As a fundamental investor, it's easy to eschew charts in favor of real, rock-hard numbers. But that's a big mistake. Taking a look at a chart can add a huge edge to your investment gains when used in conjunction with solid fundamentals. Here's what you need to know to become chart smart.

An Investor Necessity
Don't write off technical analysis – while using patterns to make investment decisions might sound dubious, it's hard to argue with the fact that skilled technicians can turn their diagrams into dollars up to 90% of the time. And while the rift between fundamental and technical analysis might seem enormous, it's actually far from it. (For more, check out our Technical Analysis Tutorial.)

At its core, technical analysis is really a way to look at qualitative factors – like investor psychology – from a quantitative standpoint. Behind every pattern you'll see in a stock chart, there's a fundamental justification.

Technical analysis fills a necessary gap in the fundamental investing toolbox as well. While fundamental analysis can point out a potentially undervalued investment, the old quote from John Maynard Keynes still rings true: "The market can stay irrational longer than you can stay solvent." With technical analysis, an adaptable investor can read the market's rationality to know when to get into a fundamentally sound play.

Technical Basics
It's not easy for fundamental investors to accept technical analysis at first. But when you consider the mechanics of technical analysis it quickly becomes clear that, contrary to popular belief, technicals and fundamentals aren't mutually exclusive – they're actually quite complementary. While I can't go over every element of technical analysis here, this article serves as a primer on blending your fundamental investing approach with charting. Let's take a look at some of the precepts of technical analysis from a fundamental point of view.

Taking on Trend
Trend is perhaps the most basic concept for any burgeoning market technician. Trend is just the general direction of a stock's price movement. If a stock is trending up, that's a bullish signal, whereas a downtrending stock is generally showing a bearish signal.

Figure 1: Upward trend

As a fundamental investor, you might not want to put your money in an uptrending stock out of concern that you'd already missed the boat on a price movement, but that could be a very bad move. That's because a stock is far more likely to move in the direction of its overall trend on any given day.

One of the best ways to confirm a trend is with volume. As volume increases, the chances that a trend will continue to hold are far greater.

From a psychological standpoint, trends make quite a bit of sense. As a rising stock begins to catch investors' eyes, it's only natural for the share price to increase as more and more investors – and traders – try to repeat others' success (pushing volume higher in the process). While some suggest that technical analysis can be a self-fulfilling prophecy, technicians argue that it doesn't matter why a technical phenomenon occurs, only that it occurs in a predictable manner.

Two important concepts related to trend are support – the price level that a stock has trouble falling below – and resistance – the price level that a stock has trouble rising above. Both of these come into play when we talk about reversals.

Watch the Reversals
It's clear that no trend lasts forever, which is why reversal patterns are so important. Reversal patterns are signals to technical analysts that a trend is about to end, and that it's time to either get out of a stock or take the opposite position on the play. Reversals also make quite a bit of sense from a fundamental perspective.

Figure 2: Reversal

When a stock rallies up to its resistance line (the $51 mark shown in Figure 2), investors will often sell off to take profits. That sell-off creates quite a bit of downward pressure that makes reaching new highs a challenge.

Likewise, when a stock falls down to its support line, some investors may see a bargain again and begin to purchase shares, raising the stock's share price and halting the downward tumble. Knowing where the support and resistance levels are can help fundamental traders choose entry and exit points in their positions.

And just as it's plain to see how a support or resistance line can hold a stock in a range, there are a number of reversal patterns – including the head-and-shoulders and the double top/bottom – that investors can look for in order to predict the end of a trend (For more on reversal patterns, see Price Patterns.)

Going Further: Moving Averages and Oscillators
Beyond patterns there are other indicators that market technicians use to gauge where a stock is headed. Among the most popular are moving averages, which chart a stock's average price over a trailing number of periods, and oscillators, which help measure a stock's momentum. (To learn more about oscillators and indicators, see our Exploring Oscillators and Indicators Tutorial.)

While fundamental and technical analysis don't seem to mesh at first glance, combining these two investing schools has its advantages and can help avoid some of the most painful losses. Fundamentals can tell you which stocks to play, but adding a bit of technical know-how can help you decide when to play them.

For related reading, take a look at Blending Technical And Fundamental Analysis.

Related Articles
  1. Economics

    Calculating the Consumption Function

    The consumption function shows the level of consumer spending as it relates to disposable income.
  2. Investing Basics

    What is the Theory of Backwardation?

    Backwardation occurs when the futures price of a commodity is lower than its market price today.
  3. Forex Strategies

    Two Great Currencies To Profit From Oil Volatility

    U.S. dollar crosses with Canadian and Australian dollars offer easy access to crude oil trends due to their tight correlation with energy futures.
  4. Fundamental Analysis

    Examining Mexico's Trillion-Dollar GDP

    Examining the gross domestic product growth and composition of Mexico, the second largest economy in Latin America
  5. Investing

    Redefining the Stop-Loss

    Using Stop-losses for trading doesn’t mean ‘losing money’, but instead think about the money you'll start saving once you learn how they work.
  6. Fundamental Analysis

    10 Major Companies Tied to the Apple Supply Chain

    Apple has one of the best supply-chain models. Here are some of the top businesses involved, and the benefits and challenges for all.
  7. Fundamental Analysis

    What Causes Inflation in the United States

    Inflation is the main catalyst behind U.S monetary policy. But what causes this phenomenon of sustained rising prices? Read on to find out.
  8. Chart Advisor

    3 Ways to Trade the Rising Volatility

    With volatility increasing in the markets, many are turning to these three volatility-capturing exchange-traded products.
  9. Chart Advisor

    Big Double Top Patterns On the Verge of Breaking

    These stocks have created big double top chart patterns, and are on the verge of breaking the patterns to the downside--a bearish signal.
  10. Term

    What are Non-GAAP Earnings?

    Non-GAAP earnings are a company’s earnings that are not reported according to Generally Accepted Accounting Principles.
  1. Cost Accounting

    A type of accounting process that aims to capture a company's ...
  2. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s ...
  3. Supply

    A fundamental economic concept that describes the total amount ...
  4. Principal-Agent Problem

    The principal-agent problem develops when a principal creates ...
  5. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  6. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  1. Tame Panic Selling with the Exhausted Selling Model

    The exhausted selling model is a pricing strategy used to identify and trade based off of the price floor of a security. ... Read Full Answer >>
  2. Point and Figure Charting Using Count Analysis

    Count analysis is a means of interpreting point and figure charts to measure vertical price movements. Technical analysts ... Read Full Answer >>
  3. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  4. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  5. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  6. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!