momentum investing

How successful investors blends fundamental analysis with technical analysis.

Have you ever bought a stock that seemed nice initially. That is, the company’s fundamentals were good. But overtime, the stock value didn’t rise. It just kept falling.

If not a stock, have you ever bought something that seemed nice and you felt you needed it. Let’s say, a T-shirt. Later on, you to regret buying it because of a certain reason. Maybe it didn’t size you. That feels bad right?

In the book “how I made $2 million in the stock market” by Nicolas Darvas. He tells his story on how he blends technical analysis to fundamental analysis. From learning fundamental analysis to technical analysis and how he became a techno-fundamentalist.

He was so interested in the stock market that he had a drive to succeed. He started by learning how to analyze company’s fundamentals. After his daily dealings. He will read through the financial statements of tens of companies. He compared their assets, their liabilities, their profit margins, cash flow etc.

He looked for companies with these characteristics:

  • Stocks with top quality ratings.
  • Stocks selling below book value.
  • Stocks with strong cash position.
  • Stocks that have a stable dividend growth.
  • Stocks in a healthy industry.

But with all these fundamental analysis. He found out that the prices of these stocks with their amazing fundamental characteristics  happen not to advance higher whenever he bought them. He was puzzled by this. He needed to overcome the fact that sometimes share prices of good businesses falls or they don’t move higher for months.

So how did he overcome this problem of buying stocks with good fundamentals that ends up falling/not rising.

He developed a concept called box theory. After researches, he noticed that stock prices don’t move upwards like a balloon. He observed that prices would oscillate fairly consistently between a low and a high.

For example, Lets say a 45/50 box will go like this: 45, – 47, – 49, – 48, – 50, – 49, – 46, – 45, – 47, – 48, – 50.

If the price fell below 45, it means the price has entered the lower box and he quickly eliminates the stock. But, if the price enters 51. He gets interested in the stock because price has advanced higher into the next box.

As the price climbs higher into the next box, the volume of the stock increases too. That proves that investors are interested in the stock. This box theory is also similar to a ranging market.
With this concept he had built a technical approach that possess characteristics like these:

  • Box theory (ranging market)
  • Increase in volume
  • Advancement in price (break-out)

Combining technical analysis with fundamental analysis. He was able grow his capital to $2 million by buying good fundamental stocks whenever upward momentum picks up.

Why should a fundamental investor buy stocks with momentum?

From the summary of the book above, Darvas lost money from company stock’s with good fundamentals.
After analyzing a company’s fundamentals you think to yourself this stock is going to make me a fortune. It’s not a gamble. It is based on infallible statistics. But yet, it still drops.

The market moves based on expectations. In the short term there will be fluctuations because it is controlled by emotions. The goal now is to know when these stocks picks upward momentum.

How to know when a stock picks momentum?

To know when a stock picks momentum. You need to understand market dynamics. You need to understand how the market moves.  After periods of frustration and observation. Darvas finally understood that the market pauses for a while between two price ranges. He referred to that area as a box which can be called a ranging market.

Now price cannot be in a range forever. It is going to break-out from the range. Buying at breakout signifies that you are buying with momentum.  It is either it breaks out upwards or downwards. You should be interested in the upward momentum of the stock.

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