Trading Tip 19: Fundamental vs. Technical Analysis - Which one is better

There are two general schools of analysis: Fundamental and technical.

Which one is better?
Which one should YOU use?

Let’s take a look at the definition of fundamental analysis:

"Fundamental stock analysis requires, among other things, a close examination of the financial statements for the company to determine its current financial strength, future growth and profitability prospects, and current management skills, in order to estimate whether the stock's price is undervalued or overvalued. A good deal of reliance is placed on annual and quarterly earnings reports, the economic, political and competitive environment facing the company, as well as any current news items or rumors relating to the company's operations" (Source: daytrading.about.com)

Wow. Sounds like a lot of work. But is it worth it?

Let’s see how technical analysis is defined:

The basic foundations or premises of technical analysis are that a stock's current price discounts all information available in the market, that price movements are not random, and that patterns in price movements, in very many cases, tend to repeat themselves or trend in some direction.
Therefore technical analysis involves the study of a stock's trading patterns through the use of charts, trend lines, support and resistance levels, and many other mathematical analysis tools, in order to predict future movements in a stock's price, and to help identify trading opportunities.

I believe in technical analysis for a couple of reasons:

• The markets are driven by greed and fear, and not by supply and demand or anything like this.
  An economic report itself is meaningless: It's the traders reaction to the report that moves the market.
  I’ll give you an example in a couple of minutes.
• Price data are more “objective”. You can interpret financial data and economic reports any way you want, but support levels are support levels, and a weekly high is a weekly high. It’s easier to interpret hard facts than financial statements, because many times they might be misleading.
  Example: IBM announces that it will meet the projected sales targets, and the shares drop like a rock, because traders hoped that they will exceed their goals. Another day DELL announces that they will meet their targets, and the shares jump up, because traders didn’t believe that they will make it due to the “difficult economic environment”.
• It’s easier (and therefore faster) to learn technical analysis. You can learn the basics by reading a couple of book, while you need to study micro- and macro-economics to interpret economic reports. And even then you might be fooled by the market.

  Here’s an example that happened towards the end of April 2006:
  Oil prices were trading at record highs above $70 a barrel. This increases the costs of energy for companies and assuming stable price levels for most goods corporations make smaller profits. Smaller profits lead to smaller earnings, and therefore the shares of a company should move down.
  But look at the market: On the day oil prices hit a record high the e-mini S&P jumped up 20 points, and the Dow was trading at the year’s high.
  The reason for this strange behavior: On that morning the Core PPI was release and rose only 0.1%. This led traders to the conclusion that higher energy costs have less influence on prices than expected. That spurred optimism, and prices rallied. Just looking at fundamental the market should have moved down, but the trader’s reaction to a certain report moved the market up.

For these reasons I recommend that you take a close look at technical analysis. Keep in mind that big trading companies like Goldman Sachs are employing analysts with PhDs in economics, and you shouldn’t expect to be smarter than them.

But looking at the price chart and using technical analysis to determine future price movements levels the playing field and provides you with a fair chance to make money in the markets.

More free information how to succeed with trading systems