Fundamental Analysis Verses Technical Trading: Do Fundamentals Predict Stock Prices?

Most traders and investors use fundamental analysis to discover stocks and make choices on how to invest. Fundamental analysis is termed as the study of external factors related to individual companies or industries. These factors can provide clues as to the supply and demand for a specific security. Technical trading is often seen as price action that considers all known facts and it is price that represents everything known about a particular market.

Can either exist on its own? Many traders say yes. They trade price in the current environment as they compare it to prices in a previous environment. All technical trading is done based on previous price action. Highs, lows, moving averages, trend lines and price patterns make up the technical trader's arsenal for decision making. A host of hundreds of indicators and oscillators is also available to the technician. None of those changes in price could occur without investors using fundamentals to make decisions in the first place. Imagine everyone making a trading decision to buy or sell without the availability of consulting fundamentals. That would be like investing without the use of an annual report, company news, the weather or government statistics. There would be little basis to make a reasonable decision.

The battle rages on as to which type of trading is more feasible, concrete and profitable. I say that you have to have the majority of traders and investors making decisions based on fundamentals alone. That takes into account all the numbers and comparisons to previous statistics and expectations. This would support the argument that fundamental based investing provides the foundation for technical trading. I am a technical trader that uses charts to trade from. I often do not know what a company does, if it is profitable or what analyst's expectations are for the future. Although I can read an annual report fairly well, I hardly ever use that information to make a trading decision.

Answering the question asked earlier, it can be said that fundamental trading can exist on its own. And technical trading is an extension of fundamental trading without concern for the fundamentals. In other words, fundamentals came first and technical analysis has been derived from it.

Therefore, it comes as no surprise that many fundamentalists think that technical trading is voodoo in disguise. It is like trading in a vacuum, because price action is the only key component of technical trading. Fundamental based investors view charts, with all the lines and indicators, as nothing more than a ghost of true facts and numbers. Those established facts being actual company revenues, profits, cash flows, assets and liabilities. You can also include new products, brokerage reviews and government statistics as items of interest to the fundamental trader.

I would argue that trading and investing using fundamental analysis is no more predictable than throwing darts at the stock pages. Dart throwing has been shown in a number of studies to be as good or even better as a method for picking stocks. And, at least comparable to the advice given by your local investment adviser. Can you really trust all those numbers and statistics? How many times does a company come back after the fact and restate its financials? And have you ever noticed how every government release of economic numbers is always revised a month or two later? Take a look at an earnings statement. Can you really tell which set of earnings properly reflects the condition of the company? Many times, earnings are stated in two or three different ways. These include diluted, non-diluted, GAAP or pro-forma and often with special charges and non-reoccurring credits. Never mind that any questionable statistics are buried deeper within the report. You practically need a personal accountant to decipher the meaning of those not so forward statements.

Another key aspect of fundamental analysis concerns company or market news. Assuming that you get the news at the same times as everyone else, you then have to know what it means to the market. You have probably heard some of Wall Street's favorite axioms like, good news is bad and bad news is good. So, what you perceive to be great news, is really bad news because all of the good news has been factored in to stock prices. How about a company that reports earnings up 50% from a year earlier? Because they missed the "analysts" expectations by a few pennies, the stock drops 10%. In this regard, stocks are trading not on fundamentals, but on the company's ability to beat Wall Street's expectations. Many companies might appear to have good fundamentals, like rising sales and new products. However, if they fail to beat the analyst's predictions, o their stocks are often punished by the markets.

When it comes down to pricing stocks based on fundamentals, one of the most critical factors is earnings per share. The exact amount of earnings in total dollars means little. It is earnings per share that matters to the investment crowd. Consider that the number of shares, over time, can be manipulated to make earnings look better. Then, those earnings are assigned a PE value by the markets. The PE value being the price-to-earnings ratio. Depending on other factors, PE ratios can vary widely from company to company. Different industries command different PE's and even similar companies within the same industry group can exhibit a wide range of PE ratios. There is no real set explanation for the variety of PE's within the markets. You can make any case you want to in justifying high or low price-to-earnings multiples. Just about any reasonable or unreasonable rationalization will fit Wall Street standards. That is because those standards flip-flop according to the most recent conventional wisdom that is sloshing its way through Wall Street.

It appears that the fundamental view is anything but etched in stone. The so-called concrete numbers can be manipulated, adjusted and interpreted in any number of ways. Quite often, the majority rules in how those "facts" are played out in the pricing of stocks. You often hear on the news that stocks moved higher or lower based on some report or event. It is impossible to know the minds of millions of investors and traders at any given moment. One market vagary is that most traders play follow the leader and have little idea of how the fundamentals are affecting price movement. The perception is that most investors interpret the same fundamental data in the same ways. But, in fact, that statement is probably more accurate for technical traders.

Certain formations and price relationships happen regularly when viewed from a technical perspective. Such formations as head and shoulders tops and bottoms, double and triple tops and bottoms, price channels and triangles occur quite frequently. Along with price breakouts and failures, higher lows and lower highs, price is consistent in testing itself. Support and resistance price points act as magnets. Stock prices are always testing previous price action. The outcome determines further price action which develops over time into some kind of measurable trend. Watching the technicals may seem like a course in hocus-pocus. But, no more than watching the fundamentals. Neither can predict price direction with utmost certainty.

You can analyze the fundamentals until every fact and figure makes sense. Still, that will not tell you where prices may go in the future. As long as most investors continue to prefer fundamental analysis, the technical trader will have a firm basis to practice his or her witch doctor methods. And no matter what camp you are in, every investment and trade comes down to three questions. How much can be won, how much can be lost and what are the probabilities that either will happen.