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Fundamental Analysis vs Technical Analysis

By Edited Jan 26, 2016 0 0

Traders have been arguing about fundamental analysis vs technical analysis for years. Realistically, the use of either type of stock analysis can be beneficial if properly used, but not everybody can succeed with them. How is it that some people can use fundamental analysis to make a boatload of money, and others can use technical analysis and achieve the same results, but then there are others that can only lose money with either? Let's take a look at each type, and the possible reasons for failure.

Fundamental Analysis

Fundamental analysis takes a look at a variety of factors to determine where price will go. Financial statements, competition, dividends, and general industry and economic health are some of the elements considered, and judgments are made based on these statements and reports. The idea behind this type analysis is to determine whether the price of a stock is valued too high, or too low.

When you consider cases like Enron, or WorldCom, the shortcoming of this theory becomes fairly obvious. Because the use of balance sheets and income statements are used for a basis of stock assessment, a lot of trust has to be placed in the hands of those that are creating the reports. Generally, I believe that most of these reports are accurate and honest, but there is always going to be a rotten apple around somewhere waiting to ruin things for everybody. Your best defense is to learn as much as you can about financial reporting, and to try to keep an eye out for suspicious reports.

Technical Analysis

Technical analysis takes a different approach in that the fundamentals are ignored, and past price trends are analyzed to try to predict future price movements. Charts are the backbone of this type of stock evaluation. Trend lines, supports, resistances, and chart patterns are just some of the tools that are used for making decisions.

The idea behind the use of technical data is that the psychology of investors can be seen in the prices, and future stock prices can be predicted with a fair amount of accuracy. You may come across fundamentalists who refer to technical analysis as voodoo, but those who use this style for trading take it seriously, and as mentioned above, can have a great amount of success using it. The down side of using only technical signals is that past price doesn't necessarily predict future price movements. And, there is always the possibility of false signals.

Fundamental Vs Technical Analysis: Which is Better?

The important thing to remember with either approach is that they are merely tools, and using them is more of an art than a science. Neither system can produce results that are always 100% accurate. This is where proper money management comes in to play. Regardless of your approach, if you just go purchasing stocks all willy-nilly without money management, then you are setting yourself up for failure. You have to decide which is better for you. If you're comfortable looking for patterns in charts, then technical analysis is for you. If you would rather look at economic conditions, and the health of individual companies, then fundamental analysis would be more up your alley.

So, if both systems are perfectly reasonable approaches that can bring in great returns, then are there people who use them that continue to lose money? In many cases the answer is simply because the trader is under-capitalized. Taking into consideration the necessity of diversification, and the commissions that are charged, you have to have enough to cover the costs. Also, you will surely have periods where you could not pick a winner to save your life. If this happens and you don't have enough money, then you're out of the game before you can even begin.

Another reason that people fail is from a simple lack of discipline when following a trading system, and an overabundance of emotional trading. People will spend a lot of money on learning the systems that the "gurus" offer, but when it comes to actually trading, all of the rules are thrown out the window. I'm sure that you've heard it time and time again, but discipline is necessary to succeed.

Conclusion

In spite of what many people who are trying to sell you trading systems may say, trading stock for a living is not a get rich quick business opportunity. It's legitimate and realistic business opportunity that takes time and effort in order to succeed. To be successful you need to learn about both styles, and use whatever supplements your character. After you learn which type of analysis supplements your character and trading/investing style, you should focus on learning about money management techniques. It will help you become a well balanced trader.

I will say that long term investors seem to prefer fundamental, while day and swing trader tend to like technical analysis. So, determining how long your holding period will be can also play a role in deciding which style to use.

You don't have to be afraid of the markets, but you should definitely take them seriously. You're a small fish that is up against some huge competition. You can succeed, but be ready to work.

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