For more than thirty years, I have had the pleasure of working with some of the best portfolio managers in the world. Many of them have been on the cover of Barron’s, The Wall Street Journal or have been interviewed on CNBC. My conclusion is that, with a few exceptions, the best money managers use both fundamentals and technicals together. An investor who has confidence in identifying which stocks to buy and the patience to wait for the technicals to agree with their fundamental conclusions has a distinct advantage over the competition.
I have had many investors, both individual and institutional, tell me that they do not believe in technical analysis. While I am not going to say that using technical analysis is for everyone, I do believe that it will help in most cases. I have watched long term professional investors follow their fundamental models and evaluations without the help of technical analysis and it has hurt their timing and their performance in most cases.
Understanding where a stock is positioned in relation to its long-term trend will help to identify whether a decline in the stock is a buying opportunity or not. The chart above shows the long-term trend (blue). The red bars are examples of a stock declining on this chart where the first would be considered good weakness – a buying chance – while the second is bad weakness – likely something that has more downside risk in the coming weeks or months. Keep in mind, for a shorter-term trader, the long term trend is derived from a daily chart or an hourly chart as opposed to a monthly or weekly. The process of analysis is the same but the time frames change.
After working with some of the best fundamental investors in existence over the past three decades, I have found that their fundamental models can often be early since the stock will pass the screen as price is moving down to their fundamental buy level. The problem is that this drop sometimes coincides with a break of key support and when that occurs the decline can continue to weaken over the next three to six months.
Warren Buffett, one of the great investors of our time, has been successful without the use of technical analysis. However, the average investor must keep in mind that he has deep pockets. He will add to his losers until they turn around. Kraft Heinz Company (KHC) is shown below. This is one of his investments which he has owned for a long time. I am not trying to find flaws in Buffett’s approach. In fact, his long-term performance speaks for itself. Nonetheless, it is important to realize that most investors cannot stomach a 50-75% drop in a stock and have the faith to see it through or keep buying. Most will give up at some point when the severity of the drop gets to be too much to stomach.
Incorporating technical analysis into your approach will help to eliminate this scenario. In fact, this method, when applied correctly should be reflected in small losses when compared to the size of your average gain. The most important factor is that it allows you to define the risk before you buy the stock. Being very diligent about the loss side of the equation and keeping them manageable is probably the most significant factor in your success over the long term.