On Balance, There Is Merit In Both Technical And Fundamental Analysis

Technical analysts are stock market wizards who claim their share price graphs have amazing predictive value. They claim history repeats itself in the stock market and that patterns can be discovered and used to predict a share price’s next move.

For example, a 20-year graph that also contains moving averages and volume data is a magnificent summary and representation of thousands of transactions. This is a depiction of the daily supply of and demand for the share and it is completely objective. Many patterns and price consolidations seem to repeat and a careful study can give some idea as to the volatility of the share.

Fundamental analysts pooh-pooh technical analysts as a lot of hocus pocus. They claim that the only theoretically defensible way of valuing stocks is the discounting of forecast cash flows. Technical analysts would counter by arguing that future cash flows cannot be reliably determined in any event, and given the accounting and management corruption in business these days, this is a fair point.

The most devout of technical analysts lock themselves in tiny dusty rooms, board up the windows and carefully study their charts. Speaking to management teams and visiting factory plants, forecasting cash flows and phoning analysts is just a waste of time for them.

A typical analysis will emphasise the following:
• Certain price patterns and shapes that have predictive powers;
• A 120 – week moving average to determine the underlying long-term trend of the share price;
• A 52 – day moving average to determine the short-term trend. This is used for active trading on a day-to-day basis;
• Volume data as volume precedes or confirms price movement for example, a significant move in the share price is more noteworthy if it is accompanied by a significant increase in the volume of shares traded. Another valuable volume indicator may be a reduction in trading activity as a share reaches lows. This could indicate that a lot of accumulation has taken place; and
• Support the resistance levels. When a support or resistance level is punctuated, the next move will be dramatic.

My biggest problem with this is that I don’t know of any very rich and famous technical analysts, while it is not difficult to think of many successful fundamental analysts and long-term investors. As in all things, I think it’s important to find a balance.
When you study a graph, you are less likely to be distracted by the collapse of the Russian empire, Saddam and Bin Laden, interest rates, American foreign policy, Israel, Eron, or the fact that core earnings on the S&P 500 still reflect a price/earnings ratio of 17 times. It is a great filter mechanism because, let’s face it, if you concentrate on all the problems facing the world today, who would want to own shares?

On the other hand, you will never understand the business economics of a company and its strengths and weaknesses by simply studying a graph. This is where technical analyst die-hards miss the point. Investors today need to use every technique and resource available to them, including technical and fundamental analysis.

But remember, although these graphs may not look like the Mona Lisa, a picture is still worth a thousand words and once all the fundamental research has been carried out, a share price graph remains a most valuable tool to assist investors in timing their purchases.