Don’t get technical; stick with fundamentals

There are two major camps of investing: technical analysis and fundamental analysis. Technical analysis dwells on charts of stock price movements and trading volume. Fundamental analysis, on the other hand, focuses on the intrinsic value of companies, studying such things as their business model, earnings growth and competitive position. While investors from the fundamental school want to understand a business from the inside out, technicians tend to remain on the outside, observing how the stock behaves in the market.

Technicians have defined many patterns in the charts they study, imbuing them with much significance. There’s already a head-and-shoulders pattern and a cup-and-handle pattern. Perhaps next we’ll see an ostrich-and-eggbeater pattern. These patterns do exist, but they don’t necessarily mean anything. Imagine someone discovering that on presidential election days, whenever the skies above Fresno were cloudy, Republican candidates won. Like many patterns, this would be a randomly occurring one, a coincidence. For you to bet any of your hard-earned savings on this would be little more than gambling.

Investors who use technical analysis focus on the psychology of the market, scrutinizing investor behavior. They try to determine where the big, institutional money is going so they can put their cash in the same places. Imagine Warren Buffett trying to follow this short-attention-span crowd instead of seeking, buying and holding great companies for the long term. Imagine the taxes and commissions. (Short-term capital gains face stiffer tax rates than long-term gains.)

Some have made money using technical analysis, but it runs counter to what many investing experts recommend: buying into growing companies at good prices and hanging on for a long time. Devotees of fundamental analysis often shake their heads at how technicians frequently buy and sell stock without understanding what the company does or what its prospects and circumstances are.

Focus on the fundamentals, dear reader. If you find a company quietly selling more and more of its wares, increasing its profit margins and earnings, and trading at a low to reasonable price, consider snapping up shares. Don’t worry about what others are doing. The true value of great companies is eventually recognized.

Ask the Fool

Q: What’s the 31-day wash sale rule? — Q.R., Miami

A: Under the IRS’s wash sale rules, if you sell a stock for a loss and buy it back within 30 days, the loss cannot be claimed for tax purposes. Don’t worry, though — the loss isn’t lost forever. You do get to claim it, just not now. The disallowed loss is added to the cost of the repurchased stock, and it’s claimed when the stock is finally disposed of in a non-wash sale way. You can avoid the rules entirely, though, by always waiting 31 days before jumping back into any stock.

Learn more about the wash sale rules and other tax issues for free at www.fool.com/taxes.