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Clinging on to Fundamental Analysis and stock picking software, only keeps you stuck in trading equities. Trading this way, compounds concentration risk in one quality class and fails to adequately diversify risks crossways Equities, Bonds, Currencies and Commodities.  There’s much more to stock option trading, than stock itself.

I cite Benjamin F. King’s study, quoted repeatedly since 1966, because it remains valid and has yet to be disproved to the point of dismissing its logic.

Market and Industry Factors, Journal of Business, Jan 1966:  “ Of a stock’s move …

31% can be attributed to the general stock market, 13% to industry influence, 36% to influence of other groupings, and the remaining 20% is peculiar to the one stock.”

There must be a more compelling reason for you to trade stock other than just for the movement, if only 20% is one-of-a-kind to the underlying equity in question.  Think about this, in context of the Fundamental Analysis or stock picking software that you purchased on a per $1 basis.  For apiece $1 dollar you spend, you “outsourced” the analysis at a cost of 80 cents, only to receive back 20 cents worth of work. Shouldn’t the 80:20 rule of “outsourcing” be the other way round? The problem is that you are still stuck with 80% of the work, to examine price movement!  Plus, the more you use FA techniques/stock picking software, the more trading capital is stuck in equities alone.

Now, you can state “special” research papers help you pick stocks.  Let’s have a look at some of the more common fundamental metrics in these research subscriptions:

1. Dividend Yield: the problem is in the variability of yields as firms are in different stages of their business development.  A Mature company that dominates in a well established sub-segment/sector is healthy to afford a different dividend yield; versus, a Young company in a growth-oriented field; versus, a Small firm in a growing area that might not be healthy to afford a dividend payout.  Bear in mind there is nothing special about firms that pay a dividend.

A company that gives away a portion of it’s retained earnings – which is what a dividend is – effectively gives away part of its valuation, which means it is not worth as much as a company that does need to give investors candy to commit capital to it.  So, a dividend paying stock has to be far better to a non-dividend paying stock for reasons other than the dividend.  If it is not, there’s no point looking for dividend paying products to trade, there are plenty of non-dividend paying Indexes to trade.

2. Price/Book Ratio: the problem is this metric varies crossways industries and from company to company, as the quality base and capital structures of companies change over time. It lacks cross sector applicability and bookkeeping complexity arises from a firm’s capital structure as it changes due to acquisitions/divestments/CAPEX for new product lines; or, product line cut-backs, as recently seen in the restructuring of major US automobile companies.

3.  Price/Cash Flow Ratio (the cousin of the P/E): bookkeeping laws on depreciation vary crossways Asia, Europe and US.  As bookkeeping rules are driven by tax codes, which change considerably crossways regions despite adoption of global bookkeeping standards, there is a demand of uniformity in homogenizing a fundamental ratio that will fit as a common benchmark crossways geographies.

These metrics change to help you compare state a Dell parented in the US to an Acer parented in Taiwan; but, is listed as an ADR in the US, even though both are competitors in the same sector as personal manufacturers.

Furthermore, the current dislocated cost of capital in credit markets, impairs the capability of corporations to optimize the operating cost of their equilibrise sheets.  In essence, corporations are left with the working capital cash flows remaining on their equilibrise sheets, as testament to their financial strength. Do not waste your money on Fundamental Analysis software or research paper subscriptions.

As there is a fundamental flaw in fundamental analysis and stock picking, how do you select trades? Trade the options of a broad-based Equity Index to replace single stock exposure.  To replace Fundamental Analysis, use the Relative Strength measure based on Point & Figure methods.

What is Relative Strength?  It is nothing more than taking one price as the Numerator, divided by another price as the Denominator, then multiplied by 100.  RS = (Price 1 / Price 2) x 100.  Typically, RS calculations use regular closing prices.  Though easy in its mathematical construction, RS is ingeniously powerful when it is applied not only within a sector; but, crossways sectors and between quality classes.

Let’s begin of within a sector.  For example, if you select 2 semiconductor stocks trading at different prices, how do you know if one stock is outperforming the other in the same sector, when the 2 stocks have price changes at different rates; plus, the sector’s price itself is also changing?

SOX = Semiconductor Sector Index, trades up from 452.24 to 467.81.

Numerator1:      Price1 = BRCM 33.15    RS1 = 7.33    Price2 = 33.80    RS2 = 7.23
Numerator2:      Price1  = TSM 9.91    RS1 = 2.19    Price2 = 13.43    RS2 = 2.87
Common Denominator:      SOX  Price 1 = 452.24           Price 2 = 467.81

BRCM’s RS1 = (33.15/452.24) x 100 = 7.33. BRCM’s RS2 = (33.80/467.81) x 100 = 7.23.  
TSM’s RS1 = (9.91/452.24) x 100 = 2.19.  TSM’s RS2 = (13.43/467.81) x 100 = 2.87.

BRCM’s price rises from 33.15 to 33.80 and TSM’s price also rises from 9.91 to 13.43.  Simply because BRCM is a larger stock, does that mean it benefits from the SOX trading up? No, the RS reading (RS1 compared to RS2) shows BRCM’s RS reading dropped (7.33 down to 7.23) against TSM’s RS reading, which increased (2.19 to 2.87).  RS confirms TSM as the outperformer rising in price strength versus BRCM’s weakened price.  RS is constructed on pure price rules.  Using an Index as the denominator, acts as a much more durable benchmark and is structurally more reliable, compared to any “magical” TA indicator; or, combination of income statements, equilibrise sheets and cash flow statements touted in stock picking programmes.

You can replace BRCM or TSM with Indexes or ETFs.  Using Indexes with Relative Strength enables a common denominator to compare Equities against Bonds, Commodities and Currencies, to crossover into quality classes other than stocks to trade.  It’s not that Relative Strength is infallible.  But compared to the fundamental metrics cited above, Relative Strength fails the least.  Break the mould on what you learnt about stock option trading.

Is there an example of an optionable and consistently profitable portfolio that trades using Relative Strength crossways multiple quality classes? Yes.  Follow the link below, entitled “Consistent Results” to see a retail online option trading portfolio that excludes the use of single stocks and Fundamental Analysis, using broad based equity Indices, Commodity ETFs and Currency ETFs.  There is no need to trade FX directly. Just trade the options of Currency ETFs.

In this article I compare these two methods of forecasting in the stock market. I give the reasoning that why technical analysis is better to fundamental analysis.

As you know, technical analysis concentrates on the study of market action, and fundamental analysis concentrates on the economic forces of supply and demand that cause price movements.

Fundamentalists try to determine the intrinsic value of the stocks. They analyze all factors that affect on price. If the intrinsic value is under the current price, fundamentalist sells the stock because stock is over priced. If price is below the intrinsic value then market is undervalued and should be bought.

Fundamentalists study the cause of market movements, but reasons of movements aren’t important for technicians. Technicians believe that the price reflects the effect of all events that make change in price. Therefore study of price action is all that they require.

Most people use both technical and fundamental analysis to trade. Many technicians have basic knowledge on fundamental approach and many fundamentalists have basic knowledge on technical analysis. But, most people have more interest on one method.

Why Technical Analysis

Fundamentalists must find the reasons of price movement. Sometimes this act is very complicated; there are so many factors that make change on price such as political, psychotically events and so on. To trade the fundamentalist must study and research tremendous amount of data that takes so much time and effort.

Technical analysis is Flexible and Adaptable

You can apply technical rules to apiece market either stocks or futures or any other market. The technician easily can follow many markets in the same time. This is a great strength because you can catch huge movements in apiece market.

Trading in different Time Dimensions

You can use technical rules for daytrading, swingtrading, long term trading and etc. rules are the same you only change time of charts. Some people state technical analysis is only suitable for short term trading, but it is not true. Using weekly and monthly charts that refer to several years has proven the strength of technical analysis for long term trading.