Stock Value and Timing
Fundamentals, Value, Technical, Timing in Stock Trading
Some of the world’s most successful stock traders use fundamental considerations to determine the market direction in which to trade or to find their stock picks, and they use technical analysis to time the entry and exit of their trades..
For example, for fundamental information our own traders make extensive use of Value Line and The Valuator to find stocks that are bargains from a fundamental perspective. For this purpose, The Valuator is faster and it has already calculated the metrics we want. Value Line has more raw data and it covers more stocks, but we have to calculate the metrics ourselves. For this illustration we will use the PEG-ratio as our primary fundamental filter. The PEG-ratio is the ratio of the PE-ratio to the earnings growth rate. The Valuator has this ratio computed for about 500 stocks, ranks them, and lists the top 44 (the 44 stocks with the lowest PEG-ratio). We then scan the charts of each of those stocks to determine if any have a chart pattern that is giving a buy signal.
Suppose one of the stocks listed as having a low PEG-ratio has been in a long-term consolidation pattern. Suppose further that it has been trading between $7 and $11 for about two years. Lately, volume has been increasing as the stock moves from $7 to $11, and decreasing as it moves from $11 to $7. This is a change in the pattern, which has not shown much variation in volume one way or the other while the stock moved up and down between these extremes. This stock is a good candidate for inclusion on our “watch list.” Of course, we would not include it on our “watch list” before checking to see if there is any resistance between $12 and $15. If there is no resistance, we should have no problem getting a return of 15% on the stock. If there is resistance a short way above $11, we would not be interested in the stock. Assuming there is no resistance, we would put the stock on our “watch list.”
The stocks on that list are monitored for signals. Say the stock breaks out of the trading range, closing at $12 on a 50% surge in volume. For us, that would constitute a buy signal. First, we know that the stock is undervalued in terms of its PE-ratio relative to its earnings growth rate. Second, we have just had a technical buy signal. The fact that the stock is one of the most undervalued stocks will likely give added endurance to any trend that develops after the breakout.
We use other fundamental metrics to find more candidates for technical analysis. For example, The Valuator calculates each stock’s earnings-based fair value, PE-ratio, a fair value based on prevailing interest rates, overall value rank and others. One approach used by stockdisciplines.com traders is to scan all 44 stocks listed in the ranking tables for various fundamental metrics. That way, we know that all the stocks we scan are acceptable from a fundamental perspective. The next step is to use technical considerations to time our entry point for any of these stocks. In our scans, we look for technical “setups.” A “setup” is a configuration that strongly suggests the stock is about to surge. We do not want to take a position and watch our stock drift for months. The whole point of using technical analysis to time our entry is to buy a stock when it is ready to surge. Let’s say that a stock has just surged to a new high. Then it “consolidates” by drifting in a sideways pattern in which there are lower and lower highs while the lows are getting higher and higher. We call this pattern a symmetrical triangle. It is a “continuation pattern,” because that kind of configuration after a significant rise more often than not concludes with a breakout and a continuation of the rising trend that it had before the consolidation. The reverse occurs if the stock was declining before the consolidation. The apex of the triangle points to the right. As the stock nears the apex, there is less and less room to move. That tells us that a breakout will soon occur.
That is how we combine fundamental and technical considerations in order to find a stock that is about to surge and that is also undervalued. A tock that has a technical setup but that is overpriced may surge a short distance. A stock that that is in a setup and that is undervalued is far more likely to begin a sustained trend.