It’s always interesting listening to fundamental and technical analysts argue.
Just as fundamental investors like to laugh at technical analysis, technicians laugh at the absurdity of investing just on fundamentals. It’s a never-ending, laughable fight.
Fundamental analysis shows us what’s under the hood, and whether or not an asset is over- or underpriced, as compared to the competition. In fact, Warren Buffett, Baron Rothschild and Sir John Templeton subscribed to this school of thought and made a fortune. They seeks to uncover the intrinsic or true value of an asset, and is dependent on future sales, earnings, and estimates. It’s pain-staking research at times.
Technical analysis on the other hand – which was panned by the likes of Buffett – offers us a glimpse of investor psyche, allowing us to view the very fear and greed generated in the crowd.
But if you’re like me, you don’t choose a side. You combine both schools of thought. That’s because both have their strengths. And what one may miss, the other may spot. Still, if I really had to choose, technical analysis is a personal favorite because of how rapidly it can spot fear and greed, offering an opportunity to strike while the fear/greed is hot.
While we can always spot max pessimism with fundamental analysis, we can also spot it by watching for excessively oversold – and overbought – momentum. To do so, we can look at Williams’ %R (W%R), relative strength (RSI) and money flow (MFI) for example.
Williams % Range (W%R)
When Williams moves to or above its 80-line, it’s an indication the asset is oversold. When it moves to or above the 20-line, it’s overbought. However, we never want to rely on a single indicator as a pivot signal, so we begin to confirm with RSI and Money Flow.
Relative Strength (RSI)
We can use RSI to confirm other indicators above. When RSI moves to or above the 70-line, we have an overbought condition. When RSI moves to or below the 30-line, we have an oversold condition. It confirmed what Williams was telling us.
Money Flow (MFI)
Money flow is another oscillator that uses price and volume to measure the strength of buying and selling pressure. We can also use MFI to confirm the other four momentum indicators above. When MFI moves to or above its 80-line, we have an overbought condition. When MFI moves to or below its 20-line, we have an oversold situation.
Each confirms the others perfectly and highlights how overbought or oversold a trade is becoming. When it comes to traders, too many of them trade on fear, which causes them to be irrational. When irrational fears (or greed) get out of hand, these three indicators above have a great track record of telling us.
Let’s examine AT&T (T) between October and December 2017.
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First, understand that fundamental analysis may not have caught the swings, as fast as technical analysis did. Between October and December 2017, you’ll notice a triple top around $39 a share. Notice where RSI, MFI and Williams’ %R stood.
All three confirmed an overbought situation. Eventually, it marked the top and failure.
Now look at what happened at the start of November 2017. Again, notice what RSI, MFI and Williams’ %R were telling us.
Here, all three confirmed an extremely oversold situation. The crowd overreacted.
If we now look at a two-year chart of AT&T, you can see the same patterns show up, highlighting exact spots where fear and greed are a bit of hand.
In short, ignoring technical analysis isn’t the safest bet. Try it, if you’re not already.
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