By: Chris Rowe — December 11, 2018
Many people believe they are good at picking stocks based on fundamentals.
In reality, they only reason they even know about those stocks is because the fundamental play has already been made (thus affecting the stock price to the point that people started buzzing about it).
If you aren’t a CFA who employs a team of assistant fundamental analysts, then it’s best to trade using technical analysis. That way, you let the "fundamentalists" do all the research for you, AND provide the buying pressure that will make your stocks move!
We can break the market down into three groups of participants -- Fundamental Investors... Technical Players... and The General Public.
Unless these players are trading billions of dollars, they have no influence on the market. They are merely asserting that a company is worth more than everyone else thinks it is. And they’re betting small money that eventually the rest of the world will see things their way.
They are basically saying that they’re right and that everyone else is wrong.It must be frustrating to feel as though you are right about every stock you own, and that nobody else gets it. It must be even more frustrating when those stocks never actually move to the valuation the fundamental player believes to be right.
To believe they’ll get in before other fundamental players realize the stock is undervalued is to say they have the research or info that major market players will eventually have.
Is this a strategy that you think you should employ?What if the big market players who can actually move these stocks higher never ever “get it at the highest level” like the fundamentalist does (sarcasm)?
What are the odds that you (or any other fundamental trader) figured something out before guys who have millions of dollars to spend on research figured it out? What are the odds that others eventually figure it out even if you’re right?
The point of investing is to bet on high probability outcomes. The fundamental scenario doesn’t sound like something that will work more times than not.
Technical Investors And Traders
This group can quickly identify when serious buying and selling is already taking place, and can participate in the upside after most of the risk has been taken by the fundamental player. And when I say “serious buying and selling”, I mean enough research has been done on a stock or sector that it’s causing billions, tens of billions, or hundreds of billions of dollars to be invested.
That doesn’t happen unless someone is sure about his or her notions.The technical trader knows that it takes the fundamental players time to enter their positions, and that stocks can double, triple, or more before the fundamental player is done buying the stock (or stocks). So the technical player starts by buying (or selling) alongside of the fundamental players, but eventually the fundamental player is finished entering the position.
This makes life easy for the technical trader. But he or she should also have a skill that I've taught to my investors, which is to realize who they are trading alongside of at each stage of the game.Early technical traders trade alongside the fundamental players. Later technical traders trade alongside some fundamental players, but mostly other technical traders.
And eventually they trade alongside the general public (who is "always the last to know").Some believe they are a hybrid of fundamental and technical traders, but typically they are just technical traders who try to confirm with fundamentals that they are indeed buying a sound company. Before I enter a bullish position, I like to let the world’s biggest players confirm that they have buying interest, and that they are willing to push prices much higher.
If I’m sailing in waters that can either be dangerous or delightful, I want to have the wind at my sails. I don’t want to try to figure out in what direction the wind should start moving at some point and then set my sails in the hope that moment finally comes. I leave that to the fundamental player, and if his convictions are strong enough, I’ll pick up on it and profit from it.
The General Public
I lump three sub-groups into this one.Of course we have the people who know nearly nothing about the market. But we also have the unsophisticated technical player and unsophisticated fundamental player. They are traders who sort of understand some technical principles... or are learning the wrong thing about the market... or people who see a stock like Apple Inc. and believe the company will continue to be successful... and so they buy it.
Meanwhile, they don’t know what the company's market cap is. Or its future earnings power, changes in profit margins, or new technology. They're not up to speed about competitors, or whether quarter over quarter earnings are accelerating or softening.
They don't know what the cash flow, PE ratio, debt or anything else is. They are just as valuable to us (the technical trader) as the general public, and they are plentiful.
Fundamental players buy, and smart technicians soon buy alongside them. Later in the cycle, technical traders trade with each other.
When the stock, ETF, or index is starting to feel selling pressure, it’s typically because the original fundamental players are distributing their positions alongside savvy technicians as the general public is buying their stock.
As an educator, I've always felt that my #1 job was to train folks on how to be group #2 -- the technical player.
If you can easily and quickly identify which sectors are showing the most strength (or weakness) as a result of the fundamental players taking action (or, more importantly, reversing their positions)...
... then you will be ahead of 90% of the players in the game.
Some of this may seem rudimentary, but if there is one place on earth where the basic principles are well known, yet overlooked and under-appreciated, it’s the stock market.
And that’s why those who are humble enough to focus hard on these simple principles will always profit at the expense of those that don’t.
See you soon!