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Technical Versus Fundamental Trading: Which is Better?
Provided by guest contributor Jennifer Gorton from Forex Traders
There are two general approaches to trading financial markets: technical and fundamental. There is an old-age
debate in the trading world regarding which method of analysis is more accurate and, most importantly, profitable.
True technical extremists are convinced that technical analysis is the only way to trade financial markets, while fundamental
extremists are convinced that fundamental analysis is the only way to trade financial markets. The reality of this debate
hits home in Jack Shwager’s best-selling classic, Market Wizards.
In the early 1980’s, Schwager was a struggling trader. He had turned $10k into more than $100k on 2 separate occasions,
but each time, he had lost all of his profits. He came up with an idea that would eventually serve to help thousands of traders
around the world. Schwager decided to interview 20 of the best traders in the world in order to discover the secret to trading success.
The result was the book Market Wizards. Market Wizards contains in-depth interviews with the world’s top traders, and Schwagers book
has been cemented as a classic because today, 25 years after the book was written, some of the traders Schwager interviewed are still
the largest and wealthiest traders in the world.
Jim Rogers and Ed Seykota are two traders interviewed in Market Wizards. They represent this age-old battle between fundamental and
technical analysis. Jim Rogers is famously known for stating he has never met a rich technician, while Ed Seykota is known for saying
he always lost money as a fundamental trader; in fact, according to his own testimony, he did not start making money as a trader until
he became a technician. Thus, you have two of the world’s top traders
saying that there is only one way to trade, and each of them is
trading in different ways! So, what is the truth? In this article, we will break down the basic elements of each.
Fundamental Analysis
Fundamental analysis is the economic and financial analysis of a security. This analysis can be both macro—global economic analysis,
industry analysis, regional analysis, etc—and it can be micro—company financials, balance sheets, cash flow, etc.
A fundamental analyst will conduct heavy amounts of research concerning specific security and then arrive at a trade decision. Fundamental analysts
operate on both the short and long side of the market.
Pros
A true fundamental analyst believes that fundamentals are what sets price, so by investigating where fundamentals are headed, one can
predict where price will be headed. This type of analysis can get a trader into a trade very early.
Cons
This type of analysis is very difficult for a small, private trader. Most firms that trade based on fundamental analysis have
an entire team of analysts and traders making these decisions. They also have access to information and news that small, private
traders do not. Therefore, relying completely on fundamental analysis as a small, private trader is a significant challenge.
Also, Jim Rogers is famously known as saying he is a horrible market timer. A fundamental trader may oftentimes get into trades
much too early, which will cause him to undergo significant drawdowns, which can be very challenging for most traders.
Technical Analysis
Technical analysis involves the analysis of price charts and other charts that depict economic data. Technical analysis takes
place on a macro level as traders look at long-term price charts dating back decades, and it also takes place on a very micro basis
as traders will look at tick charts where each tick represents 1 second of time. Thus, technical traders range from long-term
position traders to short-term forex scalping.
Pros
A true technical analyst believes that everything a trader needs to know is already stated in current price, so an analysis
of price is the best way to determine possible further direction of a security. A technical trader will rarely if ever follow
economic news since it has little to no bearing on his trade decisions.
This type of trading is very common with small, private day-traders and those who trade for a living. Many people use an endless
assortment of technical indicators that when applied to a chart offer insight into possible future price direction.
Cons
The primary challenge of a technical trader is that economic events can cause very erratic price behaviors. For example,
if a technical trader does his analysis and decides that a specific oil company security is going to appreciate according
to his analysis, then he will enter a long position. However, if that oil company causes a major oil spill or other unforeseen
disaster, then the security will most likely fall sharply, even though the technical picture indicated otherwise. Thus, unexpected
news releases tend to override technicals at times, especially in stock and forex trading.
The reality is that both technical and fundamental analysis work. The key for each trader is finding which type of market approach
most aligns with one’s personal psychological make-up, and that is the type of approach one should adopt.
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