IMPLEMENTACIÓN DEL BALANCE DE POTENCIAS

Learning Objective

5.3.1 Know the difference between fundamental and technical analysis: primary objectives;

quantitative techniques; charts; primary movements; secondary movements; tertiary movements

The methods used to analyse securities in order to make investment decisions can be broadly categorised into fundamental analysis; or technical analysis.

We will consider the key features and the main differences below.

3.1 Fundamental Analysis

Fundamental analysis involves the financial analysis of a company’s published accounts, along with a study of its management, markets and competitive position. It is a technique that is used to determine the value of a security by focusing on the underlying factors that affect a company’s business.

Fundamental analysis looks at both quantitative factors, such as the numerical results of the analysis of a company and the market it operates in, and qualitative factors, such as the quality of the company’s management, the value of its brand and areas such as patents and proprietary technology.

The assumption behind fundamental analysis is that the market does not always value securities correctly in the short term but that by identifying the intrinsic value of a company, securities can be bought at a discount and the investment will pay off over time once the market realises the fundamental value of a company.

Companies generate a significant amount of financial data and so fundamental analysis will seek to extract meaningful data about a company. Many of the key ratios that can be derived from this are considered later in this chapter.

In addition to this quantitative data, fundamental analysis also assesses a wide range of other qualitative factors such as:

• a company’s business model;

• its competitive position;

• the quality and experience of its management team;

• how the company is managed, the transparency of available financial data and its approach to corporate governance;

• the industry in which it operates, its market share and its competitive position relative to its peers.

3.2 Technical Analysis

Technical analysis also seeks to evaluate a company but, instead of analysing a company’s intrinsic value and prospects, it uses historical price and volume data to assess where the price of a security or market will move in the future.

The assumptions underlying technical analysis are:

• The market discounts everything.

• Prices move in trends.

• History tends to repeat itself.

Technical analysis uses charts of price movements along with technical indicators and oscillators to identify patterns that can suggest future price movements. (Indicators are calculations that are used to confirm a price movement and to form buy and sell signals. Oscillators are another type of calculation that indicates whether a security is over-bought or over-sold.) It is, therefore, unconcerned whether a security is undervalued and simply concerns itself with future price movements.

One of the most important concepts in technical analysis is, therefore, trend. Trends can, however, be difficult to identify, as prices do not move in a straight line, and so technical analysis identifies series of highs or lows that take place to identify the direction of movements. These are classified as uptrend, downtrend and sideways movements. The following diagram seeks to explain this by describing a simple uptrend.

1

2

3 4

5

Figure 1: A Simple Upward Trend

Investment Analysis

159

5

Point 1 on the chart reflects the first high and point 2 the subsequent low and so on. For it to be an uptrend, each successive low must be higher than the previous low point, otherwise it is referred to as a reversal. The same principle applies for downtrends.

Along with direction, technical analysis will also classify trends based on time.

Primary movements are long-term price trends, which can last a number of years. Primary movements in the broader market are known as bull and bear markets: a bull market being a rising market and a bear market a falling market. Primary movements consist of a number of secondary movements, each of which can last for up to a couple of months, which in turn comprise a number of tertiary or day-to-day movements.

The results of technical analysis are displayed on charts that graphically represent price movements.

After plotting historical price movements, a trendline is added to clearly show the direction of the trend and to show reversals.

The trendline can then be analysed to provide further indicators of potential price movement. The diagram below shows an upward trendline which is drawn at the lows of the upward trend and which represents the support line for a stock as it moves from progressive highs to lows.

Price

Trendline

Time Figure 2: Upward Trendline

This type of trendline helps traders to anticipate the point at which a stock’s price will begin moving upwards again. Similarly, a downward trendline is drawn at the highs of the downward trend. This line represents the resistance level that a stock faces every time the price moves from a low to a high.

There are a variety of different charts that can be used to depict price movements and some of the main types of chart are:

• Line Charts – where the price of an asset, or security, over time, is simply plotted using a single line. Each point on the line represents the security’s closing price. However, in order to establish an underlying trend, chartists often employ what are known as moving averages so as to smooth out extreme price movements. Rather than plot each closing price on the chart, each point on the chart instead represents the arithmetic mean of the security’s price over a specific number of days. Ten, 50, 100 and 200 moving-day averages are commonly used.

• Point and figure charts – these record significant price movements in vertical columns by using a series of Xs to denote significant up moves and Os to represent significant down moves, without employing a uniform timescale. Whenever there is a change in the direction of the security’s price, a new column is started.

• Bar charts – these join the highest and lowest price levels attained by a security over a specified time period by a vertical line. This timescale can range from a single day to a few months. When the chosen time period is one trading day, a horizontal line representing the closing price on the day intersects this vertical line.

• Candlestick charts – these are closely linked to bar charts. Again they link the security’s highest and lowest prices by a vertical line, but they employ horizontal lines to mark both the opening and closing prices for each trading day. If the closing price exceeds the opening price on the day, then the body of the candle is left clear, while if the opposite is true it is shaded.

Technical analysis charts also contain channel lines which is where two parallel lines are added to indicate the areas of support and resistance which respectively connect the series of lows and highs.

Users of technical analysis will expect a security to trade between these two levels until it breaks out, when it can be expected to make a sharp move in the direction of the break. If a support level is subsequently broken, this provides a sell signal, while the breaking of a resistance level, as the price of the asset gathers momentum, indicates a buying opportunity.

These are known as breakouts.

An example of such a breakout pattern is the triangle which is shown below. Here price movements become progressively less volatile but often break out in either direction in quite a spectacular fashion.

Price

Time Figure 3: Breakout Pattern

Other continuation patterns include the rectangle and the flag.

Chartists typically use what are known as relative strength charts to confirm breakouts from continuation patterns. Relative strength charts simply depict the price performance of a security relative to the broader market. If the relative performance of the security improves against the broader market, then this may confirm that a suspected breakout on the upside has occurred or is about to occur.

Investment Analysis

161

5

However, acknowledging that prices do not always move in the same direction and trends eventually cease, technical analysts also look to identify what are known as reversal patterns, or sell signals.

Probably the most famous of these is the head and shoulders reversal pattern, as the following example shows.

Left Shoulder

Head Price

Time Neckline Right Shoulder

Figure 4: Head and Shoulders Reversal Pattern

A head and shoulders reversal pattern arises when a price movement causes the right shoulder to breach the neckline, the support level, indicating the prospect of a sustained fall in the price of the security.

3.3 The Difference between Fundamental and Technical Analysis

Fundamental and technical analysis are the two main methodologies used for investment analysis and, as you can see from comparing their key characteristics, they differ widely in their approaches. The principal differences between them can be summarised as follows:

• Analysing financial statements versus charts

At a basic level, fundamental analysis involves the analysis of the company’s balance sheet, cash flow statement and income statement.

Technical analysis considers that there is no need to do this as a company’s fundamentals are all accounted for in the price, and the information needed can be found in the company’s charts.

• Time horizon

Fundamental analysis takes a relatively long-term approach to investment.

Technical analysis uses chart data over a much shorter timeframe of weeks, days and even minutes.

• Investing versus trading

Fundamental analysis is often used to make long-term investment decisions.

Technical analysis is often used to determine short-term trading decisions.

Although the approaches adopted by technical and fundamental analysis differ markedly, they should not be seen as being mutually exclusive techniques. Indeed, their differences make them complementary.

Used collectively, they can enhance the portfolio management decision-making process.