Trading Tools: Combining Indicators

In previous episodes of Trading Up-Close, we looked at different methods you can use to judge stocks. Now we’ll show you how you can bring several of them together to help you decide which stocks to trade and which to avoid. Why use more than one fundamental or technical analysis tool to analyze a stock? Because each tool can tell you something different about a particular stock. Remember that fundamental analysis can help you with the “what to buy” decision, while technical analysis can help with the “when to buy” part. Put them together and you can get a more holistic sense of how attractive a stock might be.

For this example, let’s imagine you’re looking for a stock from the consumer staples sector and you feel that the household products industry might offer interesting opportunities. We’ll start by using a stock screener that finds companies in our target sector and industry, and then address the “what to buy” question by displaying some key fundamental metrics. There are a lot of important considerations when using fundamental analysis, but to keep our example simple, we’ll focus on revenue growth, earnings growth, valuation (or forward P/E), and the debt to equity ratio. Then we can arrange the top four stocks in our target industry ranked by earnings growth. With that simple step alone, we can probably rule out stocks C and D because of their negative earnings growth. That leaves us two potentially attractive stocks with double-digit earnings growth. Both A and B also have relatively similar P/E ratios and debt to equity ratios of less than .4. Now that we’ve narrowed down our set of potential candidates, it’s time to address the “when to buy” side of the equation by bringing in some of the technical measures we’ve previously discussed.

Looking at measures such as moving averages, the Moving Average Convergence Divergence, or MACD; and the Price Relative Indicator can give us a signal about whether now might be a better time to choose one over the other. Here’s the chart for stock B. Some traders like to look at a stock’s recent price trends to get a sense of how it has been trading. As you’ll recall from previous episodes, we can study a trend by looking at a stock’s MACD line and a moving average. Right away, we see this stock has several positive attributes: The MACD line has crossed above its signal line and is above zero, and the slope of the 20-day exponential moving average has turned up—both attractive signals suggesting the stock could be entering an uptrend. Next, let’s check to see how this stock’s price trends compare to other stocks in the sector by looking at its Price Relative line, comparing it to the consumer staples sector. Here again, the results are appealing—it looks like stock B has been outpacing its sector since October.

Now, let’s see how stock A compares. This chart is decidedly less bullish. We notice that the MACD is below its signal line and below zero, and the 20 day exponential moving average has sloped down—potentially signaling a downtrend. Since the end of December, the Price Relative line versus the consumer staples sector shows that the stock has been underperforming its broader sector.

So, after using some fundamental measures to narrow down our set of potential stocks, we used some technical measures to help us decide that, at this moment, stock B looks like the more promising choice. For more on trading, watch the other videos in this series and subscribe to our You Tube channel.