By Charles Tumlin
Have you ever done your homework on an investment, maybe read some good things in a periodical, or gotten your hands on a fascinating research report on an up and coming company? All the pieces seem to be in place. You make your investment with confidence, but the stock heads straight down. If you have been an investor for any amount of time it has happened to you!
The “homework” that you have done is referred to as fundamental analysis, and it is the stock research in which most of us are familiar. CNBC, Money Magazine and The Wall Street Journal are most often quoting analysts who confine themselves to fundamental analysis. However, in my 18 years in the investment business, I find that most investors are missing a very important piece of the puzzle – technical analysis. Both are important components to a successful portfolio. Utilizing only fundamental analysis is like playing a guitar with only one hand – you can make noise, but you have more rhythm playing with two. While the fundamental analysis can steer you toward the “what” to buy, technical analysis can tell you “when” to buy or more importantly “when” to sell.
Technical analysis can best be described through the basic law of supply and demand. We experience these forces in our grocery shopping every day. It does not take much to understand why fruits and vegetables are more expensive in the winter and less expensive in the summer. We know why jackets cost more in the winter and bathing suits cost more in the summer. The same forces that take the products that we buy every day in and out of favor will take stocks, sectors or asset classes in and out of favor as well.
“When we look at the cause of price movement in any individual stock, the market and the sector together on average cause 80% of the price movement in a stock.”1 So if 80% of a stock’s price is affected by these outside, technical attributes, then only 20% of that stock’s price movement is being driven by the fundamentals. This is why a company’s stock will often move opposite the direction of the company’s business fundamentals?
However, we already know that most people spend up to 80% of their time on the individual stock research and less than 20% of their time on the technical (market and sector) research.
An investor’s greatest risk in being wrong lies within the market and sector forces, this is where technical analysis can help. Our success ratio in investment selection is going to be limited until we can define where this investment lies in the technical picture. Because of these factors, we structure our portfolios from a top down approach.
1King, Benjamin F. “The latent Statistical Structure of Securities price Changes.”
This article was written by Charles Tumlin, V.P. – Investments, Wells Fargo Advisors, Beaufort, S.C.
The views expressed by Charles Tumlin are his own and do not necessarily reflect the opinion of Wells Fargo Advisors, LLC or its affiliates.
Investments in securities and insurance products are: NOT FDIC INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE
Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo Company.