As we noted in the September 3rd article on fundamental investment tools: “When you buy a stock, it’s a good idea to understand exactly what you’re paying for.”
We can do that by paying attention to the fundamental tools we’ve already brought to your attention, including price-to-earnings (P/E) ratio, the price-to-earnings growth (PEG) ratio, and the price-to-sales (P/S) ratio. You also want to pay attention to historical earnings growth.
All of these tools help us determine the intrinsic value of a stock, or “the combined value of all its expected future cash flows—with the discount rate applied,” as noted by Forex.
Fundamental analysis can also give us a better handle on current and future earnings growth, sales growth, market share, product pipeline, and even the quality of management.
In short, fundamental analysis gives us a look under the hood.
Technical Analysis Gives You a Glimpse at Trader Psychology
If you want a deeper understanding of a stock, pay attention to the psychology of herd mentality with technical analysis, as well.
Granted, some traders will tell you technical analysis is nonsense.
- Warren Buffett once said: “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”
- Peter Lynch quipped: “Charts are great for predicting the past.”
- And as Benjamin Graham explained: “In the short term the market is a voting machine, but in the long run it is a weighing machine.”
However, according to investor Jesse Livermore, “The price pattern reminds you that every movement of importance is but a repetition of similar price movements, that just as soon as you can familiarize yourself with the actions of the past, you will be able to anticipate and act correctly and profitably upon forthcoming movements.”
In addition, technicians know that stocks tend to move in trends.
Once a trend has been established, analysts believe future price movements are likely to continue in the same direction. For example, if I find a stock that caught support at the exact same spot 10 times prior, there’s a good chance it’ll happen again. Or, if a stock continues to bounce along its 200-day moving average without fail, technicians can use the trend as a buy indicator. Consistency can create reliability with technical analysis.
In short, while fundamental analysis can give you a good idea of what’s under the hood, technical analysis can give you an idea of the psychology of a trade. Over time, both schools of thought can make you an even better trader and investor.
