Most traders and investors use technical or fundamental analysis when deciding to enter a transaction. For tens of years there has been a debate about which of these analyses is “correct”, which one gives the best signals, etc. There is no definite answer and most likely never will be. Let’s look at the examples and learn about the pros and cons of both methods.
Fundamental analysis
Supporters of fundamental analysis try to predict future price changes based on macroeconomic, political, monetary and credit factors. It is possible to study only a few, or dozens of indicators at once: GDP level, unemployment, growth/decline of business activity, change of consumer demand, reporting of companies. If you dig deeper, these indicators can be compared with those in other countries.
Examples:
- Every announcement by the Central Banks about the easing of monetary policy leads to a fall of this currency against most other world currencies.
- Growth of oil reserves in storages or increase of production leads to a drop in oil prices
- If the government of one of the countries resigns, the stock market of that country falls
- If a particular company issues an unexpectedly good quarterly report, its shares rise
It is important to emphasize that this is how the market works in theory, in practice it is much more complicated. Especially when different fundamental factors contradict each other. Fundamental analysts try to predict in advance the events described in the examples above and enter the deal before they occur. You can be up to date, when it comes to economic indicators and new releases with the economic calendar on the website of Bernstein Bank.
Advantages of fundamental analysis:
- Fundamental factors usually last a long time. Falling or, conversely, fast-growing economy cannot turn quickly in the opposite direction. So, if you have entered into a trend based on your fundamental analysis, then this trend can last for months and years
- The opportunity to find undervalued assets is, first of all, about the shares of individual companies. Only 3 largest American stock exchanges trade about 7000 shares. Naturally, at any point in time, some of them will be greatly underestimated from the fundamental point of view
- It seems that it’s understandable what’s causing this or that movement. From a psychological point of view, this is a great support, allowing the trader to see the obvious
Minuses of fundamental analysis:
- The main problem of fundamental analysis is that it does not give an answer to the question when exactly to enter and exit the market. Fundamental factors can just shout that you need to buy a currency pair or share, and they will stand still for months
- It is extremely difficult for newcomers without specialized education to use this type of analysis at first. It requires knowledge in the field of economics, politics, ability to study company reports correctly, etc.
- Even if you have entered a long-term deal correctly, you need to keep an eye on the market because of the possibility of new fundamental factors that were not taken into account before
Technical Analysis
Technical analysis studies previous price changes on charts. The same models and figures are repeated at different intervals. Technical analysts believe that the majority of strong movements are based on only two factors: fear and greed. And the story of human stupidity, which gives professionals to earn money, is constantly repeated.
Over the last 50 years, hundreds of different patterns have been accumulated, hundreds of indicators have been written, dozens of price figures have been found, each of which can be studied independently and then applied in trading.
Probably the most famous example is the “turtle strategy”, when a group of novice traders acted according to a strictly prescribed algorithm. It was based on the entrance to the deal with a break-down of the maximum/minimum for the last 20 days.
Every day, traders marked on the chart the level corresponding to the 20-day maximum or minimum for several futures, placed at this level of orders to enter the transaction … and were actually free until the end of the day, if the orders are not triggered. Traders were not interested in the state of economy, growth/decline of retail sales, etc. They just spent 15 minutes a day calculating the chart and that’s all.
Advantages of technical analysis:
- Investors and traders need only look at the chart to understand what is going on with the currency pair, CFD or share
- Many technical analysis methods can be learned in 30 minutes even for a complete beginner in the market
- In most cases, technical analysis takes much less time than fundamental analysis
- Huge choice of possible instruments and indicators
- Simple and understandable timing. Do not try to understand when a good profit or loss report will affect the share price, but enter the deal only when the price has moved in the right direction. For example, it reached a new maximum in 20 days
Minus the technical analysis:
- Technical analysis is very subjective. One person on the chart can see the potential for price decline, and the other for growth. One indicator can give a signal to buy, and the second one can give a signal to sell
- Technical analysis does not give a hint as to why the price is going in one direction or another, you just see a change in the chart
- With the advent of powerful computers, most of the methods and shapes that worked well a couple of decades ago are no longer working.
- Very often technical analysis gives too late signals. For example, about entering a deal by trend. At the moment of entering, most of the movement, which is based on fundamental factors, can be already passed
If you want to benefit from technical analysis check out integrated order- and charting-system Bernstein Bank provides you free of charge.
So what’s better, then? Fundamental or technical analysis? The answer is…better to use both methods together. And to enter a trade only when one method is confirmed by another.
For example, from the fundamental point of view, it seems that the bear market is coming to an end. But it is not known exactly when it will end. Maybe right tomorrow, or maybe in a month. Before entering the deal, it makes sense to wait for confirmation from the technical analysis.
Technical analysts believe that the market becomes bullish at the moment when the price rose by 20% of the last lows. So, we should wait for this confirmation, and only then enter the deal, in the place where the technical analysis confirms the fundamental view of the market.