Sunday, August 8, 2010

Fundamental Analysis VS Technical Analysis

Browsing though other blogs and I chanced upon a lively discussion on whether the hybrid of Fundamental Analysis (FA) and Technical Analysis (TA) works. Interestingly, over the past week, I have been re-reading some of the books that I have bought earlier, dealing with the subject matter of investments and markets.

The key point by the topic starter was that by combining the both methods, it may dilute the efficacy that each method was suppose to bring. His strengthens his argument against the case of hybridization by saying,

"First of all, in order for someone to claim that a certain method is workable, he needs to demonstrate, through meticulous and objective record-keeping, that the method works over the long-term...." 

" The second point which I have to make is that a practitioner of FA/TA should make his investment philosophy very clear right from the start, in order to avoid the cardinal sin of not being able to decide if a buy/sell decision stems from an FA or TA perspective..."

However, there are those who disagree with the point, say that their experience show that you can have the best of both worlds. They liken FA and TA to defense and offense in a game of soccer.

The Role Of Chance
My thoughts on this issue, stemming from the books I have read as well as personal (short) experience in the market, are that maybe both FA and TA, hence their hybrid, are useless.

As the topic starter pointed out, the case is convincingly argued by Burton Malkiel in his "A Random Walk Down Wall Street". But to add to the author's point, I think that while chance has a role in investment returns, it is not exactly 50-50. I believe that that due to many reasons, mob psychology being one of them, there are instances of trending in asset prices. While I do not know any, amateur and professional currency traders use and benefit from trends in forex pairs.

Let me try to distill my doubts about  each method. FA in my opinion, is flawed because it does not take into account expectations of investors. Of course, if you are investing for the long run, expectations should peter out and the "intrinsic value" of the stock should unlock itself. Yet this evades the question as to why some stocks garner consistently high/low PE or why after a while. Even in the long run, expectations are dynamic.

Then there are the issues of external events that impact earnings. Natural disasters (a few this year) have a very dramatic impact on listed companies' profits and they by their very nature are unpredictable (as the weather). 

In the case of TA, I believe that if it really were so effective, it could work both long and short and in any type of markets. We have seen a tremendous rally since March 2009, that has slowed downed quite a bit in 2010. Almost everyone who went long, made money.

And I might be naive, but profitable trading systems/indicators that are replicable, tend to cancel itself.  If you tell the whole world that your method works, it will not work once everybody uses it. And the more documented flaws of this method is that it racks up huge costs and forces the investor to leverage.

To illustrate in point, consider Etika International of OSIM International. TA practitioners are loathe to touch an illiquid stock like Etika, while FA people dislike the competitive environment OSIM is in. But as we all know (after the fact), they have provided those lucky enough to buy them, with tremendous returns.

Of course I am cherry picking. But the point of this examples is to illustrate that fortune favors the brave and the prepared, and the rewards are very disproportionate, c.f. from conventional theory.
The flaws, rather than the virtues of FA and TA, are compounded when you attempt to hybridize. FA causes you to believe that there is some form of "intrinsic value", when the only thing tangible provided by a listed company is its annual report and dividends. External events drive up/down prices have very real repercussions but are almost impossible to predict 1 year out. TA on the other hand, requires you to identify profitable indicators that may again be the result of luck. Just look at book sales, how many fund managers actually use TA? Maybe FA fund managers are very lucky?


  1. Hi!

    Thanks for your opinions and views. I will wait for your extended version!


  2. FA or TA is just part of stock analysis and successful stock investing starts from stock analysis and continue from it.