There are different types of strategies investors can use to trade on the stock market. Two common strategies are value investing and technical investing. Value investing is a strategy where the intrinsic value of a stock is evaluated and stocks are bought using fundamental analysis. Value investors like to buy stocks that are underpriced in the market. Technical investing looks more at the price action of the stock. By analysing price movements investors can weigh up the probabilities that a stock price will head in a certain direction.
Value investing
A value investor will look at the company’s financial figures before deciding to invest in them. These value investors try to assign a value to a company. They will use financial ratios and use financial data to calculate the estimated value of the company’s share price. They make assumptions about future earnings which help them determine that a stock is cheap and that the market has it wrong.
These investors are long term holders so they do not intend to sell their positions any time soon. They are more buy and hold investors and often require many years to pass to hopefully see the price of the company increase.
When stocks are sold off and have heavy price falls, value investors are not scared off. They will buy the stock on the way down as they believe it is an opportunity to buy it cheaply. They do not follow what the market is doing. If they believe the company has solid fundamentals then they think that the market will come to appreciate this at some point and their investment will do well over time.
Value investors do not believe the stock market prices the stocks appropriately. Hence there will always be circumstances where a stock price has been overbought or oversold and therefore present them with buying and selling opportunities.
Technical investing
Technical trading uses a strategy which looks at how the stock has been trading in the market by analysing price movement, moving averages, relative strength, volumes, and charts to determine trends and future price action.
These investors are short term to medium term investors. If a stock is not performing, they would rather sell that position and use the funds to buy a stock that has upwards momentum.
Technical analysts believe prices form a trend and look at past price action to identify these trends. Technical investing looks more closely at the price action of the stock compared to value investing. Stocks may appear fundamentally sound on paper, but the market may not be as convinced the stock is a good buy and hence this can cause the stock to price to stagnate.
Technical analysis uses support and resistance levels to help analyse the behaviour of the stock. When a stock trades under support levels, this is a negative move for the stock as it means it could fall even further. When a stock pushes above resistance levels then this a positive sign for the stock as it could mean it may head up higher. These support and resistance levels are identified by previous lows and previous highs of the stock. These levels are formed because there are large numbers of other market participants who are clearly buying or selling at these price levels. These types of investors understand that rightly or wrongly, market forces will pull stock prices in a certain direction and it is very important to be aware of what the market wants to do to a stock price before committing to buying or selling.
Lauren Hua is a private client adviser at Fairmont Equities.
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