When trading forex, you will come across the terms technical and fundamental analysis. Technical analysis is a trading style based on volume data or stock price. It is used to identify trading prospects and evaluate investment opportunities. It does this by assessing statistical trends obtained from trading activity. It uses chart trends and patterns, resistance and support levels, and volume and price behavior to detect trading opportunities that have positive expectancy.
Fundamental analysis is a method used to measure a security’s inherent value. It does this by examining correlated financial and economic factors. The idea is to identify numbers that investors can use to compare the current price of a security. This comparison will help them to determine whether that security is overvalued or undervalued.
What differentiates them?
The difference between technical and fundamental analysis boils down to determining a stock’s price and value.
Technical analysis focuses on price action giving you clues on the stock’s demand and supply dynamics. This eventually defines the stock price. Patterns tend to repeat themselves. This is mainly because investors have the same behavior when faced with the same situations.
Fundamental analysis focuses on a company’s value. This eventually depends on the company’s asset’s value and its ability to generate profits. This analysis also focuses on stock value difference and their trading price.
Pros and Cons of Technical and Fundamental Analysis
1. Technical Analysis
A significant advantage is the ability to analyze stocks quickly. You also have the option of automating some tasks, thus saving time. That way, you will be able to draw more ideas and cover stocks from a bigger universe. What’s more, you can use technical analysis to detect price targets. That way, you will make investment strategies that have reward and risk profiles clearly defined.
On the flip side, very few technical analysis approaches can be tested. Many techniques, such as Elliott Wave, are subjective, thereby relying on a person’s judgment. Using charts is also considered to be more of art than science. Moreover, it has frequent ambiguity meaning, two analysts can get different conclusions about a similar stock when they use different approaches. This often results in analysis paralysis.
2. Fundamental analysis
The most significant advantage is this analysis’ ability to educate you about different stock market complexities. That way, you will be in a better position to detect good stock. It also helps when an investor is experiencing stock panic. This is because, when stocks fall, investors can recover quickly owing to fundamentally solid stocks.
In contrast, the fundamental analysis doesn’t guarantee you profit from undervalued stock. It is also time-consuming as considerable effort is involved. This makes it a less feasible option, thereby explaining why it is not used by many.
Using both analysis together
There are many different ways fundamental and technical analysis can effectively be used together. They include:
- You’ll be able to build a stock’s watch list using fundamental analysis and then determine when and if to buy the stock using technical analysis.
- Combining momentum and value is an effective way to pick a stock. Ideally, trading stock on strong momentum but with low valuations has been seen to outperform.
- Using volume and price trends allows you to hold stock until momentum has been exhausted.
- If stocks are trading near to their fair value, chances are the price will trade or consolidate in that range. Even though the fundamental picture won’t change, technical methods can still be used to trade in that range.
If you are looking to invest in companies that aren’t listed, fundamental analysis is your go-to method. However, if the stocks are listed, you will learn quite a lot from those stock’s trading history. Tradeable security’s price is mainly affected by underlying fundamentals. That is why technical analysis has value.
Nevertheless, if you are a long-term investor, you ought to know a company’s value. This will come in handy when selecting stocks you should hold long-term. It will also help you manage portfolio risks and tell you when to withdraw from long price moves.
The future of both technical and fundamental analysis may become immaterial. The reason being, there are currently multiple approaches that are joined with systematic and quantitative investing strategies.