By Stockpickr Guest Columnist Ira Krakow

There are two basic schools of stock analysis: fundamental-based analysis and technical-based analysis.

Fundamentalists research news, analyze financial statements and SEC filings to unearth reasons that the company’s stock is either too low or too high. If the price is too low, the strategy is to buy and hold until the market realizes the company’s intrinsic value. If the price is too high, the strategy is to sell before the market socks our portfolio with losses. In either case, fundamentalists believe that their analytical skills add value, the so-called “alpha,” because the market is not always right.

Market technicians, on the other hand, believe that The Market Knows All, that price movements, as reflected in the stock chart, incorporate all knowledge about a company. They see the market as a giant eBay (EBAY) auction. If there are more buyers than sellers, the price rises; otherwise, the price falls. The alpha is that there is no alpha.

But neither approach gives us the whole picture. A stock’s fundamentals, such as a company’s revenue or profit margin, can be great, while its technical action, as reflected in its stock chart, can be lousy, or vice versa.

Here’s a recent example: Agriculture-related stocks, such as Potash (POT) and Terra Nitrogen (TNH), have been hammered over the past year because of fundamental factors such as the collapse of international demand for fertilizer. However, as this article by Dan Fitzpatrick shows, Potash has had a wonderful chart from early December 2008 till now. Jim Cramer picked up on Dan’s Potash theme, comparing Potash with Terra Nitrogen on his Jan. 11 "Mad Money" show. Although he liked the charts of both stocks, he concluded that Terra was a better choice based on its superior fundamentals.

The Importance of Time Frame

Let’s look at the auto sector, which has also had its share of news. With all of the bailout angst, the price of General Motors (GM) has certainly moved all over the place recently because of a raft of both positive and negative news. When does a piece of news signal a buy or sell signal? Look at its one-month chart, from Dec. 8, 2008 to Jan. 7, 2009:



Source: Google Finance

The letters A through I mark events that affected GM's stock price. For example, H marks the closing of the Moraine, Ohio, plant on Dec. 21, which caused the price to go down, and F marks the rescue loan approval on Jan. 1, which caused the price to go up steadily for a full week.

Is one week of gains a buy signal? Of all the events marked in the chart, which are really significant, and which are short-term catalysts for the stock price? From the one-month chart, the uptrend appears to be firmly in place. But is it really? Let’s look at GM’s three-month chart:



Source: Google Finance

The January rise now seems much more like a blip that, like many up moves these days, can vanish in an instant. We need more than just price movements to do justice to our technical analysis.

Volume Confirms the Price Action

The real key to chart-reading is a stock’s volume. Typically, only a fraction of a company’s stock trades on any given day. Breaking news can cause the volume to spike, indicating increased investor interest. The news can be either positive or negative.

Here’s GM’s three-month candlestick chart, which shows volume trends clearly:



Source: Yahoo! Finance

The chart clearly shows a strong upward move, on high volume, from Nov. 20 to Dec. 1. However, the upward move after Jan. 1, 2009, was on relatively low volume. This is a clue that the move lacks conviction and might be temporary.

Volume confirms the price movement. Savvy technical investors, seeing a move down on strong volume, would have sold before the big down move. A price move on light volume, on the other hand, is usually interpreted as a “lack of conviction,” which means that the trend might not continue.

Some Homework to Hone Your Skills

To exercise your chart-analysis skills, let’s compare the charts of Ford (F) and GM, stocks that tend to trade in tandem with each other because their fortunes are intertwined. Do the following:

Step 1: On Stockpickr, create a portfolio called “Ford vs. GM: [Your Stockpickr Username]". (To create a portfolio on Stockpickr, you'll need to first log in. If you're currently not a Stockpickr member, you can register here.)

Step 2: Add Ford and General Motors to your portfolio. Using your favorite charting site, compare the chart of the price and volume for the two companies over different time periods, including one year, six months, one month and one day. Identify times of high volume and major price changes for each company. Which company’s chart is more sensitive to breaking news? Document your reasoning in the Reason for Picking box.

Step 3: Follow each company’s news for five trading days, observing price and volume changes to see the effect of the news. Is Ford or GM a better way to play the auto industry based on breaking events?

The videos and articles of TheStreet.com's Dan Fitzpatrick are a good place to get a sense of how to time a buy (or sell). Fitzpatrick's "3 Stocks I Saw on TV" videos start with three buy recommendations from either "Fast Money" or "Mad Money" and then analyze the stock charts to identify good entry points.

To summarize, you need to do both your fundamental and technical homework before you either buy or sell. First, do you fundamentals homework. Then, look at the charts as to confirm (or not confirm) your decision. Look at different time frames, such as five days, one month, three months, six months or a year or more, and look at volume to confirm that the price trend is real.

Posted on Jan. 15, 2009