Use a Three-Pronged Approach to Analyze Stocks

Being that I am a new contributor to The Midas Legacy, I wanted to take the time to introduce myself and my investment philosophy. I have been in the financial arena for more than 25 years now with the last 14 being in financial publishing. I have been studying, trading and writing about the stock market since 1985 and received my first NASD license in 1987 when I was 20-years old. I have been around this game a long time now.

Over the years, I have learned that you have to have an advantage and you have to put in the work if you want to be a good investor or trader. One of the things that I believe in strongly is that you have to use different analysis styles. Many people will tell you that they are a fundamental analyst or a technical analyst. Personally I think you need to use both of these analysis styles and I think you need to look at the sentiment toward the investment as well. My philosophy is that fundamental analysis may tell you what to buy or what to sell, but technical analysis and sentiment analysis tell you WHEN to buy or sell an investment.

Let’s look at each of the three analysis styles and the benefits they provide. First, fundamental analysis tells us about the company itself more so than the stock. Fundamental analysis looks at things like earnings growth, revenue growth, sales and profit margins and return on equity. Essentially fundamental analysis tells us whether the company is making money, whether they are growing or not and how efficiently the company uses its resources. All of these things are good to know when trying to determine if the company is going to be worth more in the future than it is today.

Technical analysis is the study of the price of the stock. When using technical analysis you are looking for things like moving averages, patterns in the price and whether the stock is overbought or oversold. Looking at a chart can tell us whether the stock is hitting resistance or finding support. Stocks are inanimate objects and therefore they don’t have emotions, they are however traded by humans. And humans make decisions based off of emotion and they are creatures of habit. What we are really looking for in technical analysis is whether it is a good time to buy or sell a stock.

Sentiment analysis is probably the least used of the three analysis styles, but I find it to be just as valuable as the other two. Sentiment analysis involves looking at things like short-interest ratios, put/call ratios and analyst ratings. In its simplest form, investing boils down to simple economic principles. A stock goes up when the demand is greater than the supply and it goes down when the supply is greater than the demand. If there are more buyers than sellers, the price rises. If there are more sellers than buyers, the price will fall. We use sentiment analysis to tell us whether there are likely to be more buyers than sellers and vice versa.

The best opportunities arise when the fundamentals show that the company is solid, when the technicals show that the price is in an upward trend and the sentiment shows that the stock isn’t all that popular. Let me give you an example.

On March 3^rd of last year, I recommended Tesla Motors to subscribers of a newsletter that I wrote. In the recommendation, I cited the following reasons for buying TSLA:

• The stock had pulled back to its 20-week moving average
• The stock was oversold on its daily chart
• The short-interest ratio was at 20 (meaning the number of shares sold short was 20 times the average daily trading volume)
• The put/call ratio was among the highest 85% of readings for the previous year
• The company had seen earnings growth for three straight quarters
• The three year sales growth rate stood at 35% at the time and, at that time, the most recent quarter showed a sales increase of 678% over the same period one year prior

What transpired after that bullish recommendation is incredible. The stock moved from under $40 to over $190 between March and October. I wish I could tell you that the subscribers took full advantage of that rally, but the way the newsletter worked was to take a fast profit of 8%. However, you can see how such a powerful move can occur when all three analysis styles are pointing toward a bullish move.

When you are looking at an investment opportunity, I highly encourage you to implement a strategy that involves all three analysis styles. It can help you find big winners like TSLA and it can help you avoid potential losers.