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Combining Fundamental and Technical Analysis

When it comes to choosing between fundamental and technical analysis, many traders tend to go with the style that plays to their strengths. While fundamentals-focused traders relish poring over balance sheets and income statements, technical analysts may be particularly attuned to the buy/sell signals they spot on stock charts.

Of course, sticking to one style can involve trade-offs. Traders who look only at fundamentals could miss out on metrics that could help time their trades, while technical traders could be overlooking warning signals about a company’s financial health.

But why not combine them? The key is learning when to deploy a particular method to make the most of its strengths: fundamentals for deciding what to trade and technicals for deciding when to trade it.

What to trade

Determining which stocks are worth trading can be challenging. A trader looking for appealing opportunities on, say, the tech-focused Nasdaq Composite Index would need to sort through some 2,500 stocks. Even narrowing the list to health care stocks would leave hundreds of candidates to consider.

Confronted with so many choices, it can be tempting to zero in on the hottest performer, perhaps one that beat its expectations or is riding a crest of positive news. The problem, of course, is that whatever factor has driven the stock’s outperformance has probably already been priced in.

A more cool-headed approach would be to identify companies that stand out because of their underlying financial health using fundamental indicators. Many trading platforms offer fundamental screening tools you can use to isolate the top performers in a certain sector based on earnings per share (EPS) and revenue growth.

For example, Schwab clients could use the stock screener tool to apply the following criteria to health care stocks:

  • 3-year EPS growth: 25% or higher
  • 3-year revenue growth: 25% or higher

If that doesn’t sufficiently narrow the list, you can always apply additional filters. For example, you could search for stocks with a Schwab Equity Rating of “A”—meaning those Schwab’s analysts think have a good chance of outperforming the market—and a share price of $20 or higher to filter out less-established or less-stable companies.

Following those steps should help narrow your search to just a handful of stocks to consider.

When to trade it

Once you’ve assembled a manageable list of potential trading opportunities, it’s time to ask whether now is the best time to execute a trade.

There are many different technical indicators, but one of the most straightforward is a stock’s moving average, or its average price over a set number of days. When a stock breaks above its moving average, it may signal the start of an uptrend, whereas when a stock breaks below its moving average, it could indicate the start of a downtrend (see “A tale of two averages,” below). Whether you use a five-day moving average, a 200-day moving average, or somewhere in between depends on whether you’re looking to capitalize on short- or long-term trends.

You could also look to trading volume as another indicator of support or resistance. When a stock price breaks above its moving average and its trading volume is increasing, that’s a further signal of traders’ commitment to the current direction. Conversely, moves higher without a corresponding increase in volume may peter out more quickly for lack of investor enthusiasm.

The power of two

Fundamental analysis is a great way to narrow down the universe of stocks to those with strong financials—but only technical analysis can tell you whether they’re in a solid uptrend.

Certainly, combining fundamental and technical research won’t take all the risk out of investing—no approach can guarantee that—but it can help you steer clear of relatively weak candidates or avoid entering positions at an inopportune time.

What You Can Do Next

Follow along as Kevin and other Schwab trading experts break down a variety of popular trading strategies in Trading Up-Close.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

Schwab Equity Ratings and the general buy/hold/sell guidance are not personal recommendations for any particular investor or client and do not take into account the financial, investment, or other objectives or needs of, and may not be suitable for, any particular investor or client. Investors and clients should consider Schwab Equity Ratings as only a single factor in making their investment decision while taking into account the current market environment.

Schwab does not recommend the use of technical analysis as a sole means of investment research.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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