One of the primary mistakes I’ve made is mixing trading with investing. This article explains the difference between fundamental (investing) and technical (trading) analysis. Understanding this is important because mixing the two usually leads to avoidable investment losses. You are more likely to pick a great stock when you focus on value.
Hint: Trader vs. Investor.
The problem with trading rules based on technical analysis is they don’t help you make good investment decisions. Take a look at these investment mistakes.
Trading rule #1: Taking profits after a % gain.
❌ Fundamental problem: You miss out on the growth of a small company.
I did this with Roku in 2018, selling on a 100% gain, then missing out on the boom in smart TVs in the years after.
Trading rule #2: Buying at a low technical price.
❌ Fundamental problem: You buy a shrinking company.
I made this mistake with Sculptor (formerly Och-Ziff) in 2016, buying a hedge fund business in decline.
Trading rule #3: Buying/selling at support/resistance.
❌Fundamental problem: You have no idea what you’re buying.
I bought COE education based on a “cup and handle” pattern in 2017. I had no idea of its value (which turned out to be very little).
The Common Problem: Using Price to Judge Value
The problem in these cases was I used the stock price to judge the business’s value. It took me ten years on Wall Street to realize a simple truth: price ≠ value.
When you mix trading (technical analysis) with investing (fundamental analysis), you mix up price and value in your decision-making, which then leads to investment mistakes.
Trading and Investing Focus on Different Variables
“Price is all the information that exists in the market…it’s just what people think….price means nothing other than the equilibrium of liquidity…It doesn’t mean it’s good or bad; it’s just where people agree.”
—John Burbank (Passport Capital)
The key principle: market prices reflect the expectations of people in the market. Traders and investors then use different ways to forecast prices.
Traders focus on price (technical analysis) because it reflects market behavior. They trade on the expected behavior of other traders.
“Technical analysis is a method that organizes this collective behavior into identifiable patterns that give a clear indication of when there is a greater probability of one thing happening over another.”
—Mark Douglas (Trading in the Zone)
Investors focus on value (fundamental analysis) because it reflects the business. They invest in the expected returns of the business.
“Conducting superior, differentiated, non-consensus fundamental research on a business is the cornerstone of successful active investing”
—Rupal Bhansali (Non-Consensus Investing)
This is an example of trading:
At the start of 2020, I held a long position in gold futures. Central banks had signaled an intention to ease in order to target higher inflation. I thought easing meant a lower dollar (vs. other currencies) and therefore, more gold buying. Gold prices were rising, so the trade worked.
However, when the Fed lowered rates in February 2020, gold prices declined. I thought that gold was “acting funny.” So, I closed the trade and took in about a 15% return. When the Fed dropped rates to zero in March, it triggered a market disruption, and gold sold off sharply.
The trade worked because the market pattern (central bank easing = higher gold) held up. Once the pattern stopped working (gold declining with more easing), it made sense to take off the trade.
I was then lucky to get out—I avoided the sell-off that was triggered by leveraged traders forced to raise cash after the surprise Fed rate cut.
This is an example of investing:
In early 2021, I noticed that MSCI reported strong growth in its Environmental, Social & Governance (ESG) business. ESG funds were also attracting lots of capital at the time.
I researched the business opportunities of ESG and MSCI. I came to the conclusion that MSCI had a stronger earnings outlook, driven by the ESG business. Earnings were likely to be above investor expectations.
I modeled a new earnings outlook and estimated a higher valuation level. I used the analysis to recommend MSCI to my clients. The stock worked—it rose nearly 50% over the year and reached this target.
The investment worked because I made a decision based on the change in the underlying business (ESG = stronger earnings), and I estimated the value appropriately (higher earnings = higher value).
👉 If you’re reading this, I’m assuming you want to do the latter (invest). You don’t have time to monitor markets or don’t want to trade. You’d rather learn how to invest in stocks to get better returns.
Also:
✅ Investing starts with business analysis, not chart/price analysis
Here’s how to start.
To shift to an investing mindset: first, stop looking for trading patterns.
Instead, look for business value.
Your new basic framework for looking at a stock:
Think about: 1) how the business makes money and 2) what its earnings could be over the next few years. This is how you evaluate the business value and your potential returns.
The stock price is an indicator of investor expectations. Low investor expectations could mean an attractive investment opportunity, if the value is not being recognized.
💡 Once you learn to look for business value, attractive investment opportunities become clear. Especially for long term investments.
8: The business and the stock are 0% correlated in the short-term, but 100% correlated in the long-term pic.twitter.com/IengTpJdri
— Brian Feroldi (🧠,📈) (@BrianFeroldi) July 17, 2022
Here’s an example of how I found value as an equity research analyst.
Back in 2018, I researched the waste industry. An example is Waste Management (WM), a leading U.S. waste disposal company that owns a large share of the nation’s landfills.
When I evaluated the business, this is what stood out:
- First, business was stable. Sales came from waste volume, inflation, and acquisitions (each about 2%).
- Second, competition was limited. There was a fixed supply of landfills. This meant higher fees (and profit margins).
- Third, earnings were reliable. WM could generate ~10% in annual growth in earnings per share. This attracted a stable investor base.
Put together, these factors meant that Waste Management was more likely than not to increase in value each year. It was a no-brainer to recommend waste stocks like WM to our clients (and these stocks worked for years).
WM has delivered 17% in annual returns in the past ten years!
Leave the price analysis to traders. Embrace fundamental analysis to become an investor.
If you’re serious about getting better returns from stock investing, I suggest you let go of trading (technical) analysis and commit to learning the fundamental investment process.
This means you:
✅ Make decisions based on the risks and return of the business.
✅ Estimate returns based on the value of the stock.
✅ Find stocks that meet your goals through business analysis.
Trading is not the only way to make money in stocks. You’re likely better off avoiding trading analysis and using a fundamental process to pick stocks.
The process summarized:
If you’re excited to learn the fundamental investment process and develop the investment skills to pick great stocks, I’m here to help you!
The Difference Between Trading and Investing
Trading focuses on market behavior. Investing focuses on business returns. Mistakes happen when you mix the two because they focus on different variables to make decisions.
To focus on stock investing, follow this process and think: 1) how the business makes money, 2) what its earnings can be in the future. Valuation and potential returns are determined by those two things.
A great stock pick starts with good business analysis, not chart analysis.
