Both fundamental and technical analysis can provide value to your trading. Which one is best for you depends on a sum of factors, including your goals and risk tolerance.
In this article, we will explain the main differences between fundamental and technical analysis. We will also highlight the pros and cons of each one. Stay with us until the end to find out which type of analysis could work best for your trading style!
Fundamental analysis – what is it, and how does it work?
Fundamental analysis is a method of evaluating an asset’s intrinsic value, known as its true value. Traders often look at the fundamental economic factors impacting stock, currency, commodity, or other assets. Some of these factors could be financial data, industry trends, the economy's status, or even competitors' performance. Generally, these elements are made public following reports, announcements, or news events. That’s why fundamental analysis is also referred to as trading the news.
Let’s look at an example: the Coca-Cola stock. If you want to trade it using fundamental analysis, you could start by analyzing its past financial figures. You can find those by checking the company’s earnings reports. To get a better idea of what to expect from the Coca-Cola stock, compare its economic data with the competitors’. Keep an eye on industry trends, past performance, and the overall health of the U.S economy as well.
Two critical concepts here we need to mention: revenue and earnings per share (EPS).
Revenue refers to the amount of money a company reports during a specific timeframe, usually a fiscal quarter. By looking at Coca-Cola's previous fiscal quarters, you can see whether it experienced revenue growth. This will help you take a bullish or bearish view on its stock.
Earnings-per-share (EPS) is the amount of net income a company earns in a quarter divided by the total number of outstanding shares. Pay extra attention to this stat. It could reveal if a company makes money quarterly or not and if there is potential for growth.
In conclusion, fundamental analysis focuses on the asset's value, not on the market price. That’s the reason why it’s considered more subjective than technical analysis.
Since we brought that into question, let's get into the details of technical analysis as well.
Technical analysis explained
Technical analysis embraces the idea that share price movements often follow a pattern discovered by analyzing prices and traded volumes. Therefore, the technical analysis relies on market prices to forecast what could happen with a particular asset.
Traders use price action data to analyze how the markets have reacted in the past. Based on this information, they try to predict what’s most likely to happen in the future.
Technical analysis adepts use chart patterns and trends, support and resistance levels, and price and volume behavior to spot their trading options.
Relevant factors involved in technical analysis:
• Historical pricing of an asset
• Trading volumes over time
• Industry trading trends – depending on each asset group.
Do you want to learn more about patterns and indicators? Visit the CAPEX.com Trading Academy and watch our educational videos to gain valuable market knowledge!
As you can see, this type of analysis deals with statistics and math. It has nothing to do with revenues, earnings, news, or a country's economy. One of the most important things technical analysts take into consideration is the possible price movement and how the markets have reacted in the past. For this reason, technical analysis could be more suitable for short-term trading.
Fundamental vs. Technical Analysis - differences
Since you now know more about fundamental and technical analysis, it's time to list some of the most important differences between the two:
- Fundamental traders look at the intrinsic value of a company to determine an asset's price. In contrast, technical traders analyze patterns, prices, and volume data to identify trends.
- Fundamental analysis works best as a long-term investment strategy, while technical analysis is more suitable for short-term investing.
- Fundamental analysis relies on economic and political data, news reports, and other industry statistics; technical analysis only employs chart analysis.
- Fundamental analysis suits position traders; technical analysis is preferred by swing traders and day traders (read this article to see which type of trader you are)
Fundamental or technical – which one is better for you?
Overall, fundamental analysis shows its power in long term investments, while technical analysis could be better for short term trading.
With these things in mind, you can decide which type of analysis you want to adopt. There are definite advantages and disadvantages to both. Since we talked about benefits, let's stop for a moment and disclose some of the drawbacks.
For instance, short-term price movements can occur as a result of supply and demand. These have more influencing factors than mere fundamental analysis elements, thus rendering this analysis type less effective in specific scenarios.
On the other hand, you can’t use charts to determine whether a stock is under or overvalued, and its value may be years into the future. Charts are mere reflections of the past, and their value diminishes the longer the time horizon.
At the end of the day, the final decision is entirely up to you. There are several ways you can trade the markets by combining elements from both the technical and fundamental spectrum. But that's a subject for another story, some other time.
Until then, don’t forget to stay tuned to CAPEX.com and follow our featured articles series!
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