Fundamental vs. Technical Analysis
Among the many of methods people use to choose investments, two schools of thought usually define the approach; fundamental analysis and technical analysis.
Fundamental analysis assumes that knowledge is not universal so those who know more do better than those who know less.
Things to know could include what a company makes, earns, owes, how their management works, how big they are, where they are located and who are their competitors. If you can divine how their sales or earnings will change better than someone else, you have a better chance of making good investment decisions - in theory.
One of the drawbacks of fundamental analysis is that a lot of the information available is not necessarily provided by people who have your best interests at heart. Another is that you buy or sell things based on what it "should" do. If you are wrong, you could lose a lot of money waiting for everyone else get the message.
Technical analysis assumes everyone already knows everything so you can make supply and demand decisions based on whether the price is going up or down.
With technical analysis we are looking primarily at the mathematics of price movement to see if there are more sellers or more buyers. If so, which trends can be reasonably expected to continue?
Its main drawbacks are that you seldom get out at the top or in at the bottom since you need confirmed trends to act. In choppy, leaderless markets, your discipline can force you in or out of markets just before they turn in your favor. 2011 was a good example of that.
I use technical analysis, particularly point-and-figure tools, to make strategic portfolio decisions. I choose investments based on how they are doing relative to thousands of other possible choices. That process is constant. A long-term investment is defined by how long we have owned it rather than how long we want to.
A large part of my choice to at least begin with technical tools is risk management. Each investment comes with a built-in sell discipline. The price can change with market conditions but all positions have sell points that must be respected - whether I really want to or not. You can fall in love with an investment and the discipline takes the emotion out of the decision. Fundamental and technical methods all have buy and sell disciplines and lots of us use both.
My process also makes me weed the portfolio. When a stronger investment overtakes something you own, I either have to make the change or have a compelling reason not to. We don't keep ideas that didn't work or have lost momentum hoping they will pull through. Hope is not a discipline.
Fundamental analysis is much more interesting since you get all of the news and rumors about the subject. Experts argue with each other on TV. Technical analysis doesn't generate much buzz. Even so, I build our portfolio protection into unblinking numbers. In my own hard experience, I listened to the president of a previous employer assure employees that all was well as the stock went from $38 to 78 cents a share in nine months. A fundamental researcher might ask, "Don't people know this mortgage crisis is just a flash in the pan?" A technician would ask, "If it is such a good deal, why are all the insiders selling?"
Any investment process has too many nuances to write down. It evolves as well. Some of mine is just from being in the business since Ronald Reagan was president. Things have to pass a smell test too. I love to talk about the research process and would be glad to share what I've learned.
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No Strategy assures success or can protect against loss.