What We’re Up Against

There are two conflicting schools of thought behind stock investing: Fundamental Analysis and Technical Analysis.

Fundamental Analysis is the study of the company itself – in essence, the investor uses a combination of news, published financial reporting, and an independent model to discern the value of a company, and in turn, its stock. A fundamental analyst is always looking to figure out the long term implications of every action a company makes. New management, new products, changes in expenditures and changes in consumer behavior are all inputs into the ultimate valuation of a company. If the stock price is deviating dramatically from the analyst’s valuation, then there exists an opportunity to make money.

Technical Analysis is the study of stock movement. The tools here are stock charts – the combination of movement and volume, when studied over time, has revealed trends which reappear time and time again. Savvy technical investors can capitalize on these repeating trends by predicting major price movements and resistance points.

Most investors, when describing themselves, will elect to choose one of these two divergent schools of thought when it comes to their decision to buy and sell. While this is a very useful (and necessary) designation, it also results in a very incomplete understanding of the stock market on the whole.

Ultimately, while both of these philosophies are important when it comes time to make a decision regarding a position’s entry or exit point, the only phenomenon that moves a stock is Supply and Demand. Simply, a stock moves up because, at its current price, there is more demand for a stock than there is supply. A stock moves down because, at its current price, there is more supply for a stock than there is demand.

Most investors understand the effect of Supply and Demand on stocks – they will recognize that bids and asks are what cause a stock or an index to follow the random walks associated with the market. However, they will not make the most critical jump in reasoning: fundamental analysis and technical analysis do not drive stock movement. Instead, fundamental analysis and technical analysis are merely two inputs into the Supply and Demand curve that a stock’s price represents.

Armed with this knowledge, the final question on stock valuation ceases to be, “Does GOOG’s chart feature a head and shoulders pattern?” or, “Is MSFT’s projection for Microsoft Office 2010 sales accurate?” – instead, the question becomes, “What will make people want to own this stock more/less than they do today?”

If I have led you to think that I am not a believer in Fundamental or Technical Analysis, that is not the case. These are two of the best ways to gauge whether a shift in demand for a stock is taking place. However, just because you recognize that a stock is not priced properly does not mean that the stock is going to move how you predict. A stock will only move the way you predict if the market recognizes the same pricing failure that you do.

How do we use this to our advantage as investors? We continue to study charts and financial statements. We continue to look at how products are performing in different markets. We have to stop focusing entirely on the insights this research leads us to and instead focus on what event is going to make the market come to the same realization that we have come to.

This is what makes us more successful investors. This is what drives the type of excellent performance that we all want to achieve. This is what we are going to focus on at Invest Smarter.

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