Technical Analysis For Dummies
Book image
Explore Book Buy On Amazon

When figuring out what to do in the investment world, most professionals use one of two basic approaches to stock trading: fundamental analysis and technical analysis (many use some combination of the two). Both approaches are used in a number of markets ranging from the stock market to commodities. The main differences between fundamental analysis and technical analysis are pretty easy to understand:

  • Fundamental analysis goes into the economics of the company itself, such as sales and profit data, as well as external factors affecting it, such as politics, regulations, and industry trends.

  • Technical analysis tries to understand where a stock’s price is going based on market behavior as evidenced in its market statistics (presented in charts, price, and trading volume data). Technical analysis doesn’t try to figure out the worth of an investment; it’s used to figure out where the price of that stock or investment is trending.

How to combine fundamental and technical analysis for beneficial stock investing

Fundamental analysis helps you understand what to invest (or trade or speculate) in, whereas technical analysis guides you as to when to do it. Because markets ebb and flow, technical analysis can help you spot low-risk points to either enter or exit a trade. Technical analysis, therefore, helps you stack the deck a little more in your favor. Considering how markets have been going lately, every little bit helps.

Blending the two approaches to some extent has been done with success. Obviously, if the fundamental and the technical factors support your decision, then the chance for a profitable trade has more going for it. How does this blend occur?

For an example, look at the concepts of oversold and overbought. If you’re looking at buying a stock (or other investment) because you think it’s a strong investment but you’re not sure about when to buy, you want to look at the technical data. If the data tells you that it has been oversold, it’s a good time to buy.

Oversold just means that the market was a little too extreme in selling that particular investment during a particular period of time.

The technical terms oversold and overbought have a parallel to fundamental terms such as undervalued and overvalued. Because fundamental analysis is a major part of a school of thought referred to as value investing, the concepts make sense

Just as investing in an undervalued stock is usually a good idea, so is buying a stock that has been oversold. It’s logical to presume that an oversold stock is undervalued (all things being equal). Of course, the other terms (overbought and overvalued) can also run in tandem.

On the other hand, the fundamentals can help a technical analyst make a better trading decision. Say that a technical analyst has a profitable position in a particular stock called Getting Near a Cliff Corp. (GNAC). If the technical indicators are turning bearish and the new quarterly earnings report for GNAC indicates a significantly lower profit, then selling GNAC’s stock is probably a good idea.

The technician’s tools for stock analysis

When you roll up your sleeves and get into technical analysis, what will you be dealing with? It depends on what type of technical analyst you are. In technical analysis, there are two subcategories: those who predominantly use charts (these technicians are called . . . chartists!) and those who predominantly use data (such as price and volume data). Of course, many technicians use a combination of both:

  • Charts: Charts are the neat pictures that graph price movements (such as chart patterns).

  • Data: Data includes price and volume information (along with technical and behavioral indicators derived from it).

Technical analysts don’t look at the fundamentals because they believe that the marketplace (as depicted in the charts, price, and volume data) already take into account the fundamentals.

About This Article

This article can be found in the category: