Fundamental vs Technical Traders: What is the difference?

Fundamental and technical traders use different methods to analyse and trade financial assets, and two common approaches are fundamental and technical analysis.

In this article, we’ll explore the differences between these two types of analysis.

What is fundamental analysis?

Fundamental analysis is based on the idea that every asset has a fair value. Assets are priced based on rational and irrational factors. Rational drivers include company profits, guidance, and the macroeconomic environment in general, while irrational drivers include overall market sentiment and press reports.

Paying close attention to the rational drivers, fundamental traders seek to identify what can be considered to be the true value of a given asset. They can then figure out whether the true value of an asset is either higher or lower than it is trading for in the marketplace and try to make money from the assumption that it is overvalued or undervalued. If undervalued, they buy, and if overvalued, they sell or wait for the true value of the asset to go down.

When stock trading, a fundamental trader will look at a company’s earnings. When forex trading, however, a fundamental trader will react to macroeconomic indicators, e.g., GDP or inflation, of the nation in question. Shifts in monetary policy will also be considered.

Fundamental trading approaches

There are market insights that can be accessed by traders, and they can make smart trading choices based on economic indicator analysis, interest rates, geopolitical developments, commodity prices, and the economic calendar.

Economic calendar analysis

Traders must stay informed by using an economic calendar which will alert them to upcoming releases that can affect the currency market. Some major economic indicators in an economic calendar are GDP (gross domestic product), inflation, inflation, employment data, and central bank releases. Traders can forecast future market movement and make adjustments to their positions using these events.

Geopolitical events

Geopolitical events may affect the exchange rates, typically leading to greater market volatility and movements of currencies. Trade wars, elections, and natural disasters are just a few of the events that may affect the forex market. Forex traders should be aware of such events and how they may affect the markets.

Macroeconomic events

Macroeconomics deals with the overall performance of the economy and forms an integral part of fundamental trading. Macroeconomics involves the analysis of economic fundamentals, government actions, and global events, which help traders analyse different market scenarios and make rational decisions.

A critical macroeconomic measure is Gross Domestic Product, or GDP, that measures a country’s economic health. “Economists calculate it by measuring the total worth of goods and services produced. Sellers often utilise GDP statistics to measure economic growth which may influence market sentiment and currencies.

Another critical macroeconomic measure is inflation. This is the rate at which the general level of prices of commodities and services increases in an interval of time.

Besides that, policies implemented by a government such as interest rate choices and financial policies may affect the price of currencies. Central banks across the globe usually alter interest rates in order to maintain equilibrium within an economy. Traders must be aware of current policy news because they can highly impact exchange rates.

Lastly, international geopolitical tensions, natural disasters and pandemics can have an impact on the value of different currencies. Traders must remain aware of these occurrences and the impact they can have on markets.

What is technical analysis?

Technical analysis takes into account price action and market sentiment to help determine the future price of an asset.

Technical traders examine the price history of the asset, price action, and volume. While fundamentals focus on returns over the long run, technical analysis tries to maximise the potential of short-term trades.

The main technical analysis tools

Technical analysis indicators are quantitative measures that predict future prices by means of price, volume, or open interest. Most indicators are either momentum or mean reversion indicators.

Volume analysis examines the quantity of shares, lots, or contracts traded in a security or market within a certain period.

Relative strength is a comparison of the performance of an asset to a benchmark, and it helps measure its momentum and if it is outperforming or lagging.

By studying price action with chart pattern analysis traders are trying to find patterns that may represent future activity.

The type of analysis that is used to help traders gauge investor sentiment, direction of the market, and trend reversals through the use of candlestick charts is called candlestick pattern analysis.

Traders graph horizontal support and resistance lines on a price chart to mark points where an instrument’s price may halt or reverse.

Technical analysts use trend analysis to predict future asset prices based on past and current price movements Trend analysis is based on historical price information, such as price movements and trading volumes.

Advantages and disadvantages of fundamental and technical analyses

A combination of fundamental and technical analysis can be useful for traders. Technical analysis is more short-term, thus more suitable in analysing markets in shorter periods, unlike fundamental analysis which is more suited for longer term trading.

Advantages of fundamental analysis

Fundamental analysis uses common valuation ratios, terms and metrics which are easy to understand and apply.

Fundamental analysis allows traders to compare stocks directly with each other, or examine different companies’ economic performance and speculate on the future outlook.

By using fundamental analysis, it is possible to create models that can estimate valuation and forecast future earnings revenues and other financial data.

Downsides of fundamental analysis

Most components of fundamental analysis are derived from historical information that is only revised several times a year. For instance, with corporate earnings statistics this is quarterly. Another choice for data to use besides historical statistics is to employ future projections. But the longer into the future, the more inaccurate these are likely to be.

Fundamental analysis becomes increasingly complex the further you go down, especially when looking at balance sheets and cash flow statements.

Benefits of technical analysis

Technical analysis is applicable to an asset’s price in real time, as its price varies.

Moving averages and other such technical indicators can be placed over a price chart to provide a more complete view of the action of the price and direction of the market for a particular stock or other asset.

Beginner traders can easily master and utilise basic technical analysis techniques. It offers a means of understanding the markets and making forecasts about future price changes.

Technical traders believe that charts hold all the information one needs to price and trade a security.

This is based on the assumption that a price chart encapsulates the collective trading, intentions and mood of all market participants at any moment in time. It distils trader psychology, order flow, support and resistance into one graph. In addition, it can reflect important signals like breakouts and failure points in the price action.

Disadvantages of technical analysis

While there are solid rules and well-understood patterns on charts to watch out for, much of technical analysis is interpretative. It is opinion-based, dependent upon the perspective of the individual trader or analyst, especially when trying to speculate what is going to happen next.

Technical analysis has been praised for explaining past price actions but found lacking when forecasting the future.

Disclaimer:
This information is not considered investment advice or an investment recommendation, but instead a marketing communication.