There are two different methods most stock traders employ to analyze a stock as a potential investment and each is a different from the other as night and day. In fact, the subject has caused more than one healthy debate between successful traders and investors and will likely continue do so for quite some time. Fundamental vs. technical analysis, which is the best way to trade? First, I have to admit I am a devout technical analyst. I write about the subject and own a company who publishes a technical analysis stock trading course. I didn’t start out in the stock market that way but gradually came to the conclusion I understood technical criteria better than fundamental criteria. Even though I believe that technical analysis leads to more profit, less loss, and is easier to understand, I do leave room for possibility that there are investors who perform just as well as I do using fundamental analysis.
Fundamental analysis is the study of the financial condition of a publicly traded company. When you visit a financial website such as MSN Money, Yahoo Finance or CBS Market Watch and enter a stock symbol, the information that will be displayed is mostly fundamental criteria. It includes figures such as gross sales, gross profit, sales growth, income growth, net profit margin, debt to equity ratio, institutional analyst recommendations among other various criteria. The fundamental analyst compares these numbers to those of other companies in the same industry group of against the S&P 500 average and decides if the stock is worthy of being added to his of her portfolio.
Many fundamental analysts are buy and hold investors. They’re willing to add a stock to their portfolio and wait until the investment matures, which is different than most technical analysts. Fundamental analysts by nature are patient with their investing approach. They may hold an individual stock for years, allowing it time to gain a return (hopefully) and in some cases reap the dividends the stock may or may not pay.
Technical analysts decide which stock they will invest in based on criteria they see on a stock chart. The technical analyst believes that the stock chart also charts the mood of the specific market. To put it another way, the stock chart gives the investor a peek into the market psychology. While large financial institutions and brokerage houses recommend stocks to their customers based on fundamental criteria, they all have traders on the floor who honor technical criteria on a daily trading basis. You can actually watch technical rules being “obeyed” on an intraday chart as the price forms patterns indicating the stock is losing steam or there is strong buying taking place. These intraday patterns are traded by day traders but the same rules apply to daily charts and allow the technical analyst the ability to read market psychology in charts of many time frames.
The technical analyst uses the daily chart to forecast his or her trades. The different continuation, topping, bottoming and reversal patterns are to numerous to list in this article. Most technical traders buy on a price breakout and sell on the first pullback or consolidation in price. The breakout is forecast on the chart and the entry is strategically timed to a precise buy point. It takes some study and training but the rewards are great and quick.
The technical analyst is usually impatient and not willing to keep their money tied up in a stock for very long. Most usually hold for less than a couple of months, with a couple of weeks being more common. The trade is placed only to “ride the wave” and the position is exited once the wave is over.
If you haven’t begun to trade stocks and are thinking about starting, you need to decide which way YOU feel comfortable analyzing and trading stocks. It’s a personal decision based on what you feel comfortable with. Technical traders are usually a little more aggressive in their approach to trading stocks than their fundamental counterparts. Either way is OK as long as you are willing to put the time into studying your craft.