Preface

Fundamental Analysis: The study of company-related data as an aid to investment decision making

Rational Analysis: The juncture of the sets of technical and fundamental analysis1

Technical analysts believe that all useful information is already impounded in the price structure. Therefore the best source of information is the price structure itself. Fundamental analysts estimate the worth of a share based on company and economic factors and compare their estimate with the market price. If there is a sufficient discrepancy they act. In essence, technicians believe that the market is right, while fundamental analysts believe their analysis is right.

It is important to keep in mind that the stock is not the company and the company is not the stock. Though there is a relationship between a company and its stock, the connective tissue between the two is primarily psychological. Traditionally it is thought that a companys fundamentals ultimately determine the stock price. Here are a couple of counterexamples: A falling stock price can hurt a company. If key employees with stock options see the price plummet, they may go elsewhere in search of better compensation. Or even more damning, a falling stock price may prevent a company from getting the financing it needs to stay alive. No matter what the case, those investors using Rational Analysis have the upper hand, as they understand both the stock and the company.

Preface

At the end of the day it is the combination of technical and fundamental analysis that best paves the road to investment success. Employing such a combination creates an environment within which the investor or trader can make rational decisions, an environment in which emotions can be kept under control.

Emotions are the investors worst enemy. Did you ever sell into a panic, buy at the top, worry about being caught in a bear market, or fear missing the next big bull run? Rational Analysis can help you avoid those traps by giving you a reasonable basis to make fully informed decisions. Then, instead of being a member of the crowd, swayed by greed and fear and making the same mistakes time and again, you can hold your head up high as an independent investor acting in your own best interest.

Finally, to start off on the right foot, a definition: Bollinger Bands are bands drawn in and around the price structure on a chart (see Figure P.2). Their purpose is to provide relative definitions of high and low; prices near the upper band are high,

Figure P.2 Bollinger Bands, Deere & Co., 200 days.

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Preface

Table P.l Standard Bollinger Band Formulas

Upper band - Middle band + 2 standard deviations

Middle band - 20-period moving average

Lower band - Middle band - 2 standard deviations

prices near the lower band are low. The base of the bands is a moving average that is descriptive of the intermediate-term trend (see Table P.l). This average is known as the middle band and its default length is 20 periods. The width of the bands is determined by a measure of volatility called standard deviation. The data for the volatility calculation is the same data that was used for the moving average. The upper and lower bands are drawn at a default distance of two standard deviations from the average.

Now that we know what Bollinger Bands are, lets learn how to use them.

John Bollinger