THE ACADEMY OF ECONOMIC STUDIES

MASTER DAFI

Relevance of technical and fundamental analysis

of a sector quoted on BSE

Author: Toma Nicoleta

Coordinator: Conf. univ. dr. Laura Obreja Brasoveanu

Bucharest
2009
Introduction
This paper approaches the relevance of fundamental and technical analysis in a
certain sector of activity on the Romanian market. The aim is to determine which one
works better. Technical traders believe there is no reason to analyze a company's
fundamentals because these are all accounted for in the stock's price. Technicians believe
that all the information they need about a stock can be found in its charts.
The different timeframes that these two approaches use is a result of the nature of
the investing style to which they each adhere. It can take a long time for a company's
value to be reflected in the market, so when a fundamental analyst estimates intrinsic
value, a gain is not realized until the stock's market price rises to its "correct" value. This
type of investing is called “value investing” and assumes that the short-term market is
wrong, but that the price of a particular stock will correct itself over the long run.
We‘ll test these assumptions on a specific sector quoted on Bucharest Stock
Exchange. For this propose, we will identify, by analyzing fundamental and technical,
the most powerful companies we should invest in, from each method point of view. We’ll
see which of these methods would lead us to the best result.
It is interesting to see if the companies identified by fundamental analysis at the
end of 2008 differ from those chosen by technical analysis at the same time. If this
happen, we’ll see if until June 2009 the stock's market price rose to its "correct" value. A
positive result would confirm the “value investing” theory.
To implement the database we used the financial statements for the past 5 years
(they are available due to the fact that the companies are listed on the Bucharest Stock
Exchange-BSE), but also information related to these companies available on
www.bvb.ro. I chose this subject because it is interesting to see if technical and
fundamental analyses have maintained some relevance in terms of financial crisis that
distorted capital markets, especially in 2008.

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Literature review
Analysis of financial markets is often divided into these two broad disciplines,
known as fundamental analysis and technical analysis. Both forms of analysis are
different approaches to the decision making process in the context of trading or investing
in financial markets. In general terms, this process is about selecting markets and
instruments in which to trade or invest and timing when to open and close trades or
investments so as to maximize returns.
Fundamental analysis is a method of evaluating a security or asset by attempting
to measure its intrinsic value by examining related economic, financial and other
qualitative and quantitative factors. Fundamental analysts attempt to study everything
that can affect the security's value, including macroeconomic factors (like the overall
economy and industry conditions) and individually specific factors.
The end goal of performing fundamental analysis is to produce a value that an
investor can compare with the underlying assets current price in hopes of figuring out
what sort of position to take with that security (under priced = buy, overpriced = sell).
Technical analysis is a method of evaluating securities by analyzing the statistics
generated by market activity, such as past prices and volume. Technical analysts do not
attempt to measure a security's intrinsic value, but instead use charts and other tools to
identify patterns that can suggest future activity.
The field of technical analysis is based on three assumptions:
1. The market discounts everything.
2. Price moves in trends.
3. History tends to repeat itself.
Below, we review the most cited literature on technical and fundamental analysis:
Technical analysis dates from the late 1800's beginning with Charles Dow and the Dow
Indicator. Most consider the father of technical analysis to be Charles Dow, the founder
of Dow Jones and Company which publishes the Wall Street Journal. Around 1900 he
wrote a series of papers which looked at the way prices of the Dow Jones Industrial
Average and the Dow Jones Transportation Index moved. After analyzing the Indexes he
outlined his belief that markets tend to move in similar ways over time. These papers,

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which were expanded on by other traders in the years that followed, became known as
"Dow Theory". Although Dow Theory was written over 100 years ago most of its points
are still relevant today. Dow focused on stock indexes in his writings but the basic
principles are relevant to any market.
Brown and Jennings (1989) showed that technical analysis has value in a model in
which prices are not fully revealing and traders have rational conjectures about the
relation between prices and signals. Frankel and Froot (1990) showed evidence for the
rising importance of chartists. Neftci (1991) showed that a few of the rules used in
technical analysis generate well-defined techniques of forecasting, but even well-defined
rules were shown to be useless in prediction if the economic time series is Gaussian.
However, if the processes under consideration are non-linear, then the rules might capture
some information. Tests showed that this may indeed be the case for the moving average
rule. Taylor and Allen (1992) report the results of a survey among chief foreign exchange
dealers based in London in November 1988 and found that at least 90 per cent of
respondents placed some weight on technical analysis, and that there was a skew towards
using technical, rather than fundamental, analysis at shorter time horizons.
Lakonishok and LeBaron (1992) analysed 26 technical trading rules using 90
years of daily stock prices from the Dow Jones Industrial Average up to 1987 and found
that they all outperformed the market. Blume, Easley and O’Hara (1994) show that
volume provides information on information quality that cannot be deduced from the
price. They also show that traders who use information contained in market statistics do
better than traders who do not. Neely (1997) explains and reviews technical analysis in
the foreign exchange market. Neely, Weller and Dittmar (1997) use genetic programming
to find technical trading rules in foreign exchange markets. The rules generated
economically significant out-of-sample excess returns for each of six exchange rates,
over the period 1981–1995. Lui and Mole (1998) report the results of a questionnaire
survey conducted in February 1995 on the use by foreign exchange dealers in Hong Kong
of fundamental and technical analyses. They found that over 85% of respondents rely on
both methods and, again, technical analysis was more popular at shorter time horizons.

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Neely (1998) reconciles the fact that using technical trading rules to trade against US
intervention in foreign exchange markets can be profitable, yet, longterm, the
intervention tends to be profitable.
LeBaron (1999) shows that, when using technical analysis in the foreign exchange
market, after removing periods in which the Federal Reserve is active, exchange rate
predictability is dramatically reduced. Lo, Mamaysky and Wang (2000) examines the
effectiveness of technical analysis on US stocks from 1962 to 1996 and finds that over
the 31-year sample period, several technical indicators do provide incremental
information and may have some practical value.
Fernandez-Rodrıguez, Gonzalez-Martel and Sosvilla-Rivero (2000) apply an
artificial neural network to the Madrid Stock Market and find that, in the absence of
trading costs, the technical trading rule is always superior to a buy and- hold strategy for
both ‘bear’ market and ‘stable’ market episodes, but not in a ‘bull’ market. One criticism
I have is that beating the market in the absence of costs seems of little significance unless
one is interested in finding a signal which will later be incorporated into a full system.
Secondly, it is perhaps naïve to work on the premise that ‘bull’ and ‘bear’ markets exist.
Lee and Swaminathan (2000) demonstrate the importance of past trading volume.
Neely and Weller (2001) use genetic programming to show that technical trading
rules can be profitable during US foreign exchange intervention. Cesari and Cremonini
(2003) make an extensive simulation comparison of popular dynamic strategies of asset
allocation and find that technical analysis only performs well in Pacific markets.
Cheol-Ho Park and Scott H. Irwin wrote ‘The profitability of technical analysis:
A review’ Park and Irwin (2004), an excellent review paper on technical analysis.
Kavajecz and Odders-White (2004) show that support and resistance levels coincide with
peaks in depth on the limit order book 1 and moving average forecasts reveal information
about the relative position of depth on the book. They also show that these relationships
stem from technical rules locating depth
already in place on the limit order book.
Fundamental analysis became popular following the Securities and Exchange
Act of 1934 that standardized financial reporting requirements. From 1934 until the

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1990's fundamental analysis became the academic model that most theories and analysis
was based.
Graham and Dodd (1934) are among the first to formally argue the importance of
fundamental factors in share valuation exercises. Subsequent studies further detail the
relationship between share price and fundamental factors, with Gordon and Shapiro’s
(1956) Dividend Discount Model not only becoming one of the most widely cited models
in modern finance theory, but also providing the foundation for voluminous subsequent
research. In the context of the current study, the most notable extension of Gordon and
Shapiro’s (1956) work is provided by Ohlson (1995), who formulates a model expressing
price as a linear function of book value per share, earnings per share and a vector of other
value-relevant information.
Subsequent research invests considerable effort in empirically testing numerous
variations of Ohlson’s (1995) Residual Income Valuation Model, with early studies
invariably lending support to the (positive) dependence of equity values on both book
value per share and earnings per share (see, for example Collins et al. (1997)). More
recently, researchers have turned their focus to identifying variables forming part of
Ohlson’s (1995) vector of other value relevant information.
Specifically, Dechow et al. (1999) augment a two-factor model similar to that
tested by Collins et al. (1997) with a forecasted consensus earnings measure. Fitting the
resultant three-factors model reveals that, while forecast earnings is significant and
positive in explaining price, its inclusion sees contemporaneous earnings ceasing to be
value relevant. Dechow et al. (1999, p 26) suggest this result is not unexpected as
“analysts’ forecasts of next year’s earnings subsume value relevant information in current
earnings”.
In addition to exploring the importance of book values and current and forecast
earnings in explaining price, the literature also considers the value relevance of a suite of
other accounting variables (see, for example, Amir and Lev (1996); and, Amir et al.
(1997), among others), with a comprehensive summary of these findings provided by
Holthausen and Watts (2001). While recent empirical research diverges in its search for
other value relevant variables, there seems little disagreement regarding the

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appropriateness of Ohlson’s (1995) model as a foundation for these fundamental
valuation exercises.
The results of the first study on the Romanian capital market show that 70% of
investors take the decisions following its own analysis. Almost 40% of these use both
technical and fundamental analysis, a third uses prevailingly fundamental analysis and
20% prefer technical analysis. According to this study, the profile of the Romanian
Bucharest Stock Exchange investor is: young man (26-35 years old), graduate of superior
studies, with incomes bigger than the average.

Case study
The sector we chose to analyze is “equipments”, because it contains the largest
number of firms (16) compared to other sectors. This allows a relevant analysis to both
individual and industry level.
The companies listed on BSE which are part of this sector are: Aerostar Bacau
(ARS), Altur Slatina (ALT), Armatura Cluj-Napoca (ARM), Comelf Bistrita (CMF),
Compa S. A. Sibiu (CMP), Contor Group SA, Electroputere Craiova (EPT), Impact
Developer & Contractor S.A. (IMP), Mecanica SA Ceahlau (MECF), Mefin Sinaia
(MEF), Santierul Naval Orsova (SNO), Turbomecanica Bucuresti (TBM), Uamt Oradea
(UAM), UCM Resita (UCM), UZTEL SA (UZT), Vae Apcarom Buzau (APC). We
analyzed 15 of the 16 firms due to the fact that there isn’t sufficient financial information
published for Contor Group SA.
First, we realized a short description of the equipment sector, then we analyzed
fundamental and technical the companies. Fundamental analysis was based on balance
sheets, profit and loss accounts and annual reports published by the companies (we
calculated profitability ratios, liquidity ratios, solvability ratios, asset turnover ratios and
market ratios).
Following this analysis we made a clear picture about the firms and we could
forecast their future price evolution based on PER, PBR and P/S. The results indicated
the existence of opportunities in 2009 to buy or sell certain shares.
We established several criteria to figure out the most powerful companies in this sector:
- In all those 5 years the firms made profit

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 - Average growth rate of profit is positive during the period analyzed
- Average growth rate of turnover and profit are above industry averages
- The most indicators calculated are in normal values
- The price forecast shows that the companies are undervalued

The companies that meet simultaneously these criteria are: ARS, CMF, IMP, SNO,
UZT and APC.
After we realized a more detailed technical analysis of a company, we described
the picture of the whole sector: there are stocks that have followed an upward trend until
mid 2007 and stocks that have been in consolidation to this date, but all were
characterized by a downward trend from mid 2007 until the first quarter of 2009. At this
point the securities are divided again into two categories: those whose signals indicate a
possible reversal of trend and those that still follow a downward trend and don’t have
enough returning signals.
After that, we considered several criteria and we established the strongest companies the
technical analysis indicated:
- Trends by mid-2007 follow an upward trend, because I consider that the market
was growing at that time and downward trends would have represent important issues
that companies are facing with
- MACD is above zero or around this value in early 2009 and forms positive
divergence
- RSI is above the 50 and also forms positive divergence
- The channel breaks the descending trend in 2009 and the moving average
exceeds price
- The analyzed stock is performing better than the BET-C index, even for short
periods
We accept the descending trend started in the second half of 2007 which lasted
until 2009 because it was caused by global financial crisis that has affected all shares of
stock market.
Following graphs analysis, we identified the companies that meet the above
criteria. These are: ARS, CMP, IMP, SNO and APC. I noticed that the CMP, SNO and

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APC performed better than the BET-C index during the entire period analyzed. This
could help us in making investment decisions.

In the table below we have the result of those analyses, the firms that each method
shows as the most attractive:

Fundamental analysis Technical analysis

ARS, CMF, IMP, SNO, UZT, APC ARS, CMP, IMP, SNO, APC

ARS, IMP, SNO, APC

We observe that 4 of the 6 firms chosen by fundamental analysis at the end of

2008 are found after performing technical analysis at mid 2009. This may confirm that
technical analysis incorporate fundamental analysis over the long run. This result
confirm also “the value investing theory” assuming that short-term market is wrong, but
that the price of a particular stock will correct itself over the long run.

Conclusions and proposals

I realized in this paper the analysis of equipment industry quoted on Bucharest
Stock Exchange through fundamental and technical analysis.
The results of this study shows that at least during the financial crisis that hit in 2008 also
Romania, the technical analysis is better than the fundamental one.
We present below the most important findings of this study:
- The forecast of prices shares using fundamental analysis is more accurate if those shares
are characterized by a high volume of trading .
- If an investor had considered only fundamental analysis and had bought any share
indicated by that at the end of 2008, until mid 2009 would have recorded only loss or at
most would have maintained the initial investment.

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- If an investor had considered both analyses, he would have chosen the companies based
on fundamental analysis, but he would not have invested at the end of 2008 when the
technical analysis gave no sign that the market would return; this investor follows the
graphs evolution and will buy the shares identified through fundamental analysis when
technical analysis indicators will confirm the change in trend that loom in mid 2009.
- A very important observation is that 4 of the 6 firms chosen by fundamental
analysis at the end of 2008 are found after performing technical analysis at the
mid 2009. This may confirm that technical analysis incorporate fundamental
analysis on the long run.
- The investor that would have used only technical analysis would have been the
winner: he would not have invested at the end of 2008 and he would have chose n
the same companies to invest in at mid 2009, without using fundamental analysis.
The analysts who prefer technical analysis will sustain that this study has proved
that fundamental analysis is irrelevant, because technical analysis reached the same result
without analyzing fundamental factors. The advocates of fundamental analysis will use
the argument that they identified first the most powerful companies and the market just
reflected in 2009 the good financial results achieved by companies over the 5 years
analyzed.
I believe that the stock market investor (investor, no speculator) should take into
account both analyses: the fundamental to select the shares and the technical to figure
out the best time to enter into an undervalued security. An investor who prefers
fundamental analysis can say that even if he would have lost until mid 2009, further
increases will cover the loss and finally will reach profit. But why to have losses in the
beginning when we can use technical analysis to find the entry on the market? Also I
disagree with using only technical analysis, because there are shares that are not
supported by fundamental factors and following some rumors that prove false later, their
price can fabulous increase a few days, weeks or even months, after which the decrease
returns . That false increasing trend could cheat you if you don’t consider both analyses.
Therefore, the use of both analyses is valid while the stock exchange is not facing with
major macroeconomic problems. Like this study showed us, in moments in which we
deal with a financial crisis, the best is to follow mostly the technical analysis.

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