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Technical versus Fundamental Analysis

There’s been an argument ever since technical analysis started to gain in popularity. The fundamentalist argument was that the only real drivers in any market are the value, the true physical value of a given stock, and how well the company has performed over time. Only by studying reports, accounts, P/E ratios and so on, can we ever get a picture of how the company has performed, and where we can expect the price to lead.

Let’s face it, why would anyone ever buy a stock? It’s because of the expected future return. The alternative financial instrument would be putting your money away to earn interest, and because you can do that safely, without risking your capital, you would want a greater return from a riskier investment such as stocks. So on a most basic level, the price of the stock is the amount of money that you would need to give the returns that are expected. If the stock yields dividends, you can get tables of the present value of future money and almost calculate it directly. If there are no dividends, your income is the expected increase in price, which gets a little complicated. In theory, it comes down to what the stock would be worth if the company chose to give dividends in the future, which can become a circular argument so we won’t go into it in any more detail. However, these are the basic principles that are explored in fundamental analysis to determine what the value “should be”.

On the other hand, technical analysts look at the price history, and exam-ine how the market has reacted to given events over time, and, by analysing these changes, we can gauge when certain changes are likely to happen again.

One simply looks at the books and director statements; the other sees how the real market is treating that information, news, events and more in a broader sense, feeling the pulse. I won’t explain which one is which, you should know.

Who’s in the right?

Well, fundamentalists believe that you can only ever truly gauge what a company is doing, by analysing and looking at the accounts, the market and so on. In many respects they are correct. William Hamilton, who wrote in the Wall Street Journal after Charles Dow’s death, and expounded on the so-called Dow theory, believed that specula-tors could manipulate the prices, but that it was not possible to manipulate the primary trend of a stock price. The market reflects all available information, as Dow stated. How-ever, all the time, fundamental data is simply data given on events that have happened; they can’t reflect what the market has been thinking about a given company. The only one that can is technical analysis.

Fundamental data has its place. I won’t argue that fact. As I write this, the world markets are in a state and are trying to recover from what they currently think is the crash that was due. What they don’t realise, is that is just the roll of thunder before the real crash! Personal and company debt is at an all time high, and banks are lending out more money than they have in available funds and assets. Only fundamental data can give us this long term information. Charts can’t provide us this information, we can only see how the market is reacting and we measure these reactions and analyse as a result.

So do we simply ignore fundamental data and use technical analysis for our trading, or are we being foolish if we do? Fundamental data is great for long term trading, or investing, and provided we have a wide enough stop, you can do well, if you have deep pockets and ride the tide created by the intraday, daily, weekly and monthly swings in that trade. In fact, many people that invest in the markets make money (or not) that way.

However, I feel that it’s best to take the information that will reflect on the global markets supplied to us by fundamental data, but use that as an overall global view of the underlying sentiment in the market. Understanding that it is there helps us to gauge any longer term view or expectation with regards to trends. With the timeframe that is involved in typical trading, the primary trend does not result in much change in pricing, only sentiment or the way the stock is viewed can affect the price in the short term, barring any catastrophic events to the company.

Given that we trade shorter term events, and fundamentals look at the longer term view, simply because of their nature, we can still profit nicely from bounces and retraces as a result, but should be mindful of the underlying sentiment in the market provided by the longer term view of the fundamental data.

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