Combining Fundamental and Technical Analysis
When it comes to choosing between fundamental and technical analysis, many traders tend to go with the style that plays to their strengths. While fundamentals-focused traders relish poring over balance sheets and income statements, technical analysts may be particularly attuned to the buy/sell signals they spot on stock charts.
Of course, sticking to one style can involve trade-offs. Traders who look only at fundamentals could miss out on metrics that could help time their trades, while technical traders could be overlooking warning signals about a company’s financial health.
But why not combine them? The key is learning when to deploy a particular method to make the most of its strengths: fundamentals for deciding what to trade and technicals for deciding when to trade it.
What to trade
Determining which stocks are worth trading can be challenging. A trader looking for appealing opportunities on, say, the tech-focused Nasdaq Composite Index would need to sort through some 2,500 stocks. Even narrowing the list to health care stocks would leave hundreds of candidates to consider.
Confronted with so many choices, it can be tempting to zero in on the hottest performer, perhaps one that beat its expectations or is riding a crest of positive news. The problem, of course, is that whatever factor has driven the stock’s outperformance has probably already been priced in.
A more cool-headed approach would be to identify companies that stand out because of their underlying financial health using fundamental indicators. Many trading platforms offer fundamental screening tools you can use to isolate the top performers in a certain sector based on earnings per share (EPS) and revenue growth.
For example, Schwab clients could use the stock screener tool to apply the following criteria to health care stocks:
- 3-year EPS growth: 25% or higher
- 3-year revenue growth: 25% or higher
If that doesn’t sufficiently narrow the list, you can always apply additional filters. For example, you could search for stocks with a Schwab Equity Rating of “A”—meaning those Schwab’s analysts think have a good chance of outperforming the market—and a share price of $20 or higher to filter out less-established or less-stable companies.
Following those steps should help narrow your search to just a handful of stocks to consider.
When to trade it
Once you’ve assembled a manageable list of potential trading opportunities, it’s time to ask whether now is the best time to execute a trade.
There are many different technical indicators, but one of the most straightforward is a stock’s moving average, or its average price over a set number of days. When a stock breaks above its moving average, it may signal the start of an uptrend, whereas when a stock breaks below its moving average, it could indicate the start of a downtrend (see “A tale of two averages,” below). Whether you use a five-day moving average, a 200-day moving average, or somewhere in between depends on whether you’re looking to capitalize on short- or long-term trends.
You could also look to trading volume as another indicator of support or resistance. When a stock price breaks above its moving average and its trading volume is increasing, that’s a further signal of traders’ commitment to the current direction. Conversely, moves higher without a corresponding increase in volume may peter out more quickly for lack of investor enthusiasm.
The power of two
Fundamental analysis is a great way to narrow down the universe of stocks to those with strong financials—but only technical analysis can tell you whether they’re in a solid uptrend.
Certainly, combining fundamental and technical research won’t take all the risk out of investing—no approach can guarantee that—but it can help you steer clear of relatively weak candidates or avoid entering positions at an inopportune time.
What You Can Do Next
Follow along as Kevin and other Schwab trading experts break down a variety of popular trading strategies in Trading Up-Close.