Head to head: fundamental analysis versus technical analysis

Technical analysis is the preferred system for short-term trading. Indeed, the shorter the trade’s horizon, the more important technical analysis becomes. When examining and forecasting a stock’s movement over a few days or less, it doesn’t matter what product the company sells, whether their earnings are growing or shrinking, or even if the chief executive is playing on the company credit card. All that matters in the short term is the price action, and that’s where technical analysis rules.

Technical analysis is more objective than fundamentals and requires less time to perform. It’s also a fact that trades based upon fundamentals generally require a longer horizon to develop, as an undervalued (or overvalued) stock may stay that way for weeks, months, or years.

Because every trade influences the stock’s price and therefore its underlying chart, technical analysis incorporates market sentiment through technical indicators and chart patterns. Even the sneakiest investor or commercial trader cannot hide the “smart money” as it raises volume and nudges the price higher or lower, and the mathematics of technicals allow traders to score profits whether the sentiment is rational or otherwise.

Technical analysis applies across all securities and financial markets (with some slight alterations for the two-sided charts in currencies), as well as across any time frame. Technical levels such as support and resistance provide fine tuning for market entries and exits, much more accurately than fundamentals can.

However, technical analysis provides no warning if the market sentiment is irrational, nor does it incorporate major events such as earnings announcements into its market image. As well, ignoring a company’s fundamentals and assuming the market is always right can lull traders into a false sense of confidence and provide no warning before a major change.

Fundamental analysis is the big picture in trading, and therefore changes more slowly than technicals. It estimates a company’s inherent value, relative to its peers, with the assumption the market is sometimes wrong and that a company’s stock may be undervalued or overvalued. By relying upon major corporate events as well as factors driving the underlying industry and the financial markets themselves, fundamental analysis tends to outscore technicals in the longer term and is thus preferred by investors and traders who hold longer positions.

But fundamental analysis is company- and industry-specific, and cannot be applied across different financial markets, securities, or even time frames, as the trader must wait for the anticipated earnings growth to occur. It’s more subjective than technicals, relying as it does on the individual trader’s ability to correctly read the fundamental data and interpret it within the context of the company’s industry sector. As well, fundamental analysis cannot provide precise entry and exit points for trades, as technicals do.