Do Value Investors Use Technical Analysis?

Charts are an interesting part of investing. The candlestick patterns and volatility measures can become enthralling. It’s no wonder an entire discipline was built from recognizing patterns. However, investing is irrational and technical analysis strategies can begin to fall apart. So what use is this to a value investor?

Many notable value investors use technical analysis. Instead of using technical analysis as a starting point, it supports fundamental analysis. Some examples utilize technical analysis to pinpoint support levels, monitor volume, and avoid rapidly falling stocks.

I have to admit as a value investor myself, technical analysis is a bit of an afterthought. I should probably get some formal training on it. But, it doesn’t stop me from pinpointing on charts when a stock is at its lowest level in company history. This was a strategy used by famous value investor Peter Cundill.

Let’s take a look at some important points all value investors should consider when approaching technical analysis.

  • What is formal technical analysis?
  • Using technical analysis alongside fundamental analysis for maximum gain.
  • How to begin to understand investing using market analysis of short-term trends.
  • What problems and limitations you might be up against. 

What is Formal Technical Analysis?

Technical analysis predicts historical market trends through observing stock charts. Volatility, volume and price changes create a pattern over time. This can predict or estimate the direction of a company’s stock

Technical analysis is a process that provides valuable insight into a company’s financial worth by looking at historical returns of stock prices. You can then use this evidence to make a pattern that value investors use to predict the growth or decline of economic activity in a specific area.

The most famous investor to adopt this strategy was Michael Burry. 

He determined that by using chart analysis to predict the psychology of the stock market, you can make positive investment decisions, and increase your returns. 

Technical analysis differs from other forms of investment analysis, such as fundamental and quantitative analysis. It does not take into consideration shareholders or project plans and only looks at profit margins over basic returns. 

Many value investors believe that patterns in the stock market tend to repeat themselves, so for short-term investing, technical analysis is a great way to beat the stock market’s average return. 

Swing trading is one technical analysis strategy that helps investors in the medium term. It focuses on cycles and best used for cyclical industries like oil or semiconductors. Value investors focus on buying at the bottom of the swing trade and waiting until the company returns to intrinsic value.

Technical Analysis vs. Fundamental Analysis

Alongside technical analysis, value investors primarily use fundamental analysis. Fundamental analysis spots trends before they happen and technical analysis confirms these trends.

A rise in volume will signal to a value investor that it is time to start selling stock rather than buying.

Candlestick patterns like the one above are a visual representation of positive or negative volume.

Fundamental analysis is am in-depth form of investigation that scrutinizes the following: 

  • A company’s historical stock exchanges and the growth of the company over some time.
  • Its revenue and profit margins, income, and cash flows.
  • Other metrics such as new projects, ownership models, and balance sheets.

By adopting a model of looking backward at historical trends and the current situation at the company, whether you are looking at political conditions of the company itself or the general profit margins, you will be far more likely to achieve a positive outcome. 

By assuming these models, you can identify patterns inherently related to company structure, growth outcomes, and past and upcoming projects and make an informed choice about value investing with companies that are undervalued by the market. 

It is an excellent, albeit technical, way to pull companies that are not in the limelight out of the water. 

How Do Value Investors Use Technical Analysis?

Value investors use technical analysis in different ways. But they might begin by utilizing a chart to map out stock price movements on a particular company. Checking charts for statistical patterns gives the value investor an idea of how a company has fared in recent history. 

Without considering the company balance sheet or income reports that fundamental analysis requires, the focus is purely on the mapping price on a chart. This is usually done right after a preliminary screen.

When identifying a company to invest in I take these steps:

  1. Screen for stocks below book value.
  2. Identify excessive current assets.
  3. Look at chart to identify if stock has fallen recently and if it is at all time lows.
  4. Look at volume to see how easy or difficult it is to buy.
  5. Do more fundamental research to see if chart direction can reverse.

Peter Cundill Legendary Value Investor

Peter Cundill focused on book value when identifying companies to invest in. However, he also looked at charts to see if the company was at a low price compared to its historical average. This is why I incorporated step 3.

When Peter Cundill did this he identified a margin of safety and potential reversal of the trend to anticipate an upward price movement.

Just like Peter Cundill both techniques in use together is more likely to lead to better outcomes. For example, you can use fundamental analysis to decide which companies you will be scrutinizing and technical analysis to determine at which point you would like to buy in and sell out. 

Once you have narrowed down the list of companies you would like to analyze. Check the charts for volume and any support or resistance indicators that you can identify. 

Value investors also unknowingly use technical analysis alongside their fundamental research. Purists argue that this dilutes the returns of either focus, but investing is more of an art than a science anyway. 

The stock market is constantly evolving and as strategies are discovered that work, they are saturated until that strategy returns less than it did when first discovered.

Criticisms and Limitations of Technical Analysis 

Despite the positives of technical analysis it does present a few minor problems. 

Depending on your investment strategy and whether you prefer to look at the market in the long-term or short-term. Technical analysis might not be as accurate when used by itself without outside influences.

This is why value investors use technical analysis to support a thesis rather than create one.

Additionally, many experts believe that technical analysis is not exactly authoritative. Because it is a rather new approach by comparison. There haven’t been many studies to suggest that it is equal to fundamental or quantitative research. Both of which have a much more firm grounding in the investing world. 

Critics of the strategy insist technical analysis is a self fulfilling prophecy and cannot be an authoritative strategy as past performance is not an indicator of future results. 

The biggest problem with technical analysis is its lack of in-depth observation. 

Without truly understanding a company’s profit margins, leadership strategies, growth revenue patterns, profit projections, and future plans, it is impossible to know how a company will behave in the future.

Herd Mentality in the Stock Market

Despite the many criticisms, value investors who use technical analysis often emphasize, their approach is based more on the herd psychology rather than fundamentals on stock behavior

Herd mentality is one of the primary elements that drive the stock market and its often irrational appearance.

Understanding herd instinct in the stock market is one of the fundamentals behind technical analysis. It drives the idea that you can actually predict future behaviors and make a profit from them. 

For example, the Dotcom bubble is a fine example of herd mentality driving the stock market. Valuations became unmoored from fundamentals and were driven only by momentum investing. A technical analysis discipline. Which is more of a growth investor approach to technical analysis.

At the beginning of the internet rush, people were pushing to invest in young internet corporations, which inevitably ended in a market crash. This is what happens when fundamental analysis is ignored and growth is assumed rather than proven.

Final Thoughts: Do Value Investors use Technical Analysis?

A lot of value investors use technical analysis today, not just because of its ability to predict people’s movements but also because it is a fast way to identify good entry and exit points in the market. 

Using this strategy for short-term and medium-term investments, value investors can boost their portfolios with stocks that have been previously neglected.

Bryan Shealy

Bryan Shealy is an active value investor. He currently focuses on the small and micro cap stock market looking for bargains. He has written content for Seeking Alpha, Net Net Hunter and Broken Leg Investing.

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