If you are interested in knowing why technical analysis is more useful than fundamental analysis in certain situations, then here's a rundown from Bob Prechter that will make you wonder why the whole world doesn’t do technical analysis first before attempting to look at companies one by one.
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Excerpted from Prechter's Perspective, published 2004
Q.: Isn't it reasonable to say that the driving force behind long-term appreciation is always the same fundamental force: earnings? No matter what 20th century success story you're talking about, Coca Cola or IBM or Microsoft, the common element was an ability to deliver on the bottom line. So if you can forecast profits, can't you be expected to forecast rising stock prices?
Bob Prechter: How many people forecasting profits predicted the stock market one year ahead in mid-1929, mid-1930, mid-1931, mid-1932 and mid-1933. Or 1984, 1985 and 1986 when economists were bearish? The stock price is the best forecaster of earnings and profits, not vice versa. Now, once you have established that a bull market is in force, which is a task requiring technical analysis, then you can perform one type of useful fundamental analysis: you can set out to learn more about a company than the otherwise best-informed people in the marketplace. A really dedicated fundamental analyst who gets inside a new company and believes it has a huge advantage over the competition and believes that its stock price does not reflect that potential can make an intelligent choice. He is, in effect, predicting profits and, therefore, the relative price of one stock.
Q.: In the area of individual stocks, can fundamental approaches be effective in ways that even the Wave Principle is not?
Bob Prechter: Sure. In fact, I think stock selection is the only place fundamental analysis is valid. A guy doing fundamental analysis has to do his homework, he has to be on top of the company, he's got to know the key people, and he has got to really know what is going on. He has to have a good feel for the future and the competition in that area. So I think it's a valid approach in picking undervalued and/or emerging companies. This approach takes immense work. You're not just talking about investigating Microsoft. You're talking about investigating 100 or more companies just to find the next Microsoft. This approach only works on the micro level, and only after the macro level is judged to be acceptable for the exercise. Otherwise, a bear market will kill the stock price of your presumed new Microsoft.
Q.: Is there any point in a market cycle at which Elliotticians and fundamental analysts will agree?
Bob Prechter: There is a stretch in the fifth wave of a bull market when Elliotticians and fundamental analysts are on the same side. But Elliotticians know it's late in the trend, and fundamental analysts think it's early.
Q.: The Hulbert Financial Digest, a newsletter rating service, has compared the performance of the two groups and said that fundamentalists had "about an equal showing" with technicians.
Bob Prechter: The equal showing has been achieved during a period of consistently rising prices. It would be dangerous for someone to assume that these two camps would also perform equally if the market entered a bear market. It has been rather widely recognized that fundamental analysts get killed in bear markets because they're almost always "long." Undoubtedly, many technicians will be wrong as well, but the top performers will be technicians. To make assumptions using only data from bull market years will prove to be a dangerous thing when market behavior changes. The mere possibility that technical analysis can serve to help an investor avoid a bear market of historic proportion or duration gives it an edge.
Q.: The American Association of Individual Investors has reported that the likelihood of loss in buying and holding a diversified stock portfolio falls to 4.3% once the holding period reaches five years. That's with stock portfolios begun in each of the past 50 years. The odds are even better when considering a diversified portfolio of small stocks.
Bob Prechter: The fact that most of the past 50 years has seen rising markets says little about the future. To rely on that record in justifying a fully invested position is no different from relying on a mechanical technical trading program fitted to back data.
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