Applying the Combined Approach as a Diversification Method
By combining the two methods, diversification is fine-tuned and can be managed on a higher level.
Key PointBeyond expanding your analytical field, using both fundamental and technical indicators enables you to fine-tune your portfolio's diversification.
- Combinations of working capital analysis via current and debt ratios, with narrowing trading range
- Between an improving trend in revenue and profits, along with strengthening uptrend and mid-range P/E ratio
- Higher-than-expected earnings timed with an ending downtrend tracking with a trend line and candlestick formations
Another twist on this method is to combine a conservative fundamental strategy (picking solid large-cap companies or a conservative mutual fund, for example) with a higher-risk technical timing strategy. This technical side may be operated on stocks you also own in your portfolio, or on a different grouping of stocks, selected with greater market volatility. In this instance, you recognize the need for a conservative buy-and-hold segment of the fundamentally based portfolio, while also seeking maximum current income on the technical side.
The combined analytical approach may also lead you to a decision to revert from one approach to the other. For example, if you originally picked a company as a value investment but the fundamentals have since changed, the obvious step from a conservative point of view would be to sell shares and move funds elsewhere. However, what do you do if the current trend is continuing to move prices upward?
In this case, you may decide to revert from fundamental to technical and change the buy-and-hold strategy on this company to a swing-trading strategy instead. To protect paper profits, use options (covered calls or long puts) to offset any price decline. Also begin tracking the daily chart to look for signs of a coming reversal through momentum indicators, moving averages, and candlestick patterns.
Key PointNothing lasts forever. A conservative value company may deteriorate and become a high-risk one. This doesn't mean you have to sell; it could mean the stock is an excellent choice for swing trading.
The point in keeping an open mind to both forms of analysis is that it improves your overall analytical insights. Neither technical nor fundamental analysis provides you with all of the answers you need, but using elements of both is quite helpful. Whether you see the strategy as a form of diversification, confirmation, or a change based on new and emerging trends, the combined analytical approach helps you to improve your interpretation of long-term values and short-term trends, and improves your timing in both strategies.
The kinds of flexible analysis you can accomplish with combined analysis are made even more powerful when you introduce options into the equation. Options are not only speculative, high-risk, complicated tools best used by experts. There are many strategies, some highly conservative and well suited to reducing your market risk. Options to Leverage and Manage Your Portfolio introduces options basics and describes a few of the strategies designed to help you manage your portfolio and either increase current income or cut down on risk.
By Michael C. Thomsett