Should You Use Fundamental Analysis or Technical Analysis?

[Dennis Ng]

I found this article written by Alvin Chow (also a seminar graduate) on his website www.BigFatPurse.com

Should You Use Fundamental Analysis or Technical Analysis? This is a very commonly asked question. There are people who only use Fundamental Analysis. There are also other people who only use Technical Analysis (typically Traders).

Which to use? What is my view? Read on and you'll find out.

http://www.bigfatpurse.com/2011/04/shou ... -analysis/

Should you use fundamental or technical analysis?

by Alvin on April 24, 2011

Most people like to compare between the fundamental and technical analysis, which is better? Which is more effective to get you profits from the market?

Some of you may know that I have been interviewing local traders who trade for a living. Through these interviews, I was able to draw some conclusions from various traders, which could help to address questions like this. For this post, I particularly want to tribute it to Yeo Kiong Hee, Patrick Lee (aka Fat88trader), Conrad Alvin Lim and Clarence Chee for their sharing.

Kiong Hee is a forex trader who currently teach at Adam Khoo Learning Technologies Group (AKLTG). Comparing fundamental and technical analysis, he simply said, “there are people who only use fundamental analysis and are very profitable, likewise there are people who use technical analysis and are profitable. There are people who use a mixture of both and are also very profitable. On the other hand, there are people who use technical and they lose. They use fundamental, they also lose. Use both, they also lose. My point is that the tools you use is not as important as how you use them. It is how you use them that give you an edge in the market.” This addresses the crux of the problem when asking that question. Do not ask which is better but ask whether the tools that you use really give you a higher change of profiting in the market over a long period of time.

Patrick was a SIMEX floor trader in his earlier days, and now he has successfully converted to trade profitably off the floor (you would be surprised how many of them could not make the transition). Now, he mainly trades SIMSCI (the MSCI Singapore Index that tracks more stocks than our beloved STI) futures. He is a super short term trader, or a scalper as he calls it. He can make a few hundred times in one single day. As such, he said, “Basically for scalpers like us, because we trade so many contracts a day, we don’t have the time to do it. It is so fast when the market moves, and you practically don’t have enough time. Our focus is on the price. For short term traders like us, fundamental is not much of a use. To be actually being objective, I come in without any fundamental ideas of whether the market should go up or down. I just look at the chart to tell me whether I should buy or to sell.”

Clarence is a forex trader and trainer with T3B. He said, “in the past I often ignore fundamentals, We always say based on charts, that’s technical. Nowadays, I realised that technical itself is not good enough because my trading style is more of swing trades. Swing trades last for few days and even weeks. In order to make sure the trend is sustainable, it is better to do some fundamental research first, to show that fundamentals are able to support the trend then before we enter.”

Conrad is a trader and trainer with AKLTG. He also does swing trades and when asked if he uses fundamental analysis, he said, “I do, I do. And because I am trading the same securities ever so often, the fundamentals don’t change that much. Because as I am trading them, I am actually in the business and I am watching the fundamentals evolve. So I really don’t need to like always have to qualify that stock, and I am in there constantly, I am monitoring the changes, so qualifications are already done, which is why I like trading the same stocks over and over again.” What he is saying is that he would use fundamental analysis to find good stocks and continue to trade this group of stocks using technical analysis.

And not forget about Dennis Ng, my trusted teacher said, “fundamental analysis is one eye and technical analysis is like another eye. Why do you want to look at the world with only one eye? Use both!” Dennis is an investor and not a trader, and hence he is not featured in the interviews. Nonetheless, I would love to do a series of interviews for investors.

Now let’s shift our attention to somewhere further but someone very famous, Warren Buffett. We all know that he is a buy and hold investor. He actually buy businesses and own them forever. He don’t believe in selling a business that is a golden goose that continues to deliver golden eggs. Fundamental analysis is his primary tool to evaluate the health of a business. At his time frame, he does not need technical analysis at all, and that is why he is not interested in charts at all. He even say that the market can close for 10 years and he do not care.

The bottom line is that you can use either fundamental or technical, as long as it gives you an edge. But in general, I notice a relationship between the tools used and the trading/investing time frame, not sure if you did.

In a previous post, I have classified 4 trading/investment time frames, 1) intraday, 2) swing, 3) cycle, and 4) buy-and-hold. You can revisit the post for my definitions. Next, you can look at the diagram below and see if you understand what I am trying to say:

Don’t focus on the fundamental and technical analysis part, and not the rest. The shorter the time frame, the more you would use technical analysis, the longer the time frame, the more you would use fundamental analysis. The extreme cases are intraday trading where you purely use technical analysis and on the other end which is buy-&-hold, you use fundamental analysis. Anything in between, you should be using both. This is just a generalisation as I believe there are some people who use only use either fundamental or technical alone and achieve profitable results.

This is what I gathered from the interviews that I have done. I had tapped the knowledge and experience from these traders. Are you interested to read if these interviews are captured in a book? Would it help you understand trading better? Would it also help you become a better trader?

[Dennis Ng]

yes, as Alvin shares in the following article, there are Pros and Cons of using Fundamental Analysis and Technical Analysis.

My take is why NOT combine both so that you can try to maximise the Pros and minimise the Cons by making both methods complementary.

I use FA to decide what stocks to buy while I predominantly use TA to decide when to buy and sell.

To avoid having too many transactions and taking profits too early, I combine FA with TA before making final decision of Buy and Sell.

For instance, if overall stock market trend is down, I will sell a stock even if the fundamentals are good and is deemed undervalued.

Cheers!

Dennis Ng

The Good and Bad of Fundamental and Technical Analysis

by Alvin on July 26, 2010

There is always comparison between Fundamental Analysis (FA) and Technical Anaylsis (TA). There is enough supporters at each side of the house, claiming FA/TA is more superior than the other. So which is better? FA or TA?

The reason why market participants require FA or TA is because the flow of information is not perfect. This is especially so for the retail investors. Let’s imagine, if you are one of the first few people to know about something, you are able to act faster than most people. You do not need any FA or TA in this case. Hence, as a retail investor, whether you use FA or TA, you are indirectly trying to get this “information” as fast as possible. By getting this “information” faster than most market participants, you will earn a decent profit. In other words, the EARLIER and MORE RELIABLE information you get, the greater your profits. But then again, you can never do it better than the people higher up[ in the information chain.

The 2 considerations we will discuss are TIME and RELIABILITY. Let’s evaluate the pros and cons of FA and TA.

TIME – entry

FA allows you to buy EARLY (sometimes too early). When you spot a fundamentally good stock, you actually prefer to buy it when there is no hype or interest. Both volume and volatility (price fluctuations) would be low. This means that you would have got in earlier than most people, and wait for buying interest to come in when more people recognise the potential of the stock. You would be a very happy man, getting a profit in multiples of your capital invested. But there are 3 other scenarios that can happen. One, you bought too early, and you have to wait for very long, say 5 years, to see the results. Second, you bought early and the stock price went down, and stay down for a long time, proving you are wrong. Third, you bought early and the stock price went down. You recognised your mistake and sold off, only to regret when the stock rebound and reach higher heights.

TA allows you to buy EARLY ENOUGH (but less profits). On the other hand, TA allows you to buy “later”, but still early enough than most investors. TA is not able to prompt you to buy a cold stock. It will only shows a buy signal when the stock has shown it’s potential to move. But of course, you have to sacrifice some profits already. The good news is, you do not have to wait for a long time before you know you are right or wrong.

TIME – exit

FA valuates the stock price (or it is up to you when to sell). FA valuates the “true” stock price based on the earnings of the business. As a FA investor, you would usually sell when the stock price hits the valuation. If not, you are likely to hold as long as possible, provided the fundamentals do not change.

TA cut loss and profit take. For TA, the concept of cutting loss is very much embraced. The priority is to protect capital first. Once the stock price moves against your position and hit your cut loss price, you will get out of the position without questions. There are also some traders who exit when the price hits their profit target. They do this to maintain a consistent risk reward ratio. Others would want to ride the trend till it changes and reap as much profits as possible. But the key point is, TA always determine an exit point and it will save you from a market crash.

RELIABILITY

Maybe let me explain reliability first. When I say reliability, it means how accurate is it to pick a winning stock. We know that you do not need to be 100% right to win money in stocks, but you do need a certain degree of reliability to win money at the end of the day. To determine reliability, we need to know how stocks are priced. In my opinion, stock prices are basically perceptions of value to investors. And the perception is affected by valuation and emotion. Valuation means the expected worth of a particular stock while emotion refers to the state of greed and fear in the market. Sometimes, the price can be closer to the valuation, and at other times, the stock price can be ridiculously high or low.

FA is good at valuation. As mentioned previously, FA is about valuation of businesses. This is an area that FA does well. However, FA is not able to determine the market emotions. Some may argue that as more stocks becomes overvalued, it is a sign the market is euphoric. I would say it may not be so obvious, and it is also possible for you to find an undervalued stock during a bull run. And if the market crashes, your stock goes down with it.

TA is good at identifying market emotion. On the other hand, TA is basically trying to discern market emotions through the charts, and capitalise on the greed and fear of investors. The reliability of TA changes with market conditions. Some methods work badly in volatile market, getting whipsawed constantly. A FA investor would just ignore the volatility.

As you can see, FA and TA cannot cover both the causes of stock price. There are many pros and cons for FA and TA. For me, I like the FA entry, getting in at a discount. I like the TA exit, giving the ability to reap maximum profits and protecting me against a crash. It does not matter which method you use, the most important thing is to find your edge in the market. And it will take time, effort and money to find it.