Viewing the Larger Market Picture
The major difference between fundamental and technical thinking is based on a contrary attitude. Technicians tend to interpret signs—chart patterns and the DJIA are primary examples—and to conclude something about the market from those signs. As a consequence, technicians tend to react as a group and to ignore underlying fundamental information, even when that information is clear. In a sense, technicians are the conformists of the market. They are the voice of the herd.
This is why the majority of professionals are wrong most of the time. They look for signals that have several attributes. First, the signals must be easily and quickly found. Second, they must be clear as to their meaning. And third, the signals must be universally understood by the technicians. There is only one thing missing in this list of requirements: The signals must have some relevance to value and direction of the market.
The fundamentalist, in comparison, is truly contrarian. Not depending on price patterns or the Dow Jones Industrial Average, the fundamentalist who adheres to the fundamental rules will tend to identify trend patterns, to think independently, and to look for exceptional information rather than formula indicators.
In the sense of how information is reviewed, the fundamentalist recognizes that there are no clear, easy signals that everyone will interpret in the same manner. There are no secrets. There are no magic formulas that will provide insight into what is about to happen. The market is preoccupied with trying to outguess the other investors, to get insight on some change before everyone else. How does the fundamentalist use information to succeed in the long term?
The answer is not so much in interpretation of any single fundamental trend. It is with the creative combination of trends that the fundamentalist ultimately outperforms the market and the typical professional. You may set a rule for yourself that you will never act on a solitary source of information, that you will always act on confirmation of trends in two or more dependable indicators.
Example: You may use a combination of six different fundamental and technimental indicators. These may include sales volume, net margin, debt/equity ratio, PE ratio, net earnings per share, and volatility. All of these tests are performed as part of a trend and never alone. You also like to watch the odd lot statistics and overall market volume as a means for keeping an eye on general mood of the market. Your rules include the following standards:
• No decisions are made without being confirmed in at least three of the trends.
•   No hold decision will be reversed until a trend is firmly established in a majority of the indicators being monitored, recognizing that such a change is a departure from the long-term strategy.
•   No buy decision is made for new investments without a stock first being qualified in all of the indicators you watch.
Such a range of generalized rales is valuable because it places structure in your portfolio, and enables you to develop your own signals. You will discover that risk of market loss is dramatically reduced when you apply a series of sensible rules, consistently and over time. Be a contrarian in the very methods you use to develop a risk management strategy. Don't accept the general ideas offered by others if you believe that the combined approach you develop for yourself makes more sense.
r KEY POINT
Setting investment rules for yourself is necessary and smart. Without rules, how do you know how to react to changing conditions?


Also become an avid financial statement watcher. You don't have to become an accountant to comprehend the essence of what is occurring within a company. You will see gradual changes and trends as they emerge over time if you study financial reports and track the fundamentals.
Most importantly, never invest in a new company, or sell a stock you currently hold, solely on rumor or the suggestion of another person. The stock market operates on the fuel of rumor and is generally lacking in a clear direction. The auction marketplace enables a large number of people and institutions to trade efficiently, and it provides a ready market on a daily basis. But it does not offer you order or logic. Because the market operates purely on a momentary supply and demand force, there is no time for careful analysis; the daily decisions about buy, hold, and sell, and about how and why prices change, are made purely in response to ever-changing perceptions. The news and rumors floating around at any one time about a company, an industry, changes in the DJIA, politics, the economy, and other influences, are never ending. You will learn to take refuge in the fundamentals, simply by observing the irrationality of the market. The greatest danger of participating in the market is that you will become attracted to the excitement of short-term profits, speculation, and wild rumor; and that you will find more satisfaction in the frenzy than in long-term profits.
If this occurs, you may protect your capital by segmenting it. Keep the majority in long-term investments and operate on the fundamental. Take a relatively small portion to use for speculation. Try this for a year, and see which approach yields the greatest profits. Try it for two years, or for five years, and test the two approaches again. You can be sure that in the long run, the fundamental approach will be the more profitable one. A short-term spectacular return on a high-risk strategy is difficult to repeat, whereas fundamental long-term investing does work over the years.
rKEY POINT
Contrary thinking can be used for short-term speculative gains, although this is not the same range of techniques as those used by fundamentalists. For example, if you keep a small portion of your portfolio available for speculation, you may act on contrary signals.


Example: The DJIA falls by several hundred points. Many volatile stocks lose 10 points or more. This presents a short-term buying opportunity because as the market corrects from the overre-action seen in the DJIA, those stocks will tend to recover their price loss. Remember, the key advantage here grows from a tendency toward short-term overreaction in the market as a whole.
Example: A rumor begins concerning a company's major product, involving possible litigation or government intervention. If this rumor is true, the company stands to lose money. As a consequence, the stock falls by 35 percent. Again, this presents a short-term speculative opportunity. The market overreacts, so even with bad news, the degree of reaction is usually excessive. While you stand the risk of the rumor being true and the stock falling even more, perhaps even total failure of the corporation, chances are that in the short term, the immediate stock price change will reverse itself, at least to some degree.
Example: A company's stock price is rising rapidly on positive news, and investors are making big profits. However, you observe that the PE ratio is outpacing the news, and that profits are not increasing dramatically. The higher PE ratio is a danger signal when the change occurs in the short term, an indication that the stock's market price is inflated beyond reasonable levels. This may be taken as a short-term sell signal.
Notice that in all of these examples, the contrarian point of view is short term and seems to be high-risk in nature. You buy at a time when the stock's value seems most questionable; you sell when the price is climbing rapidly. It is absolutely contrary to the fever of the market as a whole; the risks are high because the action is speculative. You stand to make big profits, avoid sudden losses, and beat the market. You also stand to suffer big losses, miss out on profits, and end up losing a lot of money while the market as a whole steers clear of the risk. Such is the nature of speculation.
As you can see, contrarians can take the form of long-term fundamental investors, or short-term, high-risk speculators. In either case, the strategy makes much more sense than the more common approach, going along with what most people think. There is greater risk in following what others are doing than there is in thinking for yourself and acting against the trend.