Understanding the Mix: How we use Technical Analysis with our Fundamental Analysis
The debate of fundamental analysis versus technical analysis is an interesting one. It's an argument where both sides make very valid points, and in spite of the valid points made by each side, die-hards of one form of analysis will dismiss the other. For those who aren’t sure what the difference is, here is a brief description of fundamental analysis and technical analysis.
A fundamental analysis of a company and its stock reviews the company’s earnings, assets, liabilities, cash flow, credit rating, cash on hand, debt, and other things. This review will help to determine what the company’s value is and if the stock of the company is trading above its value or below its value. If the company is trading below its determined value, a fundamental analyst will recommend that the stock be purchased.
A technical analysis is a review of the stock, and the stock's current trading price compared to the stocks previous price. When to buy the stock using technical analysis depends on the technical analyst doing the review. Some technicians will buy a stock that has been ranging in a prize zone for a while, believing that the stock has reached a technical level of support and will trade higher from the current price zone, this is usually referred to as a breakout. Other technical analyst may wait for the stock to start trading upward, and then pull back to a previous level of support, and then initiate a buy. Other technicians will wait for the stock to retest its old high, looking to buy the stock either in anticipation of it trading above its old high or buying the stock once it trades through the old high.
No one-way of analysis is truly better than the other. A good fundamental analyst is worth their weight in gold, and the same can be said about a good technical analyst. Both are very skilled in how they read a company and read the markets. There is much to be gained by understanding both forms of analysis.
The Seville Report relies heavily on fundamental analysis. We break companies down to one share to see if there is value in the shares. However we do rely on technical analysis when attempting to determine our buy zone for a stock and where to sell the stock if the analysis is wrong or early. Lets look at an example. Below is a chart for Telecom Argentina (TEO).
(Source: E-Trade Pro)
This is where I did my fundamental analysis. The stock was trading in the $17 range. My analysis determined that the stock was worth $28-$35 per share.
This long tail or wick, this represents buying pressure at the $14 range. The stock traded down to $14 but was bought up quickly. This is a technical indicator.
The light blue line running across the screen is the 200-Day Simple Moving Average. A tool used by many technical analyst (if the stock is above the 200 S.M.A. go long/buy, if the stock is below the 200 S.M.A short/sell)
After purchasing the stock in the $17 range, the stock dropped below $16 about a week later.
I used the decline as a chance to buy more TEO at a lower price. This brought the average purchase price down, and closer to that $14 range.
Fundamentally, the analysis determined the stock was worth $28-$35, but looking at the chart from a technical standpoint, if the stock traded below $14, then I would sell and re-evaluate.
7. The stock trades above its 200-Day Simple Moving average. A good entry for some technicians
8. The stock pulls back to the 200-Day Simple Moving average, using it as a level of support before trading higher again, another point of entry for a technician.
So reviewing this case there was a $17 stock which the fundamental analysis indicated has a fair market value of $28-$35 per share. A technical indicator on the chart highlighted that the stock attempted to trade under $14 but the buyers wouldn’t allow it. This technical indicator provided a price level of support for the stock. If TEO was able to break below the $14 support level, this would indicate the sellers were in control of the stock and despite our research we need to sell to preserve the rest of our capital.
Now some may wonder if the stock was purchased at $17, with the hopes that it would go to $28, why would I sell it if it traded under $14? Why not just hold it until it gets to $28? There are two answers to this question. The first answer being, we sell because we don’t know how far the stock will fall, the stock could fall to $10 a share before trading upwards, or it could fall all the way to $2 a share. The second answer is selling at $14 allows me or any investor to preserve capital.
Although this was 2014, we still use a small portion of technical analysis when doing our fundamental analysis. Understanding if a stock is trading at a level of support or an area of resistance is a need to know when investing. There are too many technicians in the market to ignore the technical indicators of a stock chart.
If you read this with the hopes that The Seville Report would validate one method while criticizing the other, we are sorry to disappoint you. The way we view fundamental analysis and technical analysis is that both work for the good fundamental analyst and good technical analyst. Which ever an investor decides to use, they should work on perfecting their method of analysis and not waste time pointing out why one way is better than the other.
We hope this adds value to your investing. Happy investing.
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