Breaking Down Technical and Fundamental Analysis For the New Trader |
In the 1980’s,
Jack Schwager wrote a book called Market Wizards. This
classic has been a best-seller for over 30 years and is considered
one of the greatest books ever written pertaining to financial
markets. In the late 70’s and early 80’s, Schwager was a
struggling trader. Several times he had turned $10k into over $100k,
but each time he would inadvertently lose all of his gains. This
continuing struggle created an idea. He decided to interview several
of the most successful traders in America and put their interviews
into one book. He hoped that the result of his adventure would be an
understanding of what makes a trader profitable and successful. The
book was a smash hit, and has helped many traders develop winning
habits.
In the book, two featured traders are Jim Rogers and Ed Seykota. Interestingly enough, Jim Rogers says he has never met a rich technician, meaning a trader who uses only technical analysis. Conversely, Ed Seykota says he was never a consistently profitable trader until he discarded fundamental analysis and became a technician. This divergence of views is central to the basic premise of successful trading—your trading approach must be personal to you. There is no 100% perfect way to approach trading. Each individual must find an approach that is perfect for him.
There is an age-old debate in the world of trading concerning how a trader should approach financial markets. Generally, there are two ways a trader can analyze the market and come to a trading decision—fundamental and technical analysis. In this article, we will define each type of market analysis and break down the pros and cons of each. An equity or forex course generally discusses each type of analysis in great detail as well.
Fundamental analysis
Involves the financial analysis of a broad set of factors. On a macro basis, a trader may analyze the geo-political environment, the global economy, domestic economy, and overall sector outlook. On a micro basis, a trader will analyze the company financials including balance sheet, cash flow, etc. Of course, within the broad concept of fundamental analysis, a trader will find his niche and analyze accordingly. Attempting to keep a pulse on everything will only lead a trader to overanalyze and develop what is called “paralysis by analysis.” This is a state in which a trader conducts so much analysis that he becomes paralyzed due to conflicting analysis.
Fundamental analysis serves traders who are more long-term in nature. If a trader is looking to hold a position for a few days up to a period of weeks or even years, then fundamental analysis can be very effective. However, if he is looking to hold trades intraday, then fundamental analysis can be much more difficult because intraday market movements are oftentimes driven by what many market analysts call “noise.” Markets can make rather unexpected moves in the short-term, but over the long-term, the curve should smooth out. Jim Rogers is a perfect example. He says he is the world’s worst market timer, meaning that he gets into a trade as a result of his fundamental analysis, but it is oftentimes very early, and he, therefore, has to sit through large drawdowns before the trade moves in his direction.
Technical Analysis
Involves the analysis of price. A true technical analysis believes that price itself is the ultimate indicator of where a stock is headed, so he uses an endless number of tools to analyze price charts in order to determine price patterns and possible clues concerning which direction price is headed. Technical analysis is very similar to fundamental analysis in the sense that the concept involves a huge amount of possibilities. The number of mathematically-based indicators that traders use to analyze the market is in the thousands. There are common indicators such as moving averages, stochastics, and Bollinger bands, but many hedge funds and large financial firms use technical indicators that are proprietary and no one even knows exist.
Hardcore technical analysts believe that all you need to know is already stated in price; therefore, a simple analysis of price is the best method in determining future price movements. Technical analysis is a bit different from fundamental analysis in the sense that it applies equally well to all timeframes. Technical analysts can trade off 1 second charts or they can trade off monthly charts, while higher timeframes tend to be better for fundamental analysts. A guide to forex scalping can help traders learn to scalp lower timeframes.
Which Is Better?
The truth is that there are many successful traders who use only technical analysis and there are many successful traders who use only fundamental analysis. Thus, one camp is not better than the other. The best camp, in fact, may be in the middle. The best trading approaches are often those that use a good mixture of both fundamental and technical analysis. Thus, you get the best of both worlds.