Thursday, August 05, 2010

Combining FA and TA

This post was conceived and written due to the prevalence of many practitioners of methods of stock investing which purport to combine the “best of both worlds”. To recap, the world of equity investing is usually recognized to be split rather cleanly between two camps – those who practice fundamental analysis (FA), and those who practice technical analysis (TA). There are, however, a whole range of people who fall somewhere in between the two extremes; and more recently a new breed of people has emerged on forums (and some even have their own blogs) who are championing the successful merging of both disciplines. In simple layman’s parlance, FA and TA are considered to be like night and day as they employ very different philosophies, methodologies and ideologies. Let me explore a little on this (rather) contentious issue. Incidentally, value investing falls more towards the FA camp, arguably it involves more than just FA as it attempts to derive an approximate intrinsic value for a company.

First of all, in order for someone to claim that a certain method is workable, he needs to demonstrate, through meticulous and objective record-keeping, that the method works over the long-term. Long-term in this case would imply at least an investment horizon of three to five years, or one full cycle of bull to bear market, whichever is longer. Records need to be kept in detail which specify the quantity of shares bought/sold, commission paid, profits made, dividends received and dates of investment and divestment. If possible, the investor should also include details of the rationale behind the decisions made to buy or sell; including all fundamental and technical reasons which led to the decision. Most websites which combine FA and TA do not have a sufficiently long track record to be able to make a claim that the method works better than say, a passive ETF investment strategy. Since a combination of TA and FA would render an approach which is necessarily more active as compared to index investing, one should therefore demand a higher rate of return for one’s efforts. It is up to the investor to demonstrate that he is able to achieve such a return, otherwise he will be no better off investing in an index fund.

The second point which I have to make is that a practitioner of FA/TA should make his investment philosophy very clear right from the start, in order to avoid the cardinal sin of not being able to decide if a buy/sell decision stems from an FA or TA perspective. This results in “losers” ending up as “investments”, and winners being sold off too soon as they fall into the “trading” bin. If we factor in the erosion of profits from frequent transaction costs, then it would appear quite daunting for the average practitioner of an FA/TA combined philosophy to make money over the long-term.

Another point is whether one can manage to successfully “marry” both FA and TA styles to create a unique (and successful) hybrid. I would argue that it may be better to concentrate on being good at either FA or TA, rather than being a “Jack of all trades, Master of None”. Readers may feel free to dispute this (and I know my views are contentious to those who practice this), but combining FA and TA may simply dilute any advantages which each style purports to convey on the practitioner, resulting in sub-par performance over the long-term as opposed to a more “purist” approach. To give an analogy, a company which has many disparate business divisions doing unrelated work may actually increase costs and decrease profitability as there are dis-economies of scale, and may result in a case of “diworsification” as espoused by Peter Lynch.

Interestingly, and for reference, a book written by Burton Malkiel titled “A Random Walk Down Wall Street” (2006) makes direct comparisons between FA and TA, and also serves up reasons for FA and TA to work and/or fail. He presents pretty objective, persuasive arguments which are backed by facts, research and data. In short, he does not believe TA can work well consistently, and that any style which works well in the short term will soon lose its efficacy over time. On the flip side, he acknowledges the flaws in FA as well and how it could end up losing money for the investor. Basically a practitioner who is weak in FA would suffer a similar fate to one who is weak in TA; hence it seems to be more of an astute application of methodology rather than concluding if any one particular method is more superior or inherently flawed.

So, to conclude a post which might have dragged on to become unnecessarily long-winded, I am an advocate on concentrating on either FA or TA in order to excel in either; rather than try to “marry” the two methods together to produce a hybrid. Perhaps one can really come up with such a successful union, but even then it has to be rigorous, consistently applied as well as time-tested. These conditions may sound harsh, but are necessary to prove that a type of method is due to skill and not just luck.

25 comments:

Createwealth8888 said...

I post every stock transactions online providing buy and sell price, no of holding days, and net ROC (after 2-way brokerages)

e.g.

newer stock: Noble
http://createwealth8888.blogspot.com/search/label/Noble

older stock: Kep Corp since 2001

I am still holding some XX lots bought during 2001 and at the same time I have traded 93 rounds since 2001

http://createwealth8888.blogspot.com/search/label/Kep%20Corp

It is possible to hold and trade at the same time.

Royston said...

Nice comparison and analysis...there were times when i felt slightly tempted to pick up TA. But after some deliberation, i usually end up just borrowing one more book on FA to deepen my understanding of FA than to embark on TA.

Though i'm not implying that TA doesn't work...but i feel it can be confusing at times if one were to try to employ both methods concurrently. As FA tends to focus more on long term, while TA tends to focus more on short term results.

Ultimately, its up to the individual to see what he's more comfortable with and what works for him.

Createwealth8888 said...

Use FA to shortlist stocks into your watchlist and trade stocks in your watchlist using TA.

Musicwhiz said...

Hi Createwealth8888,

Do whatever works well for you! :)

I am sure you have much more experience than me when it comes to the stock market and investing in companies.

Good luck!

Cheers,
Musicwhiz

Musicwhiz said...

Hi Royston,

Thanks for relating your experience. That's how I feel too - that one should concentrate on just one discipline instead of trying to mesh them together. Oh well, but as you said, whatever works for you!

Regards,
Musicwhiz

Createwealth8888 said...

Do you still strongly agree that combining FA and TA is not possible and "resulting in sub-par performance over the long-term as opposed to a more “purist” approach" as you have mentioned it?

May be it is impossible for you due to your mindet as you see investing world either as black or white while many others see it as many degrees of grey.

JW said...

Hi MW,

allow me to share what I have written with you:

http://wealthbuch.blogspot.com/2010/02/technical-analysis-and-fundamental.html

Thanks :)

Musicwhiz said...

Hi Createwealth8888,

Without being rude, I'd say you should temper your tone somewhat. My views still stand, and I think I am entitled to them. As mentioned, as long as a person can prove the effectiveness of his method over an extended period of time, and have detailed records to back it up; then I am willing to believe it can work.

Of course, coming from a value investing angle, I must seem very "purist". But then again, this is what I do best and how I operate; and I am happy doing what I do and it gives me a decent return.

So like I said, do what works best for you; but remember that it has to be consistently applied and that it has to generate steady returns over time.

Regards,
Musicwhiz

Musicwhiz said...

Hi JW,

Thanks, it's a well-written piece! It's good if you are able to combine both TA and FA; but personally I feel a method has to be tested at least for 8-10 years before it can be proven to be "sound". Let time be the deciding factor. Even for myself, I've only been value investing for 2.5 years, so I cannot say my methods are consistently effective either.

Cheers,
Musicwhiz

Royston said...

Actually i liken FA vs TA to something like chinese vs western cuisine. Some like chinese, some western, while some just prefer fusion.

As for which one commands a higher price...really depends on your culinary skills. :)

There's no right or wrong, just a matter of personal preference. Do what works for you.

Createwealth8888 said...

You mentioned "combining FA and TA may simply dilute any advantages which each style purports to convey on the practitioner, resulting in sub-par performance over the long-term as opposed to a more “purist” approach"

Why sub-par performance?

I believe it is a fair question to ask you, right?

Of course, you deserve the right not to answer.

Musicwhiz said...

Hi Royston,

It's indeed interesting to see you use the analogy of culinary skills and cuisine! Thanks for that...haha.

Regards,
Musicwhiz

Musicwhiz said...

Hi Createwealth8888,

Notice the structure of my sentence. I said that using both methods MAY dilute the benefits which each method has to offer, as you simply do not concentrate and delve into one particular method as you would if you just practised TA or FA. The result is that performance may not be as good as practising just 1 method as you are using the superficial skills from both disciplines.

I think that was the point I was trying to make. Note that I said performance MAY be sub-par, I did not say it WILL be.

Thanks,
Musicwhiz

Ricky said...

Hi MW,

i use TA for my trades, however i also look at the bigger economic situation to assess the major trend. Is it considered FA?

I'd prefer to view the viability of any method through at least 1 bull and bear market cycle, rather than number of years.

CW8888, are you a remisier?

Musicwhiz said...

Hi Ricky,

Hmm, from what I know looking at the economy is not considered FA, it's more like macro-analysis. FA stands for fundamental analysis, which delves deep into the financials and prospects of a single company.

As for the bull/bear cycle, yes I would agree that it is a good "test" to see if your system or principles can hold up. But if one were to go through several cycles of bull/bear, it would make one's approach more robust as you refine it and improve on it along the way. That's what I intend to do anyway, for my value investing approach. :)

Thanks!

Musicwhiz

Createwealth8888 said...

Hi Ricky,

Not a remisier.

Createwealth8888 said...

To be objective, by combining the skills of FA and TA, investors MAY produce superior performance and MAY NOT be sub-par.

Musicwhiz said...

Hi Createwealth8888,

Yes, of course. It works both ways. It may or may not produce a superior performance. This is, after all, purely an academic discussion. :)

Regards,
Musicwhiz

AK71 said...

Hi MW,

I cannot resist it. I would like to share with you something I wrote:

http://singaporeanstocksinvestor.blogspot.com/2010/01/risk-and-rewards-ta-and-fa.html

Whatever works. I agree. :)

Musicwhiz said...

Hello AK71,

Thank you for your thoughts and comments, they are indeed very useful!

I would definitely agree with you that we should practise whatever works best for ourselves.

Regards,
Musicwhiz

Ricky said...

Keke, what i meant in Singaporean terms was "I've been through 1 bull, 1 bear, then still unscathed. So i qualify to come and hao lian around :)"

And i agree with you that being through more bulls and bears cycles, the system will be more robust.

Anyway, i think i'm more inclined towards TA as it can be applied to other markets easily.

Good luck on your investing!

Ricky said...

Disclaimer: I wasn't referring to myself...only started learning to invest in 07.

10 yrs later maybe...but don't want to hao lian hor, later buffett ask me to donate half my money to charity :(

Sorry, feeling lame today haha

Musicwhiz said...

Hi Ricky,

Haha it's ok I enjoy some laughs too, now and then. It's not good to be too serious!

Actually, I've found out that FA and knowledge of accounting can also be applied to other companies around the world, as accounting rules are essentially the same. It's TAX laws which are quite different though! So in a sense, FA can work outside of Singapore-listed stocks too and that will be my future direction.

Regards,
Musicwhiz

financiallyfreenow said...

Hi MW, will u be going for Kingsmen's talk during Invest Fair?

Musicwhiz said...

Hi Financiallyfreenow,

Nice blog you have! Currently, no plans to go just for that half an hour talk; will you be going yourself?

Musicwhiz