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How technical analysis and fundamental analysis can help your trading decisions



In the world of investing and trading, it's a dog eat dog world; every single edge you can obtain over your peers should be held on to as preciously as you would hold on to a 500-year-old treasure. Therefore, in order to obtain an edge and to generate consistently profitable trades, having a strategy-approached mindset is a good idea.

Broadly speaking, there are two popular groups of strategies:

1. Technical analysis: uses statistics and a stock's historical performance to forecast future stock prices.

2. Fundamental analysis: tries to predict a stock's intrinsic, or 'fundamental' value, and looks for opportunities where the live price deviates from the calculated intrinsic price.

In this article, we will try to guide you on how to go about getting started with either of these two approaches.

TECHNICAL ANALYSIS

Technical analysis uses historical stock statistics, usually price and volume data, to forecast future prices. In layman's terms, a technical analyst finds a pattern in a stock's data, makes the assumption that the pattern is going to repeat into the foreseeable future, and accordingly places his/her trade in the direction signalled by the pattern.

Technical indicators are frequently used by technical analysts to help make their trading decisions. Popular technical indicators include moving averages, MACD, regressions, support/resistance levels, etc. Technical analysts essentially look for trends in the market. Their basic assumption is that price of a stock already has all information priced into it and that a stock is either always 'trending' up, down, or sideways. Prices move in patterns and price action repeats itself. Charts are frequently used by technical analysts to help make their trading decisions.

For example, suppose a trader notices (usually with the help of a chart) that the previous 25 times, every time stock XYZ trended up 1 per cent, it was followed by a downward trend. Essentially, the trader has stumbled upon a 'zig-zag' pattern: it seems that the market begins to sell the stock every time it trends up 1 per cent. The trader has now created a signal: the next time the stock trends up 1 per cent, he/she will look to sell the stock. Similarly, traders look for other such types of patterns to help make their trading decisions.

One can get started with technical analysis by researching the aforementioned popular technical indicators. Ensure that your trading broker offers charting tools as a part of your trading software. Ask your broker what technical indicators are available and how to go about implementing them.

FUNDAMENTAL ANALYSIS

On the other end of the trading spectrum, we find fundamental analysts. A fundamental analyst is bound to clash with a technical analysis almost as viciously as an Apple user vs. a PC user!

The reasons have to do with the core tenet that fundamental analysts live by: the market cannot be depended upon accurately pricing a stock. While a technical analyst believes that external factors, such as earnings reports, economic news releases, etc. - are immediately and always priced into a stock, a fundamental analyst believes that it takes time for a stock to accurately reflect all market information; hence, when his/her 'calculated' price of the stock varies from the actual price of the stock, he/she can trade and earn a profit. While technical analysis is more associated with traders, who are constantly looking for patterns to enter and exit trades, investors are usually more drawn to fundamental analysis.

The de facto classic example of a successful fundamental analyst is the world-renowned 'value investor' Warren Buffett. Mr Buffett implemented value investing, essentially looking for stocks whose intrinsic value was higher than their market price, and was never afraid to place large, long-term trades on these stocks.

Determining the intrinsic value of a stock is the chief mission of a fundamental analyst. The fundamental analyst will look at a company's profile, seeing when its latest earnings reports were released, what type of news is expected from the company, and accordingly analyse if the market has correctly priced in all this information into the stock's price. Successful fundamental analysts do not shy away from financial statements. Analysts look at a company's revenue, expenses, assets, and liabilities and all other relevant financial aspects of a company. Taking all this data into account, the analyst attempts to understand what the true value of the stock should be.

One can get started with fundamental analysis by researching how stock prices are determined by a market. By understanding how to interpret earning reports, financial statements, balance sheets, cash flow statements, etc., the reader would understand how stock prices move in reaction to these pieces of information. That way, the next time you feel that a stock is under-priced based on what you know about the stock, you can invest in the stock more confidently.

Technical analysis and fundamental analysis are both powerful strategies that investors and traders can utilise to aid their trading decisions. Just like how you might be holding an iPhone while typing away on a PC, it IS possible to utilise both technical analysis and fundamental analysis. One just needs to keep an open mind.