When trading shares, a trader had to apply some form of analysis to the market in order to determine when he will enter and exit a position. In general, there are two types of analysis a trader can apply to share prices — fundamental analysis and technical analysis. In this article, we are going to define each method and briefly discuss the advantages and disadvantages of each.
Technical analysis of Shares
Technical analysis is typically the analysis of share price charts. A technical analyst will use some combination of indicators in order to identify potential directional price bias. There are thousands of indicators that traders can choose that range from more standard and common ones such as Moving Averages, Stochastics, Fibonnaci, etc, to more exotic indicators such as Heiken Ashi candles or the Ichimoku Cloud. New indicators are always being created by traders and programmers alike, and the possibilities are literally endless.
Technical analysis is based on the assumption that historical price data will offer insight into future share price, and this can be challenging because the truth is that historical results are not necessarily indicative of future results. Technical analysis has moved forward by leaps and bounds over the last 2 decades as computer trading models have nearly taken over the financial services industry. Today, quant traders rule Wall Street, and most of those systems are technical-based strategies.
Fundamental Analysis of Shares
Fundamental analysis is typically the analysis of economic data such as earnings report, financial data, and other pieces of economic data. Price in financial markets is essentially the reflection of how traders are perceiving the emerging fundamentals, so by analyzing the fundamentals and understanding crowd psychology, fundamental traders seek to discover supply/demand imbalances and potential shifts in directional bias before they occur.
Fundamental analysis can be very difficult for small, private traders because there is an enormous amount of economic data that needs to be assessed. In larger trading firms, there are generally teams of analysts that are assigned to specific sectors of the economy, and their research is combined in order to offer a full view of the macroeconomic picture. A stay-at-home trader does not have this luxury, however. Furthermore, stay-at-home traders are also often at an informational disadvantage. Typically, they do not have access to information as quickly as larger firms do.
Which Is Better?
Now that we have briefly introduced both fundamental and technical analysis, the next question, naturally, is which is better? Well, it depends on the individual trader. In his best-selling classic, Market Wizards, Jack Schwager interviewed about two dozen very successful traders in order to find out the secrets to trading success. Two traders he interviewed were Jim Rogers and Ed Seykota. Jim Rogers trades strictly based on fundamentals. In his interview with Schwager, Rogers says he has never met a rich technical trader.
On the other hand, Ed Seykota is a technician. In his interview with Schwager, Seykota said that he always lost money trying to trade based on fundamental analysis, and he didn’t become rich until he became a technician. Thus, here you have to extremely successful traders, and each of them sit on the opposite side of this spectrum.
This is evidence that both types of analysis can lead to trading success, and you are not fixed to one option if you want to be the best share trader you can be. The truth is that each individual will most likely gravitate toward one or the other. Many traders, however, will employ a hybrid mix of both technical and fundamental analysis. When it comes to analyzing financial markets, there is no limit to the possibilities of how a trader can analyze the market.