After investing, speculating and trading in the financial markets for more than 25 years, I’m still amazed by the frequency at which many so-called financial market “experts” claim that fundamental analysis is superior to technical analysis and visa versa.
Yet, I’ve found that using neither of those forms of analysis, exclusively, leads to superior performance results.
Quite the contrary, my experience reveals that to maximize returns and minimize risk, investors, speculators and traders should use simultaneously both of those analytical techniques.
That’s especially true when attempting to determine following:
1. The most opportune times to invest, speculate and trade in the financial markets,
2. Which securities to select for investing, speculating and trading, and
3. When to buy and sell any given security.
Although fundamental analysis tends to serve as a better method for selecting the most-profitable long-term investments, technical analysis is often better for short-term trading and for determining the best time to buy and sell any given security.
Meanwhile, both of those analytical techniques, when used together, can be very helpful in determining the most opportune times to invest, speculate and trade in the financial markets and when to sit on the sidelines.
Before discussing either of those methods further, let’s review the definitions of fundamental and technical analysis.
Fundamental analysis is a method used for evaluating any given country’s or region’s economic environment and for determining the value of any given company’s securities.
That type of analysis includes the review of an economy’s total output of goods and services, as well as factors that affect the economy, such as lending rates, employment conditions, manufacturing activity, personal consumption expenditures and business investments.
It also involves the analysis of companies’ revenues, earnings, assets, and cash flows.
Editor’s Note: How to beat the Wall Street Wolves at their own game
Although many of the economic variables mentioned above provide information only on what’s already happened, a few of those variables tend to serve as reliable leading economic indicators – the readings on those variables can be used to correctly predict the future direction of a given country’s or region’s economy, as well as the future direction of stock market indices.
In contrast, technical analysis is a method for analyzing what’s occurring currently in the financial markets and for evaluating the trading action of any given security. It reveals the actual buying and selling decisions of financial market participants.
Although either of those methods can be helpful in determining opportune times to invest, speculate and trade in the financial markets, as well as which securities to select and the best time to buy and sell any given security, I have found that using a combination of those methods tends to produce superior performance results.
For example, the readings on numerous economic variables indicated during early 2007 that economic conditions in the United States would soon deteriorate substantially and that stock prices, in general, were in the process of peaking.
However, the readings on several technical indicators suggested at that time that stocks would continue to trend higher during the ensuing months. Therefore, I advised investors during the first half of 2007 to allocate a substantial portion of their financial market assets to equity securities.
But, when several technical indicators turned negative during July 2007, I urged investors to get completely out of stocks. Only three months later, on October 9, 2007, the S&P 500 Index peaked and then declined by 57 percent over the next 17 months.
As a result of using both fundamental and technical analysis, financial market participants who followed my advice during late 2007, and throughout 2008, were able to avoid the substantial downturn that occurred in stock markets around the globe from October 2007 to March 2009.
And, when the readings on numerous leading economic indicators and several technical indicators turned positive during early 2009, investors and speculators who followed my advice were able to profit from the new bull market that began during March 2009.
In addition to using a combination of fundamental and technical analysis to avoid the big downturns and to profit from the big upturns, the simultaneous use of both of those types of analyses can also be beneficial in determining not only the right stocks in which to invest and trade, but also the best time to buy and sell those stocks.
For example, a thorough fundamental analysis of Netflix (NFLX) indicated during early January of this year that financial market participants were undervaluing the company’s stock. And, several technical indicators suggested on January 20 that NFLX was in the process of bottoming.
Therefore, I advised my clients on that day to allocate a portion of their assets to NFLX. The following day NFLX rose by a whopping 17.3 percent and continued to move higher over the past six months.
Now, I’m not suggesting that combining both fundamental analysis and technical analysis will always produce superior performance results. Yet, I see no reason why any investor, speculator or trader who’s seeking to maximize his/her returns and to minimize his/her risk would choose to use only one of those types of analysis.
In my next educational article, I plan to discuss a few leading economic and stock market indicators that you can use to avoid the big downturns and to profit from the upturns in the financial markets, as well as a few technical indicators that you can use to become a better short-term trader.
David Frazier is President and Chief Market Strategist of Frazier & Mayer Research, LLC, an independent investment research firm that offers customized research and analytical services to registered investment advisors, hedge funds and high net-worth individual investors. You can check out his latest insights at: www.investorsmonitor.com.