Today I will discuss the difference between technical and fundamental trading. First of all, technical trading based on technical analysis or technical trading is mainly concerned with the price movement of a security using the charts and technical studies to predict potential price movements. While fundamental trading, looks at fundamental analysis mainly based on specific economic factors, or “fundamentals,” which makes up the basis for fundamental trading.
Fundamental analysis looks at specific financial data of the company behind the stock to determine whether the company’s business activity will result in a higher or lower stock price. This financial data would include company revenues, profits and losses and business trends, as well as growth factors that will affect the future stock price. Fundamental analysis may also look at broader macroeconomic factors such as the business sector and the overall economy in relation to a company’s area of business. Fundamental analysis is geared toward understanding the company behind the stock. Some of the specific factors fundamental traders focus on when doing fundamental analysis are can be broken down into 2 general categories:
- General economic factors such as Supply and Demand and other economy new and specific industry factors.
- Specific data including such things as Price/Earnings ratios, Price/Sales ratios, Price/book value rations, etc. Profitability: looking at gross sales, gross profit margin, operating margins, earning per share, and net profit margin. Also, factors like growth rates, Potential revenue growth, financial strength, returns on investments and return on assets. Sometimes these many company specific factors are complicated and difficult to understand.
Fundamental Trading is generally reserved for more of a “buy and hold” style of trading as the investor is looking for long-term value.
Technical trading on the other hand looks at price action using charts patterns and technical indicators to determine potential price movements. The theory behind technical trading is that all information about a stock is built into or factored into the share price and therefore analyzing the price movements will help predict where a stock price might go.
Technical analysis is appealing to more of a shorter-term swing traders as opposed to fundamental longer term buy and hold strategies, and has become more popular in recent years, due the fact that trading systems can be developed with a specific set of rules to trigger buy and sell orders. There is also a wide range of indicators for a trader to choose from, allowing the trader to set up a trading system to fit his or her trading style.
In conclusion, there is a place for both kinds of analysis in short-term trading, I definitely prefer a technical approach to trading, where you can analyze price movement and be in and out of the market, as opposed to longer term fundamental trading which leaves you investing for longer term moves based on fundamental values. With Technical Trading you should use a trading plan based on charts using simple technical indicators, but also maintain an awareness of basic fundamental factors, especially broad economic factors, which may affect a specific stock or specific industry that you might be invested in.