I hear it all the time. I see the goofy looks. I feel the awkward stares. Being a technical analysis guy at Zacks is like wearing a Cardinals hat to the Cubs Convention. “There’s that lines on a chart dude again.” Well I’m here to put to bed a host of popular misconceptions regarding technical analysis, fundamental analysis, and all things in between.
First of all, it is not a binary outcome. It’s not good versus evil or East versus West or Bulls versus Heat. It’s great taste and less filling. You can have both and apply both at the same time. I like extending the automobile metaphor to explain it. Fundamental analysis is defining the specs of the car. It’s got a 400hp V8 (positive agreement), 5 speed manual transmission (large magnitude), a top speed of 165mph (big upside), with a 0-60 of 4.2 seconds (huge recent earnings surprise). Asking if a stock is going to go up is like asking if this car is going to drive from Chicago to Milwaukee. It certainly has the ability to do so but there are other unknowns we haven’t yet answered. Is the car heading in the right direction? How fast is it going? If it’s going 60mph on I-94 West, then eventually it will find the Brew City. If it’s going zero, then it’s not going anywhere. A stock could have zero debt, great cash flow, beat earnings every quarter and have analysts continually revising estimates upwards and go nowhere in the short run. The car is all gassed up and ready to go, but the driver (the market) is out to lunch.
Technical analysis is measuring the speed and direction of the car. TA can tell you how fast it’s going and which way it’s going, right now. It’s not predictive. It’s telling the story of exactly what is happening right now. Right now the car (stock) with impressive specs (Zacks Rank #1 Strong Buy) is doing 60mph heading towards Milwaukee on I-94 West (trading above the bullish trend line) about 50 miles away (approaching resistance).
Not to pick on Potlatch Corp (PCH - Snapshot Report) but here’s a perfect example of a Zacks Rank #1 (Strong Buy) that has all the fundamentals. It’s a Ferrari. And yet, the stock has gone nowhere. The market has ignored the fundamental story and as a result, the stock is at a 52 week low while the market is near all-time highs.
Second, a stock cannot reach new highs with bad technicals. This is an absolute law of technical analysis. How could this be? A stock reaching new highs would have good technicals because of how the indicators are calculated. Dig in the math a little with me for a second. Say you are calculating the 20 day moving average. Take the prices for the last 20 days and get the average. Well if today the stock is reaching new highs, then the prices for the previous 19 days must be lower than today’s price, otherwise it wouldn’t be a new high. If the previous 19 days are below today’s price, then the average of these would be below the price today. So the stock would be trading above the 20 day moving average and therefore have at least one major bullish technical element.
Look at the chart for Helmerich & Payne (HP - Analyst Report). Over the course of the last year this Zacks Rank #1 (Strong Buy) stock has hit new highs multiple times. Each time it does, it is trading above whichever moving average you calculate. It’s mathematically impossible for it not to.
Third, technical analysis is not predictive. Forecasting is fun, I get it. If I could somehow read the tea leaves to find the secret to the market I could be a billionaire. Guess what? There is no Holy Grail of trading. Although there is a trading system known as the “Holy Grail” system, I can assure you it’s just a marketing gimmick. This is why I often use words like “possibly”, “potential”, and “likely.” But don’t despair, just because we aren’t 100% positive about something, doesn’t mean we can’t make money off of it. If applying the Zacks Rank and technical analysis was good enough to raise your odds of winning from 50/50 to 51/49 then you just got yourself an edge. It’s exactly what keeps casinos open. Play enough hands with an edge and you will win in the long run. We don’t need something 100% right, or 99% right or even 60% right I would argue. If we put it all together and are a fraction better than random, then we will make money over the long run.
Tesla (TSLA - Analyst Report) has the fundamental story we are looking for with a Zacks Rank #2 (Buy). But how fast is the car moving right now? The recent weakness has deteriorated the technical picture. TSLA has broken below its 25 day moving average shifted to the right by 5 days and the stochastics are extremely oversold. This could be the start of a longer term downtrend right here. Or, conversely, it could be a day or two before a buy signal. Brining our metaphor back, there’s traffic and the car has come to a dead stop. Either it’s going to speed back up and re-establish the uptrend, or it’s going to continue lower. The technical picture today does not tell us in black and white where it’s going to be next week. But we do know what we need to see to feel more confident about the stock. Right now we would need to see a rally above the 25x5 at $229.50.
The moral of the story is that technical analysis and fundamental analysis are not warring factions nor are they contradictory philosophies. The two can be used in unison to find winning stock ideas. Combine the two with a sound risk management strategy and you are well on your way to many profitable days in the market.