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Sunday, June 5, 2011

Why technical and fundamental analysis are the two feet of a stock portfolio

Have you tried to stand on one foot for any length of time? Unless you are an expert in hathayoga, you won’t be able to do it for more than a few minutes. Even if you are able to balance yourself for 10 minutes on one foot, what purpose will be served? You won’t get anywhere! Like you, your stock portfolio needs to use two feet – technical analysis and fundamental analysis – to achieve success.

Being an engineer by training, technical analysis always appealed to me more when I started investing in the stock market. Semi-logarithmic charts, trend lines, symmetrical and right-angled triangles, rectangles, parallelograms, Fibonacci retracement levels were familiar terminology. I took to them like a duck to water.

Well, not quite. After losing a ton of money, I came to the fairly simple conclusion that familiarity with the terminology was not the same as knowledge of the subject matter. Understanding different chart patterns is not of any use unless you know which stock charts to study. But the alternative wasn’t intellectually stimulating enough.

Fundamental analysis meant dissecting the contents of Annual Reports. No exponentials or double integrals to apply one’s math skills. Just a bunch of numbers that needed to be added and subtracted and divided to unravel the secrets of well-disguised financial performances. Low-level clerical stuff – or so I thought.

Finally, a broker friend opened my eyes. He only had a B. Com degree but was rolling in cash and driving around in new cars. So I asked him what the secret was. His answer shook me up. Just plain grunt work, he said. Wading through annual reports to find financially strong companies that generate cash and don’t require too much capital to function.

How do you decide when to buy or sell?, was my next question. This is where a bit of knowledge of technical analysis can help, he responded. You have to first determine the trend – whether up, down or sideways. Moving average crossovers and support-resistance levels can then be used to determine entry and exit points.

That is all there is to it. No rocket science. Just school-level arithmetic, including familiarity with graphs and the discipline to go through annual reports in detail. Don’t have time and energy for all this hard work? Avoid individual stocks; buy mutual funds.

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