Fundamental and technical analysis are two of the most common forms of analysis when it comes to trading. Even though you will meet investors and traders who will swear that one or the other is better, the best results are usually achieved by combining them.

In order to utilize both approaches, we first need to know what they are and how they’re used. 
 

What is fundamental analysis?

Fundamental analysis includes analyzing a certain company and finding out the intrinsic value of the company’s stock. With fundamental analysis, companies are evaluated as if they aren’t publicly traded and current market prices shouldn’t be paid attention to. This leads to buying and selling decisions that are the result of the stock being realistically underpriced or overpriced compared to its fair value.

Even though it’s impossible to evaluate a company 100% objectively, it’s a good starting point. This fundamental analysis approach can also be implemented to analyze other assets like commodities and currency pairs. Each asset has its own factors which affect its realistic price.

Fundamental analysis is based on the competitive and financial position of the company. By looking into the business itself and not just its stock price, investors can get a better picture of the company’s true value. Especially when it comes to long term investing, fundamental analysis can be very useful for value investors who are mainly interested in companies that have something real to offer and whose value on the stock market isn’t overblown.

The highest profits are made when the majority of traders in the market are wrong and they’re usually wrong because they either haven’t done or don’t understand fundamental analysis. Buying an asset when it’s underpriced and selling when it goes all the way up is the tried and true method of making a fortune. Buy low and sell high as they say.

It aims at analyzing the economy as a whole, the industry to which it belongs, business environment and the firm itself. It is a three-phase analysis of:

• The Economy - To analyze the general economic status and condition of the country. It is analyzed through economic indicators.
• The Industry -To determine the prospects of various industry classification, with the help of competitive analysis of industries and industry life cycle analysis.
• The Company - To ascertain the financial and non-financial characteristics of the firm to find out whether to buy, sell or hold the shares of the company. For this purpose, sales, profitability, EPS, are analyzed along with management, corporate image and product quality

 

However, the fundamental analysis also has several disadvantages.

It takes a while to study each company separately and in detail which makes it difficult to evaluate a large number of companies. Even though information needed for fundamental analysis is easily available, it’s best to limit the research to companies within industries which you’re already familiar with.

Also, if you’re a short-term trader, using fundamental analysis exclusively won't be useful to you. Short-term volatility can be caused by many factors which aren’t included in the fundamental analysis.

So, we’ve seen what fundamental analysis is and isn’t, let’s now take a look at technical analysis.
 

What is technical analysis?

Technical analysis differs from fundamental analysis, in that traders attempt to identify opportunities by looking at statistical trends, such as movements in a stock's price and volume. The core assumption is that all known fundamentals are factored into the price, thus there is no need to pay close attention to them. Technical analysts do not attempt to measure a security's intrinsic value. Instead, they use stock charts to identify patterns and trends that suggest what a stock will do in the future.

One of the largest benefits of technical analysis is that it allows quick analysis of assets. It also allows for a certain amount of automation which can save time. This means that you can analyze more assets within a short time period, which is especially important if you’re focusing on daily trading. Technical analysis also helps with determining the relevant targets that the price might reach.

There are several factors that affect the price action in the short term that can’t be detected by fundamental analysis. Observing the charts allows you to determine the marketing psychology as well as supply and demand forces that are affecting the market. It is based on the premise that the price of shares moves in trends, i.e. upward or downward, relying upon the attitude, psychology and emotion of the traders.

Tools used for Technical Analysis:

• Prices - The change in the price of securities is represented in the change in the attitude of the investor and the demand and supply of securities.
• Time - The degree of price movement is a function of time, i.e. the time taken in the reversal of trend will determine the change in price.
• Volume - The magnitude of price changes can be seen in the transaction volume that characterizes the change. Suppose there is a change in the price of shares, but there is a small change in the transaction volume, then it can be said that the change is not very powerful.
• Width - The quality of change in price is gauged by ascertaining if the change in trend is dispersed across many industries or it is specific to a few securities only. It reflects the degree to which changes in the price of securities have taken place in the market as per the overall trend.

However, technical analysis has some disadvantages as well. The main disadvantage is that, while many technical analysis strategies can be tested, many can’t. Strategies such as Elliott Wave analysis and pattern trading are subjective and can prove to be unreliable. That’s why understanding charts is often considered an art form instead of exact science.

Chart patterns also differ a lot when a different time period is considered. It can be difficult to form a single approach when considering the selection of indicators and analysis methods available which leads to analysis paralysis. 
 

Key differences between fundamental and technical analysis

The difference between fundamental and technical analysis can be drawn clearly on the following grounds:

• Meaning - Fundamental analysis is a method of examining security so as to identify its intrinsic value for long term investment opportunities. On the other hand, technical analysis is a method of evaluating and forecasting the price of a security in future, on the basis of price movement and volume of transaction. It identifies what a stock will do in future.
• Relevancy and function - In fundamental analysis, longer periods are used to analyze stocks as compared to technical analysis. Hence, fundamental analysis is relevant and employed more by investors who want to invest in stocks whose value will increase in several years. On the contrary, technical analysis is used when the trade is for a short term only, therefore relevant more for the short term traders.
• Objective - While fundamental analysis aims at ascertaining the true intrinsic value of the stock, technical analysis is used to identify the right time to enter or exit the market.
• Decision making - In fundamental analysis, decision making is based on the information available and statistics evaluated. On the contrary, in technical analysis, decision making is based on market trends and the stock price.
• Focus - In fundamental analysis, both past and present data are considered, whereas, in technical analysis, only past data is considered.
• Form of data - Fundamental analysis is based on financial statements, whereas technical analysis is based on charts with price movements. In fundamental analysis the intrinsic value of the stock can be ascertained by analyzing an income statement, balance sheet, cash flow statement, profit margin, return on equity, price to earnings ratio, etc. However, technical analysts rely on the chart patterns (such as continuation pattern and reverse patterns), price actions, technical indicator, resistance and support, to analyze the future price trends. Here resistance is the point where the investor is of the view that price will not rise further and is ready to sell, and support is a point where the investor is of the view that price will not fall further and is ready to buy.
• Future prices - In fundamental analysis, the future price of the security is decided upon the past and present performance and profitability of the company. As opposed, in technical analysis the future prices are on the basis of charts and indicators.
• Type of trader - Fundamental analysis is done by a long term position trader, while technical analysis is done by a swing trader and short term day trader.

 

CFD traders - which analysis to prioritize?

From what’s been explained previously, a logical conclusion sticking out is that CFD traders should opt for a technical analysis in the first place. And it is what they do most of their research time - one would normally find them glued to their laptops, analyzing the latest share, commodity or currency prices and accompanying technical indicators. This approach is right and justified, but should not be done solely. The truth is, however, that even short term traders can often make good use of at least basic fundamental analysis and knowledge.

A trader who is, for example, trading CFDs in the shares of a particular company should at the very least be aware when that company is to make announcements regarding dividends. He or she should also be aware of any other pending news releases regarding new products or important changes in management.

The reason for this is that any such announcement could have an important and dramatic effect on the share price of the company.

Traders who are involved in CFD trading in a particular industry could do well from studying the key economic indicators for that industry. A simple example is someone trading CFDs in gold.

Not only will the gold price be influenced by specific events which could cause a significant change in the demand or supply of the metal, but it will also be influenced by macro-economic indicators such as GBP, inflation, exchange rates et cetera. Those who trade commodity CFDs should know how important it is to keep abreast of not only events influencing the price of any specific commodity, but also events that would have an effect on all commodities of a particular class.

Given this, in order to optimize the analysis done, and how it reflects one's trade, traders should find a right mix between these two analysis, with their primary focus on the technical part, while keeping up with the basics of fundamental analysis.
 

Conclusion

Price action is determined by supply and demand, as well as market sentiment in the short term. However, the effect of emotions on the market can only be proven by using price and volume information.

Charts also can’t be used to predict whether an asset is underbought or overbought and what its value might be in the future. They only reflect what has happened with the price in the past so they are unreliable for predicting the future over a longer time horizon.

Traders usually stick to one approach while completely discounting the other, which is a mistake. Both analysis strategies have their place in trading and should be used accordingly.

Fundamental analysis is often used for long-term investing while technical analysis is more popular with short-term traders. They can also be combined to maximize the gains in the medium and long term.

 

 

Sources Consulted:

1. Majaski, C. The difference between fundamental vs. Technical analysis? https://www.investopedia.com/ask/answers/difference-between-fundamental-and-technical-analysis/ (2020)
2. Bowman, R. Fundamental vs. technical analysis - Beginner’s guide with pros & cons. https://catanacapital.com/blog/fundamental-vs-technical-analysis-beginners-guide/ (2019)
3. Bettman, J. L., Sault, S. J. & Schultz, E. L. Fundamental and technical analysis: substitutes or complements? Accounting Finance 49, 21–36 (2009)
4. Surbhi S. Difference between fundamental and technical analysis https://keydifferences.com/difference-between-fundamental-and-technical-analysis.