Trade ideas usually come from one of two sources. Either they are fundamental or technical. Fundamental ideas reflect a change, or more often an expected change, in the fortunes of a company or the broader economy. That may be realizing a higher price for their product, increasing sales through higher demand, or it may be improving margins. Sometimes it is company specific and sometimes it is industry wide. Ideas of a technical nature come from the analysis of charts. Logically, historical patterns in pricing should not have any impact on the current price of a stock, nor any predictive quality. In reality, though, traders and investors pay attention to them, making certain patterns and levels worth paying attention to.
The best ideas, of course, are those that combine fundamental and technical analysis when both point to the same thing. One word of warning here, though; we are all human beings and as such are subject to something that psychologists call “confirmation bias”. In a nutshell this is our natural tendency to give more weight to things that confirm our preformed opinions than we do to things that challenge them. Inevitably a trade idea comes first from one of the two types of analysis and we have to be careful not to simply search for confirmation in the other. That is particularly true when the fundamental analysis comes first as there are many ways of reading and interpreting a chart.
For that reason, when I arrive at an idea by fundamental analysis I look to the chart as much for trade parameters as for confirmation. Recently, for example, I have been looking at Petrobras (PBR). The Brazilian state oil company is an old friend, as some pretty spectacular volatility over the last few years has made it a great trading stock. For those primarily short term trades, technical factors were usually the driver, but now, with PBR looking more like a good long term investment it is the fundamental analysis that is piquing my interest.
First and foremost this is simply a good time to buy PBR. The corruption scandal involving the company that has engulfed Brazilian politics over the last few years is finally drawing to a close, enabling them to concentrate fully on business again. That would be reason enough for many to invest, but there others too.
Obviously, as a State oil concern the price of oil is a big influence on PBR. I am not in the camp that says oil is reverting to $100 any time soon, but nor am I particularly bearish. I think that given the contrary influences, OPEC cuts and increasing demand on one side with increased U.S, supply and doubts about OPEC on the other, staying somewhere around $50 looks the most likely thing for oil in the near future. Relative stability in the price of oil is a good thing for companies in the industry, indeed many would take low volatility over a rapid jump in price as it makes decision making a bit easier.
There is also the direction of the dollar to consider. Petrobras is a non-American company that sells oil on the global market, and therefore the NYSE traded ADR that I am referring to here is doubly subject to currency fluctuations. If the dollar were to lose intrinsic value that would, at the very least, limit the downside to oil prices, but would also make Petrobras’ Brazilian Real denominated profits greater in dollar terms. Both of those things or the prospect of them, make the stock more attractive, and, despite a bounce over the last couple of days, the dollar index remains in a long term downward trend that began at the end of last year.
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As I said above, when you find a fundamental case as compelling as the above it can be hard to look at the chart with an unbiased eye. Sometimes, though, what chart analysis does is just to suggest a logical level for a stop loss, and the presence of such a level is enough to turn an idea into a viable trade. In this case the sustained support for PBR at around $8.60 is an obvious level to use, and a stop at around $8.50 would limit potential losses to less than 10 percent. A simple return to October’s highs would realize a profit of over 20 percent, so the risk/reward ratio of the trade is also in your favor.
This then, is a case where technical analysis could be said to support the fundamental case for the stock, but even if you interpret the chart as negative by placing more emphasis on the medium term downward trend than the short term bounce or long term upward channel, then the chart still suggests a close, convenient, logical stop. That is support enough for me and is why, whichever way you look at it, PBR is a buy at these levels.