Traders and investors use both technical and fundamental analysis in trading. While the two disciplines are at opposite ends of the spectrum, they can be combined effectively to study and forecast future stock prices.
Today, we’ll look at the differences between fundamental and technical trading and what each of them entails.
So, what is Fundamental Trading?
This is a method used to evaluate a company and determine the intrinsic value of its stock. Under this method, a company’s market prices are not considered.
This technique involves a trader focusing on company-specific events to determine which stock to purchase and when to purchase it. Trading on fundamentals is closely related to a buy-and-hold strategy, rather than short-term trading. This is because the decision to buy and sell a stock is usually based on whether a stock is trading at a premium or discount to its fair value.
While the value of a stock is ultimately an opinion, undervalued firms can, in the long-term, outperform expectations.
Fundamental analysts study everything, including the overall industry and economic conditions. The financial strength of companies is also taken under the magnifying glass. Fundamental analysis can be applied to other markets, like commodities and currencies. In this case, any factors which influence the asset’s value are considered.
What Is Technical Trading?
This method is based on volume data or stock price. Unlike fundamental analysis, technical analysts use volume and price behavior, support, resistance levels, chart patterns and trends to identify good trading opportunities. This method’s objective is to identify the most likely scenarios of the future, not predict the future.
These historical stock trends or price patterns are often viewed as valuable indicators of a security’s price movement in the future by technical analysts.
Other technical analysis signals include momentum indicators, trend lines and simple moving averages.
It should be noted that technical analysis doesn’t take into account the economics that impact a firm’s value or the underlying business.
Fundamental vs. technical trading: What’s the difference?
The main difference between the two methods comes down to what is used to determine the price and value of stock.
As we’ve explained above, technical trading is mainly concerned with price and volume data, as it gives clues on demand dynamics and the stock’s supply. Investors often behave in the same way in similar situations, which is why patterns are repetitive.
As such, technical analysts are primarily concerned with price action.
On the other hand, fundamental trading considers a company’s value. This is ultimately dependent on the profits a company can generate and the value of its assets. Fundamental analysts are concerned with the difference between the value of a stock, and the price the stock is trading at.
What are the tools used for fundamental and technical trading?
Technical trading uses price charts, which may include candlestick charts, bar charts or line charts. In addition to price charts, some analysts may use indicators like oscillators and moving averages which are calculated from the stock price. Complex analysis frameworks like Market Profile and Elliott Waves can also be used in technical trading.
Contrastingly, fundamental trading’s main source of data is a firm’s financial statements. This includes cash flow statements, the balance sheet and the income statement.
The data obtained from these statements can be used by fundamental analysts to calculate metrics and ratios which reflect a firm’s growth rates, health and performance. Additionally, economic factors and industry data like retail spending and interest rates can also be used to predict future rates of growth.
Ultimately, the comparison of several ratios and models helps analysts to arrive at a fair value.
What are the pros and cons of fundamental vs. technical trading?
From the above, we’ve seen that fundamental analysis involves studying a company to determine the value of its stock. While this method is effective, it is also time consuming. Fundamental trading also doesn’t reveal much about happenings in the short term, yet these can affect the price of a given asset. This is in addition to this method being less precise than most people believe.
Technical trading, on the other hand, allows stocks to be quickly analyzed, which helps save time. The method is also used to identify price targets, which enables traders to develop investment strategies with clear reward profiles and defined risk.
However, technical trading frequently results in ambiguity, which makes it a challenge to form a single view on a stock. Additionally, these trading setups have a low win rate.
Fundamental vs. Technical Trading: Which technique is better?
The debate over which method is better remains unresolved as both methods have merits and demerits.
We do know though that technical trading is better suited for market timing and short-term trading while fundamental trading is useful for long term investments.
Both methods can also be combined to execute investments over the mid- and long term.
A good example of how the two can be used together would be to use fundamental analysis to determine the parts of a business cycle which are most profitable for a firm. Once this is done, technical analysis can then be utilized to confirm anticipated trends.
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