Fundamental Analysis vs Technical Analysis Trading
by Guest Writer.
Some traders insist on using fundamental analysis (company valuation method) to base their decision-making while others rely on technical analysis (share price movement method). Fundamental analysis is about analysing facts like corporate news, relating to a given asset class while technical analysts are more interested in the price movements of a given asset class, as opposed to the inherent value of the asset itself. As a former accountant I certainly have an interest in both spheres and would say that I find fundamentals have more relevance to running a business, whereas charts and technicals are the tools for timing entry and exit points for the trading of the shares in those companies.
However, I do believe that the two ‘schools of thought’ can co-exist, and be used to complement each other. In fact, way too much emphasis is often made on the notion of Fundamental ‘versus’ Technical Analysis. But surely there isn’t any mutual exclusion between the two? I don’t think the two concepts are arch-nemesis! 🙂 Technical analysis is mostly short-term in nature and is mainly used to identify market opportunities quickly, and take advantage of trading opportunties as they arise.
In defense of those that invest based on fundamentals (the rather successful Warren Buffet being one) the first thing I would say is that a good understanding of the ‘meat and potatoes’ of a company AND the economy, is essential to investing in the medium to long term. Otherwise, you may as well throw a dart out of the window and see where it lands and invest in that…It could land on GKP at 10p…or it could land on Lehman Brothers pre-bankruptcy.
I might be trivializing/simplifying things here, but whilst I have lots of confidence in technical analysis, (personally) I wouldn’t dare put my money into any share unless it had a sound *fundamental* footing. News events can have a significant impact on the success or failure of your positions. From personal experience for instance, a good basis of the fundamentals allowed me to escape the dotcom crash of the 90’s unscathed, as I knew in good time that valuations had FAR outstripped NAV’s and that the continued rise in share prices was little more than a speculative bubble.
A chartist, with all due respect, would not have been able to see the massive sell off coming in the ‘Tech Boom’ until it had already started, or understood the reasoning behind it without at least a rudimentary knowledge of the fundamentals. Of course, many news events hit the market by surprise and it is quite hard to anticipate some types of shocks, however many pieces of newsflow are also scheduled, such as the release of economic data or company profits.
In this instance, one common mistake that traders commit over and over again is to enter a spread trade just prior to an important news release. For instance, you might buy the US dollar and sell pounds just before crucial American employment data is announced. If you know the release is coming and have an insight into what it might bring, placing a spreadbet may well turn out to be a smart decision. Frequently, though, most traders aren’t even aware the announcement is pending, let alone its significance.
However…
I do believe that a good chartist can optimise his success in the markets IN THE SHORT TERM by using charts to predict the movement of prices. He can also analyse history in a better, more methodical manner than the fundamentalist which will give him a good understanding of what one can expect in the future.
Of course, charting is not an exact science of course (which is why it comes under attack) and the chartist is powerless in the face of emerging news (i.e. Friday’s job figures of which he can only hazard a guess). Or corporate news which might influence a stock that day of which the fundamentalist has already thoughtfully anticipated based on his in-depth knowledge of the company.
Nonetheless, it is my belief that certain patterns of the market’s behaviour can (and should) be analysed and in this respect, charting cannot be beaten as it is an excellent indicator of sentiment and direction. Momentum and sentiment matter far more over brief periods than fundamental factors like valuation. I have also seen first hand how charting can help the fundamental investor by alerting him/her to a good entry point in a stock, based upon lines of resistance, support…etc and thereby maximising the investor’s profit.
For short term spread betting trades a good charting knowledge is key, as without it, I do believe that one really is trading blind and relying on luck. Try it, and see how quickly you lose money. Another point in the chartists’ favour is that sometimes fundamental knowledge is not made available to the broad market, and known only by a few – for example company X has missed its profit targets) but one can anticipate it (sometimes) in advance by a dip in the price and other tell tale charting signals and hence be able to plan in good time.
Equally, I often only buy a stock if I see that there is support in place as shown on the chart, no matter how much I like the fundamentals. I have saved a lot of money doing this, waiting for the free-fall to end and not jumping the gun.
In conclusion, key for me as an INVESTOR, rather than a short term SPECULATOR, (and one must make a difference here in this debate) is a sound understanding of fundamentals. But I try to use this knowledge AS WELL as charting knowledge to time my entries and exits and also to warn me of a change in direction of a stock or the market. If I were predominantly a day trader, I would obviously use charts more than fundamentals but would not ignore the fundamentals either.
To conclude, I would like to say that to judge the merits of both strategies discussed, one has to crucially first define whether one is a short term speculator or is a medium to long term investor but one cannot ignore the fundamentals; in these crazy markets technical analysis only goes so far…
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