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Trading Art or Science? Where Fundamentals and Technicals Meet

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July 11, 2012
Trading Art or Science? Where Fundamentals and Technicals Meet

Fundamental or technical analysis? You don’t have to choose. A combination can help with potential entries and exits.

Which is better, fundamental or technical analysis? For traders and investors, this debate may rival the classics: Hatfields & McCoys or cats vs. dogs. There can be subtle or profound differences, depending on who you ask.

Fundamental trading is a little more “art.” That is, subjective (See Figure 1). Past company earnings are fact. Yet, where company profit might be headed is anyone’s “educated” guess. Or, take share-price valuation. It’s based on math, but also requires that traders check their gut before jumping.

Technical trading (the “science” for our purposes) hinges less on why a market is performing the way it is and more on what a chart shows at a particular time. Like any science, this method isn’t fool proof either.

FIGURE 1

 A quote detail on TD Ameritrade’s Trade Architect® platform provides news, earnings, analyst estimates for upcoming quarterly results, and more. For illustrative purposes only. Past performance does not guarantee future results. Data: Penson Worldwide, Inc.

Below, two active home-based traders invite us for a peak over their shoulder. One considers herself a fundamentalist who leans on chart readings for support. The other is a technician who generates trading ideas by skimming the fundamentals. Study their research methods, analysis, and chart tricks, but keep in mind, their level of expertise or particular approach may not be the best fit for your goals and risk tolerance, or it may contradict your own preferred style. Still, you’ll get an idea of how a fundamentalist works versus how a technician works. In reality, you’ll likely find that both mix a little art and science.

Meet Toni Turner

FUNDAMENTALIST USING TECHNICAL CONFIRMATION

Why take this approach? “You wouldn't walk onto a golf course with only half your clubs. To get my own reading of what a stock is worth, I combine both,” said Toni.

Let’s watch Toni trade.

5:30 A.M. ET I begin my research by checking the stock index futures, the Asian and European markets, or choosing a sector or industry group that, as I see it, has a chance of advancing (or declining) in the current market environment. Once I focus on a sector or industry, I create a watch list of five or six equities.

8:00 A.M. Using technical analysis, I go through the daily charts of each of my target stocks. When I find a setup on the daily chart that I like, I’ll flip that daily chart to a weekly chart because the buy-and-sell signals on a weekly or monthly chart are stronger than on a daily chart.

If my weekly chart confirms it is indeed a buy signal, then I go into my TD Ameritrade account and read fundamental research. I am interested in earnings growth over the last four quarters, and also projected earnings growth. For me, the most important piece of information on the fundamental side is earnings. It only takes a few seconds to check this.

9:00 A.M. Now that I have an overview of the fundamentals, I look at setups using moving averages (MA), such as the 10-day, 21-day, 50-day, and 200-day. I like my target stock either in an uptrend or forming a base, and consolidating in a neat, orderly pattern. I’m looking for a stock that could break out of this pattern. If the stock on a daily candlestick chart (See Figure 2) has long shadows on the top or bottom of its body, that indicates intraday volatility, and I might remove that stock from my buy list. I’m not interested in a stock that has high intraday volatility if I’m swing trading. In that case, I prefer ordering patterns.

Even if fundamentals are good but my stock is trading below its major moving averages, and indicators such as Relative Strength Index (RSI) are pointing down, I’m not going into it. I use technicals for entries, and fundamentals to confirm them.

9:30 A.M. The only opening-bell trades I make are taking profits in positions that gap up from the night before, or if I need to make an emergency exit.

FIGURE 2 The candlestick for each trading day marks the high, low, open, and close. From there, moving averages and volatility can be tracked. For illustrative purposes only. Past performance does not guarantee future results. Data: Penson Worldwide, Inc.

11:00 A.M. During the day, I’ll look at economic reports due to come out the next day. I might also take some profits off the table on intraday trades.

1:30 P.M. I’ll continue scanning daily, and 5-minute charts for strong stocks in an uptrend (or downtrend for down days) that have pulled back from their session highs. I’ll focus on the stocks that are closing in on their highs (which is reversed, if shorting).

1:45 P.M. I might add a little money to open positions depending on the mood of the market. I’m still looking for potential profit-taking opportunities.

3:15 P.M. Before the 4:00 p.m. ET market close, I want to cash in on profits before other traders exit and drive prices down.

Meet Deron Wagner

TECHNICIAN WITH A FUNDAMENTAL SCREENER

Deron primarily sticks to technical analysis, focusing on RSI (See Figure 3). He uses fundamental analysis to find stock candidates.

“For my own trading, technical analysis tells me everything I need to know about deciding my bias on the direction a stock is going: up, down, or sideways. My number one indicator is price. Volume is second,” said Deron.

FIGURE 3 Relative Strength Index (RSI) is one indicator that might help answer the question “When?” by assessing the strength of a trend. For illustrative purposes only. Past performance does not guarantee future results. Data: Penson Worldwide, Inc.

9:00 P.M. ET The night before a given trading day, I filter through 300 to 500 charts that meet my trading criteria. I like stocks that are consolidating after making highs for at least several weeks, which form bullish chart patterns. The stocks that I think will be the strongest will probably be the ones with strong earnings. Other than earnings, I don’t really care about P/E ratios or other fundamental data, because I think it doesn’t determine the price action of a stock in the near term, and I’m primarily a short-term trader.

7:30 A.M. In the morning, I check out the U.S. futures market and study the Asian and European markets for breaking news.

8:00 A.M. I look for potential gaps in the stock positions on my watch list, or any stocks I’m already in. Then I look at economic data, and check for analyst upgrades or downgrades. Finally, I create a game plan, which helps me to know exactly what I will buy or sell using my target prices. By 9:15 a.m., all of my information is collected and I’m ready to start the trading day.

Screen Test

Find results relevant to your goals. Pre-defined screens include Strong Buys; RSI Bullish; Parabolic SAR Bullish; High Dividend Yield. Or, set your own criteria. 

9:30 A.M. I am managing positions—that is, buying and selling stocks. Meanwhile, I am filtering through the stocks on my watch list (a very short list) to make sure I don’t miss any entries. On the long side, I look for stocks showing relative strength to the broad market.

11:30 A.M. I go over any stock positions to see how they traded during the morning session. I determine if I need to adjust any stops or change position size.

2:15 P.M. Because, as I see it, this is often a reversal period, I keep an eye out for potential sharp reversals.

3:30 P.M. Near the end of the closing day, I check to see where the stocks I own close. If I don’t have many positions, I scan my nightly watch list to see how the stocks performed during the day.

4:00 P.M. At the market close, I log my trades into a spreadsheet and analyze profitable, or unprofitable, positions.

Deron, in fact, finds a little art and science within technical trading. “In my opinion, technical analysis is probably 70% science and 30% art. The art is learning how to translate what you see into deciding whether to buy or sell. The science part of technical analysis is really the personal trading rules, which; for me, are already in place,” he said.

The bottom line: Both approaches offer strengths and weaknesses. Combining fundamentals with a solid charting skill set may become a more popular way for traders to call it as they see it.

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