Should I Use Technical or Fundamental Analysis when Stock Picking?

Submitted by Share Trading on 20 January, 2009 - 11:22

Stock trading beginners often wonder if they should be using technical analysis or fundamental analysis.

Stock trading beginners often wonder if they should be using technical analysis or fundamental analysis. The first question you should be asking is whether you are going to be an investor or a trader of stocks. There is a fine line between an investor and a trader. An investor is also a trader, but their trading time horizon is in the long term (holding a stock for 1, 5 years or more). A trader, or more specifically a short term trader doesn’t hold stocks in the long term (unless their trade had turned sour and their short term trade automagically changed into an “investment”). A trader specifically aims to profit from a capital gain either by going long or shorting a stock. An investor, holds for capital return and any possible dividends they can reap throughout the term they hold the stock. So the question remains: should you use technical analysis (aka charting methods) or fundamental analysis?

It is said that fundamental analysis reveals the company’s internal character, which the stock chart technical analysis reveal the stock’s personality.

Technical Analysis and Fundamental Analysis are the two main methods in examining the health of a publicly traded company (other methods you may laugh at, such as astrological charting methods aka horoscope trading). Fundamental analysis involves checking the company’s papers. You will be studying their prospectus, annual report, financial reports, brokerage/stock analysts ratings, P&L and PE ratios. On the other hand is technical analysis: which is the study or time, price and sentiment as revealed on the stock charts which plot representations of the stock price against time. The theory is that, because human behaviour is repetitive, the charts will reveal repetitive formations which give the trader a set of probabilities (sounds like poker doesn’t it?) on which way the stock will move next. It is said that fundamental analysis reveals the company’s internal character, which the stock chart technical analysis reveal the stock’s personality.

So you’ve decided whether you are a short term trader or a long term investor. Short term traders tend to rely on technical analysis. Investors like to use fundamentals. The wisest of all traders and investors use a hybrid approach and use both techniques. Although they do like to focus on certain techniques. Traders would focus more on their technical skills as, in the short term price action is more volatile – while fundamental factors don’t tend to change day to day. For example, (assuming no news or reports for the company is coming out) the price action of a stock goes up by 5% in one day – but nothing fundamental has changed. Earnings haven’t changed, directors haven’t changed – the company is essentially the same today as it was yesterday. The price may have moved as traders traded the stock off some resistance, or it could have been in a trading range. But remember, don’t always go searching for a reason for moves sometimes there just isn’t any explanation.

If you are a trader or an investor it is wise to use both technical and fundamental analysis when stock picking. As a long term trader aka investor, you would not want to buy any stock, even if their fundamentals are great, if the stock price has been in a gradual slide over the past few months. As a short term trader, you don’t want to buy into a stock which is ailing fundamentally (although some do – looking into the company’s fundamentals will allow you to be prepared for any risks if you do decide to ride the bubble).

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