Just as fundamental investors like to laugh at technical analysis, technicians laugh at the absurdity of investing just on fundamentals.
Fundamental analysis shows us what’s under the hood, and whether or not an asset is over- or underpriced, as compared to the competition. In fact, Warren Buffett, Baron Rothschild and Sir John Templeton subscribed to this school of thought and made a fortune.
They seek to uncover the intrinsic or true value of an asset, and is dependent on future sales, earnings, and estimates. It’s pain-staking research at times.
Technical analysis on the other hand offers us a glimpse of investor psyche, allowing us to view the very fear and greed generated in the crowd.
But if you’re like me, you don’t choose a side.
You combine both schools of thought.
That’s because both have their strengths. And what one may miss, the other may spot.
While we can always spot max pessimism with fundamental analysis, we can also spot it by watching for excessively oversold – and overbought – momentum. To do so, we can look at Williams’ %R (W%R), Relative Strength (RSI) and Money Flow (MFI) for example.
Williams % Range (W%R)
When Williams moves to or above its 80-line, it’s an indication the asset is oversold. When it moves to or above the 20-line, it’s overbought. However, we never want to rely on a single indicator as a pivot signal, so we begin to confirm with RSI and Money Flow.
Relative Strength (RSI)
We can use RSI to confirm other indicators above. When RSI moves to or above the 70-line, we have an overbought condition. When RSI moves to or below the 30-line, we have an oversold condition. It confirmed what Williams was telling us.
Money Flow (MFI)
Money flow is another oscillator that uses price and volume to measure the strength of buying and selling pressure. We can also use MFI to confirm the other four momentum indicators above. When MFI moves to or above its 80-line, we have an overbought condition. When MFI moves to or below its 20-line, we have an oversold situation.
Each confirms the others perfectly and highlights how overbought or oversold a trade is becoming. When it comes to traders, too many of them trade on fear, which causes them to be irrational. When irrational fears (or greed) get out of hand, these three indicators above have a great track record of telling us.
Let’s examine Canopy Growth (CGC) between February and August 2018.
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First, understand that fundamental analysis may not have caught the swings, as fast as technical analysis did. But notice where how RSI, MFI and Williams’ %R did.
- RSI was at its 30-line
- MFI was at its 20-line
- Williams’ %R was below its 80-line.
All three confirmed an oversold situation. Eventually, it marked the top and failure. Each time, it marked a bottom for the stock, which ran not long after.
We can use the same indicators to pinpoint tops, too.
Using the same time frame, when:
- RSI was at its 70-line
- MFI was above its 80-line
- Williams’ %R was above its 20-line
Here, all three confirmed an extremely overbought situation. Not long after, shares of CGC would pivot and move in the opposing direction.
In short, ignoring technical analysis isn’t the safest bet. Try it, if you’re not already.
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