Written in early June 2002, this is a revision of the article in Indonesian, of September 22, 2000

Fundamental and technical analysis are both needed, the first mentioned for price evaluation and the last for the anticipation of succeeding price moves. A basic difference between the two approaches is the dominant presence of exact science in fundamental analysis, while intuition plays an important role in technical analysis.

When evaluating price moves in the stock market two approaches are possible, analysis of the fundamental or technical type. Each approach has its rather fanatical followers causing antagonism as if one is superior over the other.

Fundamentalists maintain the opinion that prices move at random and their direction cannot be predicted in advance. Attempts in this direction are merely speculative, which opinion naturally is unacceptable to market technicians who like to joke with an accelerated pronounciation referring to them as funnymentalists.

Such antagonism is not necessary if we take the following aspects into consideration.

The basic price estimation is the stock’s intrinsic value influenced by fundamental factors like financial reports and other material information which may change from time to time as announced by a public company, macro economics, news in other areas like politics, social developments, the weather, and other items considered relevant. All such factors are followed for at least the last two years. Naturally this involves work of colossal proportions, if the reviewing job would be done in depth and devoted to total commitment.

It would be impossible for anyone to absorb all the information totally presented. A certain limit should be decided based on priority considerations and the time as well as resources available. Such limitation as determined by analysts are decided according to their differing needs.

In addition thereto, access to the information being made available would not be at the same level for all parties involved, from a time frame as well as quantity point of view. Such limitations in the analyst’s room for action will have an influence on the price estimation process leading to different perceptions on the intrinsic value considered proper.

If the differing motivations nurtured by he variety of participants in the stock market is included in the picture, the resulting price moves will also be influenced by non-fundamental or irrational considerations as well. Those considered maintaining a consistently pure fundamental approach are long term investors who from time to time need to adjust their portfolios, but always try to select stocks with the best performance.

A group of participants not always doing so, but still following a rational course, are the market makers, because their job is to create a demand for certain stocks. Among the market makers we can find the group of specialists which by law are forbidden to create unjustified demand, because the stocks they represent actually dont meet the fundamental prerequisites.

The specialists are required to maintain a liquid and lively trade for certain stocks they are entrusted in turn for some privileges from stock exchanges in the United States. The difference in such motivation by investors from market makers already account for the observation that the best stocks do not always result in the highest prices. It may happen that some fundamentally inferior stocks create more demand than the better ones.

Stock market participants with a lower percentage rate in the more advanced exchanges, but higher in the less developed markets, are the irrational speculators. Such participants consist of two categories, both entertaining the notion that it is easier and faster to make money trading an exchange than doing business the conventional way. One group indeed is in possession of excess funds they have obtained in some way and put their entire capital in the market to have it wiped away totally. This dreadful experience would hurt them, but a lesson has been learned that trading requires preparation by doing time consuming and tiring analyses instead of relying on rumors or pure instinct.

The other category of the same type of irrational speculators are those not in possession of excess funds, but have some money they dont need immediately like savings for medication, education or housing for instance. Because just like the other category of irrational peers they have no notion about money management, they even dont have any spare money left to absorb the loss which may have arrived before or just when they were in need to pay for the intended savings purposes. Such a horribly painful experience would bar them forever from trading an exchange again, simply because they may even had to borrow to meet te expenses they had been saving for.

Concluding from the manner fundamental factors are gathered and processed as well as the variety of participants affecting the stock market, the attempt to lock a price to a stock in advance, cannot be done successfully as experience prove that the expected figure does not always appear in the exchange.

What can be done with the fundamental approach is to base their buy or sell decisions on the comparison between the result of their analysis to the reality they are dealing with. Sell when the stock is considered overvalued or buy if the opposite is happening, so when the stock is undervalued. Such a rational course of action will produce profits indeed when the time frame taken into account has been set on a sufficiently long extended span. Yet is a buy-and–hold strategy for undervalued stocks going to yield maximum profts or gain?

Basics of Technical Analysis and its Synergy with the Fundamental Approach

A group of participants in the stock market not yet dealt with are those applying technical analysis. A unique aspect of this approach is that they start working to do their job only after the price has been established in the market. We should remember that the fundamental approach is the opposite because the work is done before the price appears in the market. The buy and sell decisions are based on the observation if stocks have become under or either overvalued. It is therefore clear from the course of events that fundamental analysis should be done before the technical approach is being attempted. But continuous price formation is based on the collective forces exercising their influence in the market, from the fundamental, technical as well as speculative sides. Perhaps this is what George Soros meant with his theory of reflexivity in his book The Alchemy of Finance, because underlying values and stock prices have a reciprocal influence on each other.

The result of such forces which can be reduced to merely two involved in the battle between supply and demand through bid versus asked prices, is studied in technical analysis. Supply and demand collectively and cumulatively produce the chart of price movements, which if well understood can serve as a guide for buy or sell decisions leading to eventual and total profit taking.

In the eyes of a chartist or market technician all fundamental factors are already discounted in and reflected by the resulting prices, hence the underlying considerations have become obsolete. After the price has been established the ability to read and understand the direction it is going go move will become the decisive factor.

Referring to the above question with regard to the buy-and hold strategy, if some stock has become overvalued, is it necessary to sell it promptly or is it better to postpone such action to increase the gain? When is it expected that a reversal of the price movement will take place? This is the moment to consult technical analysis.

The conclusion can therefore be drawn that fundamental and technical analyses complement each other, the first to support price formation and the last to anticipate succeeding price movements. A basic difference between them is the presence of exact science in the first, tending its followers to feel superior in theory, while the last includes intuition to some extent based on past experience taken into consideration, making its followers’ attitude tend to be more realistic and practical.

In the local stock market some people contend that demand is created artifically by a limited number of players, perhaps to be considered as marketmakers, producing abnormal prices. Technically such behavior can be accomodated because the tools employed deal with mass psychology rather than calculations on paper, hence fundamentally people may become confused indeed.

Jack D. Schwager as the author of the books The Market Wizards (1989, New York Institute of Finance/Simon & Schuster) and The New Market Wizards: Conversations with America’s Top Ten Traders (1992, Harper Business), after having interviewed dozens of traders in the stock and commodity markets, wrote that fundamental and technical analysis can be used separately or in combination successfully.

In a later book Schwager on Futures (1996, John Wiley & Sons) he admitted in the introduction that formerly had been a pure fundamentalist and severely denounced technical analysis. But after having tried to apply chart analysis, he changed 180 degrees from his earlier skepticism.Such changes have occurred to a good number of fundamentalists through their open mindedness enabling them to perform experiments. Therefore fundamental and technical analysis need not be pitted one againtst the other, as both are required to obtain maximal results.

Speculation is not a technical factor

The scope of technical analysis, merely paying attention to the nature and pattern of price movements, is indeed not as extensive as that of fundamental analysis taking into consideration various disciplines like accounting, micro and macro economics, socio-political matters, the weather, etc. Nevetheless this type of analysis cannot be regarded as simple either, even more so because the latest computer software deploys over 150 indicators or analysis tools to perform a selection of the best from thousands of stocks in a few minutes.

Those utilizing technical analysis correctly are certainly no speculators acting on some hunch without understanding the considerations of what they are doing. As a matter of fact the terminology of the stock as well as commodity exchange industry describes participants not concerned with investing or trading, as being involved in speculating. Because speculators usually apply the technical approach, they tend to be considered as associated to such type of analysis. Beginners in the exchange community most probably use it and perform quite bad, but technical analysis is not speculating perse unable to produce good results consistently.