Let’s cut to the chase – when it comes to technical analysis vs fundamental analysis – which is better?
Well, when it comes to trading stocks then Technical Analysis is the winner.
When it comes to trading stocks, we do not buy or sell a stock based on a gut feeling. Traders base their buying and selling using technical analysis.
Technical analysis simply refers to the analysis of price, volume, and derivative patterns and indicators. This differs from fundamental analysis, which focuses on the health and performance of the underlying company.
The balance between the two may be thought of in this way: Fundamental analysis can help you decide what to buy and sell; technical analysis helps you decide when to buy and sell.
Lets take a look at the benefits of technical analysis.
1. Technical Analysis is real-time
One of the key sources of fundamental analysis information for most traders and investors is the quarterly earnings report. of course, there are other reports and news releases that may be issued more frequently, but the quarterly new tends to be dominant.
Based on events and performance of the previous quarter, the company compiles their results and that becomes the basis of the quarterly report. Now consider that by the time you read the report, a few months or longer may have passed since the occurrence of those events.
In other words, the key reports that you rely on for fundamental analysis are lagging the events that drive the reports by weeks or months.
Compare the time lag that is inherent to fundamental analysis with the real-time nature of technical analysis. Technical analysis starts with price an volume, which dynamically update with each trade. A a trade occurs, the price and volume instantly reflect the new information. For that reason, technical analysis is a much more responsive analysis for traders.
Price and volume are expected to reflect all that the market knows about a company’s news, expectations, performance, and so on. Although an individual trader may not know about pending litigation, poor sales or any of the other factors that may be influencing a company’s fundamental position, the market as a whole will absorb and process this information and reflect the collective consensus through the price charts.
In effect, the fundamental analysis of the market as a whole becomes distilled into real-time technical analysis for the individual trader.
2. Technical Analysis is Simpler
The bread and butter of technical analysis is price and volume. Price simply reflects the current price that a buyer and seller agree on for the trade. Volume is typically a cumulative number that resets after each trading session. When a buyer agrees to purchase 1,000 shares from a seller, the transaction is complete and the total volume for that day rises by 1,000 shares. These concepts are very simple and straight forward.
Beyond price and volume there are a handful of relatively simple technical concepts such as price gaps, support, resistance, and trends. These help the trader determine price direction, momentum, and other key factors that make up the technical analysis.
Beyond the relatively simple concepts, there is a variety of other advanced technical indicators and concepts. The main point here is that primary aspects of technical analysis aren’t dependent on complex concepts; they rest on the basics.
With fundamental analysis, there are various financial and accounting metrics that feed into a complete analysis. Furthermore, it is incumbent upon the investor to calculate how these metrics will ultimately translate into price. After all, profit or loss from a trade is entirely a function of the difference between the purchase price and the sales price.
So although it is often useful to understand the fundamental dynamics behind the company, the trader still must decide how that will influence the stock price. For example if you’ve looked at the price/earnings to growth (PEG) ratio, what can this tell you about the direction of the stock price? Compare that to a simple candlestick chart gives a simpler and more immediate indication that the buyers are in control for a short-term uptrend.
3. Technical Analysis is More Responsive
When a trader is choosing the correct balance between fundamental and technical analysis, the trader’s trading time horizon should be considered. As a general rule, the longer the time horizon for the trade, the more important fundamental analysis is. In contrast, the value of fundamental analysis diminishes as the time horizon shortens. Short-term day traders rarely, if ever use fundamental analysis.
Earnings per share (EPS) really has no influence on where the stock price will in in 15 minutes. Therefore, technical analysis is the primary tool for determining strategy and execution for short-term traders.
However, don’t misunderstand that long-term traders and investors then should use fundamental analysis to the exclusion of technical analysis. Though day traders find little use for fundamental analysis, the other end of the time horizon is different.
Long-term traders and investors can use technical analysis very effectively to complement their fundamental views. Technicals can help with identifying a trade candidate through fundamental analysis, technical analysis can focus on the best timing for executing the trade.
4. Technical Analysis Shows What Traders Doing, Not Just What They’re Saying
There is an old saying, “Pay attention to what they do, not what they say,” is never more true than in the markets. Words are cheap, but actions reveal the truth more accurately.
Today’s market is full of news programs, articles, web sites, and trading rooms that are always full of opinions and analyses from all corners. A CEO will appear on a CNBC interview and give a variety of reasons why his company’s stock should outperform the market. Also, gurus are always offering a bullish or bearish assessment of a stock price. In short, everyone has something to say about a particular stock.
The beauty of technical analysis is its dispassionate delivery of facts. Every TV news program may be talking about reasons why a certain stock should be falling, but if the charts continue to show an uptrend with sustaining volume then the fact remains that buying pressure exceeds selling pressure.
Never lose sight of an important tenet of mass media programming: Market shows are in business to make money through building their audience, which then commands greater ad revenue. Market programs are not successful because you become more successful as a trader. Therefore, your success in the markets is incidental to their success. If the tv program can capture your attention, work your emotions, and connect with you as a trader, the information and analyses they offer are secondary. The best analysis for your trade is up to you.
5. Technical Analysis is essential for managing risk
Traders cannot effectively manage risk without an understanding of the basics of technical analysis. This is partly due to the fact that technical analysis is real-time, whereas fundamental analysis has built-in time lag.
Information flows too quickly these days for you to expect t hat you can respond to news or shifting fundamentals before the rest of the market. Technical analysis is a real-time monitoring system to alert you when it’s time to exit the trade.
A proper analysis of price targets for both profit and loss. If the trade moves against you, you have a precise point at which you’ve determined in advance that you’ll exit the trade for a limited loss.
Risk management based on technicals then becomes a binary decision. If your analysis tells you that support is at $40 and your exit (stop order) is at $38, then anything about $38 keeps you in the trade. If the stock is trading at $38.01, you don’t worry and fret over your next move; you stay in the trade. At $38, you don’t start to rationalize why you should or shouldn’t exit the trade. You have a plan based on an analysis of the charts and you execute without hesitation. Without technical analysis, tat precise price at which you exit a trade to limit your losses is little more that a guess.