Technical analysis vs. fundamental analysis: Which is more important for investing in growth stocks?
New investors are likely to notice that a number of different CAN SLIM-style stock analyses mention both elements. Both terms can mean any number of things when used in different settings.
In the realm of stock charts and analysis, they are very specific. Technicals refers to factors related to a stock’s price and volume action. What you see on stock charts are generally technical elements, a stock’s price and volume of shares traded on any given day. Fundamentals are measures that describe a company and its performance, not its stock.
Technical Analysis Basics
Bases seen on charts, breakouts, correct buy points, proper buy zones and rebounds from support at the 10-week moving average all fall into the technical category. So do sell signals, and discussions of whether a stock base is early or late stage.
Fundamentals include a company’s quarterly and annual results, products and the markets it serves. Level of debt, employee costs, capital spending, and research and development costs are all fundamental. Inside IBD Stock Checkup an investor can quickly get a sense of the strength of a company’s most important fundamentals: earnings increases, revenue gains, profit margins, and return on equity.
It’s obvious that the terms describe two very necessary sides of a coin in researching, understanding and investing in a particular stock. The CAN SLIM acronym sets out a basic list of what to look for as new investors begin learning how to conduct their research. Investor’s Corner offers key references, as well as “How To Make Money In Stocks” by Investor’s Business Daily founder William O’Neil.
Technical Analysis: How Stock Charts Send Signals
The fundamental and technical attributes are often jumbled together in discussions of a stock. There is no hard and fast reason to keep them separate, or to know which is which. For instance, is a stock’s float, the number of shares available for trade on the market, technical or fundamental?
There are a few places where technical and fundamental factors cross paths. Consider a stock buyback program. This involves capital spending in order to reduce the number of a company’s shares outstanding (technical) which, in turn, increases its earnings per share (fundamental).
But there are clearly cases when it’s vital to understand which is which. Consider a leading stock as it goes into a major topping process after a long, successful run. The adage, “Technicals break down well before fundamentals do,” is practical wisdom when you want to keep your hard-earned gains.
The adage means that a stock’s chart will throw up warning signs as it nears the end of the winning run, even as fundamentals such as earnings and revenue growth show no negative effect.
Technical Analysis: The Right Time To Take Profits In This Stock
Let’s look at United Rentals (URI) in late 2014. The stock turned in a run of more than 750% after clearing an initial base in October 2010, through an early September 2014 peak. Earnings per share rose 41% in 2014, accelerating to a 49% gain in Q1 of 2015. Sales growth in that first quarter slowed from high teens to 12%.
United Rentals punched below its 10-week moving average several times during 2014, in February, April and July. But each of those moves reversed back above support within two sessions. After United slipped below the line during two weeks in late September to early October (1), it not only failed to retake support, it drove much lower in heavy volume during the week ended Oct. 10 (2).
Technical Analysis And Why It Helps You Lock In Gains Correctly
Investors sitting on a big profit cushion and looking at the stock’s strong fundamentals may have hoped for another base and another breakout. But the chart was sending a serious technical signal that the stock was in trouble.
The following week, United dove to test its 40-week moving average for the first time in 16 months (please see a MarketSmith chart for the 40-week line). It then broke below that line in heavy trade.
Shareholders who held on may have felt validated as the stock rallied from that low over the next five weeks. But the advance did not come close to a breakout from a new base. United staged its final breakdown during the week ended Dec. 12 (3). That put the stock once again below both its 10- and 40-week moving averages.
Despite United’s continued strong fundamentals, the stock’s technical attributes were waving red flags. The stock plunged 65% from its September 2014 peak of 119.83 over the next 14 months. United needed nearly a year to recover and hit new highs.
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