TA versus FA

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By nukejohn
July 29, 2002

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This is a slightly revised post of a previous post I made on the NPI board, but I thought in light of the recent discussion on the validity of TA, some might find it useful. Here goes...

After spending the past 3 years studying this issue, I feel somewhat qualified to offer my opinion. In the past 2-3 years, I have read over 100 books on Investing, everything from the classics (Lynch, Graham, O'Neil, LeFevre, Mamis, etc.) to the newer Tech Investing books (Moore, T. Smith, et. al.) to a variety of TA Books (Weinstein, Elder, Achelis, etc.). In case you're interested, I have rated all the books in my library from 5 stars to zero stars.

Now, I'd like to share with this board what my investment philosophy is... now that I have spent over 20 years investing, and the last 3 years studying the issue of FA versus TA. In a nutshell, it is my belief that for best overall returns in the long run, an investor should use FA first to identify good solid companies (and of course I'm partial to high tech growth companies), and then use TA for entry and exit points. I have studied and played with a variety of TA parameters, and while I don't consider myself an expert, I feel very comfortable reading a chart. To learn the basics of TA in my opinion, it is only necessary to learn price and volume relationships, how support and resistance works, and maybe 5 TA parameters (how Moving Averages work, MACD, RSI, and maybe a few more). After my extended study, I have actually developed a FA/TA combination system that I have fully explained on the KP Board. Here is my initial post where I explained how my system works.

In a nutshell, here is how I invest (trade).

I select potential candidate stocks from a variety of sources (IBD, TMF discussion boards, Red Herring, Forbes, Fortune, Kiplinger's, friends, neighbors, etc.) I look for stocks that I feel have some type of unique competitive advantage (distribution channel, patents, manufacturing costs, etc.). For my "long watch list" I then look at the fundamentals, and make sure that company is profitable, with growing revenues and profits (no dot coms with no profits). If they pass this criteria I will follow these stocks on a watch list, but I won't purchase until my TA system says the time is right. My TA system requires the stock to be at least 3% above it's 50 day EMA, and have a positive MACD, rising RSI, and volume >40% above the ADV. All 4 criteria must be met on the same day before I will buy a stock. Once I buy (or short), I use protective stops. My protective stops range from 8% to 12% depending upon the stocks beta (higher the beta, higher the stop). As a stock I have bought rises, I increase my stops. I also keep a short watch list of companies that I think are overvalued or are facing a difficult future based on market and economic conditions. I get some of my potential short candidate stocks right here on Mish's board. Once a stock on my short watch list drops below it's 50 day EMA on high volume (and has a negative MACD)I short it. As a stock I have shorted goes down, I lower my stops. I also sometimes buy LEAPS (both calls and puts, depending upon the technicals).

I look at the long and intermediate trends to determine the ratio of my short and long positions. Currently, I'm about 70% short and 30% long.

But for those of you that don't want to dig into TA to this extent, let me give you a very simple system. Use any methodology you wish to identify potential companies that have unique competitive advantages, (i.e.: distribution channels, patents, manufacturing costs advantages, etc). Once you have identified a watch list of say 20 to 50 companies that you think have the possibility of being big winners long term (or in the case of shorts, big losers), don't buy them until they rise up above their 200 day Exponential Moving Average after they have been below it for several months. Set a stop loss of 10% when you buy, and as the stock rises, raise your stop loss to 10-15%% below the new high closing price, or wait until it drops back below the 200 day EMA. It's as simple as that. Let's take a look at a couple of stocks. Here's a 5-year chart of CSCO.

If you had bought in Feb 97 when it broke through it's 200 day EMA at about $6, you would have held it until it hit 70 or so in March 2000, and then started falling back. You could either sell at a predetermined % loss, or when it breaks back through its 200 day EMA. In this case it would have been in August 2000 at around $60 a share (a nice little ten bagger in 2 1/2 years.) You could also short when it breaks below its 50 day EMA on higher than average volume.

Here is QCOM.

But you say, this is a bear market and stocks don't keep growing in bear markets. Well, you must not have taken a look at a lot of other sectors like homebuilders, restaurants, etc. For example, take a look a Panera Bread (PNRA).

PNRA is a 10 bagger in the past 2 years, before it started dropping.

If you are interested in TA, one of my favorite books is Stan Weinstein's "How to Profit in Bull and Bear Markets". I highly recommend you read it. There is a TMF Weinstein discussion board on this book. One of the best posters on this board was inv44 (before he left). Take a few minutes to check out this post and then buy the book (if you're interested in how to evaluate the stages of a stock).

For those that are interested, the KP board has named my system, NJTA (NukeJohn Technical Analysis). Here is the response from another poster to the question a newbie asked, "What is NJTA?" This post lists a variety of my posts on the TA topic.

One final note. I am not one of those TA advocates who think that people can look at a chart and predict the future from stock patterns (well not with any high degree of consistency anyway). There are those that say, "this is a cup with handle or a pennant that will break out and be up 10-20% next month", ... well, I just don't buy it. However, I do believe the charts reveal when a stock is being accumulated (or distributed for that matter), and it is a good idea to learn the basics of support and resistance.

Well this has been a long post that I'm sure many will take issue with, but hopefully I have at least provoked some thinking on the topic.

Keep up the good work. I continually use Mish's board to add companies to my short watch lists.


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