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.