Nicolas Darvas described himself as a “techno-fundamentalist.”
He based his trading strategy, the Darvas System, on a combination of BOTH technical analysis and fundamental analysis. This reliance on both types of analysis separated Darvas from many trend traders, back then and still today.
Some trend traders rely exclusively on technical analysis and disregard the fundamentals. They believe that every fundamental that can be known about a stock – past earnings, projected earnings, market direction, market outlook, etc. – is already reflected in the actual price of the stock.
This reasoning seems logical. However, I think the viewpoint misses something key.
Yes, the technicals ARE more important than the fundamentals to a trend trader. That is, no matter how great the fundamentals look, if the technicals are poor, the stock needs to be avoided. You can’t “force” the technicals to match up with the fundamentals no matter how much you think (or hope) they should.
However, traders who have learned to properly recognize trends and technical patterns can take their success rate to a much higher level when they add fundamental analysis to their repertoire.
The NCAA basketball tournament offers us a helpful analogy.
Every year in the tournament of 68 teams, there are a few “Cinderella” teams who pull off upsets and advance further into the tourney than anyone expected. This is a great story in the world of sports and everyone starts pulling for these Cinderella teams who overcome the odds stacked against them.
But why are the odds stacked against such teams in the first place? After all, they play by the same rules as all the other teams. They have the same number of scholarship limitations. They only play five players at a time. They’re not allowed to foul or double-dribble or travel. They usually have the exact same number of scholarship players as every other team. And on and on this list of similarities goes…
With this in mind, what makes their success such a surprise? The entire NCAA field of teams must play by the same rules and those rules are specifically put in place to give everyone an equally fair chance at success.
Obviously, what makes an underdog an underdog is the talent, tradition, and resources these Cinderella teams appear to lack.
They don’t have top-rated recruiting classes and an elite level of talent (both players and coaches) compared to the major programs. They don’t enter the tournament with a long tradition of success like programs such as Kansas and Kentucky have. They don’t have the big budgets that upper-echelon programs like Indiana and Louisville have.
A team’s talent level, tradition, and budget are similar to a stock’s fundamentals.
For instance, the talent a team has could be compared to the earnings a company has. A team’s tradition could be compared to a company’s recent economic condition. A team’s budget could be compared to a company’s financial stability and future growth prospects.
Now obviously, some of these Cinderella teams get hot. They get on a winning “trend” and ride their momentum to unexpected victories.
However, these types of winning trends are much less likely to be continued (or repeated) compared to a team that has the superior “fundamentals” of talent, tradition, and budget.
Cinderella stories make for great sports moments, but if you were a betting man with equal odds on two teams, you’d be a fool to bet against the team with much better fundamentals – no matter what kind of winning streak (or winning “trend”) the team with much weaker fundamentals had been on.
Of course, when the fundamentals ARE very similar between two teams, you’d bet on the team that was riding the winning trend into the game.
It’s the same thing with the stocks you choose to trade.
Sure, there are going to be stocks that achieve explosive gains and look great technically despite having lousy fundamentals. But these stocks are few and far between.
The bottom line is this: stocks with better fundamentals have a much higher likelihood of advancing on a long and successful trend than those with weaker fundamentals. Put simply, the odds are stacked in favor of those companies with better fundamentals.
When you come across a stock with great fundamentals AND great technicals, you’ve entered that rare “techno-fundamentalist” territory Nicolas Darvas talked about.
This is exactly what we’re looking for as Darvas traders.
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