Value investing is all about investing in the underlying business and paying attention to the fundamentals. With this being the case, you would be forgiven for thinking technical analysis has no place in value investing.
But that is not the case.
Indeed, several well-known and highly respected value investors have spoken on the topic of technical analysis before, and how analysis of the charts can help make investment decisions as they time the market (another no-no of value investing).
Incorporating technical analysis in value investing
Michael Burry is perhaps the most famous investor to have incorporated technical analysis into his trading strategy. Early in his career, he wrote:
“I prefer to buy within 10% to 15% of a 52-week low that has shown itself to offer some price support. That's the contrarian part of me. And if a stock -- other than the rare birds discussed above -- breaks to a new low, in most cases I cut the loss.”
In some situations, Burry was looking for a bounce from the lows and used a stop-loss in the form of a break of the lows. Walter Schloss favored a similar approach, as shared in "Factors Needed to Make Money in the Stock Market":
“When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it is attractive. Three years before, the stock sold at 20, which shows that there is some vulnerability in it.”
Similar to Burry’s idea the lows of a stock should be respected, Schloss was not happy buying at any price when the stock could fall lower.
Incorporating technical analysis into a value strategy is not an entirely rubbish idea. Even though it might seem like a waste of time and effort, trying to avoid the market’s worst dogs by selling companies falling to new lows repeatedly will likely help you avoid the biggest losers.
Burry has commented on the benefits of using technical analysis many times in the past. He decided to include chart reading in his strategy because “it reflects crowd psychology.” Granted, value investors are trying to run against the crowd, but making use of the crowd to accelerate returns with undervalued stocks is an attractive concept.
Some more comments from Burry on the topic:
“In futures, I learned a lot about TA. The frustrating thing was it worked. You could actually predict the moves. But slippage ate away everything. I was up big at times, never down big.”
“Mainly I use it only to avoid falling knives and to find buy points at very solid support. I try not to use it to sell stocks because my horizon remains long term. With the market this toppy though, I find it hard to ignore when TA says sell after a fast rise. It’s the old take the money and run. It has helped me tremendously, and I have been hurt when I ignore it completely.”
The interesting thing about the quotes from both Schloss and Burry is that neither investor uses technical analysis as the main starting point. They both use the strategy to find a base and avoid the biggest falling knives. A great example: Dryships Inc. (DRYS, Financial) has looked undervalued for years, but the stock has gone nowhere but down since 2008. Selling at a breach of the lows would have kicked you out years ago.
This article is not designed to sway readers either way. Everyone’s investment strategy is different. That said, finding and avoiding value traps is an almost impossible process; you often do not discover a trap until it is too late. Technical analysis can help with this, and it can also be a helpful tool to try and determine when to buy (if you are aware of anchoring bias and how it may impact your investment decisions). I believe this is just one of the many tools value investors can use to get the most from their strategies and achieve above-average returns.
Disclosure: The author owns no stocks mentioned.
