When you first being to look at companies and stocks, in general, there is something you will come across, it is the battle between the best type of investment analysis.In one corner there is technical and the next, fundamental. These are like two sides of a coin, completely different. Each of them has their die-hard followers who will do nothing but that type of analysis. Fundamentalists think the technicians are stupid and vice versa. Both of them has their pros and cons but at the end of the day, I believe one is superior for investors which I will get to.
But first, we must look in detail at both. An answer to a question is great but if you have little to no backup information then your answer is pointless. We will look at three main categories for each analysis to determine which one can be better for long-term investors; the tools each type of analysis requires, the time horizon appropriate for each type of investing, and whether there is more a trading or investing mindset when using the approach. You will see that one tends to favor trading more and the other investing.
First, we will use the type of analysis that might seem to be foreign to most of you. If you have just began to look at investing then usually it’s a lot to learn. Technical analysis is used when you look at stock charts. A stock chart is a representation of the price movement over the course of a period of time. Some will track the movement of the price for minutes at a time or hours. It is all over the place with the type of chart.
Technical analysts believe that stocks work in a certain way and if you study the price chart you will be able to see where the price can and can not go. They begin to see different companies as separate human beings. The begin to assert personalities to companies. They spend enormous amounts of time studying trends, backtesting strategies, looking at indicators, and at the very least you can expect a technical analyst to be staring at screens for a long period for time. When you look at pictures of Wall Street trades sitting in front of 6 screens looking at charts, this is what they are doing.
Technical analysis separates the idea that a company is underlying the stock price. Instead, they look for a company that might have momentum and studies the chart. They don’t care much about the real underlying business, only what the price is doing. This is a large difference between the two.
The biggest tool in the toolbox for technical analysts are stock charts. If it wasn’t for this, they would not have technical analysis. These are the building blocks for everything else they do. There are many different types of charts like line charts, bar charts, candlestick charts. The one you will see most often is the candlestick chart.
“The trend is your friend” is a commonly used phrase in technical analysis. You want to be able to identify it then ride the wave. The idea is that the stock has this type of momentum in one direction and it can be profitable to continue to ride that trend. They just want to be able to ride the wave long enough and get out before a reversal happens.
Momentum and Volume:
One common theme you will see in the technical analysis is identifying what has a lot of momentum or volume. Usually, if there is a lot of volume it means the probability of a big price move is higher. Technical analysts live for big price moves, the biggest thing they need to get in on the right side of them. Momentum and volume will push the price in either direction, they want to capitalize on the big price movement. Without either volume or momentum usually, an analyst will look elsewhere.
Technical analysis uses a lot of different indicators and tools to help them identify if a price is going to move in any certain direction. They will try everything underneath the sun if it might give them an advantage. Moving averages are looked at as an indicator of possible price action. Some will use the short term like 5,10,20,50 day moving averages. Others will opt for the long-term ones like the 100 or 200 day moving averages. The basic idea is that if the price crosses a certain moving average there could be some signal showing where the price could go from there.
Support and Resistance Levels:
Like I said before there are numerous technical factors that an analyst will look at to see if they are able to spot something that someone else has not been able to. One of those features is what is called support and resistance levels. These price levels are what analysts believe give the price either support or resistance. Support is defined as a price level that has been a point where the price has touched but has bounced back up. Resistance is the point that the price has reached but was rejected and sent lower. Analysts believe that if they can spot these levels they have a better chance of predicting the prices next move.
There are a million different indicators that can be used. Each technical has their own specific ones they like to use. It is a lot like how value investors value business. Everyone has their own way of doing it. Some of the indicators include the MACD, The RSI (relative strength index), Bollinger bands, and a stochastic oscillator.
Now that we have covered what technical analysts use to make their decisions let us move to see how they usually conduct their investments. The time frame in which technical analysts hold their positions varies. Usually, when you use technical analysis the time frame is relatively short. I am talking days to maybe weeks. Some analysts will only day trade while others will hold for weeks at a time. There does seem to be one constant notion though. They will be selling the position as soon as they reach the mark they have determined with no regard to how the underlying company is performing. I have never heard of a technical analyst that looks at charts in the years time frame. Usually holding a position determined from technical analysis is not held for years. That is a big difference between the two. The time horizon is on average much shorter than that of a fundamental analyst.
Trading vs Investing
If you take all of the information from learning about technical analysis, we can come to the logical conclusion that this type of action is trading. Shorter time frames and the lack of regard for the underlying company really point this out. Usually, the main focus of a technical analyst is to spot some type of pattern then capitalize on it as soon as they see it occur again. This repetitive behavior of buying and selling means that the only concentration is on the price action. When compared to the other type of analysis this is very different.
Technical analysis is used more for people who are looking to trade. In the long run, we know that the companies will be priced relatively accurately with their underlying business in mind. The technical analyst does not care about the underlying company. The man focus is price action. What the price has done in the past and they try to use that information to try and predict what the price could do in the future. When it comes to this, all analysts are the same they take information about the past and try to predict the future. Which is near impossible.
Fundimental analysis is the other main type of analysis analysts will use. This is more of a company focus than price focus. When you purchase stock in a company there is one underlying factor, the company itself. There is a company behind every share and fundamental analysts fully understand that. Instead of looking at stock charts they study financial statements with the same hope of technical analysts; they can spot something no one else was able to see. Just instead of seeing patterns and focusing on price, fundamental analysts are more worried about the company and how it is performing.
Fundamental investing is all about the underlying company and some companies will go to great lengths in order to try and gain a competitive edge in their investing. I have actually heard of a situation where a big hedge fund has a satellite in space tracking the traffic at certain malls so they can invest in the companies that will profit from that. Of course, normal people do not have access to that type of advantage you could call it. But it is all about the company and what it is doing. They believe that the stock price will reflect the business it is either booming or going down.
The biggest tool in a fundamental analysts toolbox are the financial statements of the company itself. In fact, without these, there would be no fundamental analysis. There are three main statements: Income statement– this is the place where you can see the companies financial performance over a specific period of time, the balance sheet– a statement where you can see the company’s assets, liabilities, and shareholders equity over a specific amount of time, then lastly the cash flow statement– The statement that shows you how cash has flowed in and out of the business. All of these give the investor plentiful information needed to get a full picture of the operations of the company.
The annual report is where you go to see the year in review. The annual report will be filled with tons of information that will reflect the past performance of the company and will give you commentary of the year. There is something you should look out for though, annual reports are typically written by the public relations department. There will be a positive tone in all of them. The trouble investors face is trying to pick through the information and see what is useful information and what it just public relations B.S. overall though, serious investors will take a grave amount of time to go through the annual report to understand how the company operates.
The annual report is the better-looking sibling of the 10-K. The 10-K is the lesser publicized annual report. It will have the commentary of the previous year and everything that is required by the SEC. Sometimes companies will just use their 10-K as their annual report but if you want the official document you download the 10-K. This document will cover everything and anything about the company. The business overview, risks, debt, management discussion about the performance, notes to financial statements. I have heard many times before that if you want to be a serious investor you have to love 10-Ks. They are not as pretty as the annual reports but they have all the information you need to determine if a company is good or not. To professional investors, if you don’t read the 10-K you should not invest in the company.
The fundimental analysis comes from analyzing the company itself, well it is very helpful to find that information when the company has an investor relations page. The investor relations is like a buffet for fundamental analysts. It includes many things like all the SEC filings, annual reports, earnings calls, transcripts, events, and presentations. If there is something you want to see about a company this is where you can find it. Fundamentalists will dig deep into this section and find everything they can about the company they are looking at. Going through every presentation, reading every earning call, listening to the CEO speak is all a part of being a fundamental analyst.
Even though the 10-K goes under this section I wanted to get the point across that the SEC filings are some of the best tools in the toolbox of great fundamental investors. The SEC filings are all filings that need to be submitted by public companies. Here you will find filings such as the 10-Q, Form 4, and the 10-K. These are just a few examples there are many more.
Unlike the technical analysts who take time into account, fundamental analysts tend to have a different view when it comes to the time frame. The majority of fundamental investors are invested for the long run. There are few fundamental investors that will have a short time frame simply because the market can be so irrational most of the time it’s not worth trying to invest in a short-term time frame.
These bets can position can be taken for or against the company. But all of these big investments are based on the fundamentals of the business themselves. For example, Bill Ackman had a large short position against Herbalife (HBL). By large I mean a $1 Billion dollar short. That is a huge short. Why is he betting against them? He believes that the company is a pyramid scheme and that eventually, they will fall. He doesn’t know when or how soon but the point is that he is willing to ride this position until he is right. This long time frame is what will separate him from the pack. He came to the conclusion that the company was worthless by fundamental analysis.
There are many time horizons associated with the stock market but when it comes to fundamental investors the longer the time frame the better. Unlike their counterpart fundamentalists believe that when you buy an undervalued company that company will yield returns for years to come. There is usually no time frame placed on investments for fundamentalists.
Trading vs Investing
Fundamental analysis is more of the investing type of people. Trading is something that is done on a short-term time span and trying to predict price action based off of fundamentals is extremely hard. The market acts irrationally a lot and some days it will see goods news and rise and the other days it will see good news and go down, not an uncommon occurrence on Wall Street.
Fundamental investing is a type of investing that usually will not yield results right off of the bat. To become really good at fundamental investing one must develop a thick skin. The market can be a brutal place to invest your money on a short-term basis and if you don’t have the stomach to handle it then it can be emotionally crippling. Fundamentalists fully believe that the price action of a stock in the long term will reflect how the company does. Studying the fundamentals of a business is not for short-term riches but rather a long-term wealth creation.
So Which One?
Between the two me there seems like a superior one. Obviously, if you are an “investor”, which means you are more interested in being involved with the operations of the business rather than the exact price of the company at a certain time, you will favor fundamental analysis over technical analysis. There seem to be a few obvious reasons for this.
The Tools– The tools needed to give you a competitive edge with technical analysis come have to be learned and can seem rather confusing. They are all connected to the price, volume, and momentum of the company rather than the company’s performance itself. The tools used by fundamentalists can be easily found and understood. They all have to do with the company’s performance and everything that has to do with the companies operations. In fact, you will not find many mentions of the stock price but more about creating value for the shareholders. Trust me, the value is much better than price as long as it can be recognized at some point.
The Time Frame – Technicians will obsess over the price and the price action. This can lead to massive amount of time and stress just staring at screens and doing nothing but look at the price. This repetition can lead to a very stressful life. When your life depends on something that is pretty much out of your hands you are nothing but subject to the reaction of the crowd. Sometimes they act rational, other times not. Why would you want to base your earnings off of something you practically have no control over in the short term. When the time frame you have for an investment is short (by short I mean a year or less) you are putting yourself in the way of a train that could or could not possibly is stopped.
When you have a much longer time horizon the stress of price fluctuation goes away. I have been there and done that, I decided to step away from trading because I hated the stress of it. Some people can handle it, I give them a lot of credit me? I would much rather just be invested in a company that gets better the longer I am invested. Fundamentalists have time horizons of years to decades. Time is the best thing for a great business.
The Thinking Behind It– This to me is the most obvious reason why fundamental analysis is much better than technical analysis. When you are looking at stocks from a technical analysis point of view you look at nothing but price and movement. There is no analysis of the companies itself, THE WHOLE UNDERLYING FACTOR. When you buy shares, you own a portion of a company. To ignore this would be a massive mistake.
Over time the reason your investment should become successful is that the company itself is doing better. If you do enough research you should be able to identify whether this company will continue to prosper well into the future and therefore give you a successful investment. Any idea of using stocks with any other idea in mind is foolish and can be associated with gambling. In the short term stocks can be extremely volatile and being involved with that can be deadly both financially and mentally. Rather, in the long run, investment in great companies can yield wonderful returns. Last time I checked Warren Buffett did not make an investment in a company only looking at the movement of the price and nothing else. For long-term intelligent investors, fundamental analysis is the way to go.
Peace and Love,