IT’S EASY: Add Fundamentals to Your Trading

As a trader, I spend most of my time analyzing price action.

But today, I want to explain how you can incorporate fundamental analysis into your own trading process…

An old Peter Lynch adage for investing is “Invest in what you know.”

The renowned Fidelity manager of Magellan, the largest mutual fund of its time, used this principle as a starting point to help individual investors find undervalued stocks.

His approach was developed out the necessity for investors that didn’t have the time or knowledge to evaluate the fundamentals of a company. They wanted a sound selection process, as opposed to throwing a dart at the Wall Street Journal pages. After all, it was an arduous task to look at corporate financial statements, cash flow, and income statements. A fundamental analyst looks at these and other factors to find the intrinsic or “real” value of a company as an investment. That can range from the overall current unemployment and interest rates, to market share, or return on investment from quarterly corporate reports to evaluate worth. This longer-term approach attempts to quantify all information to place a value on a company.

Fundamental analysis can be incredibly complex, of course. Thankfully, technological advances have leveled the playing field for investors by providing access to analysis once only available to professionals. The internet and personal computers allow individuals to compile both fundamental financial report data and the technical price analysis for stocks — a win-win!

Most brokerage and financial websites provide fundamental breakdowns for stocks as well as analysts ratings. This compiled information is easily available without the task of thumbing through pages and pages of annual reports or manually doing the accounting math. Specific stocks can be evaluated for their relative fundamental performance to their competitors and market sectors.

One major area of concentration in studying fundamentals for a company is the earnings track record. The widely anticipated quarterly numbers are a measuring stick of performance and often determine short term direction. Earnings growth can be an indicator of corporate strength like another fundamental of continuing high dividend yields.

The focus on earnings has accelerated in the last few years. Even if you knew exactly what the number is going to be, it’s still near impossible to make money. That’s because the market’s reaction is often unpredictable. Some will be disappointed while others can find optimism and pessimism when the data is released. One certainty is that for only a few brief moments, analysts can focus on the present before again looking to future reports.

Much like technical analysis, which focuses on the price action of the stock, the fundamentals are only one tool in the investment process. There aren’t specific buy or sell thresholds for the fundamental ratios for sales, profits, or earnings. But they can provide a basis for further examination if certain personal fundamental criteria are met for investments.

Ultimately, a trader’s goal is to develop a disciplined plan that minimizes emotional decision making. An investment methodology that combines both some fundamental and technical analysis is commonplace for most individual investors.

Keep it In the Money,

Alan Knuckman

Alan Knuckman
Editor, In-The-Money

Chart of the Day: Waiting for a bounce

Greg Guenthner

Keep your head on a swivel — I don’t think the pullback is over just yet…

Even though the averages attempted to stabilize last week, we could be in store for more selling. It might be another week or two of quick retreats and choppy action before we see a flush — then perhaps a “bottom” will be in place.

Of course, this doesn’t mean you can’t find new trades… but the averages could still need to blow off steam before we see another significant broad-market rally.

Let’s take a look a potential landing zone for the Nasdaq:

COMPQ

If this move back toward 11,300 fails (which appears likely) we could see another drop toward 10,500. That’s the next level of support we should monitor for a tradable bounce.

Trading Tip of the Day

When in doubt, do less.

The summer doldrums are over. Low-volume, choppy action is typical of the final weeks of summer. The pros are out of their offices and hitting the beach or visiting with family. The news is quieter. On many days, we were subjected to more fake-outs than breakouts.

But Labor Day weekend has come and gone. We’ve endured a 10% correction in the Nasdaq. The volatile fall trading season has officially begun. Our first order of busines is simple: Don’t give back our hard-earned profits booked during the melt-up rally off the March lows.

Less is more in this environment. You’re always better off not forcing trades. Keep your win rate up and take the time to “reset” your thought process. Run some fresh scans to see if any new names pop up. And most importantly, stay patient. The market will reveal new opportunities soon enough.

— Greg Guenthner

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Alan Knuckman

Alan hails from the home of options trading in Chicago, where he began working as a clerk on the floor of the Chicago Board of Trade (CBOT). Beginning with his days on the floor, Alan’s worked with all aspects of the options markets for the past 25+ years.

Transitioning from a clerk to a floor...

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