Technical vs Fundamental Analysis, in this article I will break down some of the core differences between the two.
When it comes to making a trading decision, it’s important to take both fundamental and technical analysis into account. However, there are major differences in both methods so the aim of this article is to cover foundations of both theories to provide a clearer view of how these technical analysis methods can affect your trading decisions.
Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a given financial instrument. Fundamental analysts study everything from the overall economy and industry conditions, to the financial condition and management of companies. Earnings, expenses, assets, and liabilities are all important characteristics to fundamental analysts.
Technical analysts, on the other hand,
believe that instruments’ price and volume are the only inputs, and that the
future price movement is based on its past patterns and trend.
Limitations of Technical Analysis
One criticism of technical analysis is that history does not repeat itself exactly, so price pattern study is of dubious importance and can be ignored. Prices seem to be better modelled by assuming a random walk theory.
Another common criticism is that technical analysis works in some cases, but only because it constitutes a self-fulfilling prophecy. For example, many technical traders will place a stop-loss order below the 200-day moving average of a certain pair. If a large number of traders have done so and the pair reaches this price, there will be a large number of sell orders, which will push the pair down, confirming the movement that traders anticipated.
Then, other traders will see the price
decrease and also sell their positions, reinforcing the strength of the trend.
This short-term selling pressure can be considered self-fulfilling, but it will
have little bearing on where the asset's price will be in the coming weeks or
months from now. In sum, if enough people use the same signals, the movement
could be foretold by the signal, but over the long run, this sole group of
traders cannot drive price.
What Assumptions Do Technical Analysts Make?
Professional technical analysts typically
accept three general assumptions for the discipline. The first is that, similar
to the efficient market hypothesis, the market discounts everything. Second,
they expect that prices, even in random market movements, will exhibit trends
regardless of the timeframe being observed. Finally, they believe that history
tends to repeat itself. The repetitive nature of price movements is often
attributed to market psychology, which tends to be very predictable based on
emotions like fear or excitement.
How Is Technical Analysis Used?
Technical analysis attempts to forecast the price movement of any tradable instrument that is generally subject to forces of supply and demand, including stocks, bonds, futures, and currency pairs. Across the industry, there are hundreds of patterns and signals that have been developed by researchers to support technical analysis trading. Technical analysts have also developed numerous types of trading systems to help them forecast and trade on price movements.
Events, economy news releases and
announcements can trigger price movements. On the other hand, participants in
markets can also create trend movements based on their trading psychology,
therefore it’s important not to ignore both sides of the analysis to really capture
the whole market and maximise the probability of profitable trades.
What’s the major Difference between Fundamental and Technical Analysis?
Fundamental analysis and technical analysis, the major schools of thought when it comes to approaching the markets, are at opposite ends of the spectrum. Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a stock. (Christina Majaski, 2021)
The core assumption of technical analysis, on the other hand, is that all known fundamentals are factored into price; thus, there is no need to pay close attention to them. Technical analysts do not attempt to measure a security's intrinsic value, but instead, use stock charts to identify patterns and trends that might suggest what the security will do in the future.
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