By and large, investors and traders are split into 2 camps. Investors tout the strength of a fundamental approach, while traders boast of the advantages of a technical approach. Each side claims that their approach to asset growth is superior, offering would be students convincing arguments why they should prefer one approach over the other.
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Is it necessary to choose one approach or the other? Can you not combine both?
Investors rely on company financial statements and economic developments to make their investing decisions. They dig deep into company reports, breaking the numbers down into many different ratios. They analyse these ratios alongside past data, making future projections before coming to a conclusion as to whether an investment is worthwhile at the current market price.
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Traders, on the other hand, call up charts of the stocks they intend to trade. They look at price action, analyse the price structure, and make various markings. Some add oscillators and overlays to gain a better sense of the market enthusiasm behind the price moves. After assessing a list of factors, they decide if the trade is worthwhile given the ratio of risk to reward.
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These activities hardly seem to come into conflict with one another. Why then are investors and traders opposed in their approach towards asset growth?
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The 1st reason behind the rift is philosophical. Investors believe that stock price movements occur in a random walk where past price movements cannot be used to predict future price movements. In a fair and efficient market where no participant has an informational advantage over any other, there is no advantage to be had from attempting to time the market. If that were true, technical analysis can be nothing but hype. Traders on the other hand believe that stock price movements capture all information relevant to the particular stock to date. If this were true, there is nothing further to gain from fundamental analysis. Poring through financial statements and analysing economic trends would just be a waste of time.
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But do these philosophical beliefs fit reality?
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Traders have identified many price patterns which have been found to repeat themselves. These patterns have been found to possess an uncanny ability to foretell future price developments beyond that which can be explained by random probability. Investors have found that stocks possessing certain characteristics tend to outperform over the long term. This, beyond the ability of any chart pattern in forecasting long term price developments.
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As soon as we open our minds to reflect on the dogma we have been impressed with, we begin to tamper the strong assumptions underlying a fundamental or technical approach to asset growth. We start to consider the possibility that while price movements move in a random fashion most of the time, sometimes, it may offer an astute investor an edge over the market. That is precisely what traders believe. Traders do not see price movements as offering predictable advantages all the time. Rather, reliable profits can be made during small windows of opportunity which present themselves from time to time. We start to think that there may be important pieces of information beyond what is captured in price charts. Sources of such information include what investors turn to when they look at financial reports and economic data. While fundamentals may not explain all price movements, they offer important clues as to where stock prices are likely to tend towards over the long term. Thus, we are freed from the mental chains that bind us to one approach or the other.
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The 2nd hurdle is practical.
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It is often said that a fundamental approach runs into conflict with a technical approach because a fundamental approach tells you to buy when prices are low, while a technical approach tells you to sell when prices fall beyond a certain point. This conflicting recommendation leads some to believe that these 2 approaches must be irreconcilable.
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But this conclusion rests on a mistaken belief. This conflict arises only because the entry rules associated with a pure fundamental approach do not agree with the exit rules of a pure technical approach. Yet, neither of these rules are intrinsic to the respective approaches. They exist only because they are required to complete the respective strategies. Modify the rules, and there is no more conflict.
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Now that we have overcome the hurdles to combining the fundamental and technical approaches, all we have to do is to apply both skill sets in analysing a single stock. First, perform fundamental analysis to understand the long term prospects of the stock. Then, perform technical analysis to find potential entry points. If the stock displays strong fundamentals, invest on the long side. Wait for prices to pullback to an advantageous level before buying in, or wait for prices to breakout from key levels and ride the momentum. If the stock displays weak fundamentals, avoid it altogether, or trade it from the short side.
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The following is an example of how these approaches can work in tandem.
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After evaluating the said company, you decide that it is a robust company with good prospects selling at good valuation. Your preference is for capital gain without having to tie your money down for an overly extended period. You observe that the stock price is entering a phase of consolidation.
Knowing that the price tendency is towards the upside, you wait for the price to breakout from the trading range. Once it does, you execute your trade.
Soon, you are rewarded with substantial profits.
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Fundamental analysis and technical analysis are not opposing approaches. If we are willing to open our minds to learn, they complement one another and can be combined to produce outstanding results.
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At FinMach Global, we believe in empowering individuals to choose an approach that suits them, and advocate a holistic approach to asset growth. To find out more, come attend one of our free Workshops.
Disclaimer: This article is purely for educational purposes and is not intended as a recommendation to buy or sell the stock concerned. The author holds a small position in the stock mentioned, and does not intend to buy or sell the stock in the near future.