price and/or a favourable selling price upon liquidating a position.
Pay particular attention to when a stock pushes through what is 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 long-term breakout patterns.
Reactions over time
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.
Fundamental versus technical analysis
Fundamental analysis
- Select stocks to include in your investing universe or 'watch list'.
- Determine whether a stock is overvalued or undervalued relative to its intrinsic value.
- Avoid overvalued stocks or debt-ridden companies to reduce your risk.
Technical analysis
- Time the entry into an already filtered fundamentally sound stock.
- Manage the investment execution.
This article does not constitute financial or product advice. You should consider independent advice before making financial decisions.
