Stock Chart Analysis or Fundamental Analysis?

By Dr. Winton Felt

Sometimes fundamentalists make the argument that technicians think their charts predict future stock prices.  Of course, that is nonsense.  Charts are simply records of the effects of past transactions on the price and trading volume of stocks.  It is people who make inferences about what the past activity of traders says about the probable future activity of traders.  A fundamental analyst's report reflects the opinion of that particular analyst at that particular time.  A chart reflects the cumulative opinions of the entire marketplace over a period of months or years regarding the desirability of holding shares in a company.. 

The fundamental analyst may say that the company is likely to earn $1.54 a share in the coming quarter and that figure may be 25% above the figure for the same quarter a year earlier.  The fact that earnings are up 25% over a year ago does not mean the stock will rise 25%.  The way that the figure is likely to translate into market behavior is that people might be more favorably inclined toward the stock.  The actual change in price might be loosely related or even unrelated to the increase in earnings.  In fact, the stock could decline on the analyst's earnings announcement. 

If a technician sees that the stock rose to $50 four times in the last eighteen months and each time there was selling with heavy volume, he is likely to conclude that there is massive supply at $50 (overhead resistance).  He can be reasonably sure that when the stock approaches $50 again, there will be some resistance to a further rise in price due to selling pressure.  In fact, by looking at the chart, he can tell where the forces of supply and demand have drawn their "lines in the sand."  That is, they can make reasonably accurate estimates about where the buyers and sellers will line up to face each other.  There is no stock behavior that a fundamental analyst can associate with his metrics with anywhere near that level of correlation or accuracy.

However, the fundamental analyst can determine that a stock is undervalued and by approximately how much.  He can say that given a company's growth in sales and its reduction in production costs its stock is selling at about half what it is worth.  Therefore, though he will not attempt to predict a stock's price behavior during the next few weeks, he can say that some time during the next 12 to 18 months the stock should reach his price target at about twice its current price.

Our stockdisciplines.com traders often use both technical and fundamental analysis when trading, depending on their projected holding period and approximate price objective.  So, what is the difference?  The technical analyst's estimate of price behavior is more precise but much more immediate.  That is, his accuracy is limited to stock price behavior over a few weeks.  He can say that because a stock has just had a period of low volatility as evidenced by the standard deviation of it price excursions over the last six weeks, and because it has just had a price spike that has taken the stock's price to a close more than two standard deviations above its average price during this period of low volatility, it is likely that the stock will continue to rise for at least a short time.  Also, if there is a considerable amount of supply (shares in the queue waiting to be sold) at a price $5 above its current price, the stock is not likely to rise more than $5 in the coming move.  He cannot always draw conclusions like this from a chart because charts often have ambiguity that can be interpreted in more than one way.  However, charts often do provide enough clarity for the technician to draw very useful conclusions.

The technical analyst has little rationale for drawing the kind of conclusions possible for the fundamental analyst.  The technician's area of expertise is focused on relatively short-term stock behavior, not on a company's financial performance (the kind of data that translates into long-term stock behavior).  The fundamental analyst has little rationale for estimating short-term stock behavior. His data and analysis are nearly useless for that purpose.  His expertise has to do with the financial data and progress of the company.