Technical Versus Fundamental Analysis

Technical Versus Fundamental Analysis

A picture is worth ten thousand words (Old Chinese proverb)

Twice in October 1987, over 600 million shares with a total market value of about $25 billion were traded on the New York Stock Exchange. Exchanges of shares valued at $10 billion are now considered almost routine for a day’s trading on the big board. And this is only part of the story. A large volume of trading is also carried out on the American Stock Exchange, on the over-the-counter markets, and on a variety or regional exchanges across the country. Professional investment analysts and counselors are involved in what has been called the biggest game in town.

If the stakes are high, so are the rewards. New trainees from the Harvard Business School routinely draw salaries of well $100,000 per year. Experienced security analysts and successful salesmen, euphemistically called “account executives,” make considerably more. At the top of the salary scale are the money managers themselves – the men and women who run the large mutual, pension, and trust funds. “Adam Smith,” after writing the Money Game, the number-one bestseller of 1968, boasted that he would make a quarter of a million dollars from his book. His Wall Street friends retorted, “You’re only going to make as much as a second-rate institutional salesman.” Admittedly, the depression that hit Wall Street after the crash of 1987 has made such talk appear somewhat overstated. Still, it is fair to conclude that while not the oldest, the profession of high finance in certainly one of the most generously compensated.

Academicians are a notoriously picayune lot. With their ringing motto, “Publish or perish,” they keep themselves busy by preparing papers demolishing other people’s theories, defending their own work, or constructing elaborate embellishments to generally accepted ideas.

The human mind will not be confined to any limits (Johann Wolfgang von Goethe)

The attempt to predict accurately the future course of stock prices and thus the appropriate time to buy or sell a stock must rank as one of man’s most persistent endeavors. This search for the golden egg has spawned a variety of methods ranging from the scientific to the occult. There are people today who forecast future stock prices by measuring sunspots, looking at the phases of the moon, or measures the vibrations along the San Andreas fault. Most, however, opt for one of two methods: technical or fundamental analysis.

The alternative techniques used by the investment pros are related to the two theories of the stock market. Technical analysis is the method of predicting the appropriate time to buy or sell a tock used by those believing in the castle-in-the-air view of stock pricing. Fundamental analysis is the technique of applying the tenets of the firm-foundation theory to the selection of individual stocks.

Technical analysis is essentially the making and interpreting of stock charts. Thus its practitioners, a small but abnormally dedicated cult, are called chartists. They study the past – both the movements of common stock prices and the volume of trading – for a clue to the direction of future change. Most chartists believe that the market is only 10 percent logical and 90 percent psychological. They generally subscribe to the castle-in-the-air school and view the investment game as one of anticipating how the other players will behave. Charts, of course, tell only what the other players have been doing in the past. The chartist’s hope, however, is that a careful study of what the other players are doing will shed light on what the crowd is likely to do in the future.

Fundamental analysts take the opposite tack, believing the market to be 90 percent logical and only 10 percent psychological. Caring little about the particular pattern of pas price movement, fundamentalists seek to determine an issue’s proper value.

Value in this case is related to growth, dividend payout, interest rates, and risk, according to the rules of the firm-foundation theory. By estimating such factors as growth for each company, the fundamentalist arrives at an estimate of a security’s intrinsic value. If this is above the market price, then then the investor is advised to buy. Fundamentalists believe that eventually the market will reflect accurately the security’s real worth. Perhaps 90 percent of the Wall Street security analysts consider themselves fundamentalists. Many would argue that chartists are lacking in dignity and professionalism.

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.