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Fundamental vs technical trading: which route should I take?

As trading attracts a wider audience it's important to understand that there is no right or wrong approach

May 7, 2014 | By:

With more and more people trading online and through apps, Chris Beauchamp, Market Analyst at brokers IG, explains two key approaches to making the most of your investments

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There are two well-trodden paths, but which will best suit your trading needs?

For many years, trading financial markets was perceived as the preserve of City professionals, an activity that only experts could hope to master.

However, over the past decade or so this view has slowly begun to change. The financial crisis of 2008, for one, led to a growth in media coverage of financial markets and industry jargon, allowing more of us to form a better understanding of how markets work.

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This understanding has led to an increased interest in how we can trade in these markets ourselves. And the tools needed to do so have developed too:  we can trade online or on our mobile. Trading has been increasingly democratised.

It is also these developments in technology that have led to the establishment of two very different schools of thought when it comes to trading: the technical and the fundamental. I hope this brief guide can help you in your own decisions.

The fundamentals

Fundamental analysis is the more well-known or ‘traditional’ approach to trading in which the financial soundness of a company is scrutinised, as well as its business prospects .

When attempting to find the true value of a stock, fundamentals take a relatively long-term approach and weigh up everything from financial statements to revenue forecasts to quality of management, earnings and projected growth.

They then make a judgement on the stock, perhaps compared to its sector or market peers, about whether it is over or undervalued at the present time.

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Fundamentals try to anticipate future movements of a stock based on external events and influences. One of the most famous and successful fundamental analysts of all time is Warren Buffett, who has achieved a compounded annual gain of around 19 per cent since 1965, compared with just nine per cent for the S&P 500.

When deciding where to invest, fundamental analysts typically look at:

  • Company revenues: the amount of sales taken over a set period of time
  • Earnings per share: whether margins and share prices are rising alongside sales
  • Industry fundamentals: wider industry trends that may impact a company’s performance
  • The bigger picture: an overview of the wider macroeconomic climate
The technicals

In comparison, technical analysts look to take the emotion out of trading and instead seek to profit by anticipating the psychological biases of buyers and sellers across a range of markets.

A famous example of a technical analyst is hedge fund manager Paul Tudor Jones, a trading expert who looks solely at the movement patterns of the market itself.

These patterns can provide technical analysts with insight into how buyers and sellers are behaving. Since certain types of behaviour patterns have been seen repeatedly in the past, it’s possible to identify trends as they emerge in the present, something that helps with predicting the likely future shape of the market.

Which way is the market moving? How far up or down will it go? When will it move all the way? For technical analysts, the underlying key is to be able to spot a trend and go with it, so questions like these are important.

If, for example, there were a sharp sell-off in a given stock, a technical analyst would only be concerned with asking how this price movement fits into the ongoing trading pattern being tracked.

The fundamental analyst, in comparison, would look for reasons why the company’s share price has fallen. Algorithms and charting tools are used heavily within this approach.

The debate

Whether to embrace a technical or fundamental trading style is an ongoing industry debate, one that continues to divide many. For years the fundamental approach has held sway among the majority of both professional and private traders.

However, the emergence of easily available charting tools and the ability to trade using other people’s algorithms, (rather than having to develop them yourself) has made the technical approach more accessible to a broader number of people.  

And while the validity of the discipline has often been thrown into question, over recent years it has begun to enjoy some mainstream credibility.

As trading grows in appeal and attracts a wider audience, it is important to understand that there really is no right or wrong approach to how to trade.  

As the above shows, there are clear arguments to be made on both sides. One thing is for certain, each involves a skillset that improves with experience.

Mixing the components of technical and fundamental analysis is often frowned upon by the most devoted groups in each school. But there are clear benefits to be gained by having a basic understanding of each.

Some technical traders may look at fundamentals to add strength to a spotted trend and, similarly, fundamental analysts may look for technical insight around past behaviour patterns.

Whichever school of thought you align yourself with, it is important to consider each and develop a trading style that is unique to you.