Can chart readers, financial analysts peacefully coexist?

Are you a technician or a fundamentalist? Ask this question if you want to know a stock market player’s investment style. Most of the time, technicians and fundamentalists have diverging views on when or what stocks to buy.

Technicians are chart readers. Their investment decisions are determined by share price actions reflected in charts. Is the stock on an uptrend or a downtrend? Is it close to support or resistance? Since they make decisions based on charts alone, they tend to be very quick in buying and selling stocks, and have short investment time horizons, that could be as short as a few hours.

Fundamentalists are financial analysts. They study the financial results of companies to understand their businesses and to calculate their fair value. They make investment decisions based on what they have inferred from these studies. Since the analysis process is time consuming, fundamentalists take time to decide on whether to buy or sell a stock. Since they have deep knowledge about the stocks they buy, they tend to hold on to their stocks and have longer investment time horizons.

Technicians and fundamentalists have conflicting views about the stock market because technicians prefer to buy strong stocks that break out of resistance levels while fundamentalists are often wary about these stocks because the significant increase in price usually makes these stocks expensive. Moreover, many stocks that show significant price increases are either speculative issues or go up for reasons that are not sustainable. Technicians love buying these stocks while fundamentalists avoid them.

Technicians avoid stocks that are on a downtrend and are breaking below support levels. Fundamentalists often love these stocks because the significant drop in price usually makes these stocks cheap, creating an opportunity to generate above average returns over the long term.

Nevertheless, experience has taught me that technicians and fundamentalists can learn from each other and peacefully coexist. In fact, using both disciplines can help stock market players generate higher returns.
For example, technicians can use the findings of fundamental analysts to create a short list of stocks to monitor. One of the drawbacks of trading based purely on technical analysis is lower success rates as many stocks suffer from false breakouts. However, the likelihood of a fundamentally attractive stock suffering from false breakouts is much less, improving technicians’ “hit ratio.” As such, technicians that stick to fundamentally attractive stocks benefit from lower transaction fees and higher success rates which translate to better returns.

Technicians can also increase the size of their trades when buying fundamentally attractive stocks with good chart patterns. For example, from a bet of only P20,000 when trading speculative issues, a trader can comfortably increase the size of his bet to P100,000 when trading a fundamentally attractive stock.

Also, fundamentally attractive stocks tend to be more liquid, making it easier to buy and sell a sizeable position. As a result, although the percentage return of nonspeculative issues tends to be smaller, the peso amount of returns can be higher. After all, a P20,000 portfolio would have to increase by 50 percent to generate a return of P10,000 while a P100,000 portfolio would only have to increase by 10 percent to generate a return of P10,000.

Fundamentalists can also learn from technicians. Studies show a strategy of buying stocks on the uptrend and selling them when they break their uptrend generate higher returns.

When a fundamentally attractive stock “breaks down” technically, it could be a sign that something is fundamentally wrong. Admittedly, fundamentally attractive stocks can be sold down for many reasons, some of which have nothing to do with the stocks’ fundamentals such as fund flows or contagion. This is something fundamentalists need to recognize and respect and will help them in their analysis in the future.

While attractive valuation is a compelling reason to buy a stock, knowing the technical picture can help fundamentalists time their buying. After all, cheap stocks can become cheaper and can stay cheap for a long time. By using technical analysis, fundamentalists can buy closer to the low than to the top, helping improve returns when stocks finally rebound.

Are you a technician or fundamentalist? I hope your preferred style does not stop you from using what you can from technical or fundamental analysis as both disciplines have strengths that can help you generate higher returns.