Fundamental vs. Technical

By: Oliver Velez

The following is an excerpt from Oliver Velez’s Trade for Life

Ever since the first mathematician plotted some sort of graph that compared price to time, there has been a debate about whether price patterns or the basics of the underlying security are better predictors of price movement.

Investors who believe that fundamentals are the primary reason to buy and sell stock are relying on the underlying economics of the business itself, the industry, and the economy as a whole.  They look to things like the balance sheet of the company, earnings reports, and raw material supply.  They look at the experience and depth of the company's management.  They look at economist's outlook for the industry.  They look at the prime rate and if the government is likely to cut rates.  They tend to hold for a longer term, primarily because the things on which they are basing their decisions do not change overnight.  Most fundamentalists would agree that they wound not buy AMZN (Amazon) in the morning and sell it in the afternoon based on fundamental reasons.

Traders who believe that technical analysis is the primary reason to buy and sell stocks are relying on three beliefs.  Technical traders, or technicians, believe that the price is a total reflection of all forces in the market, and this includes all economic and fundamental information.  They believe prices move in trends and are repetitive, sometimes in a predictable way.  They believe that people's emotions are a large driving force in prices, and these patterns can be seen in charts.  Technicians will hold stocks for a variety of time periods, from a small part of the day to weeks or months.  However, they do not believe in the buy and hold philosophy.

I have given you a quick summary of both approaches.  However, I am not going to deceive you. I am going to show you why I believe the technical approach to be the superior one.  When I started, I went through this same dilemma, as I am sure many of you have, believing that only fundamentals are the way to buy and sell stocks.  Later, I believed that only technical analysis was the way to go.  Usually, when dilemmas like this hit, we land somewhere in the middle.  However, for me this is not the case.  I believe technical analysis is the best and only buy and sell indicator. 

Notice above that I used the term "investor" for the fundamentalist, and the term "trader" for the technician.  This is a reflection of the longer term outlook you must have when using fundamentals.  Due to the many changing things in the market place, we believe that the concept of 'buy and hold' no longer is valid.  There are several reasons, but consider the following.  Years ago the major companies were more industrial.  They had big plants that required big start-up costs.  No one could open a competitor to General Motors overnight.  It took huge resources.  Today, many of the biggest companies are high tech, producing computers, related devices, and software.  This technology changes quickly and almost anyone can enter the field with a good idea and some creativity.  It is the concept that two kids in a garage can bring a company to its knees.

Was there money to be made in Internet companies in the 1990s?  There were stocks that literally went from one dollar to hundreds in some cases.  They did this on no earnings, no earnings predictions for the next year, and on borrowed money.  No fundamentalist could justify purchases in most of these.  Yet technicians had a field day.

Even if you do believe that fundamentals should figure into the equation, how do you handle the realization that we really don't know what the fundamentals are?  The Enron debacle has opened the eyes of many investors to what has always been the case.  Companies can twist things any way they like.  What information can you believe?

Despite belief to the contrary, it is the technical trader who has less risk than the fundamental investor.  In all things, we can be more certain of what will happen tomorrow than we can of what will happen next year.  Technical traders sell losing positions as part of their philosophy.  Fundamental investors hold under the belief that all is well until the fundamentals that were the basis for their entry change.  It brings up an interesting question that many fundamentalists have a hard time answering.  Just when do you enter a stock based on fundamentals?  When do you take profit?  When do you cut your losses and move on?  The answers to these questions usually are random numbers, or they simply do not exist.

I believe in making decisions from the charts.  My core trades, which are designed to last weeks to months, may be long term, but still get their primary buy and sell signals from charts.  You will find that fundamental information usually is reflected in price changes in the stock before it is reported as a fundamental change.  It is not that technicians believe that fundamentals are wrong; it is simply that we believe they are already built into the charts.