Technical Analysis for Fundamental Investors
I haven’t written about technical analysis in a long time. Given my shift away from trading and technical analysis to a more long term value focus, it’s probably to be expected. But, I realize that a lot of investors out there have their interest piqued by technical analysis and hope to incorporate it in their investment analysis. I also realize that true value investing can be difficult. Many of us don’t have the time or the expertise to do extensive balance sheet analysis to determine liquidation value of our investment targets. How, then, can we invest with true margin of safety? Obviously, the main objective is to determine your fair valuation through fundamental means – multiples analysis, financial projections, DCF, etc – and invest in stocks trading at a discount. But, how do we enter without risking too much to the downside?
This is a situation where I may differ with Benjamin Graham and Warren Buffet. I don’t necessarily have the bankroll to continuously average down my positions. Further, I live by the tenet that paper losses can often turn into material losses with the passage of time and unexpected needs for liquidity. Thus, I realize that often times the trend really can be your friend. In the words of an investor I admire, it is often better to be in the wrong stock at the right time than in the right stock at the wrong time. So, how do we determine the “right time”?
The Rightside Chart
Here’s Google’s weekly chart from January 2005 to January 2008. This is a near perfect longterm up trend. This is what all investors wish their stocks’ charts looked like 50-week moving average (1 year) support as well as the longterm trend coincide nearly perfectly signaling a modest and sustainable trajectory. Using a weekly chart gives you the overarching trend or, as an investor I admire calls it, the stock’s continuum, and can provide context when you’re fretting over more volatile day-to-day price movements.
Trend Reversals
Here’s Apple’s chart between mid 2002 and early 2004. Apple was notoriously trading near cash on the books before investors realized that this was not the same Apple of the mid-1990s and the rest is history. Given Apple’s history of poor cash usage and inability to get traction in its computer business, even the most seasoned value investor might not necessarily have felt completely comfortable with the stock. But, a look at the chart provides technical confirmation that the market is beginning realize the intrinsic value at Apple.
First, we see the stock trade towards it’s 50-day moving average and weakly break towards the 200-day moving average. The stock subsequently spends 6-months testing prior resistance while the 50-day and 200-day moving average converge. Finally, as highlighted, we see a breakout on heavy volume simultaneously with inversion of the 50-day moving average as well as a moving average cross over. In subsequent months, we see the formation of a new rightside chart where the 50-day moving average acts as support for the initial acceleration phase and we’ll eventually see the 200-day moving average (roughly equivalent to the 50-week moving average) become the support for the long term continuum.
Apple’s chart shows reversal happening in a swift and nearly simultaneous fashion. The truth is, reversals can be longer and more painstaking. Generally, several steps will be accomplished:
- Breakout through the 50-day SMA
- Initial “weak” rise towards 200-day SMA
- Retracement and testing of the 50-day SMA (accumulation)
- Repeated testing of 200-day and 50-day resistance and support leading to convergence between the two moving averages
- Strong breakout above the 200-day and the formation of a new rightside chart
A Case Study for Today
The Buckle is a company I’ve been watching for a while. The stock has been punished by the current retail pull back despite being one of few retailers able sustain same store sales growth, no debt, and significant upside for square footage growth (in the event of an economic turn around). Retailers, particularly ones with true growth stories, are rarely true value plays. They typically rent locations and source their clothes from other manufacturers and thus have few hard assets and, if run properly, are inventory light. For example, the Buckle has just $6.87 in tangible book value per share, a significant amount of downside risk if the Company were to be forced into liquidation for one reason or another.
But, given how well the Company has managed to perform through the downturn and management’s shareholder friendly policies including a significant dividend (3.5+% at current prices) and a buy back plan, it would seem that the fair value for this stock is likely significantly better than $20-$22/share. Despite this, even if I believe that this stock has significant value above the current price, I’d be reticent to invest at these levels given the current risk/reward trade off. Looking at the current chart, though, it seems that the stock has found downside support and has begun base formation (accumulation). For me, I would be willing to trade a few basis points of return for a confirmation breakout which would provide a higher likelihood of immediate return and series of resistance levels to use as stop losses.
Full Disclosure: Long shares of Apple and Google at the time of writing.
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Comments
Volumes, moving averages and trend lines have been used in these examples. What are other technical indicators that can be used reliably to time entry and exits from stocks?
To be honest, I think this is all you need. Using other technical indicators is often redundant to good analysis of volume, trend, and moving average as they are the building blocks of other indicators. For example, the oft-used MACD is built off of SMAs or EMAs. OBV is built off of volume. And, Relative Strength Index are simply ratios built off of previous price closes which are ultimately conveying the same information as a moving average. If you’re really interested in learning about other technical indicators, I’d suggest my technical indicators tutorials which you can find here – http://thecuriousinvestor.com/category/tutorials/technical-indicators/
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