Technical vs Fundamental Analysis – Which one is best?
Once you’ve decided to trade the financial markets, you need to determine the approach you’re going to use to analyze these markets. Technical analysis and fundamental analysis are among the most important schools of thought when it comes to deciding how and when to open and close a trading position, so you’ll likely be choosing between these 2.
Let’s discover both approaches in this article, their advantages, and their limits, so then you can better decide which one you should add to your trading plan.
What is meant by technical analysis?
Technical analysis is a method used by traders to identify trading opportunities solely based on an asset price action, trading volume, and other statistical, technical, and mathematical data about the price of an asset.
There are 3 main assumptions with technical analysis:
- Prices reflect all the information available at a given time
- Assets always move in trends
- History repeats itself
Support and resistance levels, trendlines, trading volume, and technical indicators, as well as chart patterns, are the most well-known technical analysis tools.
- With this technique, you don’t have to know how to assess a company’s financial health. You only need to learn how to read charts to determine the main trend, key price levels, and chart figures that can help you decide when to enter/exit the markets.
- Technical analysis is a great way to take into account market sentiment and the way it influences phases of momentum.
- This technique improves your timing when you decide to open/close a trade.
- There are many charting and technical analysis indicators and tools available in your broker’s trading platform, which makes technical analysis cheap and easy to use.
- This method can be used with any time frame or financial market.
- As technical analysis is limited to analyzing the price of an asset without considering how the instrument or the industry is truly working, it might not provide all the required keys to understand what’s really happening.
- It takes time to learn how to interpret information on charts, which means that charts can easily be misinterpreted.
- Sometimes, technical indicators send mixed signals, which can cause confusion in trading and investment decisions.
- Many critics of technical analysis do not believe in Eugene Fama’s Efficient Markets Hypothesis (EMH) – they believe that thinking that prices incorporate all available information is a flawed idea.
- History doesn’t always repeat itself. So, the assumption that markets follow a random walk would make more sense.
- Some traders believe that technical analysis primarily works because it is a self-fulfilling prophecy, reinforcing what most technical analysts learn to believe is true.
What is meant by fundamental analysis?
Fundamental analysis takes into account fundamental factors about an asset to determine its intrinsic value, comparing this to its market value to see if it is currently over or undervalued by the market.
Mostly used on the stock market, the fundamental approach uses qualitative and quantitative information about a company and the overall sector:
- the company’s performance per se
- the firm’s performance relative to its peers (sales, profits, revenue, margin, etc.)
- its growth prospects
- its development projects
- its level of indebtedness
- the stock return
- its dividends
- its competitors
- its management team
- the prospect of the industry
- the health of the global economy
- the evolution of the exchange rate and the price of commodities and how they will affect the company
- the regulatory, fiscal, monetary, and budgetary policies in place (or any upcoming changes)
Note – ActivTrades provides great market news that can have an impact on the price of the assets you’re trading. Market analyses, economic calendars, market summaries, in-depth analyses, videos – we give you all the keys to be on top of what makes the market move on a fundamental level.
- Fundamental analysis is a technique that helps you determine long-term trends in a market or industry and which asset to focus on.
- A thorough analysis of a company’s performance and industry truly helps you understand the specifics of a company and its industry.
- This method also helps determine how a company compares to its peers in a given industry, helping you choose the ones with the best potential.
- Because you’re looking to understand the real value of an asset, it is a preferred method to potentially invest in high-earning assets over a long-time with a high chance of success.
- This market analysis technique involves considerable effort and time to do correctly and decide which assets to buy or sell.
- It is mostly used for the stock market.
- Based on reported and publicly available data, fundamental analysis relies on information shared by the management and accounting departments of a company. Therefore, if there is a mistake or the information is wrong, then your decision could also go wrong, as you won’t be using accurate and relevant data.
- You can also misinterpret the financial details of a company and make incorrect assumptions when it comes to a company’s valuation and projected profitability.
- Some critics of fundamental analysis believe that fundamental analysis overly relies on past data, which might sometimes be outdated, especially if the expected growth rate evolves quickly.
- Unexpected changes happening in an economy (war, sanitary crisis, monetary and fiscal policies, significant investment plans from a government…) can have a strong impact on the industry and suddenly affect a company’s profitability.
How to choose between technical and fundamental analysis
While fundamental analysis is all about discovering the real value of an asset through fundamental factors to determine trading opportunities by comparing it to the market value, technical analysis ignores the fundamentals to focus on the price action of an asset to determine in which direction an asset will go next.
There is not a single method that’s better than the other, as you have to decide which one better fits your trading style and strategy, as well as your overall trading knowledge and experience. So take into consideration your trader profile, time horizon, trading knowledge, as well as financial goals before making a decision.
Time horizon and Trading style – Short-term traders like scalpers and day traders rely on technical analysis to take advantage of short-term price changes, while swing traders and position traders might more often use fundamental analysis than technical analysis.
Trading goals – Most of the time, technical analysts try to spot short to medium-term trades to make relatively quick profits, while fundamental analysts are looking for longer-term investments.
Combination of techniques – Some traders and investors also like to use both methods for a combined approach. An investor will use fundamental analysis to spot an undervalued asset and rely on technical analysis to best decide entry points, for instance. However, some analysts seem to believe that technical and fundamental analyses cannot co-exist, as they believe that they are mutually exclusive.
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