Fundamental Analysis
Fundamental analysis can be used to evaluate various trading instruments such as stocks, indices, currencies, and commodities. Before deciding to buy or sell, some traders want to weigh economic factors like a country's GDP, unemployment rate, company profitability, and industry health. These are all fundamental data.
Taking stock trading as an example, fundamental analysis can be used to assess factors such as company performance, news reports, and industry conditions. For instance, a trader using fundamental analysis as part of their trading strategy is trying to determine how the stock of XYZ Airlines might perform in the coming days, weeks, or months. To do this, they have to consider factors that might affect travel in the industry where the airline operates, such as oil prices, tourism data, or even political unrest. This is because rising oil prices would make flying more expensive for airlines, while political instability could hinder tourism, ultimately affecting profitability and the company's stock price.
Technical Analysis
Those who only look at price charts are known as technical analysts. They believe that all the information you need to know about a specific asset, whether it's a stock, forex currency pair, or commodity, is already reflected in the price. Technical analysts plan their trades and investments based on price trends, chart patterns (such as head and shoulders), and more mathematical chart indicators like moving averages.
For very short-term trading, it could be said that most people tend to use charts. One obvious reason for this is that many traders are looking for relatively small moves, and while we may now have access to more news than ever before, there aren't that many major news stories appearing all day long that continue to impact the markets.
Choosing Between Technical and Fundamental Analysis
As a new trader, which route should you follow? Which approach is best? The honest answer is both! It's possible to make money using only technical or fundamental analysis, but perhaps there's a happy middle ground where a mixed style can yield the best results.
It's certainly worth paying attention when important fundamental news is released. At the very least, even the most chart-focused traders should be aware of when central banks around the world are announcing interest rates or other policy decisions. Add to this the release of major data such as unemployment figures, which can really move markets. Ignoring these data releases can be costly, as market volatility often increases.
If everyone is expecting a big change, such as a rise in interest rates or higher-than-expected unemployment, it could mean that a few words can send a chart pattern in a completely different direction. But traders can use charts after the data release to see if sentiment has really changed or if the burst of volatility was just a five-minute wonder.
If the trend on the chart reasserts itself after some unexpected news, then clearly the market doesn't think the news was really that important. Chart-watching traders also have an advantage over those who only follow the news and are convinced the market should be reacting differently, which can often be a dangerous approach.
Risk Management
Risk management is another area where technical and fundamental approaches can be used together. Economic news may tell you that market attitudes towards a financial asset are changing, but it doesn't necessarily indicate when your view of the market is wrong. For example, traders focused on fundamental analysis could manage the risk of adjusting their market view if it ultimately proves incorrect by combining the use of traditional chart points such as support levels and trends.
A mixed approach can also help confirm trends. For instance, if most people expect interest rates to rise but they actually don't, the currency of that particular country usually falls. If the currency continues to rise, it may indicate that other factors are at play and the interest rate factor isn't important. Technical traders can still use the market's reaction to fundamental news.
It's perhaps to be expected that there's no clear-cut answer, and the debate between fundamental and technical analysis approaches will certainly continue.
As always, there's no method that guarantees we'll always be right. But there are many different and profitable trading strategies, whether purely technical analysis, fundamental analysis, or a combination of both. The key is to find an approach that suits your unique trading style.
