Should You go for a Technical or Fundamental Analysis

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Blending Technical and Fundamental Analysis

People often ask if technical analysis can be used as an effective substitute for fundamental analysis. Although there is no definitive answer whether technical analysis can be used as a whole substitution for fundamental analysis, there is little doubt that combining the strengths of both strategies can help investors better understand the markets and gauge the direction in which their investments might be headed. In this article, we’ll look at the pros and cons of technical analysis and the factors that investors should consider when incorporating both strategies into one market outlook.

The Best of Both Worlds

Some technical analysis methods combine well with fundamental analysis to provide additional information to investors. These include:

1) Volume Trends: When an analyst or an investor is researching a stock, it’s good to know what other investors think about it. After all, they might have some additional insight into the company or they might be creating a trend.

One of the most popular methods for gauging market sentiment is to take a look at the recently traded volume. Large spikes suggest that the stock has garnered much attention from the trading community and that the shares are under either accumulation or distribution.

Volume indicators are popular tools among traders because they can help confirm whether other investors agree with your perspective on a security. Traders generally watch for the volume to increase as an identified trend gains momentum. A sudden decrease in volume can suggest that traders are losing interest and that a reversal may be on its way. (See also: Gauging The Market’s Psychological State.)

Intraday charting is growing in popularity because it enables traders to watch for spikes in volume, which often correspond with block trades and can be extremely helpful in deciphering exactly when large institutions are trading. (See also: Volume Oscillator Confirms Price Movements and The Pros And Cons Of Institutional Ownership.)

2) Tracking Short-Term Movements: While many fundamental investors tend to focus on the long haul, the odds are that they still want to obtain a favorable buy-in price and/or a favorable selling price upon liquidating a position. Technical analysis can be handy in these situations as well.

More specifically, when a stock punches through its 15- or 21-day moving average (either to the upside or the downside), it usually continues along that trend for a short period of time. In other words, it is largely an indicator of what to expect in the coming term. Incidentally, 50- and 200-day moving averages are often used by chartists and some fundamental investors to determine longer term breakout patterns. (See also: Moving Averages.)

For those looking to time a trade or to solidify a favorable entry or exit price in a given stock, these types of charts and analyses are invaluable.

3) Tracking Reactions Over Time: Many fundamental analysts will look at a chart of a specific stock, industry, index or market to determine how that entity has performed over time when certain types of news (such as positive earnings or economic data) has been released.

Patterns have a tendency to repeat themselves, and the investors who were lured (or put off by) the news in question tend to react in a similar manner over time.

For example, if you take a look at the charts of various housing stocks, you’ll often see that they react negatively when the Federal Reserve chooses to forgo a cut in interest rates. Or check out how home improvement stores tend to react when reports of new and existing home sales decline. The reactive move lower is pretty consistent each time.

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In short, by analyzing historical trends, investors can ballpark the possible reaction to a future event. (See also: Why Do Stock Prices Change following News Reports?)

The Downside to Blending

Technical analysis may also provide an inaccurate or incomplete perspective on a stock because:

1) It’s History: While it is possible to decipher and anticipate certain movements based on patterns or when a particular stock crosses a major moving average, charts cannot usually predict future positive or negative fundamental data—instead they are heavily focused on the past.

However, if news leaks out that a company is about to release a good quarter (for example), investors might be able to take advantage of it and this good news will be apparent in the chart. A simple chart cannot provide the investor with crucial long-term fundamental information such as the future direction of cash flow or earnings per share.

2) The Crowd is Sometimes Wrong: As mentioned above, it’s nice to buy into a stock that has upside momentum. However, it is important to note and understand that the crowd is sometimes wrong. In other words, it is possible that a stock that’s being accumulated en masse this week may be under heavy distribution the next. Conversely, stocks that are being heavily sold this week may be under accumulation in the weeks to come.

A terrific example of the “crowd is wrong” mentality can be found in the large amount of money that went into technology shares at the turn of the millennium. In fact, money kept flowing into shares of companies such as CMGI or JDS Uniphase, as well as a number of other high-tech issues. When the bottom dropped out, the money flow into these stocks and the stock markets on which they traded dried up almost overnight. The charts did not indicate that such a harsh correction was coming. (See also: The Madness of Crowds.)

3) Charts Don’t Typically or Consistently Forecast Macro Trends: Charts also are generally unable to accurately forecast macroeconomic trends. For example, it is nearly impossible to look at a major player in the oil and gas sector and decipher definitively whether OPEC intends to increase the amount of oil it pumps, or whether a fire that just started at a shipping facility in Venezuela will affect near-term supplies.

4) There is Subjectivity: When it comes to reading a chart, a certain amount of subjectivity comes into play. Some may see a chart and feel that a stock is basing, while another person might see it and conclude that there is still more downside to be had.

So who is right? Again, there’s no calculation that can be done to solve the argument, as might be the case with fundamental analysis. When it comes to charting, only time will tell which way the markets will actually go.

Bottom Line

Technical analysis can be a valuable tool, but it is important to realize the benefits as well as the limitations before diving in. There is no definite answer about whether technical analysis should be used as a substitute to fundamental analysis, but many agree that it has its merits when used as a compliment to other investing strategies. (See also: The Basics of Technical Analysis.)

Fundamental vs Technical. What Analysis Type to Choose?

A lot of traders believe in either technical or fundamental analysis. The adherents of the former state that the market is a perfect validating machine and all factors (that can affect the asset price and are widely known) are by default reflected in the price chart. It can, therefore, be used on its own in the decision-making process. Those who believe in fundamental analysis pay more attention to the intrinsic value of the asset, which, according to them, is not always taken into account by the market. In today’s article we will take a closer look at both types of analysis and decide which one to choose — if there is at all the need to pick one.

Fundamental Analysis

Fundamental analysis is a method of an asset assessment based on the concept of intrinsic value . The latter is the ‘true’ value of an underlying asset, that is not always reflected in its market price. Indeed, when we say that a stock is trading at a premium/with a discount, we mean that its market price is not identical to its intrinsic value. Economic, financial and political factors are taken into account when evaluating a security from a fundamental viewpoint. The end goal of this type of analysis is to come up with a target price, that can then be compared to the market price. Should the intrinsic price be lower than the current price, it is wise to consider selling the asset. Should the opposite hold true, it is wise to buy it.

Although this method is usually applied to stocks, it can actually be used for almost any asset. In order to evaluate a currency pair (traded on the Forex market), the trader may want to look at the key interest rate, the rate of inflation and the GDP growth rate. All of the above can heavily influence the exchange rate. For stocks, earnings, revenue and their derivatives play the most noticeable role. Warren Buffett, dubbed the Oracle of Omaha, is an adherent of this exact approach.

Here is an example of fundamental analysis and how it works. When Facebook released one of the earnings report back in the days, the market was expecting a 43% increase in earnings, but the company demonstrated only a 42% increase. That and decelerating user growth have resulted in a 20% price decrease of its stock price. Quite a hit! It is worth saying that a suchlike price plunge could have hardly been predicted with the help of technical analysis.

Don’t forget that as not all fundamental factors are quantitative, there can be two opposing interpretations of the same set of readings.

Technical Analysis

Technical analysis, in turn, is based on the use of historical market data, namely trading volume and price . This type of analysis is not particularly interested in intrinsic value and its practical applications. Technical analysts believe that the past performance of the asset, displayed on the price chart, is a better indication of its future behavior than the intrinsic value. This school of thought postulates that patterns can be observed in the behavior of any asset and, most importantly, they tend to repeat themselves over time. Technical analysts, therefore, try to predict the said patterns and capitalize on them.

Since all the important information is openly available on the market (anything else would qualify as insider trading, which is illegal), the price is believed to always reflect “the sum total knowledge of all market participants.”

Every asset, traded on the market, is subject to the basic laws of supply and demand. Low supply and high demand push the asset price higher. Conversely, high supply and low demand push it lower. Technical analysts track the discrepancies between the two in order to predict the future performance of the asset. Over the years, a huge variety of technical analysis indicators were created. Some of them help determine the prevailing trend. The other excel at pinpointing reversals. There is no single best indicator. Each of them has unique features and helps to solve a particular problem.

It can be said that while fundamental analysis pays off on longer time frames, technical analysis is predominantly used by day traders and traders working on shorter time frames.

What to choose?

You may believe that there is one type of analysis that will better suit your trading style, and you may be right. However, as there is no one-size-fits-all technical indicators, there is no right or wrong method to predict future price fluctuations . Better think of technical and fundamental analysis techniques as two sides of the same coin that perfectly complement each other. According to Michael Marcus, an iconic trader who has multiplied his account 2,500-fold over the course of ten years, fundamental and technical analysis should both confirm your prediction for a deal to close in the green. It doesn’t mean that this combination will never fail. Still, the chances for a positive outcome are much higher this way.

*I nformation regarding past performance is not a reliable indicator of future performance.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
In accordance with European Securities and Markets Authority’s (ESMA) requirements, binary and digital options trading is only available to clients categorized as professional clients.

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Should You go for a Technical or Fundamental Analysis?

In the cryptocurrency, Forex or binary options trade sectors, there are several strategies and techniques that may be categorized in two primary ones: Technical analysis and Fundamental analysis.

How does it relate?

When you are to make a choice about either of the two, it is important to have a sound understanding of what they entail and stand for. One of the very basic questions relates to the efficiency of each analysis. However, there are other questions circulating these two types of analyses in the binary options market; e.g. can we conduct technical analysis without the fundamental one? In this article, we overview the two analysis and clear the conceptualization of these analyses.

Let’s Get ‘Technical’, First!

Well, as the name suggests, this analysis has all the technical fancy aspects within it. As a trader, you would find indicators, trend lines, formations, oscillators and more technical jargon in a ‘technical analysis’. It often sounds counter-intuitive and cumbersome but it would provide you with the foundations of binary options or forex strategy building and you would be able to devise a well-researched trading strategy.

One of the underlying principles of technical analysis relates to ‘history’. What this means is that according to technical analysis, history has a tendency of repeating itself over and over again. Therefore, it is fruitful to analyze trends and potential repetitions of patterns in trade market. This insight into the repeated patterns of similar nature, provides a certain margin of safety and edge to the traders while selecting a trade option. For example, if you have observed that X has been often followed by ‘Y’ previously, it is very likely that a similar pattern recurs in near future.

If you are the kind of trader, who has been into trend lines, graphs, indicators, pin bars, or Fibonacci lines, then you wear the hat of a ‘technical trader’. This simply means that you are more specific about the technical aspects of trade. If you translate this aspect in the binary options jargon; it would mean that such strategies usually make the assumption about particular formulas or monitoring tactics, that they actually play a role in improving the chances of a trend movement in a specific direction. A lot of traders go for this analysis type as this provides a weighted predictive value.

Going Back to the ‘Fundamentals’!

This isn’t like the technical analysis; in a fundamental analysis you explore the data related to macroeconomics. For instance, in case that you are considering to trade USD/EUR it would be only wise to stay aware of a piece of information that may be somehow relevant to the USA and EU economic conditions.

You would be interested in the import and export (or the payment balance), the rate of unemployment, political situation, real estate market and the exchange rate of the central bank. This data would offer you a foundation to figure out the final rate and then consider whether the final rate happens to be way too low or high. You can easily adopt this strategy for cryptocurrencies or trading shares.

Which analysis should you opt for?

A lot of traders are looking for an absolute answer to this question and often think that it is an either-or situation. However, the best answer is that it all would depend on the situation. Both types of analyses offer some advantages and have certain shortcomings as well. Let’s take the example of technical analysis, that functions well if you are concerned with a short run trade. So, if you are a trader who is involved in daily trade decisions, then, technical analysis would be best suited to your needs. While, fundamental analysis is best for longer duration.

Basically, everything would rely on the specific type of trade that you are involved in. Being a forex or binary options trader, you must rely on both the analyses and make use of the combined strength and insights. When you are using insights from technical analysis, that doesn’t have to discount all the aspects of fundamental analysis.

When the market is going through extensively volatile period, technical analysis in exclusion may not pay off much. When making use of technical analysis, It is a thumb of rule to never trade during the time of an important news publication. On the other hand, when drawing insights from the fundamental analysis, you need to carefully assess the situation however, never move against a technical pattern of strong nature.

At the end of a trading day, it does not matter whether you have been using fundamental analysis or technical one. All that matters is how much progress and profits have you been able to make. The technical analysis functions best during short periods of time, while the fundamental one is beneficial for longer duration.

Which of two analyses do you put to use most? Share your tips and tricks when using either fundamental or technical analysis, in the comments below!

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