Rondeau’s Roundup: Technicals Or Fundamentals? Why Not Both!

June 15, 2010

Which is better: technicals or fundamentals? Well, both. But Ray Rondeau, IndexUniverse.com’s technicals columnist, makes it clear that the devil is always in the details.

One of the great debates among investors is technical analysis versus a focus on market fundamentals. So, which is better for deciding which securities and markets are worth pursuing as an investor? It’s fair to say a majority of market participants these days consider the answer to be a bit of both. That’s because people now have enough tools and knowledge to see how the two clearly complement one another.

Ray RondeauStarting with that core principle, let’s turn our attention to analyzing this week’s subject: State Street Global Advisors’ Financial Select SPDR Fund (NYSEArca: XLF).

Below is a daily chart that shows approximately one year of XLF’s price action. What’s apparent at first glance—the green horizontal line in the middle of the chart—is that there’s been intermediate-term support around the $13.73 price level. It’s here that buyers have stepped in on five separate occasions to propel prices back upward.

So, returning to the idea that technicals are for more than technicians, how can the information about key technical support on this chart assist the fundamentally oriented investor?

 

Technicals or Fundamentals?

 

Let’s say that someone formed a bullish opinion on financials in early May when the price of XLF was about $15.25 On the chart, that’s the “*$*”written in yellow. The exact reasons behind the investor’s opinion about XLF are irrelevant. What’s important is to recognize that a close reading of the chart could help the investor make a more profitable decision.

The technicals here indicate that it might be more prudent to wait to buy some XLF shares after they’ve dropped lower than the $15.25 level where the investor started getting keen on financials. That’s because of that obvious $13.73 support level in the chart above, which the majority of bullish technicians would likely be waiting for XLF to approach or touch before beginning their purchases.

If the purchase is executed at that key support area, the investor would be spending $1.52 a share, or $152 per 100-share lot, less. If indeed the fundamentals do support rallying prices over the longer term, the technical analysis has just added another 10 percent of return to that “bullish opinion.”

I can hear the doubting Thomsases already and, truth be told, technicals don’t provide a guarantee that price action will unfold exactly as the charts suggest they might.

 

Probabilities, Not Certainties

First off, it’s entirely possible that the $13.73 support level doesn’t end up holding, and near-term price movement takes XLF to an even lower price. If this scenario does come to pass, then the reading of the chart that suggested holding off buying until that support level is reached would still save the investor $1.52/share.

The other important caveat is that XLF may not revisit that support at around $13.73, and will instead take off much like the investor thinks it and other financial stocks will. Although this is a very real possibility, most professionals’ first focus is on risk and not returns, and they understand that there will always be another opportunity and they’re usually willing to wait for it.

In the end, it’s important to remember that technical analysis is based on probabilities, while fundamentals are predicated on hopefully well-reasoned insights into what’s going on in the broader economy or in a particular industry. But in the end, there are no guarantees. The interpretation of XLF’s chart above simply implies that more likely than not, the ETF’s price will probably fall back to that $13.73 area, helping the investor obtain the security at a more favorable price.

As a predominantly technically oriented trader, even I acknowledge that fundamentals will always drive long-term prices of particular securities and markets in general. This seems undisputable. I recognize, however, that whatever fundamental opinions I have, they’re very general and give me little indication as to where and when I should actually transact.

So I rely on technicals to guide the timing of my purchases and the timing of when I should sell a security to take profits. Charts can assist us in clarifying and displaying these higher-probability, lower-risk/higher-reward areas to transact, improving returns on investment ideas that may have originated with a focus on fundamentals. Try it, you’ll like it.

Have a profitable week and remember always, “Keep it in Perspective.”

 

Disclaimer: All data and information provided in this column are for informational purposes only, and should not be regarded as recommendations to buy or sell securities.

All charts created with TradeStation. ©TradeStation Technologies, Inc. All rights reserved.


Ray Rondeau is president of the Boston Chapter of The American Association of Individual Investors. When he’s not trading using technicals, he presents to various groups on technicals and trading in
New England and beyond. He can be contacted for presentation information at http://www.investorstein.com.

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