A common dilemma facing anyone who invests in the stock market is whether one should buy shares based on the fundamentals of the company, or one should follow the momentum of stocks as indicated by technical analysis.
A -fundamental- investor studies companies in detail.
He looks at the standing and expertise of the promoters, the quality of management, the fortunes of the sector in which the company operates, the comparative position of the company with regard to other companies in that sector, existing and anticipated -external environment-, mainly government policies with regard to taxation, licensing, pollution control, intervention impacting raw material supplies, etc.
He also studies the performance of the company for at least the past three years and the acceptable projections for the next couple of years.
If he is happy with what he sees, he puts his money into shares of that company.
The "fundamental" investor is by nature a long-term investor, because he does not look at what happens to the share price in the next few months.
He believes that the share prices will go up as the company does well over the next few years.
A "technical" investor is one who follows the movement of the price of a company's shares, and makes his decisions based on his reading of what direction the share prices will take in the near term.
He studies the historical data regarding movement of the share prices, extrapolates this information into the future, and makes his own forecast about share movements.
He decides on the price levels that will trigger an upward or a downward movement of the price of that particular stock.
If he thinks the price will go up, he goes long on that stock, if he predicts a fall, he goes short.
The -technical- investor is not as concerned about the fundamentals of the company as the -fundamentalist-.
He is impatient, and is unwilling to wait for two or three years to see a reasonable return on his investment.
Now comes the question - should one invest based on fundamentals or should one go by technicals? If your intention is to make as much profit as possible from your investments, but without taking unacceptable risks, then you need an investment strategy that takes into account both the fundamental soundness of a business as well as the expected movement of the shares of the company over the near term.
First, you will use fundamental analysis to create a list of companies that are doing well and are also likely to do well in future.
This list is your "investment universe", you will consider investing only in these shares.
Next, you will study the movement of the shares of these companies.
Technical analysts use different methods to predict the movement of shares over the near future.
All of them are based on the past behavior of the shares over a long period, and this information is used to forecast how the share will behave in the coming months.
From this study you will make a list of the companies whose shares you expect to go up soon, and another list of companies whose shares you expect to go down.
Now, you make your investment decision.
Naturally, you will be buying shares of solid companies whose shares you expect to move up in the near term, and out of (or go short on) companies whose shares you expect to move down.
You have managed to make profits sooner, and at the same time you have avoided junk stocks.
Why should we follow this fundamentals-plus-technicals strategy? If your investment is based only on fundamental analysis, you will no doubt be holding shares of valuable companies.
These are blue chips that you can hold, and bequeath to your heirs.
But there is no certainty that these shares will go up in value any time soon.
In fact, there are so many blue chip stocks that just seem to stay put price-wise for months together.
When you restrict your investment to these companies you are likely to hold a portfolio of valuable companies.
But when you also use technical analysis and invest in momentum stocks, you will make money sooner.
You can also move in and out of stocks several times over the year, depending on what your technical analysis tells you about stock behavior.
Once a stock has lost momentum in its upward movement you exit that stock, and invest in another one in your "fundamental" list that is ready and rearing to go up.
That, dear investor, is the way to stock market riches.