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Marrying a long term fundamental view with a short term trading view: A conundrum

Posted by: Garth Mackenzie Posted on: 2013-08-01


I watch HotStoxx on CNBC Africa (DSTV410) religiously every morning while I am preparing for the day ahead. I find the insight and views expressed by Paul Theron and his expert guests very interesting. There is a great deal of excellent content presented on HotStoxx and in most instances I agree with the views expressed on the show. But the trade of the day of 31 July 2013 (Short British American Tobacco) was a trade that I did not agree with. (Recent HotStoxx videos can be viewed here)

 

Paul made the argument that British American Tobacco operates in a gradually dying industry and that the company is overvalued, and that it therefore does not present a good investment prospect. I agree with this view on a long term basis. I also agree with his view that electric cigarettes are a ridiculous idea and don’t present a realistic business alternative to traditional cigarettes. However in the short term, the trading action of the stock does not suggest that the share is a short. To me it looks more like a long than a short on a short term basis. This got me thinking that this would be an interesting topic to debate: The risks of marrying a long term fundamental view to a short term trading view.

 

Ultimately, fundamentals win out in the long term and share prices will ultimately conform to the long term fundamental principles of earnings growth (or lack thereof). But in the short term, share prices are determined by sentiment, and the collective views of every buyer and seller in the market. To my mind, technical analysis is the best tool to use to measure this short term sentiment. At the end of the day, a share price chart is just a representation of the collective views of buyers and sellers. When buyers are stronger than sellers, the share price will rise, and visa-versa. When you are trading with a short term view, this dynamic between buyers and sellers is all that matters. Long term fundamentals are often ignored by short term trading dynamics.

 

In light of this, I have included my analysis of British American Tobacco with this blog post. I first show a long term weekly chart of BTI, and then a shorter term daily chart.

 

The weekly chart shows that the stock is in a well-defined upward trend, and it has spent the past two months consolidating in a controlled fashion. These consolidations are healthy within a rising trend and there are many examples of these brief consolidations over recent years while the share price has been chugging higher. The bottom line is that on a long term basis, buyers are clearly the stronger force here, and as a result the share price is in a rising trend. There is a well-known saying in financial markets: “The trend is your friend”. Basically what this means is that you have better odds of success by trading in the direction of the trend, rather than trying to fight it. By shorting a stock that is in a rising trend, you are effectively fighting against  the stronger force. This is equivalent to trying to swim upstream in a river. You may get somewhere, but it’s unlikely and will be difficult.

 

The short term daily chart more clearly shows the consolidation of the past two months. This has been a very gradual, healthy consolidation. These are normally bullish within an uptrend as they allow the buyers to reload and buy in again. The stochastic is turning up from oversold territory and the share price is breaking above the downtrend of the past two months. This is a bullish short term signal and suggests that the buyers are resuming their dominant position in this share. The price has also been down to test an area of lateral support at around R510.00 during this consolidation.

 

To me, the trade here is to buy the stock on this breakout, and to set a stop loss as a convincing break under R505.00. That looks like a much higher probability trade than shorting it now.

 

I know Paul will have a stop loss on with his short trade, and if it is triggered he will exit the trade for a small and manageable loss. That’s a trait of a disciplined trader. But my big question here is whether the trade should have been entered in the first place given that the trading action in the short term is bullish and seems to be in conflict with the long term fundamentals.

 

Please join in the discussion and let us hear your views.

 

By Garth Mackenzie (Founder and Editor of TradersCorner.co.za)

 




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Reply to this post 1 Rudolph Garth, Nedbank Private Wealth just sent an email agreeing with you on the breakout buy signal for BTI... 

Reply to this post 2 AntonK You are right and wrong!. Paul is supossedly the expert and not his guests. He has been "short talking" the stock for the last 3 years. Like he has been buying ABIL from R23 going down!  

Reply to this post 3 Masike Well said. Fully agree with your explanation on both fundamental and technical analysis. 

Reply to this post 4 Johann Robbertze Your reference to a conundrum is apt. The conundrum is, fundamentalists like Paul and most his guests, having to deal with short-term trading positions for the benefit of the show. This will be a recurring problem unless they bring on-board a trader like yourself which could be more beneficial to his audience.  

Reply to this post 5 Paul Theron The trend is your friend, until the bend at the end.. 

Reply to this post 6 Thembani Skoti "The trend is your friend, don't buck it" 




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